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spk05: Good morning, and welcome to the Service Properties Trust's second quarter 2023 earnings conference call. All participants will be in a listen-only mode, and should you need any assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please also note that this event is being recorded today. I would now like to turn the call over to Stephen Colbert, Director of Investor Relations. Please go ahead, sir.
spk03: Good morning. Joining me on today's call are Todd Hargraves, President and Chief Investment Officer, and Brian Donnelly, Treasurer and Chief Financial 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 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 SVC's present beliefs and expectations as of today, August 8, 2023. 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 filings with the SEC, which can be accessed from our website at svcreep.com or the SEC's website. 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. In addition, this call may contain non-GAAP financial measures, including normalized funds from operations or normalized FFO and adjusted EBITDA RE. Reconciliations of these non-GAAP financial measures to net income, as well as components to calculate AFFO, are available in our supplemental operating and financial data package, which can be found on our website. With that, I'll turn the call over to Todd.
spk04: Thank you, Stephen, and good morning. SVC's second quarter results reflect the continued improvement in our hotel portfolio. as year-over-year comparable RevPAR gains outpaced the industry for the sixth consecutive quarter, driven by increases in both ADR and occupancy. Portfolio RevPAR for our 219 comparable hotels increased 2.8%, with ADR increasing 2.4% and occupancy increasing by 30 basis points. While leisure demand has softened in markets like Miami, Scottsdale, Fort Lauderdale, and Hilton Head, SVC's portfolio benefited due to our higher relative exposure to urban markets and reliance on business travel. We reported year-over-year REVPAR gains in our select service and full-service portfolios of 3.8% and 3.6% respectively, resulting from the recovery of urban markets, specifically on the East Coast and Midwest, and improving trends in business transient group and contract business. Revenues at our 48 comparable full-service hotels increased by $19.7 million from the previous year quarter, with Sunessa posting a record quarter for ADR for its 39 full-service hotels, driven by sizable year-over-year increases in group, corporate negotiated, and contract of 25%, 16%, and 11%, respectively. The largest increases in business travel were in Los Angeles, Boston, and Washington, D.C., And the increase in contract-related business was largely driven by our hotels in Redondo Beach and Fort Lauderdale. The negative impact from reduced leisure demand was mostly experienced at our hotels in Kauai, Hilton Head, New Orleans, and Florida. Our portfolio of 61 select service hotels reported revenues that were $3.1 million greater than the previous year quarter. The revenue gains were driven by group business, which was up 35% or $2.3 million. Excluding four properties under renovation, REF ARDA portfolio of 40 Senesta Select hotels increased 7% year-over-year, and REF ARDA portfolio of 17 Hyatt Place hotels increased 3.6%. Lastly, our portfolio of 110 Extend Stay hotels increased revenues by $1.6 million over the previous year quarter, as both ADR and group revenues came in with the highest figures since the most recent brand conversions in 2021. Weekday occupancy, specifically at our Senesta Select Hotels, has lagged the balance of our portfolio, but we are now seeing the gap between weekday and weekend occupancy converge as leisure demand softens and business travel increases. In June, Senesta's portfolio reached a new post-pandemic weekday occupancy high of 68.7%. Senesta is also seeing improvement in its loyalty program as travel pass revenue as a percent of total revenue increased from 19.8% in Q2 2022 to 21.9% in 2023. On the expense side, we continue to see inflation headwinds and costs like insurance and labor continue to pressure margins. For example, our annual insurance program was recently renewed and our largest operator, Senesta, expects to see premium increases of 60% or $6.8 million for the second half of 2023. On the labor front, contract labor expense per occupied room declined for a third consecutive quarter, However, we expect the use of contract labor will remain elevated given challenges in hiring full-time positions such as housekeepers, F&B attendants, and engineers. Turning to our net lease portfolio, which represents 45.4% of SQC's portfolio by investment, as of June 30, 2023, our 763 service-oriented retail net lease properties were 96.1% occupied with a weighted average lease term of 9.3 years. Importantly, our largest tenant in the portfolio, TA, which represents 68% of our minimum rents, is now backed by an investment-grade rated subsidiary of BP. The aggregate coverage of our net lease portfolio's minimum rents was 2.94 times on a trailing 12-month basis as of June 30, 2023, an increase versus the same period last year. Our near-term lease expirations are manageable as we have 856,000 square feet of leases expiring in the remainder of 2023 and 2024, representing only 3% of aggregate annualized minimum rent, most of which we expect will renew. Regarding our movie theater exposure, annualized minimum rents from our AMC movie theater portfolio declined by $2.1 million from the previous year quarter, related to AMC vacating three properties and converting to a percentage rent structure on two others, and by $1.8 million due to the recent lease restructures in connection with Regal's bankruptcy. In June, we completed the acquisition of the Nautilus Hotel, an upper-upscale hotel in a near-replaceable location in the heart of Miami's South Beach, which upon renovation will be rebranded under Senesta's lifestyle brand, The James. This hotel expands our resort destination offerings, provides an