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Service Properties Trust (SVC 0.08%)
Q2Â 2020 Earnings Call
Aug 7, 2020, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to Service Properties Trust's Second Quarter 2020 Financial Results Conference Call. [Operator Instructions] [Operator Instructions]
I would now like to turn the conference over to Kristin Brown, Director of Investor Relations. Please go ahead.
Kristin Brown -- Director of Investor Relations
Good morning. Joining me on today's call are John Murray, President; and Brian Donley, Chief Financial Officer; and Todd Hargreaves, Chief Investment Officer. Today's call includes a 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 SVC. 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, August 7, 2020.
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 operation or normalized FFO and adjusted EBITDAre. Reconciliation 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. Please note that John will provide commentary on IHG's default during his prepared remarks, but we will not be taking questions related to the ongoing discussions between SVC and IHG.
And with that, I'll turn the call over to John.
John Murray -- President and Chief Executive Officer
Thank you, Kristin, and good morning. The COVID-19 pandemic and related lockdown of most of the United States has had a dramatically negative impact on our economy, and that's hit hotels, restaurants and other service retail businesses, like theaters and fitness centers, particularly hard. Although significant uncertainties remain as to the time frame and trajectory of a recovery, we are confident that the most severe effects are behind us as we have seen a gradual improvement across our portfolio since April when the impact of the pandemic was at its most acute. We continue to take the necessary steps to preserve capital and solidify our liquidity during these challenging times. We have raised new debt capital and largely addressed our 2021 debt maturities. We also amended our $1 billion revolving credit facility to ensure continued access to undrawn amounts and obtained waivers of certain covenants we knew we would not meet in this operating environment. Brian will discuss these financing transactions in more details in a few moments.
Other steps we have taken to further reinforce our financial position include reducing our quarterly dividend, deferring nonessential capital spending and moving forward with certain of our previously planned hotel sales, which Todd will discuss in a moment. As we announced in late July, we did not receive payment from IHG for the $8.4 million balance of July minimum returns after applying the remaining $9 million of IHG's security deposit or the August minimum returns and rents of $18 million due to us. As a result, we sent IHG a notice of default and termination of the IHG agreement in late July. We have begun discussions with IHG regarding its management agreement with us to see if there may be a mutually beneficial resolution. Absent a cure of these defaults or if no settlement is reached, we currently plan to transition management and branding of these 103 hotels from IHG to Sonesta. As a reminder, SVC owns 34% of Sonesta.
The second quarter of 2020 marked a historic low for both the industry and our hotel results. Average occupancy for our comparable hotels in the second quarter was 31.2%, down 46% points from last year. Average daily rate was $83, down 31.5% from last year's quarter and RevPAR was $26, down 72.3% from last year. Importantly, we have seen continued gradual improvement in most markets each week since the middle of April. While none of our hotel portfolios were spared the immediate dramatic impact of the pandemic, our suburban extended stay hotels and select-service hotels outperformed our urban full-service hotels, reflecting demand from airline crews, healthcare workers, special projects or extended staying guests using the hotel's temporary housing. Our 183 extended stay hotels reported occupancies of 45.7% during the quarter compared with occupancies of 16.4% and 12%, respectively, for our 95 limited service and 51 full-service hotels.
Results also varied by portfolio as leisure, first responder, social groups, project and government demand, outweighed business and group travel. The results favorite portfolios with competitively priced offerings in the non suburban locations that could accommodate extended stays as needed. For our comparable hotels, our Sonesta and Wyndham portfolios performed the best in terms of both nominal RevPAR and percentage decline from last year's quarter. Conversely, our Radisson and Marriott portfolio saw the greatest percentage RevPAR declines versus last year and the weakest nominal RevPAR results. Subsequent to quarter end, hotel performance continues to improve. Albeit gradually, industrywide, with a few plateaus in markets that have experienced moderate virus resurgence and various degrees of rollbacks in terms of travel restrictions. All but 10 of our 329 hotels are now open and overall, occupancy has steadily increased to 43.4% for the four weeks ended August 1, from a low of 21% in April.
Looking ahead, our operators are seeing continued stabilization in the third quarter and the start of a recovery in the fourth quarter. We expect our diverse portfolio of suburban extended stay in select-service hotels will continue to outperform our urban full-service hotels throughout 2020. As stay-at-home orders are lifted, we expect guests will prefer smaller hotels in less densely populated suburban communities to large urban group hotels. At least until this health crisis is behind us. Also, extended stay hotels with full kitchens provide maximum flexibility for guests in markets with still restricted restaurant access. Turning to our net lease retail portfolio. TravelCenters of America, which represents about 25.6% of our minimum returns and rents, has continued to operate throughout the pandemic due to its designation as an essential service by many public authorities.
