Service Properties Trust (SVC) Q2 2021 Earnings Call Transcript

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Service Properties Trust (SVC -0.62%)
Q2 2021 Earnings Call
Aug 6, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Service Properties Trust Second Quarter 2021 Financial Results Conference Call. This call is being recorded. At this time for opening remarks and introductions, I would now like to turn the call over to Director of Investor Relations, Kristin Brown. Please go ahead.

Kristin Brown -- Director of Investor Relations

Good morning. Joining me on today's call are John Murray, President; 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 SVCs present beliefs and expectations as of today, August 6th, 2021. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made on 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 on file with 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 it over to John.

John G. Murray -- President and Chief Executive Officer

Thank you, Kristin, and good morning. Last night, we reported second quarter normalized FFO of $0.16 per share and adjusted EBITDAre of $118.6 million, which reflects improvement in economic fundamentals for our properties, as the economy has continued to reopen and stabilize from the COVID pandemic.

This has led to steady improvement in revenues at our hotels, continued strong performance at our travel centers, and steady cash collections and improving operations at our net lease service-oriented retail properties whose businesses are operating in a more normal environment.

Our second quarter operating results reflect improvement in SVC's hotel portfolio, as we move past the transition disruption from the rebranding of over 200 hotels to Sonesta. Our hotel EBITDA turned positive in April and hotel fundamentals steadily improved each month from March through June despite headwinds created by industrywide labor shortages and concern over COVID variants.

Demand remains the strongest at leisure-oriented properties, like our Sonesta hotels in Hilton Head, San Juan and Miami, which posted occupancies in excess of 80% during the quarter. With summer travel underway, demand across the portfolio continues to be stronger on weekends versus weekdays, but weekday stays have shown a noticable increase as we begin to see the early stages of business travel returning. And while the COVID-19 delta variant presents a potential risk to recovery for business travel, we anticipate increased momentum after Labor Day, when schools reopen in person and more employees return to the office.

Average occupancy for our 283 comparable hotels was 57.9% in the second quarter. Average daily rate was $92.59 and RevPAR was $53.61. Our extended stay hotels have maintained double-digit occupancy premiums relative to the industry when compared to our non-extended stay hotels, a trend we have seen throughout the pandemic. Our 160 extended stay hotels reported occupancies of 71.6% during the quarter compared with occupancies of 45.7% and 46.4% respectively through our 93 select service and 51 full-service hotels.

Our full-service hotels outperformed industry growth on a year-over-year basis due to strong occupancy gains across all of SVC's operators, supported by leisure travel and the reopening of many urban locations. Excluding the potential impacts of the delta variant, we expect the second half of 2021 to show further progress toward recovery and stabilization and for our RevPAR to continue to improve in the second half as business travel is slowly emerging and extended stay occupancies remain stable or growing.

Labor continues to pose a challenge for the lodging industry and our portfolio. Wage increases to attract or retain staff, the use of expensive contract labor and lost revenues from out of water rooms which could not be cleaned, have negatively impacted results. Offsetting these costs was increased productivity on a cost per occupied room basis which was approximately 22% lower than a year ago, partially due to labor savings due to open positions and relaxed brand standards.

Now I'll provide more color on the hotels that we transitioned to Sonesta in the fourth quarter of 2020, which included 112 hotels rebranded primarily in December. Sonesta has now managed these hotels for two full quarters and we are generally pleased with the progress to date with RevPAR increasing over 58% to $55.67 in the second quarter compared to $35.12 in the first quarter. For the 88 hotels we rebrand in February and March, we are also seeing steady progress with RevPAR increasing over 83% to $61.64 in June compared with $33.64 in March.

While hotel transitions are always disruptive and it is difficult to build brand awareness during a pandemic, we believe Sonesta's brand awareness is growing and most of the transition disruption is behind us. Even as hotel industry demand recovers and its brand awareness improves, Sonesta is realizing the benefits of its much larger scale.

