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Hospitality Properties Trust (NYSE:HPT)

Q2 2014 Earnings Conference Call

August 11, 2014 13:00 ET

Executives

Katie Strohacker - Director IR

John Murray - President, COO, Assistant Secretary

Mark Kleifges - CFO, Treasurer

Analysts

Ryan Meliker - MLV & Company

Wes Golladay - RBC Capital Markets

David Loeb - Baird

Operator

Good day, and welcome to the Hospitality Properties Trust Second Quarter Financial Results Conference Call. This call is being recorded.

I'd now like to turn the call over to the Director of Investor Relations, Katie Strohacker. For opening remarks and introductions, please go ahead at this time ma'am.

Katie Strohacker

Thank Steven, and good afternoon, everyone. Joining me on today's call are John Murray, President; and Mark Kleifges, Chief Financial Officer. John and Mark will make a short presentation, which will be followed by a question-and-answer session.

Just a reminder, the recording retransmission and transcription of today's conference call is prohibited without the prior written consent of HPT.

Before we begin today's call, I would like to read our Safe Harbor statement. 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, August 11, 2014. 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 Web site. 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 today with the SEC and in our supplemental operating and financial data found on our Web site at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

Before I turn the call over to John and Mark, you should be aware that TravelCenters of America's first and second quarter 2014 reports on Form-10Q remain pending as of today and accordingly the company's remarks today with respect to TA's operating results will be limited and we will not respond to questions related to TA's first or second quarter 2014 performance. We understand that TA believes and maybe fully current of its financial reporting beginning with report made to the 2014 third quarter.

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

John Murray

Thank you, Katie. Good afternoon and welcome to our second quarter 2014 earnings call. Today HPT reported second quarter normalized FFO of $0.87 per share as we continue to reap the benefits of the extensive hotel renovation program that began in 2011.

As Katie noted, we are not yet able to update you on TA's performance for the first or second quarters of 2014 because they have not yet reported their results for those periods. TA is working to complete its filings as soon as possible and we will then be able to update our disclosures on their performance. TA remains current on its rent payments to HPT.

Turning to HPT's hotel investments, second quarter RevPAR was up 8.5% across HPT's 288 comparable hotels. Ongoing hotel renovations continue to impact our results. Excluding non-comparable hotels and the 21 hotels under renovation during the quarter RevPAR was up 11.2% this quarter.

The strong top line performance which was comprised of both occupancy and rate gains reflects strong results at the 61 hotels that completed renovations during 2013 with RevPAR gains of 21.3% and the 120 hotels that completed renovations during 2012 with RevPAR gains of 9%. This helped to offset performance at our 21 renovation hotels this quarter which experienced RevPAR declines of 18.5% or from lost occupancy.

Fifteen of the 21 comparable hotels under renovation this quarter were Sonesta branded hotels. We have now completed five Sonesta renovations each of which has been well-received in its market. We are hopeful that the current renovation program coupled with Sonesta's efforts to increase brand awareness will lead to meaningful occupancy and rate gains later in 2014 and 2015.

While three of the five newly renovated Sonesta hotels are ES Suites that just has completed their renovations, the full service Sonesta in Hilton Head and Royal Sonesta in Houston completed renovations in May 2013 and January 2014 respectively. Hilton Head's 2014 second quarter RevPAR increased 82% over last year's quarter and GOP margin percentage jumped from 1.4% to 40.1%. In Houston, which just completed renovations last quarter RevPAR was up 8.8% and GOP margin jumped 690 basis points versus the 2013 quarter to 26.4%.

The second quarter started slowly due to the timing of the Easter holiday in April 2014 which negatively affected our primarily business hotels. The long winter in many parts of the country also weighed on April's results. Nonetheless, for the entire quarter, we continue to see strong RevPAR performance across the Midwest and the South Atlantic states and along the West Coast all with double-digit gains.

Our Wyndham portfolio had a strong quarter with RevPAR growth of 19.2% and GOP margin percentage up 340 basis points versus second quarter 2013 as management's focus shifted from completing renovations to delivering on operations and improving guest mix. We expect strong results to continue for this portfolio and improving group dynamics will also benefit the Wyndham portfolios full service hotels.

While the hotels renovated during 2013 had the most significant positive impact on second quarter 2014 performance as they ramp back up, we are encouraged that our hotels renovated in earlier periods continue to experience above market level growth as well.

For example, excluding all hotels renovated since second quarter 2013, the remaining 217 hotels in our portfolio grew RevPAR 8.6% and improved GOP margin percentage by 150 basis points to 44.2% this quarter.

