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Hospitality Properties Trust  (NASDAQ:HPT)
Q3 2018 Earnings Conference Call
Nov. 06, 2018, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to the Hospitality Properties Trust, Third Quarter 2018 Financial Results Conference Call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Katie Strohacker, Senior Director of Investor Relations. Katie, please go ahead.

Katie Strohacker -- Senior Director, Investor Relations

Thank you. Good afternoon, everyone. Joining me on today's call are John Murray, President and Chief Executive Officer and Mark Kleifges, Chief Financial Officer. In addition, we are joined by Brian Donley, who is been appointed as Chief Financial Officer and Treasurer, effective January 1, 2019.

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

I'd 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 HPT's present beliefs and expectations, as of today, November 6th, 2018. 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. A reconciliation of normalized FFO and adjusted EBITDA 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.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

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

John G. Murray -- President and Chief Executive Officer

Thank you, Katie, and good afternoon. Before we discuss this quarter's results, I want to take a moment to discuss recently announced management changes at HPT. As you may know, Mark Kleifges, our Chief Financial Officer has decided to retire at the end of this year. Mark and I have worked together on HPT business since it became a publicly traded REIT. He has made numerous beneficial contributions to HPT and RMR and his guidance, professionalism and friendship have been invaluable.

We thank him and wish him the best. Going forward, we will all miss him. Effective January 1st, 2019 as Katie mentioned, Brian Donley will become HPT's next CFO. Brian has worked closely with Mark and supported him for the last dozen or so years, and I'm confident, he will do a fine job as HPT's, CFO.

Brian will be with Mark, Katie and I at NAREIT later this week. This morning we reported third quarter normalized FFO of $1.06 per share, a decrease of 0.9% compared to the $1.07 reported in the third quarter of 2017 due to higher interest expense associated with higher debt levels and reduced additional returns in certain portfolios, partially offset by increased minimum returns in rents from acquisitions and renovation fundings at our hotels and travel centers.

Starting with performance in HPT's travel centers, total gross margin increased by $12.7 million, or 4.1% in the third quarter due to a $6.2 million or 9.9% increase in fuel margin due to higher per gallon fuel margins in the 2018 quarter, partially offset by modest fuel declines and a $6.5 million or 2.6% increase in non-fuel margin.

Property level rent coverage for the quarter was 1.68 times, down slightly from the prior year due to a one-time credit in the 2017 period that Mark will discuss in more detail. You may know, the TA has reached an agreement to sell its convenience store business, and has stated it plans to use the expected proceeds of approximately $300 million to reduce its leverage levels.

TA has approached us with a proposal to reduce its lease obligations to HPT as one possible way to reduce its leverage. Our management is evaluating the proposal, and we'll share with our Board, which has formed a special committee comprised of our Independent Trustees to consider TA's proposal. It's too early for us to discuss this in more detail or assess the likely outcomes.

Turning to performance of HPT's hotels, third quarter 2018 comparable RevPAR decreased by 0.5% versus the 2017 quarter driven by rate growth offset by occupancy declines. A relative underperformance versus the industry average primarily reflects a combination of hotel room supply growth and increased number of hotels under renovation and difficult weather related comparisons.

We believe renovation hotels had -- comparable renovation hotels had a negative 0.9% impact on RevPAR, this quarter, and the net effect of a solar eclipse and three major hurricanes last year versus nominal impact from Florence in the 2018 quarter, also had a negative -- net negative 0.9% impact.

Comparable GOP margins declined versus the 2017 quarter to 40.5% as increased food and beverage revenues were offset by higher wages, benefits and sales and marketing costs. The aggregate coverage of annual minimum returns and rents at all our hotels was 1.11 times this quarter, down from 1.18 times in 2017.

Our comparable Sonesta portfolio grew RevPAR, 4.3% this quarter, led by 2.3% increase in rate and a 1.5 percentage point increase in occupancy. Portfolio occupancy was supported by growth in transit (ph) and corporate group business. Sonesta full-service hotels led the portfolio's performance with gains of the Chase Park Plaza, Houston, New Orleans and Boston, Royal Sonesta Hotels and Hilton Head in Philadelphia Sonesta hotels.

Comparable Sonesta portfolio GOP margin percentage decreased by 12 basis points with cash flow available to pay our minimum return increased 5.1%.

Our Marriott 234 portfolio, our second largest portfolio by number of rooms reported flat year-over-year RevPAR growth due to decreased group business, supply growth and renovation of the residents in Raleigh-Durham. Average daily rate increased 1% for this portfolio driven by a shift in business mix toward more corporate negotiated business.

A comparable Radisson hotel portfolio RevPAR decreased by 5.8% caused by occupancy declines related to ongoing renovations at 3 of the 8 comparable hotels in non-repeat group business, the Radisson Salt Lake City.