For example, Sonesta's increased size is enabling it to utilize cluster staffing in concentrated markets like Atlanta, Dallas and Chicago to reduce labor costs. Sonesta has also integrated systems to reduce IT expenses and lower per transaction reservation costs through its own network and through OTAs by approximately 15% to 20% versus 2019.

As hotel industry fundamentals continue to improve, we expect Sonesta will deliver solid results in both the top line and bottom line. SVC is well positioned to participate in any upside realized by the evolution of Sonesta as a major hotel brand management and franchise company to its 34% ownership.

I also want to provide an update on our relationship with Radisson. The limited guarantee provided by Radisson to support SVCs minimum returns was exhausted during the second quarter. We are attempting to negotiate a mutually agreeable path forward for some or all of the hotels under this management agreement. And we are reasonably optimistic about how this is going.

Turning to our net lease assets, this portfolio is largely back on track. Rent collections, including our largest tenant TravelCenters of America were 98% during the second quarter. While we continue to work with select tenants in the most impacted retail sectors, we are not receiving new requests for rent deferrals. As you may have seen, earlier this week, TA reported very strong earnings as its transformation plan takes hold. This is good news for TA as our largest tenant, and also because we own approximately 8% of their shares.

We have taken steps to preserve capital and solidify our liquidity including maintaining a nominal dividend, deferring non-essential capital spending, working with our operators to control costs and completing select asset sales. To further improve liquidity, last week we initiated the sales process with respect to approximately 69 Sonesta branded hotels which we expect to sell encumbered by the current brand and which Todd will discuss in more detail.

Supported by steady cash flow from TA and our net lease portfolio and with our hotels now cash-flow positive, we are well capitalized with ample liquidity and well positioned with a diverse portfolio of assets to improve the Company's overall performance.

With that, I'll turn it over to Todd to discuss the net least portfolio in further detail as well as our recent transaction activity and planned dispositions.

Todd Hargreaves -- Vice President and Chief Investment Officer

Thanks, John. As of June 30th, 2021, we owned 796 net lease service oriented retail properties including our TravelCenters with 13.4 million square-feet requiring annual minimum rents of $371.9 million. Representing 42.5% of our overall portfolio based on investment, our net lease assets were 98.5% leased by 171 tenants with a weighted average lease term of 10.5 years and operating under 130 brands in 21 distinct industries at quarter end.

The aggregate coverage of our net lease portfolio's minimum rents was 2.3 times on a trailing 12 month basis as of June 30, 2021. Rent collections from our net lease tenants were stable at 98% for the second quarter versus 93% in the first quarter and a low of 81% for April 2020. During the second quarter, we entered into rent deferral agreements for $1.1 million for two net lease tenants and as of June 30, 2021, $10.2 million of deferred rents remain outstanding.

During the second quarter, we also recorded reserves for uncollectible revenues of $1.2 million for certain of our net lease tenants primarily select movie theaters and restaurant leases compared to $4.8 million during the first quarter. As a reminder, we recognized all changes in the collectability assessment through an operating lease as an adjustment to rental income.

Turning to our recent transaction activity. During the second quarter, we sold six hotels with 576 rooms for an aggregate sales price of $32 million and two net lease properties totaling 35,000 square feet for an aggregate sales price of $1.7 million, excluding closing costs. SVC has entered into agreements to sell four net lease properties with an aggregate of 27,000 square feet for an aggregate sales price of $2.2 million excluding closing costs. Subject to certain closing conditions, we expect to complete these sales by the end of the third quarter.

As we've discussed on previous calls, we continue to evaluate both the legacy and recently transitioned Sonesta hotels to determine which assets we view as disposition candidates based on various criteria, including properties in markets or locations where SVC wants to reduce exposure as well as hotels that are historical underperformers relative to the overall portfolio.