Also our comparable non-renovation portfolio's strong performance continues to be balanced across property types. RevPAR and gross profit margin percentage among our comparable non-renovation full service hotels were up 13.2% and 420 basis points. Our select service hotels were up 9.1% and 90 basis points, and our extended stay hotels were up 11.1% and 240 basis points respectively this quarter.

While our extensive portfolio renovation program has begun to wind down, we expect 15 hotels to be under renovation during the third quarter, eight in the fourth quarter and three in 2015. This renovation activity will be principally at our Sonesta hotels.

Looking forward our operators are optimistic about the balance of 2014 as high occupancies and continued steady demand enable strong rate growth. Hotels along the West and East Coast and around top 25 markets continue to lead the way. In addition, most of the hotels in our portfolio have now recently been significantly renovated so our product quality is very good as we continue through 2014.

Based on the strong first half of 2014, we now expect an average RevPAR increase of between 7% and 9% and an average GOP margin percentage increase of 200 to 250 basis points across our comparable hotel portfolio for the full year versus 2013.

Turning to disposition and acquisition activity in April, we sold the Sonesta ES Suites in Myrtle Beach for net proceeds of $4.2 million. The location was seasonal and the capital investment needs were significant which caused us concern about its long-term value within the portfolio.

On May 30, we acquired a 240-room hotel in Fort Lauderdale, Florida and an adjacent parcel of land for $65 million. This hotel was completely renovated in 2010 with essentially all new systems and a bright life style design. We converted this hotel to the Sonesta Fort Lauderdale Hotel taking advantage of Sonesta's strong South Florida reputation.

Aside from the new signage and IT equipment, very little capital was needed for this hotel over the next couple of years. The hotel has 240 ocean facing guestrooms approximately 9000 square feet of top floor meeting space with amazing ocean views, two restaurants, three bars, an infinity pool, and fitness center.

We continue to see a healthy pipeline of hotel acquisition opportunities. However, competition is substantial especially in large cities along the East and West Coast. The debt markets are wide open for hotel financing and we are seeing terms reminiscent of 2007 in some cases even buyers going hard upon signing purchase and sale with no diligence period.

We intend to remain disciplined. When we acquired select service assets we tried to do so in a portfolio format with credit support, all non-renewals, pooled FF&E reserves and subordinated management fees. When we look at full-service hotels, we will acquire one-off assets if they can be added to existing portfolios.

We remain optimistic about this lodging cycle due to the steady demand as economic growth albeit flow continues. We expect continued rate growth and GOP margin improvement, particularly with our nearly fully renovated hotel portfolio. We are monitoring supply growth which is picking up pace but not yet a headwind. As performance continues to increase more portfolios reach or exceed one-times coverage and our renovation capital need subside there should be confidence to continue to increase our dividend as we did most recently in April 2014.

I'll now turn the call over to Mark.

Mark Kleifges

Thanks John. Operating results at our 288 comparable hotels were strong this quarter, with RevPAR up 8.5% and a 200-basis-point increase in GOP margin percentage. Hotel renovations continued to have both a positive and negative impact on hotel operations this quarter. RevPAR, at our 267 comparable hotels not under renovation this quarter was up 11.2%, versus the prior year quarter, on a 3.6 percentage point increase in occupancy and ADR growth of 6.2%.

This quarter's results benefited from the RevPAR outperformance of the 41 hotels that were under renovation during the 2013 second quarter, with RevPAR up 34.2% at these hotels on occupancy and ADR gains of 10.9 points and 15.1%, respectively, in the current quarter. This strong performance was partially offset by the weak results at the 21 hotels under renovation this quarter, with RevPAR down 18.5% at these hotels on lower occupancy. Our portfolios with the highest RevPAR growth this quarter were our Wyndham and IHG portfolios, with increases of 19.2% and 11.3%, respectively, versus the prior year quarter.

Growth in hotel profitability was also strong this quarter, with gross operating profit for our 288 comparable hotels up $21 million, or approximately 14.1% from the 2013 quarter, and GOP margin percentage up 200 basis points to 41.5%. Our Intercontinental portfolio continued its outstanding performance this quarter, with gross operating profit up over 15% and GOP margin percentage up 180 basis points, versus the 2013 quarter.