Nonetheless, portfolio coverage was 1.25 -- 1.24 times this quarter. Our Wyndham portfolio RevPAR decreased by 5.5% driven by occupancy declines of 3.1 percentage points, and a decrease in rate of 1.4%. Wyndham's portfolio performance was negatively impacted primarily by supply growth and non-repeat (ph) hurricane demand, RevPAR declines at our full-service Wyndham Houston and Wyndham Atlanta drove the declines caused by the loss of hurricane-related demand. The Hawthorn Suites Hotels continue to struggle with supply growth.

During the 3 months ended September 30th, 2018, Wyndham continue to pay HPT 85% of the minimum returns due under the management agreement, approximately $1 million less than the contractual amounts due. HPT's Hyatt portfolio RevPAR declined by 4.3% driven by a 0.8% increase in rate, offset by a 4.1 percentage point decline in occupancy due primarily to supply growth and renovation.

Supply impact was most evident in Austin, Dallas, Hendersonville and Kansas City. HPT's asset management team worked with Hyatt (ph) during the quarter to assist their hotel management proactively addressing expected supply growth to mitigate the impact more effectively.

HPT's Marriott number one hotel agreement RevPAR declined 1.4% due to a 0.9% increase in rate, offset by 1.7 percentage point decline in occupancy. There were 4 hotels under renovation in the third quarter, which had a negative 0.5% impact on portfolio RevPAR results. Supply increases in Boston and Los Angeles negatively impacted RevPAR by 0.8%.

Portfolio results were also weakened by the impacts of hurricanes Irma in 2017 and Florence in 2018. In particular, the lack of certainty regarding Florence's path resulted in revenue losses at several hotels in the Carolina.

Turning to our investment activities, in October of 2018 HPT acquired hotels with 164 suites located in Scottsdale, Arizona for a purchase price of $35.9 million, an additive to our management agreement with Sonesta. Minimal capital investment will be required at this hotel and HPT expects to earn a cash return on this investment in excess of 8% in its first full year of operation.

Looking ahead, despite a solid economic outlook and lower employment, we continue to see headwinds associated with supply growth, renovation disruption and wage related cost pressures. We believe the pace of supply growth will gradually slow moving into 2019 due to increased interest rates, higher costs associated with skilled labor and bank lending discipline. As we enter the final quarter of 2018, we will have 40 comparable hotels undergoing renovations.

The comparable hotel renovations are soft-good renovations to refresh lobbies and guest rooms and will be primarily funded from our FF&E reserves. Based on this backdrop HPT's managers now project that for 2018, we will experience RevPAR growth through rate improvement such that comparable RevPAR will be flat to up 1%, while GOP margin may decline by approximately 100 basis points, largely due to wage and benefit cost pressures.

Despite current headwinds, we are cautiously optimistic that our operators will meet their projections. Finally, we are in the middle of 2019 budget reviews and accordingly, we are not yet able to provide 2019 guidance. I'll now turn the call over to Mark.

Mark L. Kleifges -- Treasurer and Chief Financial Officer

Thanks, John. Starting with the performance of our travel center investments, for the quarter, fuel gross margin increased by $6.2 million or 9.9%, primarily because of $0.015 (ph) or 10.5% increase in per gallon gross margin in the 2018 third quarter. This was partially offset by a slight decline in fuel sales volumes.

The increase in per gallon gross margin is primarily a result of more favorable purchasing environment in the 2018 period, while the decline in fuel volume over the prior year was due to the continued effects of fuel efficiency gains and increased competition.

Non-fuel travel center revenues increased 2.8% versus the prior year, due primarily to growth in convenience store and truck service revenues, which increased 3.7% and 3.4% respectively.

Non-fuel gross margin percentage decreased 20 basis points from the prior year quarter to 60%. As a result, our travel centers grew non-fuel gross margin, $6.5 million or 2.6% versus the 2017 quarter to $256.7 million, and non-fuel sales generated approximately 79% of the total gross margin dollars of our travel centers in the quarter.

Site level operating expenses increased $13.6 million or 7.1% from the prior year. In the 2017 third quarter, TA reversed $4.2 million of transaction fees in connection with the favorable settlement of the dispute with a fuel car provider.

Excluding the impact of this expense reversal, site level operating expenses increased 4.8% versus the prior year, due primarily to increased labor costs associated with the increase in non-fuel revenues and higher repair and maintenance expense.

Third quarter property level EBITDA of our travel centers decreased by approximately $900,000 or 70 basis points compared to the third quarter of 2017, and annual minimum rent coverage under our leases was 1.68 times compared to 1.73 times last year. Adjusting for the impact of $4.2 million reversal of transaction fees in 2017, EBITDA increased 2.8% in the quarter and rent coverage was unchanged between years.

Turning to the operating results for our 307 comparable hotels this quarter, RevPAR decreased 0.5%, GOP margin percentage decreased by 139 basis points and cash flow available to pay HPT's minimum returns and rents decreased by 5.1% reflecting the negative impact of renovations, supply growth and increased operating costs.

