Item 1.  Financial Statements

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.  

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except share data)

(Unaudited)

Note 1.  Basis of Presentation

The accompanying condensed consolidated financial statements of Hospitality Properties Trust and its subsidiaries, or HPT, we, our or us, are unaudited. Certain information and disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted. We believe the disclosures made are adequate to make the information presented not misleading. However, the accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2016 , or our 2016 Annual Report. In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included in these condensed consolidated financial statements. These condensed consolidated financial statements include the accounts of HPT and our subsidiaries, all of which are 100% owned directly or indirectly by HPT. All intercompany transactions and balances with or among our consolidated subsidiaries have been eliminated. Our operating results for interim periods and those of our managers and tenants are not necessarily indicative of the results that may be expected for the full year. Reclassifications have been made to the prior years’ condensed consolidated financial statements to conform to the current year’s presentation.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates.  Significant estimates in our condensed consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets, impairment of real estate and the valuation of intangible assets.

We have determined that each of our taxable REIT subsidiaries, or TRSs, is a variable interest entity, or VIE, as defined under the Consolidation Topic of the Financial Accounting Standards Board, or FASB, Accounting Standards Codification™.   We have concluded that we must consolidate each of our TRSs because we are the entity with the power to direct the activities that most significantly impact the VIEs’ economic performance and we have the obligation to absorb losses and the right to receive benefits from each VIE that could be significant to the VIE, and are, therefore, the primary beneficiary of each VIE.  The assets of our TRSs were $36,085 and $26,676 as of March 31, 2017 and December 31, 2016 , respectively, and consist primarily of amounts due from, and working capital advances to, certain of their hotel managers.  The liabilities of our TRSs were $110,687 and $101,602 as of March 31, 2017 and December 31, 2016 , respectively, and consist primarily of security deposits they hold from and amounts payable to certain of their hotel managers.  The assets of our TRSs are available to satisfy our TRSs’ obligations and we have guaranteed certain obligations of our TRSs.

 

Note 2.  New Accounting Pronouncements

On January 1, 2017, we adopted FASB Accounting Standards Update, or ASU, No. 2017-01, Clarifying the Definition of a Business , which provides additional guidance on evaluating whether a transaction should be accounted for as an acquisition (or disposal) of assets or of a business. The update defines three requirements for a set of assets and activities (collectively referred to as a “set”) to be considered a business: inputs, processes and outputs. As a result of the implementation of this update, certain property acquisitions, which under previous guidance were accounted for as business combinations, are now accounted for as acquisitions of assets. In an acquisition of assets, certain acquisition costs are capitalized as opposed to expensed under the previous guidance.

On January 1, 2017, we adopted FASB ASU No. 2016-09, Compensation - Stock Compensation , which identifies areas for simplification involving several aspects of accounting for share based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. The adoption of ASU No. 2016-09 did not have a material impact in our condensed consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue From Contracts With Customers , which outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers. ASU No. 2014-09 states that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” While ASU No. 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate or equipment. In August 2015, the FASB provided for a one-year deferral of the effective date for ASU No. 2014-09, which is now effective for us beginning January 1, 2018. The majority of our revenue is from hotels managed under TRS structures. We do not believe the standard will materially affect the amount or timing of revenue recognition for revenues from room, food and beverage, and other hotel level

sales of our managed hotels. A lesser portion of our revenue consists of rental income from leasing arrangements, which are specifically excluded from ASU No. 2014-09. We are continuing to evaluate ASU No. 2014-09 (and related clarifying guidance issued by the FASB); however, we do not expect its adoption to have a significant impact on the amount or timing of our revenue recognition in our condensed consolidated financial statements. We currently expect to adopt the standard using the modified retrospective approach.

In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities , which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. This update is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted subject to certain conditions. Currently, changes in fair value of these investments are recorded through other comprehensive income. ASU No. 2016-01 states that these changes will be recorded through earnings. We are continuing to evaluate this guidance, but the implementation of this guidance will affect how changes in the fair value of available for sale equity investments we hold are presented in our condensed consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases , which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). ASU No. 2016-02 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease. A lessee is also required to record a right of use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales type leases, direct financing leases and operating leases. ASU No. 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently assessing the potential impact the adoption of ASU No. 2016-02 will have in our condensed consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , which requires that entities use a new forward looking “expected loss” model that generally will result in the earlier recognition of allowance for credit losses. The measurement of expected credit losses is based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. ASU No. 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We are currently assessing the potential impact the adoption of ASU No. 2016-13 will have in our condensed consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments , which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact the adoption of ASU No. 2016-15 will have in our condensed consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash , which clarifies how companies should present restricted cash and restricted cash equivalents. Companies will show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The new standard requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheets. ASU No. 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact the adoption of ASU No. 2016-18 will have in our condensed consolidated financial statements.