We've made significant progress and have identified 69 Sonesta branded hotels in 27 states to market for sale and convert with brand. This includes 46 extended stay hotels with 5,404 keys, 19 select service hotels with 2,461 keys and four full service hotels with 1,098 keys. These hotels had an aggregate net carrying value of $627.3 million as of June 30, 2021. We have engaged brokers and plan to formally launch the offering processes in August with the intention of executing the majority of sales by the end of the first quarter of 2022.

I'll now turn the call over to Brian.

Brian Donley -- Treasurer and Chief Financial Officer

Thank you, Todd. Starting with our consolidated financial results for the second quarter of 2021, normalized FFO was $25.8 million or $0.16 per share, a sequential increase of $67.8 million over the first quarter of 2021. Adjusted EBITDAre was $118.6 million for the second quarter, a sequential increase of 143% over last quarter.

The major drivers impacting normalized FFO this quarter included the results from our hotel portfolio, which generated $29.9 million of positive hotel EBITDA for the second quarter of 2021 compared to negative $48.5 million of hotel EBITDA in the prior year quarter and negative $38.2 million in the first quarter of 2021.

Guaranty [Phonetics] payments and security deposit utilization that supported our hotel returns under our historical agreements declined $115.8 million, negatively impacting year-over-year comparisons. Rental income from our leased properties for the second quarter of 2021 declined $1.8 million year-over-year, primarily as a result of the conversion of one hotel from being subject to a lease agreement in the prior year to being operated under our management agreement in the current year.

Interest expense increased $19.3 million over the prior year quarter as a result of our 2020 financing activities and our revolver draw in January of 2021. G&A expense increased $2.6 million in the current year quarter, primarily as a result of increased business management fees due to RMR as a result of an increase in our market capitalization when compared to the prior year period.

We account for our investment in Sonesta under the equity method of accounting and include our share of Sonesta's results in our earnings. Our share of Sonesta's normalized FFO recognized from our 34% ownership interest was $2.4 million, an increase of $4.1 million or $0.03 per share over the prior year quarter. Our share of Sonesta's adjusted EBITDAre for the quarter was $2.4 million, an increase of $4.3 million over the prior year quarter.

Turning to our hotel portfolio results for our 283 comparable hotels this quarter. RevPAR increased 107.1%. Gross operating profit margin percentage increased by 27.4 percentage points to 27.5% and gross operating profit increased by approximately $61.1 million from the prior year period. Below the GOP line costs at our comparable hotels increased $8.9 million from the prior year, primarily as a result of an increase in management fees, driven by higher revenues at our hotels and increased insurance costs.

Our consolidated portfolio of 304 hotels generated hotel EBITDA of $29.9 million compared to operating losses of $48.5 million in the prior year quarter. Our 160 extended-stay hotels continue to have the strongest performance, generating $24.5 million of hotel EBITDA during the quarter. Both our 51 full-service and 93 select-service hotels also turned positive for the quarter, generating $4 million and $1.4 million, respectively.

78% of our hotels had positive cash flow for the month of June compared to 44% in March. Overall, RevPAR increased 62.7% sequentially to $57 this quarter as a result of strong leisure demand and the ramp-up from rebranding 88 hotels in Q1. RevPAR is still down approximately 46% from the second quarter of 2019 levels, but improved from a 61% decline in Q1 2021 as compared to Q1 2019. The positive trends we have been seeing since March continued into July with overall RevPAR of $73.42, an 11.9% sequential increase compared to June 2021.

Turning to liquidity; our overall corporate cash flow was positive before capital expenditures for the second quarter. Based on our current outlook and expectation for improved lodging activity in the back half of 2021 and stable rent collections from our triple-net lease portfolio, we continue to expect to be cash flow positive for the full year 2021 at the corporate level before capital expenditures. Capital improvements made at our properties was $24 million during the second quarter and we expect to fund $100 million over the second half of 2021 for a total of $150 million projected for the full year.

