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Edited Transcript of HPT earnings conference call or presentation 8-Nov-19 3:00pm GMT

Q3 2019 Service Properties Trust Earnings Call

Newton Nov 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Service Properties Trust earnings conference call or presentation Friday, November 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian E. Donley

Service Properties Trust - CFO & Treasurer

* John G. Murray

Service Properties Trust - President, CEO & Managing Trustee

* Kristin A. Brown

Service Properties Trust - Director of IR

* Todd Hargreaves

Service Properties Trust - VP

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Conference Call Participants

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* Bryan Anthony Maher

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Service Properties Trust Third Quarter 2019 Financial Results Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Ms. Kristin Brown of Investor Relations. Ms. Brown, the floor is yours, ma'am.

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Kristin A. Brown, Service Properties Trust - Director of IR [2]

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Good morning. Joining me on today's call are John Murray, President; Brian Donley, Chief Financial Officer; and Todd Hargreaves, Vice President.

Today's call includes a presentation by management followed by a question-and-answer session with analysts. Please note that the recording, transmission and transcription of today's conference call is prohibited without the prior written consent of SEC.

I would like to point out that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on SEC's present beliefs and expectations as of today, November 8, 2019. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC.

In addition, this call may contain non-GAAP financial measures including normalized funds from operations or normalized FFO and adjusted EBITDAre. Reconciliations of normalized FFO and adjusted EBITDAre to net income as well as components to calculate AFFO are available in our supplemental package found in the Investor Relations section of the company's website. Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10-Q to be filed later today with the SEC and in our supplemental operating and financial data found on our website at www.svcreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

And with that, I'll turn the call over to John.

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John G. Murray, Service Properties Trust - President, CEO & Managing Trustee [3]

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Thank you, Kristin, and good morning. This morning, we reported third quarter normalized FFO of $0.95 per share, a decrease of 10.4% compared to the $1.06 per share reported in the third quarter of 2018, primarily related to our disposition of 20 travel centers and the related lease amendments with TA we completed in January, lower returns recognized in our hotel portfolio and higher interest expense, partially offset by our acquisition activity.

The most significant event this quarter was completing our transformative $2.4 billion net lease portfolio acquisition from SMTA REIT and the name change to Service Properties Trust.

The SMTA transaction added 767 net lease service-oriented retail properties leased by 279 tenants under 163 brands in 23 industries. We believe the new name more accurately represents our portfolio composition of hotels, service and necessity-based retail net lease properties. As previously announced, we are targeting $800 million of dispositions to reduce leverage incurred to complete the SMTA transaction.

Going forward, we expect hotels to generally comprise 55% to 60% of our portfolio and triple net lease service retail including travel centers to comprise 40% to 45%. Todd will provide an update on the positive progress we've made so far in asset sales in a moment.

Turning to the consolidated results of our hotel portfolio. SVC's comparable non-renovation hotels exceeded industry performance with a 0.9% increase in RevPAR this quarter. Hotels that were renovated in 2018 recognized healthy double-digit RevPAR growth this quarter, and we expect growth from these hotels through the balance of the year. However, renovation disruption continued headwinds from new supply and reduced citywide compression in certain markets offset this tailwind.

In the third quarter, we had 13 comparable hotels under renovation versus 16 hotels under renovation in the third quarter of 2018. Renovations were evenly divided across the IHG, Marriott No. 234, Sonesta and Radisson portfolios. Many of the historically well-performing full-service hotels under renovation will have materially completed renovations by year-end and are expected to switch from a negative impact to a positive as we move into 2020.

Turning to the performance of our hotel portfolios. Our Marriott No. 1 portfolio RevPAR increased by 0.8% due to a 0.6 percentage point increase in occupancy while rates were flat. Solid post renovation results and strong results in Pennsylvania and Virginia were offset by market-specific weaknesses in Torrance and San Jose as well as 1 renovation hotel. Coverage at our Marriott No. 1 agreement remained solid at 1.16x for the trailing 12 months.

Our Marriott No. 234 portfolio experienced a RevPAR decline of 0.8% with a 0.7 percentage point increase in occupancy, offset by a 1.7% decline in rate. This portfolio had 3 hotels under renovation in third quarter where RevPAR declined in aggregate by 17.5% as well as citywide softness in Chicago and Nashville. Coverage at our Marriott No. 234 agreement remains positive at 1.04x for the trailing 12 months.