 

Note 3.  Revenue Recognition

We report hotel operating revenues for managed hotels in our condensed consolidated statements of comprehensive income. We generally recognize hotel operating revenues, consisting primarily of room and food and beverage sales, when goods and services are provided.

We report rental income for leased hotels and travel centers in our condensed consolidated statements of comprehensive income. We recognize rental income from operating leases on a straight line basis over the term of the lease agreements except

for one lease in which there is uncertainty regarding the collection of scheduled future rent increases. See Note 8 for further information regarding this lease with Morgans Hotel Group, or Morgans.  Rental income includes $3,008 and $3,752 for the three months ended March 31, 2017 and 2016, respectively, of adjustments necessary to record scheduled rent increases under certain of our leases, the deferred rent obligations payable to us under our leases with TravelCenters of America LLC, or TA, and the estimated future payments to us under our TA leases for the cost of removing underground storage tanks at our travel centers on a straight line basis.  See Notes 8 and 10 for further information regarding our TA leases.  Due from related persons includes $45,166 and $42,254 and other assets, includes $2,375 and $2,279 of straight line rent receivables at March 31, 2017 and December 31, 2016 , respectively.

We determine percentage rent due to us under our leases annually and recognize it when all contingencies have been met and the rent is earned, which is generally at year end. We had deferred estimated percentage rent of $604 and $260 for the three months ended March 31, 2017 and 2016, respectively.

We own all the FF&E reserve escrows for our hotels. We report deposits by our third party tenants into the escrow accounts as FF&E reserve income.  We do not report the amounts which are escrowed as FF&E reserves for our managed hotels as FF&E reserve income.

 

 

Note 5.  Shareholders’ Equity

Distributions

On January 17, 2017, we paid a $0.4453 per share distribution, or $5,166 , to our Series D preferred shareholders.

On February 21, 2017, we paid a regular quarterly distribution to common shareholders of record on January 23, 2017 of $0.51 per share, or $83,777 . On April 11, 2017, we declared a regular quarterly distribution payable to common shareholders of record on April 21, 2017 of $0.52 per share, or $85,419 . We expect to pay this amount on or about May 18, 2017.

Preferred Shares

On February 10, 2017, we redeemed all 11,600,000 of our outstanding 7.125% Series D cumulative redeemable preferred shares at the stated liquidation preference of $25.00 per share plus accrued and unpaid distributions to the date of redemption (an aggregate of $291,435 ). We reduced net income available for common shareholders for the three months ended March 31, 2017 by $9,893 , which represents the amount by which the liquidation preference for our 7.125% Series D cumulative redeemable preferred shares that were redeemed during the period exceeded our carrying amount for those preferred shares as of the date of redemption.

Cumulative Other Comprehensive Income

Cumulative other comprehensive income represents the unrealized gain on our available for sale equity investments and our share of the comprehensive income of Affiliates Insurance Company, or AIC. See Notes 10 and 13 for further information regarding these investments.

 

Note 6.  Indebtedness

Our principal debt obligations at March 31, 2017 were: (1) our $130,000 of outstanding borrowings under our $1,000,000 unsecured revolving credit facility; (2) our $400,000 unsecured term loan; (3) an aggregate outstanding principal amount of $3,200,000 of public issuances of unsecured senior notes; and (4) our public issuance of $47 outstanding principal amount of convertible senior unsecured notes.

Our $1,000,000 revolving credit facility is available for general business purposes, including acquisitions.  The maturity date of our revolving credit facility is July 15, 2018 and, subject to our payment of an extension fee and meeting other conditions, we have the option to extend the stated maturity date of our revolving credit facility by one year to July 15, 2019 . We can borrow, repay and reborrow funds available under our revolving credit facility until maturity, and no principal repayment is due until maturity. We are required to pay interest on borrowings under our revolving credit facility at an annual rate of LIBOR plus a premium, which was 110 basis points as of March 31, 2017 . We also pay a facility fee, which was 20 basis points per annum at March 31, 2017 , on the total amount of lending commitments under our revolving credit facility. Both the interest rate premium and the facility fee are subject to adjustment based upon changes to our credit ratings.  As of March 31, 2017 , the annual interest rate for the amount outstanding under our revolving credit facility was 2.08% . The weighted average annual interest rate for borrowings under our revolving credit facility was 1.95% and 1.53% for the three months ended March 31, 2017 and 2016, respectively.  As of March 31, 2017 and May 9, 2017, we had $130,000 and $61,000 outstanding and $870,000 and $939,000 available under our revolving credit facility, respectively.