important entry into the South Beach market, and is representative of the type of hotel SVC may target as we take a disciplined approach to adding to the portfolio. Finally, before I turn it over to Brian, I want to emphasize the actions the company has taken over the last several quarters through refinancings, asset sales, and improved hotel performance to position SVC to address our upcoming debt maturities in 2024 and 2025. After the recent completion of our $650 million revolving credit facility, And closing on the TA transaction, we now have over $1 billion of liquidity and have a large pool of valuable unencumbered assets, including all of our TA travel centers, which provide us access to a range of financing alternatives where we can be selective in securing the best relative execution from both a leverage and cost standpoint in these ever-fluctuating capital markets. I will now turn the call over to Brian to discuss our financial results in more detail.
spk06: Thank you, Todd, and good morning. Starting with our consolidated financial results for the second quarter of 2023, normalized FFO was $95.1 million, or 58 cents per share, versus 54 cents per share in the prior year quarter, an increase of over 7%. Adjusted EBIT to RE increased 1.9% year-over-year to $185.3 million. The increase in normalized FFO this quarter was driven by lower interest expense, increased rental income, and improved hotel results, partially offset by our provision for income taxes. The decline in interest expense is largely the result of repaying amounts outstanding on our revolving credit facility and senior notes that were maturing last year. Regarding our income tax provision, we recorded a tax benefit of $3.8 million in the first quarter of 2023. This quarter, we recorded a tax expense of $5.2 million, or three cents per share. The swing sequentially is a result of the seasonal ramp up of our hotel portfolio. We're projecting a full year tax expense of $1.5 million. Most of our tax provision relates to certain state income taxes as well as our foreign operations. Rental income increased by $2.7 million this quarter compared to the prior year, largely as a result of the TA transaction closing mid-quarter. We recognize $3.5 billion of percentage rent during the quarter under the legacy TA lease terms. As a reminder, the new lease structure is a 10-year term and calls for fixed annual 2% increases with no percentage rent component. TA also prepaid $188 million of rent, and we will receive $25 million of rent credits annually in return. Annual cash rents for the first year of our TA leases is $254 million of fixed rent, less the $25 million prepayment credit. We will recognize $271 million of annualized rental income in our earnings over the 10-year lease term, which reflects our recognition of the fixed rents, the 2% rent escalators, and the effect of the prepaid rents on a straight-line basis in accordance with generally accepted accounting principles. The increase in rental income this quarter from TA was partially offset by an increase in reserve for uncollectible rents and the movie theater closures that Todd outlined. Turning to the performance of our hotel portfolio, for our 219 comparable hotels this quarter, REVPAR increased 2.8%, gross operating profit margin percentage declined by 128 basis points to 34.4%, and gross operating profit increased by $3.5 million from the prior year period. Below the GOP line costs at our comparable hotels decreased $3 million from the prior year, driven by successful tax abatements, and lower insurance costs driven by deductibles expensed in the prior year period related to various insurance claims. Our hotel portfolio generated hotel EBITDA of $93.1 million, a 3.5% increase over the prior year. By service level, the increase was driven primarily by improvement in our 111 extended stay hotels, which generated $28 million of hotel leave during the quarter, an 11.6% increase over the prior year quarter. Our 61 select service hotels also improved, generating hotel leave with $13.5 million in the second quarter, a 26.2% increase over the prior year period. Our 49 full service hotels generated hotel leave with $51.6 million, a 3.1% decline over the prior year period. Turning to our expectations for Q3, preliminary July 2023 rep bar was $100.52, and we're currently projecting full quarter Q3 rep bar of $91 to $97 in Hotel Ibiza in the $76 to $86 million range. Turning to the balance sheet, in June, we successfully executed on our new four-year $650 million secured revolving credit facility. Facility is secured by 66 hotels and three net lease properties and bears interest at SOFR plus 250 basis points. We currently have $5.8 billion of fixed rate debt outstanding with a weighted average interest rate of 5.75%. Our next debt maturity is $350 million of senior notes maturing in March, 2024. We have over 600 unencumbered assets across both of our real estate segments, including all of our travel centers leased to TA. that have a gross book value of over $7 billion. We believe this vast asset pool will provide us flexibility as we look to address our 2024 debt maturities in the coming quarters. Turning to investing activity, during the second quarter, we acquired the Nautilus Miami Beach for $165 billion and sold two net lease properties for a total price of $620,000. As part of the TA transaction, we received $102 million for the value of the TA common shares we held, and $89 million for the TA trade name we sold to BP. We made $42.8 million of total capital improvements in our properties during the second quarter, and we expect capital expenditures of $140 to $160 million over the remainder of 2023. We currently have over $1.1 billion of total liquidity, including $500 million of cash today. In July, we announced our regular quarterly common dividend of 20 cents per share, which we believe is well covered, representing a 45% normalized FFO annualized payout ratio on the trailing 12 months ended June 30, 2023. That concludes our prepared remarks. We're ready to open the line for questions.