Although negatively impacted by the closure of its full-service restaurants and a significant decline in the sale of gasoline, TA's primary services to the trucking industry, including diesel fuel sales, quick service restaurant offerings and truck repair services have shown resiliency and enabled it to navigate the pandemic better than most of our tenants. TA is current on their rent obligations to us. Property level coverage at our TA locations was 1.91 times in this quarter. Among our service retail net lease tenants, rent collections have also trended upward to 80% in July from a low of 45% in April as businesses that were temporarily closed due to government mandates or guidelines continue to reopen.
Our service retail asset management team continues to work with our net lease retail tenants to evaluate rent deferral requests on a case-by-case basis. Request for deferrals have slowed significantly, except for certain tenants in the hardest hit industries like movie theaters, whose reopening prospects have changed. Todd will discuss this in detail in a moment. We are hopeful that the gradual lifting of restrictions and good sense in social distancing, mask usage and hygiene will allow recovery to take hold in our hotels, restaurants, theaters, fitness centers and other service retail assets across our portfolio. Although significant uncertainties remain as to the time frame and trajectory of a recovery, we believe we have endured the worst of this crisis and that we are well capitalized with ample liquidity and well positioned with a diverse portfolio of assets.
With that, I'll turn the call over to Todd to discuss our net lease portfolio in further detail as well as our recent investment activity.
Todd Hargreaves -- Vice President and Chief Investment Officer
Thanks, John. As of June 30, 2020, we owned 809 net lease service-oriented retail properties, including our travel centers, with 13.7 million square feet, requiring annual minimum rents of $369.4 million, which represented 38% of our total annual minimum returns and rents. The portfolio was 99% leased by 180 tenants with a weighted average lease term of 11.1 years, operating under 129 brands in 23 distinct industries. The aggregate coverage of our net lease portfolio's minimum rents was 2.16 times on a trailing 12-month basis as of June 30, 2020. Rent coverage for our largest tenant, TravelCenters of America, was 1.83 times for the trailing 12 months ended June 30, 2020, versus 1.97 times for the prior year period due to lower gross margins as a result of the pandemic and lower fuel prices, representing 25.6% of our minimum rents and returns, TA is current on all of its lease obligations due to SVC.
For our other net lease tenants, which represent 12.8% of our total minimum rents and returns, we expect coverage metrics will continue to decline for various retail tenants as the full effect of the pandemic is realized. We collected 59.3% of rents from these tenants during the second quarter, increasing to 75% in June from 45% in April and 58% in May. We collected 80% of July rents from these tenants. To date, we have entered into rent deferral agreements with 80 net lease retail tenants with leases requiring an aggregate of $59.3 million or 6.2% of total annual minimum rents and returns. Generally, these rent deferrals are for one to four months of rent and will be repaid by the tenants over a 12- to 24-month period beginning in September 2020. We have deferred an aggregate of $11.3 million of rent to date. Turning to leasing activity during the second quarter.
We entered lease renewals for an aggregate of 507,000 rentable square feet at weighted by rentable square feet, average rents that were 7% higher than prior rents for the same space. The weighted average lease term was 13.7 years and leasing concessions and capital commitments were $7.5 million or $14.80 per square foot. We also entered into new leases for an aggregate of 40,000 rentable square feet at weighted average rents that were 25.9% below prior rents for the same space. The weighted average lease term for these leases was six years, and leasing concessions and capital commitments were $0.2 million or $3.93 per square foot. Turning to our recent investment activity. During the quarter ended June 30, 2020, we sold four net lease properties with an aggregate of 810,000 square feet in four states for an aggregate sales price of $56 million.
We've also entered into agreements to sell seven net lease properties totaling approximately 68,000 square feet in six states, with leases requiring an aggregate of $332,000 of annual minimum rents for an aggregate sales price of $6.9 million, excluding closing costs. We expect these sales to be completed by the third quarter of 2020. At the onset of the pandemic, we were targeting to raise $300 million from hotel sales. While some of these sales will be delayed until later in 2020 or 2021, we've entered agreements to sell eight Marriott-branded hotels and one Wyndham-branded hotel with 1,178 rooms in five states with a net carrying value of $38.3 million for an aggregate sales price of $48.8 million. We expect these sales to be completed in the fourth quarter of 2020 and the use of proceeds to repay outstanding debt amounts.