Our revolving credit facility is governed by a credit agreement with a syndicate of institutional lenders, which also governs our term loan. Our $400,000 term loan, which matures on April 15, 2019 , is prepayable without penalty at any time.  We are required to pay interest on the amounts under our term loan at a rate of LIBOR plus a premium, which was 120 basis points as of March 31, 2017 .  The interest rate premium is subject to adjustment based on changes to our credit ratings.  As of March 31, 2017 , the annual interest rate for the amount outstanding under our term loan was 1.98% . The weighted average annual interest rate for borrowings under our term loan was 1.98% and 1.62% for the three months ended March 31, 2017 and 2016, respectively. 

Our credit agreement also includes a feature under which maximum aggregate borrowings may be increased up to $2,300,000 on a combined basis in certain circumstances.  Our credit agreement and our notes indentures and their supplements provide for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, such as, in the case of our credit agreement, a change of control of us, which includes The RMR Group LLC, or RMR LLC, ceasing to act as our business manager. Our credit agreement and our senior notes indentures and their supplements also contain a number of covenants, including covenants that restrict our ability to incur debts or to make distributions under certain circumstances and generally require us to maintain certain financial ratios. We believe we were in compliance with the terms and conditions of our credit agreement and our senior notes indentures and their supplements at March 31, 2017 .

On January 13, 2017, we issued $600,000 aggregate principal amount of senior notes in public offerings, which included $200,000 aggregate principal amount of 4.500% senior notes due 2023 and $400,000 aggregate principal amount 4.950% senior notes due 2027.  Net proceeds from these offerings were $593,300 after discounts, premiums and expenses.

On March 15, 2017, we repurchased at par plus accrued interest $8,431 of the outstanding principal amount of our 3.80% convertible senior notes due 2027, which were tendered by the holders of these notes for repurchase by us. On April 24, 2017, we redeemed at par plus accrued interest the remaining $47 of the outstanding principal amount of these notes.

Note 7.  Real Estate Properties

At March 31, 2017 , we owned 308 hotels and 198 travel centers.

During the three months ended March 31, 2017 , we funded $34,721 for improvements to certain of our properties which, pursuant to the terms of our management and lease agreements with our hotel managers and tenants, resulted in increases in our contractual annual minimum returns and rents of $2,717 . See Notes 8 and 10 for further information about our management and lease agreements and our fundings of improvements to certain of our properties.

During the three months ended March 31, 2017 , we acquired two hotels. We accounted for these transactions as acquisitions of assets. Our allocation of the purchase price of each of these acquisitions based on the estimated fair value of the acquired assets and assumed liabilities is presented in the table below.  

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except share data)

(Unaudited)

On March 16, 2017, we entered into an agreement to acquire the 389 room Chase Park Plaza hotel located in St. Louis, MO for a purchase price of $87,750 , excluding acquisition related costs. We currently expect to complete this acquisition during the second quarter of 2017. We plan to convert this hotel to the Royal Sonesta hotel brand and add it to our management agreement with Sonesta International Hotels Corporation, or Sonesta. See Notes 8 and 10 for further information regarding our Sonesta agreement.

On May 3, 2017, pursuant to the terms of our June 2015 transaction agreement with TA, as amended, we purchased from, and leased back to, TA a newly developed travel center located in Columbia, SC for a purchase price of $27,602 , excluding acquisition related costs. This property was added to our TA No. 4 lease and our minimum annual rent under the lease increased by $2,346 as a result. See Notes 8 and 10 for further information regarding our TA leases.

Our pending acquisition is subject to conditions; accordingly, we cannot be sure that we will complete this acquisition or that this acquisition will not be delayed or the terms of this acquisition will not change.

Note 8. Hotel Management Agreements and Leases

As of March 31, 2017 , we owned 308 hotels and 198 travel centers, which are included in 14 operating agreements. We do not operate any of our properties.