spk05: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. And to withdraw your question, please press star, then 2. At this time, we will pause just momentarily to assemble our roster. And our first question here will come from Brian Maher with B-Rally Securities. Please go ahead.
spk00: Thank you and good morning. Maybe starting with a big picture question on leisure travel softening, and yours is not the first company we've heard of that. How much of that do you think is related to maybe revenge travel, exhaustion, post COVID, and how much of it do you think might be related to maybe some consumer belt tightening or pushback versus the rates that the industry has been pushing?
spk04: Hey, Brian, good morning. Yeah, you know, we're certainly seeing the softening of leisure travel in our portfolio. I think, you know, the good news with our portfolio is we do have more relative exposure to urban hotels and hotels that are more focused on business travel. But, you know, I think our overall year-over-year rep, our growth, especially in full service, would have been even higher if it wasn't for the hotels that were more focused on leisure. You know, I think it's a combination. I think it's a lot of the reasons that you pointed out. You know, it is the revenge travel component, you know, that we saw in 2021 and 2022. I think just right now people have less money to spend on discretionary travel. You know, interest rates are up. You know, people are spending more on car payments and other things. You know, I think we're also seeing it, you know, from what we're seeing at least, and most of our hotels are domestic, but, you know, I think you're also seeing a lot more outbound international travel. You know, I think the strength of the dollar is kind of leading to that as well. I think, you know, most travel restrictions, have been lifted, so you're seeing more people travel to Europe or, in some cases, Asia, rather than going to our hotels in Hilton Head or Fort Lauderdale or New Orleans or Scottsdale, for example. So I think it's a mix of revenge travel, the belt tightening, as well as more outbound international travel.
spk00: Okay, thanks for that. And then shifting to your liquidity and your capital availability, And the maturities that, and I know you addressed this in your prepared comments, but when we think about your liquidity over a billion dollars, and then the recent purchase of the Nautilus for 165, and I think that there's a couple of air pockets, maybe in some gateway or leisure markets where you might want to have a Nautilus type situation. How should we think about deploying some of that capital? Should we think about maybe another one or two of those type of assets, but not four or five in order to not want to stretch your liquidity position in front of next year? Where's your head on that?
spk04: Sure. Yeah, it's a good question and something we're certainly discussing here. every day with, you know, we are looking at potential acquisitions, but we obviously have other uses of that cash, whether it's capex into the hotels or, you know, kind of these debt maturities that are coming up in 2024, 2025. I think that Nautilus was a very unique opportunity in a market that we thought we were underexposed and a critical gateway market for a hotel company of our size to have something in. But we looked very hard at 10 to 15 hotels in different areas of Miami, most in South Beach, but also Brickell and Coral Gables and Coconut Grove. It's challenging to find an opportunity that kind of works for SVC, given our cost of capital and given our yield hurdles. The Nautilus was something we think we could get in there, do a renovation, reposition that hotel, and get an outsized yield, especially for that specific area of South Beach. um got in at a we think is a very good basis but you know frankly we're not seeing a lot of opportunities like that we didn't see a lot of other opportunities like that in south beach we're also looking like we've talked about before in southern california other destination type markets um and you know especially with the hotel recovery i think a lot of you're not seeing a lot of distressed sales i think a lot of owners are looking at their portfolio and saying you know, we've made it through the worst of it. I don't want to sell something for 70 or 80 cents on the dollar. You know, financing markets are tough. So we're being very aggressive in looking at opportunities, but we're not finding a lot of things that make sense, and we're not going to force it. You know, again, we have other needs for that capital. So back to your initial question, you know, it's certainly not going to be four or five. It's either, you know, it could very well be that the Nautilus is the only property acquisition SVC makes in 2023. So I think it's either zero or one or two, most likely.