Our annual minimum returns due for Marriott will be reduced by the amount allocated to the Marriott-branded hotels sold, which was $7.9 million as of June 30, 2020. For the nine hotels under contract to sell, we've received offers in line with pre pandemic pricing. Generally, the Marriott and Wyndham-branded extended stay hotels that were previously in the market to sell have maintained their values, and we continue to receive significant interest in these portfolios from all cash buyers. As a result, we believe the timing for disposition of many of these hotels may be earlier than our expectations at the time of our Q1 earnings call. Our management agreement with Wyndham expires on September 30, 2020, and we also expect to transition management and brands of these hotels to Sonesta at that time unless sooner terminated with respect to any hotels that are sold.
I will now turn the call over to Brian.
Brian Donley -- Treasurer and Chief Financial Officer
Thanks, Todd. Starting with the operating results at our 306 comparable hotels this quarter, RevPAR increased 72.3%, gross operating profit margin percentage decreased by 40.5% to 1.95% and gross operating profit decreased by approximately $182.6 million, driven by the sharp occupancy declines during the quarter, particularly in April. Below the GOP line, cost at our comparable hotels were down $24.5 million from the prior year as a result of lower FF&E reserve contributions, which were suspended for certain of our hotel agreements and lower system and other fees paid to the brands. Cash flow available to pay our minimum returns and rents for our comparable hotels declined $158.1 million or 121% to a loss of $27.5 million for the quarter. Cash flow coverage of our minimum returns and rents for our 306 comparable hotels decreased to negative 0.23 times for the 2020 second quarter compared to 1.1 times to the prior year quarter.
All of our hotel operators were quick to implement cost savings measures amid scale back operations. However, we've also made necessary investments in the operational changes to support employee and guest safety across the hotels portfolio. We estimate approximately $10 million of incremental expenses have been spent year-to-date to mitigate COVID-19. It's too early to say what the permanent impacts of operational changes will be to hotel operations. Turning to our consolidated financial results. Normalized FFO was $78.2 million in the 2020 second quarter compared to $168.8 million in the prior year quarter, a decrease of $0.55 per share. The decrease was due primarily to operating losses at our Sonesta and Wyndham hotels, the unguaranteed portion of our Marriott minimum returns, the suspension of FF&E reserve contributions across the portfolio and an increase in interest expense, partially offset by the impact of the SMTA transaction we closed in the third quarter of 2019.
Adjusted EBITDAre was $152.2 million in the 2020 second quarter. Our adjusted EBITDAre to interest coverage ratio was 2.1 times for the second quarter, and net debt to annualized adjusted EBITDAre was 10.2 times at quarter end. G&A expense for the 2020 second quarter was $11.3 million compared to $12.2 million for the second quarter of 2019 as management fees paid to RMR decreased based on our equity market capitalization. Turning to our balance sheet and liquidity. As of quarter end, debt was 51.7% of total gross assets, and we had $49.9 million of cash, including $29.7 million of cash escrowed primarily for future improvements to our hotels. During the second quarter, our hotel operators funded $121.2 million of the shortfalls of hotel cash flows to our minimum returns and rents in the form of security deposit applications and guarantee payments. As of June 30, 2020, the balance of our security deposits and guarantees available to cover shortfalls and cash flow available to pay our minimum returns and rents under certain of our hotel agreements was $45 million.
The credit support in our hotel agreements have been pressured more quickly and deeply than we've ever seen before. We exhausted both our security deposit and guaranty under our Marriott agreement during the second quarter, and in July, we applied the remaining $9 million of security deposit under our IHG agreement. Based on current estimates, we project our Hyatt guaranty could be exhausted as soon as the fourth quarter of 2020. As John noted, IHG defaulted on its minimum payment obligations in July. Absent in cure agreements defaults or amended agreement with IHG, going forward, we will only receive the operating cash flows from IHG-branded properties. Under our Marriott agreement for 122 hotels, we have received payments or utilize the available security deposit for an aggregate of 80% of the minimum returns due for the six months ended June 30. Given the security deposit and guarantee from Marriott is depleted, Marriott is required to fund any shortfall of cash flows generated by the hotels and 80% of the annual minimum returns due to us.