Turning to 2014 second quarter coverage. Hotel cash flow available to pay our minimum returns and rents this quarter increased $11.2 million, or approximately 9.8% from the 2013 quarter. As a result of this growth, coverage for the quarter under 7 of our 9 agreements improved, versus the prior year quarter, and portfolio-wide coverage for our hotels increased to 1.09x compared to 1.04x in the 2013 quarter.

The improvement in coverage between periods was mitigated by the combined $5.1 million, or 4.7%, increase in minimum returns that resulted from our funding of hotel improvements, and the scheduled increases in FF&E reserve escrow requirements under our IHG and Marriott 234 agreements. Despite the negative impact of these increases, 6 of our 9 hotel agreements had coverage of both 1x for the 2014 second quarter. Information regarding all of our security deposit and guaranteed balances at quarter end is included in our supplemental.

Turning to HPT's consolidated operating results for the second quarter. This morning, we reported normalized FFO of $129.7 million, compared to normalized FFO of $109.2 million for the 2013 second quarter. The increase in normalized FFO from the 2013 quarter is due primarily to a $11.2 million or 7.1% increase in minimum returns and rents earned this quarter and a $6.3 million increase in FF&E reserve contributions.

Second quarter 2014 normalized FFO per share of $0.87 was up a strong $0.09 or 11.5% from the 2013 second quarter. We paid a $0.49 per share of common dividend in the quarter and our normalized FFO payout ratio was only approximately 57%.

Adjusted EBITDA was $170.7 million in the 2014 second quarter, a 11.1% increase from the 2013 quarter. Our adjusted EBITDA to total fixed charges coverage ratio for the quarter remained strong at 4.3x, and debt to adjusted EBITDA was only 4.1x at quarter end.

In July, we announced we would redeemed at par, our $280 million of five and one eight percent senior notes due in 2015 on August. We plan to initially fund this redemption with borrowings under our revolving credit facility and expect to permanently fund it with a new unsecured senior note issuance later this year.

Next, I'll provide an update on where HPT stands with its capital funding commitments and liquidity at quarter end. We funded $40 million of hotel improvements in the second quarter and to complete our hotel renovation program, we expect to make additional fundings of $94 million in the second half of this year and $33 million in 2015.

In addition to our hotel renovation fundings, we funded $16 million of improvements to our TravelCenters this quarter and expect to fund an additional $58 million during the remainder of 2014.

With respect our balance sheet and liquidity at June 30, we had approximately $15.5 million of cash which excludes $29.2 million of cash escrowed for improvements to our hotels and we had only $40 million outstanding under our $750 million revolving credit facility. Our debt to total book capitalization at the end of the quarter was 48%.

In closing, we remain optimistic about the prospect of continued strong operating results, including the continued positive impact our extensive renovation program is having on the performance of our hotels.

Operator, we're ready to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from the line of Ryan Meliker of MLV & Company. Please go ahead.

Ryan Meliker - MLV & Company

Hey, good afternoon guys. I just had a couple of questions. First of all, nice quarter it looks like RevPAR really is continuing to hold up following the renovations, so kudos to you guys for making that happen.

But with regards to what you mentioned in the call, you had indicated that your outlook now is for 7% to 9% RevPAR growth for the full year which obviously is better than where it was a quarter ago and a quarter before that. But it's also you are at 8.9% through the first half of the year implying that things might be decelerating at the back half of the year, obviously, we are not seeing so much of that from the STR numbers out so far in 3Q. Just wondering if it’s just a – do you think the renovation, disruption or the renovation benefits are going to start to wind down a little bit in the back half of the year. Is that what's driving that?

John Murray

It is an increase in our expectations. I want to point that out first of all, and we always try give what we think is a realistic expectation, but tempered by the level of uncertainty in there. There are a number of renovations that are taking place across the number of hotels. And so we are feeling very confident about the quality of our portfolio and how our RevPAR performance has been ranking versus the rest of the industry. And so we are confident, but we don't want to over promise.

Ryan Meliker - MLV & Company

Got you. So you are continuing to expect the benefits from the renovations still to kind of hold on at current pace through the rest of the year?

John Murray

Yes.

Ryan Meliker - MLV & Company

Okay. That's helpful. And then, the second question I had was just with regards to TA and I know you can't give color on specifically on TAs results, but can you talk to us a little bit about; I mean you guys obviously work closely with TA both externally managed by RMR. At what point does this start to become a bigger concern for HPT given, I know they filed their K, but are still now two quarters in arrears.