spk00: Okay, thanks. And just last for me, on the net lease portfolio, X the TAs, do you plan on doing continued selective pruning there? And specifically as it relates to the movie theaters, I think you have 18 or so, $160 million investment. Given that movies are in the press these days in a fairly big way, is there any bid on those types of assets at this time?
spk04: Sure, yeah. We haven't really necessarily been pruning that portfolio. I think we're more or less selling assets that may have become vacant or assets that we don't think We're going to have success releasing, which is common for these type of granular assets. A lot of times the best exit is going to be through disposition to a developer, for example. Yeah, so on the movie theater side, we're down to eight AMCs, we're down to five Regals, and then four B&B and one Marcus Theater. Yeah, I mean, movies are coming back. Box office revenues are getting back to 2019 levels. So I think the theaters that are doing well, and we have a number of those in our portfolio, I think you're starting to see those come back, and those may be strong long-term holds for us. I don't think it's the right time to sell. I don't think you're going to get anything better than a than a 10 cap on any movie theater today. Maybe it's in an excellent location you could, but we haven't taken any to market. We don't really plan to, but maybe in a couple of years it will be the right time to dispose of some of those assets.
spk00: Thanks, Todd.
spk04: Thanks, Brent.
spk05: And our next question will come from Dori Keston with Wells Fargo. Please go ahead.
spk01: Thanks. Good morning. On your reduced expectations for CapEx this year, can you walk through the reason for that and if your expectation is the cost will be pushed to 24?
spk06: Good morning. I'll take that one. Some of it's just timing. We had originally projected up to $250 million for the year. Some of the projects are just slower to get started, particularly with our high-in-place portfolio. Yeah, we're still in the planning phase, ordering FFD, that sort of thing. But the renovations will kick in later this year. So some of it's just going to be a spillover to 2024. But we haven't really changed our plan as far as the number of hotels we plan to deploy capital into. It's just a matter of timing at this point.
spk01: Okay. And is your three-year guide still around 750, excluding Nautilus?
spk06: That's right. Yeah, that's our best guess now is sort of a $250 million run rate for the next three years. Okay.
spk01: And then I guess based on internal expectations for 24 taxable income versus 23, would you expect to need to increase your quarterly dividends?
spk06: That's a good question. I don't believe we would be – forced to under REIT rules and have any sort of required distribution. You know, SVC and I'm sure a lot of other lodging REITs have built up some NOLs from what we've seen the last few years that we could offset taxable income on. So my short answer is no. But, you know, the dividend today is very well covered. It's something we talk about all the time. And, you know, if we continue to see improvement in the hotel portfolio, that's a conversation we could have as far as, you know, whether or not we move the dividend.
spk01: Okay. Where are your NOLs today?
spk06: We have various NOLs at the hotel slash taxable rate subsidiary level as well as the corporate level. We'll call it around $500 million today.
spk01: Okay. And then any key takeaways from your first few months partnering with BP? And do you have a sense of how much capital they'll be investing in these assets over the next few years?
spk06: Yeah, I mean, I think at this point, BP is really just like any other tenant. It's no longer sort of a related party connection as we had in the prior periods with having a share of PA and being an affiliate of RMR. You know, beyond what their public statements were when they announced the deal, we don't really have much visibility into what they've deployed to date. But they did say they're going to invest upwards of $200 million per year in this portfolio. They have various initiatives they're looking to do, whether it be, you know, for ESG purposes and others.
spk01: Okay. Thank you.
spk05: Thank you. And again. If you have a question or a follow-up, you may press star the one to join the queue. Our next question will come from Tyler Batari with Oppenheimer. Please go ahead.
spk02: Thank you. Good morning. First question for me, in terms of the Synesta brand, can you talk a little bit about how it's resonating with consumers, how it's competing in the marketplace, what you're seeing in terms of RedPAR index and any uptick in the loyalty program usage as well?