Regarding our common dividend, we continue to expect to maintain the current quarterly distribution rate of $0.01 per share through mid-2022. At quarter-end, we had approximately $915 million of cash on our balance sheet and our next debt maturity is in the third quarter of 2022. We currently believe we have adequate liquidity through 2022, and we will continue to assess and explore all of our options to ensure we are well-positioned until the effects of the pandemic are behind us and lodging fundamentals stabilize.

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

Questions and Answers:

Operator

Thank you. And we will now being the question-and-answer session. [Operator Instructions] Our first question today will come from Bryan Maher with B. Riley FBR. Please go ahead.

Bryan Maher -- B. Riley Securities, Inc. -- Analyst

Good morning. Just wanted to drill down a little bit on the asset sales and kind of the criteria you used in identifying those properties. Was it you could get strong pricing? Was it these properties needed more capex than the rest? Was it competitive new supply? How did you think about that when deciding on which ones to sell?

Todd Hargreaves -- Vice President and Chief Investment Officer

Hey Brian. Good morning. This is Todd. We looked at -- I think the primary criteria is that these hotels relative to the overall portfolio lagged in terms of occupancy, ADR, REVPAR, or generally in markets where we're projecting flat or decreased rent -- rate growth going forward. Some of them were older with capex needs, some were just in markets where we wanted to reduce SVC's owned exposure.

But at the same time, like you point out, we wanted to put together a portfolio that would get a lot of interest. And these are quality assets. I think if you look at SVC's portfolio overall, they are the bottom tier, but these are probably higher quality than the assets that we brought to market and sold last year.

But all indications so far is that there's going to be a lot of interest in these. There's really not a lot of product out there for sale, right now, especially this amount of hotels on the extended-stay and flex service specifically. So, we think it's good timing to go out to market now and we think we'll get good execution on pricing as well.

Bryan Maher -- B. Riley Securities, Inc. -- Analyst

Great. And kind of like a second derivative of that, when we think about your capex spend, I think you said $150 million for this year with $100 million in the back half of the year. First of all, is that total portfolio or is that mainly just the hotels?

Brian Donley -- Treasurer and Chief Financial Officer

That's -- Brian, thanks for the question. Yes, that's the total portfolio. So $100 million in the back half of the year, $35 million of that is renovations at some of the full-service hotels; the three specific assets that we've been putting significant capital into their repositioning. About $50 million of that is maintenance capex and we still have some carryover of the conversion costs based on delays of getting some of those projects done.

Bryan Maher -- B. Riley Securities, Inc. -- Analyst

And so, when we think about 2022, and I know it's a little bit early, would you think that there is some deferred capex you're kind of pushing out from '21 into '22. And what would be the size of that? Would it be like $25 million, $50 million?

Brian Donley -- Treasurer and Chief Financial Officer

Yes, Brian, I think -- yes, you're right. We've been pretty careful on our capex spending and to protect our liquidity this year. So there's definitely some stuff that we've deferred, and there'll just be general lags in deploying capex projects. But your range is a fair number. But I think overall, that sort of $125 million to $150 million for a calendar year is safe -- is sort of a safe estimate at this point in time. We did announce that the Hyatt portfolio would go under significant renovation. So there's $50 million that we've dedicated for that portfolio alone, plus our typical sort of maintenance capex number, which we've said before is $65 million to $75 million.

Bryan Maher -- B. Riley Securities, Inc. -- Analyst

Okay, great. And then...

John G. Murray -- President and Chief Executive Officer

I would just add to that Brian that Sonesta has been -- in addition to transitioning the hotels that they took over, they've been working on new brand standards for their newer brands. And so some of the deferral was just waiting to make sure that we have well-established brand standards to work from.

Bryan Maher -- B. Riley Securities, Inc. -- Analyst

Great. And just last for me and then I'll hop back into the queue is, with the use of proceeds, this is going to be a sizable amount of cash if you get anywhere close to the carrying costs. Is the plan to simply reduce debt or would you be looking to eventually recycle some of that capital into new assets?