As of March 31, 2017 ,  305 of our hotels are leased to our TRSs and managed by independent hotel operating companies and three hotels are leased to third parties. As of March 31, 2017 , our hotel properties are managed by or leased to separate subsidiaries of Marriott International, Inc., or Marriott, InterContinental, Sonesta, Wyndham Hotel Group, or Wyndham, Hyatt Hotels Corporation, or Hyatt, Carlson Hotels Worldwide, or Carlson, and Morgans, under  nine agreements. These hotel agreements have initial terms expiring between 2019 and 2103. Each of these agreements is for between one  and 96 of our hotels. In general, the agreements contain renewal options for all, but not less than all, of the affected properties, and the renewal terms range between  20 to 60 years. Most of these agreements require the third party manager or tenant to: (1) make payments to us of minimum returns or minimum rents; (2) deposit a percentage of total hotel sales into reserves established for the regular refurbishment of our hotels, or FF&E reserves; and (3) for our managed hotels, make payments to our TRSs of additional returns to the extent of available cash flows after payment of operating expenses, funding of the FF&E reserves, payment of our minimum returns, payment of certain management fees and replenishment of security deposits or guarantees. Some of our managers or tenants or their affiliates have provided deposits or guarantees to secure their obligations to pay us.

Marriott No. 1 agreement . Our management agreement with Marriott for 53 hotels, or our Marriott No. 1 agreement, provides that as of March 31, 2017 we are to be paid an annual minimum return of $68,835 to the extent that gross revenues of the hotels, after payment of hotel operating expenses and funding of the FF&E reserve, are sufficient to do so.  We do not have any security deposits or guarantees for our minimum returns from the 53 hotels included in our Marriott No. 1 agreement. Accordingly, the minimum returns we receive from these hotels managed by Marriott are limited to available hotel cash flows after payment of operating expenses and funding of the FF&E reserve. Marriott’s base and incentive management fees are only earned after we receive our minimum returns.  We realized minimum returns of $17,188 and $17,093 during the three months ended March 31, 2017 and 2016 , respectively, under this agreement. We also realized additional returns of $839 during the

three months ended March 31, 2016, which represents our share of hotel cash flows in excess of the minimum returns due to us for the period. We did not realize any additional returns during the three months ended March 31, 2017 .

We funded $1,990 for capital improvements at certain of the hotels included in our Marriott No. 1 agreement during the three months ended March 31, 2017 . We currently expect to fund $2,110 for capital improvements under our Marriott No. 1 agreement during the remainder of 2017 . As we fund these improvements, the annual minimum returns payable to us increase by 10% of the amounts funded.

Marriott No. 234 agreement.  Our management agreement with Marriott for 68 hotels, or our Marriott No. 234 agreement, provides that as of March 31, 2017 we are to be paid an annual minimum return of $106,360 .  We realized minimum returns of $26,590 and $26,560 during the three months ended March 31, 2017 and 2016 , respectively, under this agreement. Pursuant to our Marriott No. 234 agreement, Marriott has provided us with a security deposit to cover minimum return payment shortfalls, if any.  Under this agreement, this security deposit may be replenished and increased up to $64,700 from a share of hotel cash flows in excess of the minimum returns due to us. Marriott’s base and incentive management fees are only earned after we receive our minimum returns. During the three months ended March 31, 2017 , our available security deposit was replenished by $267 from a share of hotel cash flows in excess of the minimum returns due to us for the period.  The available balance of this deposit was $16,747 as of March 31, 2017 .  Pursuant to our Marriott No. 234 agreement, Marriott has also provided us with a limited guarantee which expires in 2019 for shortfalls up to 90% of our minimum returns, if and after the available security deposit has been depleted.  Marriott was not required to make any guarantee payments to us during the three months ended March 31, 2017 because the hotels generated net operating results in excess of the guarantee threshold amount ( 90% of the minimum returns due to us). The available balance of the guarantee was $30,672 as of March 31, 2017 .  

Marriott No. 5 agreement . We lease one hotel in Kauai, HI to Marriott. This lease is guaranteed by Marriott and we realized $2,540 and $2,529 of rent for this hotel during the three months ended March 31, 2017 and 2016 , respectively.  The guarantee provided by Marriott with respect to this leased hotel is unlimited. Marriott has four renewal options for 15 years each. On August 31, 2016, Marriott notified us that it will not exercise its renewal option at the expiration of the current lease term ending on December 31, 2019.

InterContinental agreement. Our management agreement with InterContinental for 96 hotels, or our InterContinental agreement, provides that, as of March 31, 2017 , we are to be paid annual minimum returns and rents of $174,393 .  We realized minimum returns and rents of $41,608 and $38,203 during the three months ended March 31, 2017 and 2016 , respectively, under this agreement.  We also realized additional returns under this agreement of $311 and $329 during the three months ended March 31, 2017 and 2016, respectively, from our share of hotel cash flows in excess of our minimum returns and rents due to us for those periods.