spk04: Good morning, Tyler. Yeah, the Senesta brand continues to make improvement. You know, I think it is different depending on the service level. If you look at our Royal Senesta branded hotels, If you look at our Simply Suites Hotels, which is a mid-scale extended stay brand that's next to launch during the pandemic, both of those are competing at the high end with their peers with those brands. The select service hotels, so the Sonesta Select, we've talked about this on previous calls, that continues to be the area where they're lagging the competition the most. You know, those are the hotels that are very reliant on that midweek business traveler. But like you point out, Tyler, that those hotels are also very dependent on more than any other service level in terms of Rewards points and guests using rewards points to travel to those hotels. So we're seeing the right signs and the right trends with Nessa. It is gradual, but they are, you know, the loyalty program revenues through the travel pass continues to increase, went up from 19.8% to close to 22% year over year. But if you look at some of the brands that are leaders in that space. Some of them are as close as 50%. So there's still a lot of room to go there. But, you know, Sonesta continues to, you know, we continue to see results from their advertising and brand awareness campaigns. You know, we continue to see more traffic coming in through brand.com. You know, we think, you know, they're The hotels that they own in New York, the new hotel that we just purchased in Miami, will only lead to more kind of brand recognition for Sonesta. So still a lot of room to go, but they're headed in the right direction.
spk02: Okay. Thank you. How about on EBITDA margin for the hotel portfolio? I mean, I think that the guy that supplies low 20s for Q3, you know, you called out some of the items. impacting that. Just kind of based on seasonality and based on the timing of some of those items, I mean, is it reasonable to expect margin to decelerate in Q4 versus Q3? And then also remind us where EBITDA margin roughly was for this portfolio on a comparable basis pre-COVID.
spk06: Sure, I'll take that one. It is reasonable to expect the fourth quarter will soften and margins will decline. You know, the fourth quarter starts off pretty strong in October through mid-November, and then you see that the season will drop off as we get into the holiday season. So we do expect bottom line hotel even to margins, call it the high teens at this point for Q4, which, you know, for the average for the year will put us in that high teens, low 20 range. As far as the portfolio, pre-COVID, we were sort of in that mid-20s, high 20% range.
spk02: Okay. A couple of follow-ups on the capital allocation topic, and you're talking about acquisitions on the hotel side of things. Tom, what are you seeing in terms of net lease transactions? Is that something that might make sense? Is there anything interesting out there, maybe from a portfolio perspective that you could look to grow your net lease exposure?
spk04: Sure. Yeah, we continue to, yeah, I know we focused on the hotels in the previous question from Brian, but we're looking just as hard as net lease acquisitions as well. I think we're seeing a similar trend challenge in terms of finding a yield that really makes sense for SVC. I mean, there's some assets, some portfolios out there that, you know, could work given our cost of capital, but frankly, they're just not the quality, both from a real estate and tenant quality that we're looking for. We are starting to see cap rates continue to move out slowly. So there could be some opportunities out there, but you know, just like on the hotel side, we don't feel the need to force it. But we continue to look at net lease properties. And eventually, you know, we're going to be back in a period where we're going to be more acquisitive. And, you know, we want to grow that portfolio long term. So we just don't know if right now is the right time to do it. Okay.
spk02: And then last question for me, in terms of options on the table for the 2024s. Where are market rates right now secure for some secured debt? And if you did utilize the Travel Center assets, what sort of pricing improvement could you see versus the transaction you did earlier this year?
spk06: Sure, it's a great question. It's top of mind for us as we look to take out those maturities in the coming quarters. You know, if you look at where our public bonds are trading today, you know, it would be in the 9% to 10% range, which is obviously very expensive debt. We did the ABS net lease transaction in Q1 at an effective debt yield of right at 7%. If we were to utilize the TA assets, you know, it would probably be in that ballpark. You know, looking through to BP's credit on those net leases, you know, it's going to give us a lot of flexibility and value, you know, to be able to raise money utilizing those assets if we choose to go down that path. So we think there's easily 200-plus basis points difference between the public bonds and what we could do in the secured markets, and really it just comes down to what exactly we put together for a package if we're going to do a secured financing.
spk02: Okay. That's all from me. Thank you for the recap. Thank you.
spk05: This concludes our question and answer session. I'd like to turn the call back over to Todd Hargreaves for any closing remarks.
spk04: Thank you everyone for joining today's call. We appreciate your continued interest in SVC.
spk05: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
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