The 0.5% decrease in RevPAR this quarter resulted from a 1.8% increase in ADR and a 1.8 percentage point decrease in occupancy.

Our comparable Radisson and Wyndham portfolio had the weakest RevPAR performance with declines of 5.8% and 5.5% respectively versus the prior year quarter. Our Radisson portfolio had 3 hotels under renovation during the quarter. The portfolio with the highest RevPAR growth this quarter was our comparable Sonesta portfolio with an increase of 4.3% versus the prior year quarter.

GOP margin percentage for our comparable hotels decreased by 139 basis points from the 2017 quarter to 40.5% and gross operating profit decreased approximately $7.9 million or 3.6% from the 2017 third quarter. The decline in gross operating profit, combined with a small increase in below the GOP line costs resulted in an $8.1 million or 5.1% decrease in cash flow available to pay our minimum returns and rents versus the prior year quarter.

The two portfolios with the largest percentage declines in cash flow were our comparable Hyatt and Radisson portfolios with decreases of 19% and 17.7% respectively. Both portfolios were negatively impacted by renovations during the quarter.

Our comparable Sonesta portfolio increased cash flow by 5.1% which increases to 10.9% if you exclude the recently converted Clift Hotel. Cash flow coverage of our minimum rents and returns for our 307 comparable hotels decreased to 1.11 times for the 2018 quarter compared to 1.18 times for the prior year quarter.

Coverage for all 325 of our hotels declined to 1.08 times due to 16 of our 18 non comp hotels undergoing renovations for all or part of the 2018 quarter. With coverage for the 2018 quarter above 1 times for several of our agreements, the balances of available security deposits and guarantees increased by $4 million during the quarter bringing the aggregate balance of available security deposits and guarantees at quarter end to $231.4 million.

Turning to HPT's consolidated financial results. Normalized FFO was $174.7 million in the 2018 third quarter compared to $175.5 million in 2017 quarter. Normalized FFO per share was $1.06 for the third quarter, a decrease of $0.01 from the 2017 quarter. This decrease was primarily due to a $2.7 million increase in interest expense and the $2.6 million decline in additional returns recognized under our IHG and Marriot Number One agreements, partially offset by $4.3 million increase in minimum returns and rents.

Adjusted EBITDA was $225.7 million in 2018 third quarter, a 1% increase from the 2017 quarter. Our adjusted EBITDA to interest coverage ratio was 4.6 times for the quarter and debt to annualized adjusted EBITDA was 4.6 times at quarter end.

Turning to our capital improvement fundings and commitments; we funded $31.5 million of hotel improvements and $15.8 million of travel center improvements in the third quarter. In the fourth quarter, we expect to fund $90.3 million of hotel improvements and $13.6 million of travel center improvements. Most of these improvements are expected to be funded from operating cash flow.

Turning to our balance sheet, as of quarter end, debt was 40.9% of total gross assets and we had $85.5 million of cash, including $65.6 million of cash escrowed for future improvements to our hotels.

Operator, that concludes our prepared remarks. We'd like to open up the call for questions please.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). The first question today comes from Matt Boone with B. Riley FBR. Please go ahead.

Matthew Boone -- B. Riley FBR -- Analyst

Good afternoon. Why would you say you had the bigger impact on RevPAR during the quarter between hurricane activity versus supply pressure and how would you expect that to trend as we head into 2019?

John G. Murray -- President and Chief Executive Officer

Thanks for that question. It is a tough -- it's tough to really quantify very accurately the impact of supply growth, but supply growth in the upscale segment where most of our hotels, 80-plus percentage of our hotels are -- has been highest this year, demand growth has been very high in the upscale segment as well, but I think that supply growth probably had at least as much impact as renovations this quarter.

Matthew Boone -- B. Riley FBR -- Analyst

Great, thanks. And then sorry if I missed this but for the acquisition that was completed in October, can you share what cap rate that was acquired at and how that compares to the broader market, as it stands today from a pricing perspective?

John G. Murray -- President and Chief Executive Officer

You know, our cap rate was about 8%, cap rate on -- and place (ph) cash available, we think that, that compares favorably, this is a strong performing recently renovated hotel in the Gainey Ranch section of Scottsdale. So it's very well located, again recently renovated. Easily the leader in its competitive set and so we think that, that was a very competitive cap rate for a full service hotel in that market.

Matthew Boone -- B. Riley FBR -- Analyst

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to John Murray for any closing remarks.

John G. Murray -- President and Chief Executive Officer

Thank you all again for joining us today. We look forward to seeing some or all of you at NAREIT's REIT World on Thursday in San Francisco. Thank you.

Operator

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 22 minutes

Call participants:

Katie Strohacker -- Senior Director, Investor Relations

John G. Murray -- President and Chief Executive Officer

Mark L. Kleifges -- Treasurer and Chief Financial Officer

Matthew Boone -- B. Riley FBR -- Analyst

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