Pursuant to our InterContinental agreement, InterContinental has provided us with a security deposit to cover minimum payment shortfalls, if any.  Under this agreement, InterContinental is required to maintain a minimum security deposit of $37,000 and this security deposit may be replenished and increased up to $100,000 from a share of future cash flows from the hotels in excess of our minimum returns and rents. During the three months ended March 31, 2017 , $1,574 of the available security deposit was utilized to cover shortfalls of hotels’ cash flows from the minimum payments due to us for the period.

During the three months ended March 31, 2017, we amended our InterContinental agreement in connection with each of the two hotel acquisitions we made during that period. See Note 7 for further information regarding these acquisitions. As a result of the amendments, the annual minimum returns and rents due to us increased and InterContinental provided us an aggregate of $12,604 to supplement the existing security deposit.

The available balance of the InterContinental security deposit was $83,777 as of March 31, 2017 .

We did not make any fundings for capital improvements to our InterContinental hotels during the three months ended March 31, 2017 . We currently expect to fund $6,243 for capital improvements under our InterContinental agreement during the remainder of 2017 . As we fund these improvements, the annual minimum returns and rents payable to us increase by 8% of the amounts funded.

Sonesta agreement. As of March 31, 2017 , Sonesta managed nine of our full service hotels and 25 of our limited service hotels pursuant to management agreements for each of the hotels, which we refer to collectively as our Sonesta agreement, and a pooling agreement, which combines those management agreements for purposes of calculating gross revenues, payment of hotel operating expenses, payment of fees and distributions and minimum returns due to us.

Our Sonesta agreement provides that we are paid a fixed annual minimum return equal to 8% of our invested capital, as defined therein, which was $90,227 as of March 31, 2017 , if gross revenues of the hotels, after payment of hotel operating expenses and management and related fees (other than Sonesta's incentive fee, if applicable), are sufficient to do so.  Our Sonesta agreement further provides that we are paid an additional return based upon operating profits, as defined therein, after payment of Sonesta's incentive fee, if applicable. We do not have any security deposits or guarantees for our hotels managed by Sonesta.  Accordingly, the returns we receive from our hotels managed by Sonesta are limited to available hotel cash flows after payment of operating expenses. We realized returns of $10,662 and $8,766 during the three months ended March 31, 2017 and 2016 , respectively, under our Sonesta agreement.

Pursuant to our Sonesta agreement, we paid Sonesta management, reservation and system fees and reimbursement costs for certain guest loyalty, marketing program and third party reservation transmission fees aggregating $5,729 and $5,300 for the three months ended March 31, 2017 and 2016 , respectively. In addition, we paid Sonesta procurement and construction supervision fees of $81 and $343 for the three months ended March 31, 2017 and 2016 , respectively. These amounts are included in hotel operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

Our Sonesta agreement does not require FF&E escrow deposits, but does require us to fund capital expenditures that we approve at our hotels managed by Sonesta. We funded $3,531 for renovations and other capital improvements to hotels included in our Sonesta agreement during the three months ended March 31, 2017 .  We currently expect to fund $17,409 for renovations and other capital improvements during the remainder of 2017, and $18,708 during 2018. If and as we acquire the hotel that we expect to add to our Sonesta Agreement as described in Note 7 above, we expect to fund additional renovations at this hotel during 2017 and 2018, but the amount and timing of this additional renovation funding have not yet been determined. The annual minimum returns due to us under the Sonesta agreement increase by 8% of the amounts funded in excess of threshold amounts, as defined therein. We owed Sonesta $783 and $5,484 for capital expenditure and other reimbursements at March 31, 2017 and 2016, respectively. Amounts due to Sonesta are included in due to related persons in our condensed consolidated balance sheets.

See Note 10 for further information regarding our relationship with Sonesta and Note 7 for further information regarding the effects of certain of our property acquisitions on our agreements with Sonesta.

Wyndham agreements . Our management agreement with Wyndham for 22 hotels, or our Wyndham agreement, provides that as of March 31, 2017 , we are to be paid annual minimum returns of $27,342 .  We realized returns of $6,801 and $6,654 during the three months ended March 31, 2017 and 2016 , respectively, under this agreement. Pursuant to our Wyndham agreement, Wyndham has provided us with a guarantee, which is limited to $35,656 , subject to an annual payment limit of $17,828 , and expires on July 28, 2020. As of December 31, 2016, $1,090 remained available to cover payment shortfalls of our minimum returns due under the management agreement. During the three months ended March 31, 2017, the hotels under this agreement generated cash flows that were less than the minimum returns due to us and the remaining guarantee was depleted. This guarantee may be replenished from future cash flows from these hotels in excess of our minimum returns. As of May 9, 2017, Wyndham has paid all of the minimum returns due to us under our Wyndham agreement.