John G. Murray -- President and Chief Executive Officer

I think we expect to do quite a bit better based on our opinions of value than our carrying costs as a first statement. But in the current time because of our covenant situation as a result of the pandemic, we don't have the ability to invest in new assets. So initially, the expected use of proceeds is to reduce indebtedness and maintain liquidity until such time as we're in compliance and can go back on offense, which probably won't be until the early part of next year.

Bryan Maher -- B. Riley Securities, Inc. -- Analyst

Yeah, thank you.

Operator

And our next question will come from Jim Sullivan with BTIG. Please go ahead.

James Sullivan -- BTIG -- Analyst

So John, I have a couple of questions on the hotel business and what so far is a pretty impressive rate of recovery. First of all, when you talk about the assets sold, can you just clarify, I think there was a comment in the -- to this effect in the prepared comments, are the assets initially being offered subject to the Sonesta management contract? Number one. And number two, how will -- what would be the response if a buyer would like the entire package, but want to buy it not subject to the management agreement?

John G. Murray -- President and Chief Executive Officer

Thanks, Jim. Those are good questions. The plan is to sell them encumbered by brand, but not encumbered by the Sonesta management agreement. So investors who might buy the portfolio or groups of hotels within the portfolio encumbered by brand could manage themselves or engage third-party managers if they so choose or they could engage Sonesta. And we're expecting that these are probably going to be sold in small portfolios, maybe between five and 10 hotels in different regions of the country.

But, we expect that we also will get some portfolio bids, and we're going to evaluate whether the bids come in encumbered or unencumbered. We're going to evaluate all the offers and do what we think is in the long-term best interest of SVC. So one of the benefits of selling encumbered is that it maintains the growth profile of Sonesta, and will enable them to have a broader base of franchisees from which they should be able to continue to grow the franchise revenue stream.

And that maintaining the distribution and brand awareness and continuing to grow the platform without SVC having to put additional capital in. I think as a 34% owner of Sonesta, that's a net positive for us. But obviously, if somebody is willing to pay more for -- to get it unencumbered, we will certainly do the math on where the difference is and do what's best for our shareholders.

James Sullivan -- BTIG -- Analyst

Okay, thanks for that. And there was a prepared -- in the prepared comments, there was a comparison between second quarter RevPAR this year versus, I think 2019 was the comparison -- of course, July numbers are that much stronger than what you just reported in June. And I'm curious, this obviously seasonality impacts, particularly in leisure business as we're approaching the end of the summer. But when we think about the third quarter potential, is the July number representative of the trend you're expecting by month in the quarter, i.e., continued strength in both pricing and -- second quarter?

John G. Murray -- President and Chief Executive Officer

I think we continue to see strength across the portfolio, still largely driven by leisure travel. We expect leisure travel to continue even past Labor Day, although at a slower pace once school is back in session and colleges are back in session, but we think that there is still a lot of pent-up demand for travel and there are a lot of young professionals, in particular, who are working remotely and can do long weekends where they're perhaps working on a Friday and Monday, but still in Fort Lauderdale or Hilton Head or San Juan or other locations like that.

So we expect that business to hold up pretty good. And the wildcard is going to be once you get to September, how quickly the business travel returns. Yes, the big focus in the portfolio now is we've gotten occupancy to a pretty good level but we really need to start pushing rate. A lot of the business that we've gotten in this past quarter was -- came through OTA channels. So we're -- we have a number of strategies to push that business toward brand.com and to push rate.

And a lot of that comes through the extended-stay side where we had very high occupancies throughout the pandemic, but a lot of that business was traveling nurses and government business, some construction business, but lower-rated to maintain high occupancies. But now that we're over 70% occupancy in the extended-stay hotels we're moving to better balance the mix of length of stay. So we get some transient business in there as well, and that will drive higher rates in the extended stay segment too.