The 80% threshold and settlement of cash amounts are calculated on a monthly basis after hotel results are finalized each period. We will receive July's results later in August to determine any amounts due for Marriott. During the 2020 second quarter, we advanced an aggregate of $80.5 million of working capital to certain of our hotel operators to cover projected operating losses. We are currently projecting an additional $20 million of working capital advances could be funded over the remainder of the year. Generally under the terms of our hotel agreements, working capital advances are reimbursable to us from a share of future cash flow from the applicable hotel operations in excess of the minimum returns due to us and certain management fees, if any. As Todd discussed, we've deferred $11.3 million of rent date to date for certain retail tenants. During the second quarter, we recorded reserves for uncollectible revenues of $5 million for certain of our net lease tenants. Notably, $2.5 million of this reserve related to certain AMC Theater leases and $800,000 related to a retail tenant at the property we sold during the quarter.
In May, we amended the credit agreement governing our revolving credit facility under our $400 million term loan. As a reminder, the amendment gives us continued access to undrawn amounts include the waiver of certain financial covenants through March 2021. During the second quarter of 2020, we funded $39 million of capital improvements, and we currently expect to fund approximately $32 million of capital for the remainder of 2020, primarily for maintenance capital and ongoing renovations. In June 2020, we repurchased $350 million of our $400 million senior notes due in February 2021 in the tender offer. Also in June, we issued $800 million in aggregate principal amount of new 7.5% unsecured senior notes due 2025 that are guaranteed by certain of SVC subsidiaries than underwritten public offering. We used the net proceeds of this offering to repay amounts outstanding on our revolving credit facility, including the amounts drawn for the tender offer. As of today, we have almost full availability on our $1 billion revolver, subject to a $125 million minimum liquidity requirement under our amended credit agreement. And our next debt maturity is the remaining $50 million of 2021 senior notes outstanding due in February. Operator, that concludes our prepared remarks.
We're ready to open up the line for questions.
Questions and Answers:
Operator
[Operator Instructions] First question comes from Bryan Maher of B. Riley FBR.
Bryan Maher -- B. Riley FBR -- Analyst
Good morning, everyone. A couple of quick questions, or maybe not so quick. When it comes to the hotel expenses, we were a little bit surprised at how low they were for the quarter. Can you talk a little bit about what actions were taken there and how the agreements with Marriott, InterCon and others might impact how low those expenses were for the quarter?
Brian Donley -- Treasurer and Chief Financial Officer
I'll start on the income statement for SVC, the credit support we receive in the form of security deposits and guarantees are presented in the income statement as a reduction to operating costs. So the underlying hotel expenses were higher than what's in the GAAP consolidation in order to show the right the correct profit due to debts we see during the period, we have to show sort of a contra expense amount, if you will, on the P&L. So expenses actually exceeded revenues in the period to make sure we're clear on that.
But the hotel portfolio lost, I think, I said $27 million for on a comparable basis for the quarter. So hopefully, that gives you a little clarity on how the expense side works. I mean, obviously, cost initiatives and reductions across the portfolio were enacted. But I just wanted to make sure you're clear on the presentation and the income statement. Savings wise, labor was down 60% on an operational level. And other cost measures right down the line based on the impact of COVID.
Bryan Maher -- B. Riley FBR -- Analyst
Right. That's what I thought it was in reading the footnotes, but I just wanted to clarify. John, I think you mentioned that the Marriott hotels underperformed. Any particular reason why that might have been?
John Murray -- President and Chief Executive Officer
I think Marriott really historically has excelled in the strength of their rewards program and their corporate negotiated rates and group sales and business transient drivers. And in the pandemic, that business has really dried up. And I think maybe it's a reflection of how many people have been furloughed or else, it's a reflection that that historically, they've had it so good that they're not as well prepared to sell to other types of business when events like this hit but they just they didn't really drive the business like some of the other portfolios.
Bryan Maher -- B. Riley FBR -- Analyst
Okay. And then kind of moving on to hotel asset sales, I was pleased to hear that those are starting to ramp-up again. And I'm going to assume that they're being done at reasonable pricing. I didn't catch what was said on the call regarding the Sonesta hotels, which I think earlier this year, you had designated to sell some or all of. But given the instance in which IHG might not come to an agreement with SVC and those IHG hotels be branded as Sonestas, would it make sense to hold off selling the other Sonestas? Because at that point, you have a really meaningful brand in Sonesta that could gain traction on the recovery. What are your thoughts there?