We also lease 48 vacation units in one of our hotels to Wyndham Vacation Resorts, Inc., a subsidiary of Wyndham, or Wyndham Vacation, which requires that we are paid annual minimum rents of $1,407 .  The guarantee provided by Wyndham with respect to the Wyndham Vacation lease for part of one hotel is unlimited.  We recognized rents of $454 during both the three months ended March 31, 2017 and 2016 under our Wyndham Vacation lease agreement. Rental income for the three months ended March 31, 2017 and 2016 for this lease includes $102 and $112 , respectively, of adjustments necessary to record rent on a straight line basis.

Our Wyndham agreement requires FF&E escrow deposits equal to 5% of total hotel sales for all hotels included in the agreement subject to available cash flows after payment of our minimum return.  No FF&E escrow deposits were made during the three months ended March 31, 2017 due to insufficient available cash flows generated at these hotels.

We funded $4,313 for capital improvements to certain hotels included in our Wyndham agreement during the three months ended March 31, 2017 .  We currently expect to fund $6,787 for capital improvements under this agreement during the remainder of 2017 .  As we fund these improvements, the annual minimum returns payable to us increase by 8% of the amounts funded.

Morgans agreement.  We lease The Clift Hotel in San Francisco, CA to a subsidiary of Morgans. This lease is scheduled to expire in 2103 and requires annual rent to us of $7,595 , which amount is scheduled to increase on October 14, 2019 and every five years thereafter based upon consumer price index increases of no less than 10% and no more than 20% at the time of each increase. Although the terms of this lease might have qualified this lease as a direct financing lease under GAAP, we recognize the rental income we receive from Morgans on a cash basis because of uncertainty regarding our collection of future rent increases. In December 2016, we notified Morgans that the closing of its merger with SBE Entertainment Group LLC, or SBE, without our consent was a breach of its lease obligations and shortly thereafter we commenced an unlawful detainer action in the California state courts to compel Morgans and SBE to surrender possession of this hotel to us. We are currently pursuing this litigation and simultaneously engaging in discussions with Morgans and SBE regarding this hotel. The outcome of this pending litigation and our discussions with Morgans and SBE is not assured, but we believe Morgans may surrender to us possession of this hotel or that the court will determine that Morgans and SBE have breached the lease. We also believe that this hotel may require substantial capital investment to remain competitive in its market. The continuation of our dispute with Morgans and SBE is causing us to incur legal fees. Despite the continuation of this dispute, Morgans has paid the rents due to us through May 9, 2017; however we believe that we may suffer some loss of future rent from this hotel, at least until this hotel is renovated and operations improve.

TA leases. As of March 31, 2017 , we leased to TA a total of 198 travel centers under five leases.

We recognized rental income from TA of $68,581 and $68,117 for the three months ended March 31, 2017 and 2016 , respectively. Rental income for the three months ended March 31, 2017 and 2016 includes $2,912 and $3,644 , respectively, of adjustments necessary to record the deferred rent obligations under our TA leases and the estimated future payments to us by TA for the cost of removing underground storage tanks on a straight line basis. As of March 31, 2017 and December 31, 2016, we had receivables for current rent amounts owed to us by TA and straight line rent adjustments of $68,920 and $65,332 , respectively. These amounts are included in due from related persons in our condensed consolidated balance sheets. In addition, as of March 31, 2017 , TA owed us deferred rent of $150,000 , which is due and payable on various dates from 2024 through 2032.

Our TA leases do not require FF&E escrow deposits. However, TA is required to maintain the leased travel centers, including structural and non-structural components. Under our TA leases, TA may request that we fund capital improvements in return for increases in TA’s annual minimum rent. We funded $24,908 for the three months ended March 31, 2017 of qualifying capital improvements to our TA leases. As a result, TA’s annual minimum rent payable to us increased by $2,117 . We currently expect to fund $53,769 for renovations and other capital improvements to our travel centers during the remainder of 2017. TA is not obligated to request and we are not obligated to fund any such improvements.