James Sullivan -- BTIG -- Analyst

And John, I just wonder if you can help us because obviously, some of your hotel REIT peers talk a lot about the timing of the business transient as well as the business group recovery. And some of them -- well, most of those companies have not changed brands and whether it's a Marriott or a Hilton or what have you, those major brands that have been operating for many years have kind of a profile in terms of how much of their total demand is business versus leisure.

And they have corporate rate business, which they can talk about corporate rate, whether it's coming back or not in business groups and so forth. And I wonder if you could just update us on -- I know that you don't run Sonesta, but -- or maybe you do, I'm not really sure, but if you could help us understand Sonesta's pace of business travel and what they're doing to ensure that the portfolio doesn't lose ground with its share of the business travel as we get past Labor Day?

John G. Murray -- President and Chief Executive Officer

Sure. I'm not running Sonesta, so you're correct on that. Sonesta has a number of initiatives. I think historically, they were a smaller company and competed better with the big brands on the leisure side more so than for the business travel. They didn't have the same customer accounts with national accounts because they didn't have a national presence to the same extent to some of the larger brands. That has changed with the transition of over 200 hotels over the last six months or so.

And so Sonesta is actively engaged in RFPs to get established customer accounts with those national brands so that they can drive more business travel. They're also running promotions in local markets and have a, I think, a fairly sophisticated sales program that's getting out and driving business at the local market level backed up with some marketing and advertising. I think the opportunity -- in addition to pushing rate, the opportunity for Sonesta is that they have, I think, a well-trained group of salespeople who are aggressively looking for business and finding some success with that, whereas our experience generally with larger brands is that they've gotten a little bit -- maybe this is changing as a result of the pandemic, but they were getting complacent. There was enough business coming in from brand.com that they didn't actually have to go out and sell.

And so really being good salespeople is -- I think Sonesta salespeople are better than the salespeople that you would find at some of the other brands. And so it's going to take some time, and you don't build brand awareness overnight, but we think that Sonesta is going to close that gap that currently exists between their business travel, performance, and the larger brand's performance.

James Sullivan -- BTIG -- Analyst

Okay, thanks for that John. And one final question on the hotel business and Sonesta really related to Red Lion. There's been some discussion on earlier calls about the franchising initiative at the time of the Red Lion acquisition. And Red Lion as a hotel company had actually been losing units and to some extent, that may have been directed by the Red Lion, given quality concerns or what have you.

But I'm just curious, as you think about the potential for Sonesta to grow the Red Lion brand and the other brands that they got when they acquired Red Lion through franchising. Are you optimistic or confident that the hotels under the Red Lion stable of brands will increase beginning next year?

John G. Murray -- President and Chief Executive Officer

I think Sonesta's team that has been put in place at Red Lion has really started out doing a really great job. The EBITDA generated at Red Lion is substantially higher than what we had originally projected already. The loss of franchisees has abated and the Red Lion brands are growing again, albeit slowly. And that -- we saw definite value in the Red Lion brands and the ability to grow those lower-tier hotels in those lower-tier segments, but a large part of the value we saw in the Red Lion acquisition was the ability to have a platform we could quickly get franchise disclosure documents filed for the Sonesta brands.

And in particular, on the extended-stay side, we believe that the franchise development team at Red Lion, which is now also the Sonesta franchise development team will have disclosure documents filed hopefully by October 1, and we'll be able to significantly bolster franchise sales in the Sonesta brands as well as the Red Lion brands. So we're -- so far, our expectations have been exceeded, and we're tracking well with getting Sonesta's documents filed. So we feel very good about that acquisition and those brands.

James Sullivan -- BTIG -- Analyst

Good. Okay, thanks John.

Operator

And this will conclude the question-and-answer session. I'd 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 very much for joining us on today's call. And we look forward to hopefully seeing some of you at NAREIT later in the year. Thanks.

Operator

[Operator Closing Remarks]

Duration: 37 minutes

Call participants:

Kristin Brown -- Director of Investor Relations

John G. 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 Securities, Inc. -- Analyst

James Sullivan -- BTIG -- Analyst

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