John Murray -- President and Chief Executive Officer
I think you pretty much nailed it, Bryan. We have been evaluating the Sonesta ES portfolio. When the pandemic hit, we were right about to launch a marketing effort to sell those assets. But as the impact of the pandemic settled in, obviously, we saw that the extended-stay hotels were performing much better than any other hotel type. And so we stopped any marketing efforts. We also had been evaluating whether some of those hotels might be converted to an alternative use like multifamily, and that's something we're still considering.
But in light of the IHG situation, you're absolutely right, that would significantly increase the amount of extended stay hotels that Sonesta operates, if we're not able to work something out with IHG. And so we're not currently moving forward or we've changed our plans with respect to the Sonesta ES portfolio for now and we're going to reevaluate as we move through the recovery and see what transpires.
Bryan Maher -- B. Riley FBR -- Analyst
Thank you very much. Good luck to the 3rd quarter.
John Murray -- President and Chief Executive Officer
Thank you.
Operator
The next question comes from Dori Kesten of Wells Fargo.
Dori Kesten -- Wells Fargo -- Analyst
Thanks and good morning, guys. Can you tell us if all the hotel managers other than InterCon paid their July returns? And what percent of the net lease rent payments were received in July?
Brian Donley -- Treasurer and Chief Financial Officer
So from a hotel standpoint, IHG, which we've talked about in our release in-depth in the script, we utilized the rest of the security deposit for July and did not receive the rest of that payment. Marriott works a little bit differently. It's all done in arrears. To date, we've collected more than 80% of the returns. So each period, we have to relook at what the hotels have generated and how much we've received to date and then figure out who owes what for the hotel portfolio. Hyatt and Radisson continue to honor their guarantees.
And Sonesta and Wyndham, just based on cash flows of the properties, which are currently running losses in recent months. So on the net lease side of it, collections have continued to ramp-up, below of 45% in April, has gone up to 80% in July. And TA has been current in all their obligations on top of that. So we feel pretty good about the trend on the net lease side of things. July's early excuse me, August's early collection results seem to be trending a little bit better than July as well. So we continue to see that as a good sign.
Dori Kesten -- Wells Fargo -- Analyst
And for asset sales, I think, you initially said $300 million, but I assume that was also including all of the Sonestas, which you just mentioned, the Sonesta ES Suites may stay in the portfolio. And then I think previously, you had said you were marketing for sale the 20 Wyndhams. And in this release, it said that any unsold would go to Sonesta. So I'm just trying to reconcile the original $300 million with what's, I guess, currently on the market or is being planned to be sold?
John Murray -- President and Chief Executive Officer
Yes. Since the pandemic hit, the sale process has been dicey. So I apologize if it's gotten a little confusing. The $300 million did not include the Sonesta ES portfolio. So we had it was based on the 20 Wyndham-branded hotels and the 33 Marriott-branded hotels. And Todd mentioned, the transactions we have currently under agreement, we're very close on purchase and sale agreements for two other groups of assets, the portfolio of 15 Hawthorn Suites and a portfolio of 16 Marriott-branded hotels, that's 13 court yards and three residents ins, that per our agreement can remain will remain in the Marriott brands.
And I think probably within the coming week, we'll most likely sign the purchase and sale agreements there. So it's possible that those will close late in the fourth quarter. But together, the pricing is in the $170-ish million range on those two.
Dori Kesten -- Wells Fargo -- Analyst
Okay. So the $300 million was the 33 Marriotts and the 20 Wyndhams.
John Murray -- President and Chief Executive Officer
Correct.
Dori Kesten -- Wells Fargo -- Analyst
Okay. Got you. And I guess if Marriott follows the path of IHG, should we assume that that those hotels could be rebranded as Sonestas also?
John Murray -- President and Chief Executive Officer
Yes. I mean, we're hopeful that, that doesn't come to pass, but if it were to happen, there isn't any there's no reason why we would treat Marriott any differently than we're treating IHG. We would try to protect our agreements and our returns.
Dori Kesten -- Wells Fargo -- Analyst
Thanks.
John Murray -- President and Chief Executive Officer
Thank you.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to John Murray, Chief Executive Officer, for any closing remarks.
John Murray -- President and Chief Executive Officer
Thank you very much for joining us today. Stay well.
Operator
[Operator Closing Remarks]
Duration: 32 minutes
Call participants:
Kristin Brown -- Director of Investor Relations
John Murray -- President and Chief Executive Officer
Todd Hargreaves -- Vice President and Chief Investment Officer
Brian Donley -- Treasurer and Chief Financial Officer
Bryan Maher -- B. Riley FBR -- Analyst
Dori Kesten -- Wells Fargo -- Analyst