On previous calls, we have told you that we've been in discussions with Marriott regarding the Marriott Kauai and possible outcomes, which include combining the Kauai Hotels, Marriott No. 1 and 234 hotel portfolios when the Kauai lease expires on December 31, 2019. We have made progress in our discussions with Marriott and are working towards a goal of documenting an agreement by year-end. In connection with the discussions with Marriott, we are also considering the possibility of selling approximately 30 hotels.

RevPAR at our comparable IHG portfolio declined 2%, caused by a 1.9% decline in rate, coupled with flat occupancy. Renovation disruption in 4 hotels, including 2 full-service hotels, which is closed, was the primary driver behind the decline along with supply growth in Chicago, Seattle and Portland, which negatively impacted 3 of our Kimpton hotels.

Our comparable Sonesta portfolio increased RevPAR by 1.5% driven by occupancy increases of 2.9 percentage points, partially offset by a 2.5% decline in rate. RevPAR gains of 8.8% in the extended stay portfolio mitigated the impact of 3 full-service renovations.

RevPAR at our Wyndham hotels was up slightly at 0.3% this quarter, reflecting a 2.2 percentage point increase in occupancy, partially offset by a 2.7% decline in rate. Wyndham continued to pay SVC 85% of the returns due under the management agreement, approximately $1 million less than the contractual amounts due for the third quarter.

SVC amended its management agreement with Wyndham in October 2019, so that the term will expire on September 30, 2020, unless sooner terminated as hotels are sold or rebranded. Under the amended agreement, Wyndham will pay SVC the cash flow of the hotels after payment of hotel operating costs. Wyndham will not be entitled to base management fees for the remainder of the agreement term.

In connection with the agreement, the Wyndham Grand Chicago and the Wyndham Irvine were rebranded to Royal Sonesta and Sonesta Hotels, respectively, on November 1. Also, in connection with the rebranding of the Chicago hotel, the timeshare lease with Wyndham Destinations was amended to terminate on March 31, 2020. The remaining 20 Wyndham branded hotels are being marketed for sale or may potentially be rebranded.

Between the sale of approximately 20 Wyndham and 30 Marriott hotels, we are confident we will reach our goal of $300 million in proceeds from hotel sales during the first half of 2020.

Our Hyatt portfolio RevPAR declined 4.1%, caused by a 3.3% decline in rate and a 0.7 percentage point decline in occupancy, with weakness driven by competition from new supply and erosion in transit demand.

Our Radisson Hotel Group portfolio RevPAR increased 5.8% this quarter versus last year with material post-renovation lift and multiple properties, modestly offset by renovation disruption at the Radisson Seattle.

For the fourth quarter of 2019, we expect 17 hotels to be under renovation compared to 38 last year. While we are seeing positive lift this year from the 49 hotels that completed the renovations in 2018, operators are contending with new supply coupled with stagnant or declining demand in many markets. As a result, rate growth expectations have declined. Hotels are increasingly taking longer to fill, allowing less opportunity to push higher short-term rates.

SVC's managers now project that for the remainder of 2019, we will experience RevPAR growth from occupancy gains driven by postrenovation improvement but with little change in rate, which results in a reduction to prior forecasts. Such that full year comparable RevPAR is likely to be in the minus 1% to plus 1% range. Full year GOP margin is expected to decline by 50 to 150 basis points given flat revenue, continued pressure on wages and benefits.

I'll now turn the call over to Todd to discuss our net lease portfolio, progress on asset sales and recent hotel investment activity.

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Todd Hargreaves, Service Properties Trust - VP [4]

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Thanks, John. As John mentioned, we closed on the SMTA transaction in late September. As of September 30, 2019, SVC owned 946 net lease service-oriented retail properties, including our travel centers, with 17.6 million square feet, requiring annual minimum rent of $419 million, which represented 41% of SVC's total annual minimum returns and rents. The portfolio was 98% leased by 280 tenants with a weighted average lease term of 11.3 years, operating under 163 brands in 23 distinct industries. The aggregate coverage of SVC's net lease portfolios' minimum rent was 2.27x as of September 30, 2019.

Rent coverage for our largest tenant TravelCenters of America was 1.92x for the quarter, up from 1.9x in last year's quarter, driven by increased fuel volumes sold, fuel margin and nonfuel margin. Coverage was 1.84x for the trailing 12 months ended September 30, 2019, up from 1.79x for the prior 12 months.