In addition to the rental income we recognized from TA during the three months ended March 31, 2017 and 2016 as described above, our TA leases require TA to pay us percentage rent based upon increases in certain sales. We determine percentage rent due under our TA leases annually and recognize any resulting amount as rental income when all contingencies are met. We had aggregate deferred percentage rent under our TA leases of $604 and $250 for the three months ended March 31, 2017 and 2016, respectively.

See Note 10 for further information regarding our relationship with TA and Note 7 for further information regarding the effects of certain of our completed and pending property acquisitions on our leases with TA.

Other management agreement and lease matters. We also have hotel management agreements with Hyatt ( 22 hotels) and Carlson ( 11 hotels). As of May 9, 2017 , all payments due to us from our managers and tenants under these agreements were current.  Minimum return payments due to us under these hotel management agreements are supported by guarantees.  The guarantee provided by Hyatt with respect to the 22 hotels managed by Hyatt is limited to $50,000 ( $18,875 remaining at March 31, 2017 ).  The guarantee provided by Carlson with respect to the 11 hotels managed by Carlson is limited to $40,000 ( $29,500 remaining at March 31, 2017 ).

Guarantees and security deposits generally. When we reduce the amounts of the security deposits we hold for payment deficiencies at our managed and leased hotels, we record income equal to the amounts by which this deposit is reduced up to the minimum return or minimum rent due to us. However, reducing the security deposits does not result in additional cash flows to us of the deficiency amounts, but reducing amounts of security deposits may reduce the refunds due to the respective lessees or managers who have provided us with these deposits upon expiration of the respective lease or management agreement. The security deposits are non-interest bearing and are not held in escrow. Under these agreements, any amount of the security

deposits which are applied to payment deficits may be replenished from a share of future cash flows from the applicable hotel operations pursuant to the terms of the respective agreements.

Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $16,924 and $16,429 less than the minimum returns due to us in the three months ended March 31, 2017 and 2016 , respectively.  When the managers of these hotels fund these shortfalls under the terms of our operating agreements or their guarantees, we reflect such fundings (including security deposit applications) in our condensed consolidated statements of comprehensive income as a reduction of hotel operating expenses. The reduction to hotel operating expenses was $6,662 and $4,377 in the three months ended March 31, 2017 and 2016 , respectively. We had shortfalls at certain of our managed hotel portfolios not funded by the managers of these hotels under the terms of our operating agreements of $11,889 and $12,052 in the three months ended March 31, 2017 and 2016 , respectively, which represent the unguaranteed portions of our minimum returns from Sonesta.  

Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $2,791 and $8,363 more than the minimum returns due to us in the three months ended March 31, 2017 and 2016 , respectively. Like the security deposits we hold, certain of our guarantees may be replenished by a share of future cash flows from the applicable hotel operations in excess of the minimum returns due to us pursuant to the terms of the respective operating agreements.  When our guarantees and our security deposits are replenished by cash flows from hotel operations, we reflect such replenishments in our condensed consolidated statements of comprehensive income as an increase to hotel operating expenses.  We had $1,504 and $2,522 of guarantee and security deposit replenishments in the three months ended March 31, 2017 and 2016 , respectively.

Note 9. Business and Property Management Agreements with RMR LLC

We have no employees. The personnel and various services we require to operate our business are provided to us by RMR LLC. We have two agreements with RMR LLC to provide management services to us: (1) a business management agreement, which relates to our business generally, and (2) a property management agreement, which relates to our property level operations of the office building component of one of our hotels.

Pursuant to our business management agreement with RMR LLC, we recognized net business management fees of $29,770 and $13,781 for the three months ended March 31, 2017 and 2016, respectively. The business management fees for the three months ended March 31, 2017 include estimated 2017 incentive fees of $19,620 based on our common share total return as of March 31, 2017 . Although we recognized estimated incentive fees in accordance with GAAP, the amount of incentive fees payable to RMR LLC for 2017, if any, will be calculated based on our common share total return, as defined, for the three year period ending December 31, 2017, and will be payable in 2018. The net business management fees we recognized for the three months ended March 31, 2016 included $5,316 of then estimated 2016 incentive fees; in January 2017, we paid RMR LLC an incentive fee of $52,407 for 2016. The net business management fees we recognized for the 2017 and 2016 periods are included in general and administrative expenses in our condensed consolidated statements of comprehensive income. 

Pursuant to our property management agreement with RMR LLC, we recognized property management fees of $10 and $14 for the three months ended March 31, 2017 and 2016, respectively.  These fees are payable to RMR LLC in connection with the management of the office building component of one of our hotels. These amounts are included in hotel operating expenses in our condensed consolidated statements of comprehensive income.