Mark Kleifges

Yes. I think Ryan -- this is Mark. I think the best way to characterize it is, TA, if you recall the 10K was delayed principally due to some tax accounting matters those have been resolved and I guess the way I characterize where they are today is, they're in catch-up mode with closing out the first and second quarter getting the independent accountants through those two quarters getting the audit committees of the Board through the quarter. And so they are really in catch-up mode as Katie mentioned in the opening remarks they're hopeful that they'll be caught up by Q3 and that will be kind of -- this would be the last time we have to talk about this. We continue to receive property level data from TravelCenters and we continue to be pleased with the performance of the properties.

Ryan Meliker - MLV & Company

Yes. I mean obviously, you guys are still getting the cash flow from the rent so that's certainly a positive. I guess, what I was kind of wondering is, obviously, it took a long time for the K to get filed and it got filed there were no real issues obviously to HPT that were result, but it's now been two months since that was filed and we still don't have the 1Q, 10Q. And I am just starting to question whether does the external manager not have the staff on board and to make this happen and if that’s the case, are you seeing any implications with regards to HPT and may be staff resources moving more towards TA to try to get things caught up, which might limit your growth profile or any other implications from the external manager that might be impacting HPT?

Mark Kleifges

Yes. I think this TA structure versus HPT structure is a little different. We do have the business management agreement with RMR as well as our hotel managers are responsible for pulling together our numbers. TA has its own management team, its own accounting team. That work is not performed by RMR and so I don't see any implications to HPT.

Ryan Meliker - MLV & Company

All right. That's it for me. Nice quarter, thanks a lot.

Mark Kleifges

Thanks.

Operator

(Operator Instructions) And we have a question from the line of Wes Golladay of RBC Capital Markets. Please go ahead.

Wes Golladay RBC - Capital Markets

Hey, good morning or good afternoon guys. What are you seeing in your pipeline, is it more full service more select service? And can you give us any indication of may be what contracts you'd be able to have the most deal activity with for the balance of the cycle based on your current pipeline?

John Murray

I'd say today we're seeing in terms of the opportunities that are attractive to us was probably looking at more full service opportunities. The select service opportunities that we've seen have not had the types of structuring that we’re comfortable with and so we've been looking at a fair amount of both but we haven't looked for long -- number of the select service portfolios and have instead focused more closely on some of the full service opportunities. And it really just depends on the markets and the types of hotels whether we -- with which existing partner or a new partner we would look at an opportunity with.

We're looking at one, currently that would be if it happens would be with the new partner. We've looked at one, we looked it up in the past two quarters, we've looked at deals with several of our other partners and just so far only the acquisition of Fort Lauderdale has occurred. So it's broad based, in any given market some of the brands that we have may have a full plethora of brand or locations already. So even if you think a hotel might make a good Marriott, if there is already Marriotts and Renaissances and ACs, and Ritzes, then it doesn't really matter.

Wes Golladay RBC - Capital Markets

Okay. And with the one you are looking at, would that more of a value add or would be a core hotel at the moment and with similar type of returns as the existing contracts?

John Murray

Yes. As I indicated in our prepared remarks we don’t intend to really change our stripes in terms of our structuring and historically we try to buy hotels that are functioning pretty well and cash flowing as opposed to -- big turn around stories so.

Wes Golladay RBC - Capital Markets

Okay. Well, thanks for taking the questions, a nice quarter.

Mark Kleifges

Thanks Wes.

Operator

Our next question in queue comes from the line of David Loeb of Baird. Please go ahead.

David Loeb - Baird

It's still morning for me John and I – Wes had something sort of the – on the direction I wanted to ask. You commented about competition for single asset purchases, but when you're looking at portfolios, are you just seeing substantially more competition from private equity non-traded REITs then you were say a year or two years ago.

John Murray

We are seeing more competition I think the private equity sector has gotten more comfortable with select service assets then it was perceived that it used to be. But that's not the reason why we haven't been more active there. We like portfolios of hotels where there are effectively a group of hotels on one contract, so you have some leverage in the transaction as opposed to a collection of 20 or 30 or 40 individual contracts. To us there is a difference between a group of hotels and a portfolio of hotels. We like portfolios, groups of one-offs private equity can have those.

David Loeb - Baird

Fair enough. Thank you.

Mark Kleifges

Thanks.

Operator

(Operator Instructions)

John Murray

Thank you very much for joining us on today's call. I appreciate it.

Operator

All right, ladies and gentlemen, it does conclude our conference call for today. On behalf of today's panel, I'd like to thank you for your participation in today's conference call and thank you for using AT&T. Have a wonderful day you may now disconnect.

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