As we previously announced, we plan to sell approximately $500 million of the net lease properties we acquired in the SMTA transaction. We are on track to execute sales in excess of $500 million by year-end 2019. In October, we entered in agreement to sell 126 net lease properties for $438 million. We expect this transaction to close in November.

We also sold 2 additional net lease properties in October for $63.2 million. This included the sale of the Las Vegas office property at a 6.4% cap rate or $411 per square foot, a record price per square foot for the Las Vegas office market.

We have one additional net lease property that is currently being marketed. The net lease assets we selected for sale are generally a cross-section of assets across various industries and certain assets that did not strategically fit the portfolio.

Turning to other recent investment activity. In October, we acquired the 261-room Chicago Palomar Hotel for a purchase price of $55 million or $211,000 per key, which we believe is well below replacement cost. This hotel opened in 2010 as 43 suites, has over 10,000 square feet of function space and 1 food and beverage outlet. The hotel was added to our IHG management [Group].

I will now turn the call over to Brian.

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Brian E. Donley, Service Properties Trust - CFO & Treasurer [5]

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Thanks, Todd. Starting with operating results at our 322 comparable hotels this quarter, RevPAR decreased 0.3%, GOP margin percentage decreased by 176 basis points to 39% and gross operating profit decreased by approximately $9.4 million, which was the result of the negative impacts of renovations and increased operating costs. All our comparable portfolios experienced declines in GOP with the exception of Radisson, but results from our IHG, Marriott No. 234 and Sonesta portfolios made up the majority of the decrease.

Labor-related cost increased approximately 4% across the portfolio, while repairs and maintenance and additional marketing efforts also contributed to increased expenses this quarter.

Below-the-line GOP costs at our comparable hotels increased by $4.8 million from the prior year driven primarily by increased real estate tax expenses and tax appeal settlements recorded in the prior year at certain hotels.

Cash flow available to pay our minimum returns and rents for our comparable hotels declined $14.2 million or 9.4%. Cash flow coverage of our minimum returns and rents for our 322 comparable hotels decreased to 0.97x for the 2019 quarter compared to 1.09x for the prior year quarter.

As of quarter end, the balance of our security deposits and guarantees under our hotel operating agreements remained unchanged from the prior quarter at $217 million.

Turning to SVC's consolidated financial results. Normalized FFO was $155.6 million in the 2019 third quarter compared to $174.7 million in the 2018 quarter, a decrease of $0.11 per share. The decrease was part due primarily to the disposition of 20 travel centers and our lease amendments with TA in January, declined in realized returns under our IHG and Sonesta agreements and an increase in interest expense. This was partially offset by increases in minimum returns and rents from our acquisition activity and our funding of capital improvements at our properties.

Adjusted EBITDAre was $209.5 million in the 2019 third quarter, a 7.1% decrease from the 2018 quarter. Our adjusted EBITDAre to interest coverage ratio was 4x at the quarter end, and debt to annualized adjusted EBITDAre was 6.6x at quarter end.

As we have previously stated, our target leverage is to be around 6x. And we believe we are well on our way to achieving this goal through our disposition strategy.

I'd like to take a minute to discuss the impact of the SMTA transaction to our results. For the third quarter, the SMTA portfolio resulted in approximately $5.2 million of EBITDA contribution. For modeling purposes, on a run rate basis, we expect the quarterly EBITDA contribution of the SMTA portfolio to be approximately $42 million before any asset sales. The 128 net lease asset sales we have sold or expected to be sold represent approximately $9.8 million of quarterly EBITDA contribution.

Turning to our capital improvement activity. We funded $36 million of hotel improvements in the third quarter. We expect to fund approximately $128 million of hotel improvements in the fourth quarter. The majority of these hotel improvements are expected to be funded from operating cash flow. We do not expect to find any improvements to our net lease portfolio for the remainder of 2019.

Turning to our balance sheet. As at quarter end, debt was 51.8% of total gross assets, and we had $70.5 million of cash including $53.5 million for cash escrowed primarily for future improvements to our hotels.

As previously announced, we sold all the shares we held at the RMR Group, Inc. on July 1 at a price to the public of $40 per share, resulting in net proceeds of $93.6 million.

To finance the SMTA transaction, we issued $1.7 billion of unsecured senior notes in September 2019 and used our revolving credit facility for the balance of the purchase price. Upon completion of our senior notes offering, we terminated the $2 billion term loan facility commitment we arranged for the SMTA transaction. And as a result, we recognized a loss on extinguishment of debt of $8.5 million in the 2019 third quarter related to the financing cost of this facility.