We are generally responsible for all of our operating expenses, including certain expenses incurred by RMR LLC on our behalf. We reimbursed RMR LLC $46 and $38 for property management related expenses related to the office building component of one of our hotels for the three months ended March 31, 2017 and 2016, respectively. These amounts are included in hotel operating expenses in our condensed consolidated statements of comprehensive income. In addition, we are responsible for our share of RMR LLC’s costs for providing our internal audit function. The amounts recognized as expense for internal audit costs were $67 for both the three months ended March 31, 2017 and 2016. These amounts are included in general and administrative expenses in our condensed consolidated statements of comprehensive income for these periods.

Note 10. Related Person Transactions

We have relationships and historical and continuing transactions with TA, Sonesta, RMR LLC, The RMR Group Inc., or RMR Inc., AIC and others related to them, including other companies to which RMR LLC provides management services and which have trustees, directors and officers who are also our Trustees or officers. 

TA .  TA is our largest tenant and property operator, leasing 36% of our gross carrying value of real estate properties as of March 31, 2017 . We lease all of our travel centers to TA under the TA leases. We are also TA’s largest shareholder; as of March 31, 2017 , we owned 3,420,000 common shares of TA, representing approximately 8.7% of TA’s outstanding common shares. RMR LLC provides management services to both us and TA. See Notes 7 and 8 for further information regarding our relationships, agreements and transactions with TA and Note 13 for further information regarding our investment in TA.

Sonesta.  Sonesta is a private company owned by our Managing Trustees. As of March 31, 2017 , Sonesta managed 34 of our hotels pursuant to management and pooling agreements. See Notes 7 and 8 for further information regarding our relationships, agreements and transactions with Sonesta.

Our Manager, RMR LLC. See Note 9 for further information regarding our management agreements with RMR LLC.

RMR Inc. RMR LLC is a subsidiary of RMR Inc. and RMR Inc. is the managing member of RMR LLC. The controlling shareholder of RMR Inc., ABP Trust, is owned by our Managing Trustees. As of March 31, 2017 , we hold 2,503,777 shares of class A common stock of RMR Inc. See Note 13 for further information regarding our investment in RMR Inc.

AIC . We, ABP Trust, TA and four other companies to which RMR LLC provides management services currently own AIC, an Indiana insurance company, in equal amounts. We and the other AIC shareholders participate in a combined property insurance program arranged and reinsured in part by AIC. As of March 31, 2017 and December 31, 2016, our investment in AIC had a carrying value of $7,373 and $7,123 , respectively. These amounts are included in other assets in our condensed consolidated balance sheets. We recognized income related to our investment in AIC, which amounts are presented as equity in earnings of an investee in our condensed consolidated statements of comprehensive income. Our other comprehensive income includes our proportionate part of unrealized gains on securities which are owned by AIC related to our investment in AIC.

For further information about these and other such relationships and certain other related person transactions, please refer to our 2016 Annual Report.

Note 11. Income Taxes

We have elected to be taxed as a real estate investment trust, or REIT, under the United States Internal Revenue Code of 1986, as amended, or the IRC, and, as such, are generally not subject to federal and most state income taxation on our operating income provided we distribute our taxable income to our shareholders and meet certain organization and operating requirements. We are subject to income tax in Canada, Puerto Rico and certain states despite our qualification for taxation as a REIT. Further, we lease our managed hotels to our wholly owned TRSs that, unlike most of our subsidiaries, file a separate consolidated tax return and are subject to federal, state and foreign income taxes. Our consolidated income tax provision includes the income tax provision related to the operations of our TRSs and certain state and foreign income taxes incurred by us despite our qualification for taxation as a REIT.

During the three months ended March 31, 2017 , we recognized income tax expense of $356 , which includes $115 of foreign taxes, $11 of federal taxes and $230 of state taxes.  During the three months ended March 31, 2016 , we recognized income tax expense of $375 , which includes $32 of foreign taxes, $53 of federal taxes and $290 of state taxes.

Note 12.  Segment Information

We aggregate our hotels and travel centers into two reportable segments, hotel investments and travel center investments, based on their similar operating and economic characteristics.

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except share data)

(Unaudited)

 

 

Note 13.  Fair Value of Assets and Liabilities

The table below presents certain of our assets carried at fair value at March 31, 2017 , categorized by the level of inputs, as defined in the fair value hierarchy under GAAP, used in the valuation of each asset.

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except share data)

(Unaudited)