As of today, we have $700 million outstanding on our $1 billion credit facility and intend to continue to pay down the outstanding balance on that line with proceeds from asset sales. We have no term debt maturities until February 2021.

In August, we paid a regular quarterly dividend to our common shareholders of $0.54 per share. In October, we declared a regular quarterly dividend to our common shareholders of $0.54 per share or $2.16 per year to be payable on or about November 15. Our dividend is well covered, and we had a normalized FFO payout ratio of 56.8% for the third quarter.

Operator, that concludes our prepared remarks. We are ready to open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from Bryan Maher of B. Riley FBR.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [2]

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Oh, great. So can you give us any idea kind of going forward, John, what you're thinking in the way of acquisitions, being that it's been a pretty active capital recycling year and you think you're out of the game for a while? Or is it very selective? Or are you going to focus on one area over the other?

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John G. Murray, Service Properties Trust - President, CEO & Managing Trustee [3]

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That's a good question, Brian. We have during the last quarter, really, a couple of quarters, been focused on disposition plans to reduce leverage in connection with the SMTA transaction. But we have -- we did complete one Kimpton Hotel acquisition with IHG this quarter, and we are currently looking at both, net lease acquisitions and hotel acquisitions at the current time. We are being selective, and we had dialed things back a bit while we focused on the disposition plan. But we expect to generally have approximately a 50-50 mix of hotel and net lease property acquisitions. They'll probably be a little bit lumpy, particularly as we ramp up our net lease acquisition activity. But we're going to focus on master leases. We're going to focus on diverse tenant base. We're going to focus on coverage, monthly financial reporting by the tenants. So there's a lot of things we're looking for there, but we have good relationships with a number of brands on the hotel side and -- as well as relationship with Sonesta. So we expect acquisition activity on the hotel side as well, probably in the range of a couple of hundred million dollars on both sides over the course of...

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [4]

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As you've gotten your hands dirty with the net lease portfolio and with dispositions, was there a geography or an asset type that you felt less comfortable with, and thus, that was in the pool of divestitures? And going forward, is there a segment of net lease that you're now involved in that you seem to like that you might expand upon?

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John G. Murray, Service Properties Trust - President, CEO & Managing Trustee [5]

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I think generally speaking, we're trying to avoid those areas of retail where we think there's better opportunities for disruption from e-commerce. And so you'll probably see us avoid retail that's apparel based, probably avoid retail that's home furnishings type basis, we're going to probably -- we're weighted a little bit more towards restaurants and quick service restaurants today. So we're not -- we're not in a rush to grow that side of things dramatically but we'll probably do some acquisitions there, and you know what, probably won't grow our movie theaters as much.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [6]

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Okay. And then last for me, on the Sonesta rent coverage. We noticed kind of a downtick there. Can you tell us maybe what's going on there? Was that an aberration? Is it -- is there a problem there? How should we be thinking about Sonesta?

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Brian E. Donley, Service Properties Trust - CFO & Treasurer [7]

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This is Brian. I'll take this one. So there's a little bit of noise in the portfolio. Just to give you some context, the 12 full-service hotels in that portfolio represent approximately 70% of the revenues. And we had 4 full-service hotels that were under renovation are closed. The Clift Hotel in San Francisco was closed in the third quarter for a complete renovation, hotel in (inaudible) California, the Chase Park Plaza in St. Louis, and our Fort Lauderdale hotel also had a drag. You strip those 4 out, coverage was actually up a little bit, 0.78x versus 0.76x. In the full-service hotels, the 8 that are remaining outside of those 4, coverage is over 0.9x. So again, it was a noisy quarter. The extended stay properties, there's some renovation ramp-up going on, but also a little bit of weakness as well. But overall, I think the renovation activity is the primary reason.

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Operator [8]

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(Operator Instructions) At this time, we're showing no further questions. So we'll go ahead and conclude today's question-and-answer session. I would now like to turn the conference call back over to Mr. John Murray for any closing remarks. Please go ahead, sir.

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John G. Murray, Service Properties Trust - President, CEO & Managing Trustee [9]

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Thank you all for joining us today, and we look forward to hopefully seeing some of you at the NAREIT conference next week in Los Angeles. Thanks.

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Operator [10]

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And we thank you, sir, also for your time today and to the rest of management team. Again, the conference call has now ended. At this time, you may disconnect your lines. Thank you. Take care and have a great day, everyone.