Summit Hotel Properties, Inc. (INN) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Summit Hotel Properties Inc. Earnings Conference Call. My name is Pam, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Dan Boyum, Vice President of Investor Relations. Please proceed.

Thank you, Pam. Good morning, everyone, and welcome to Summit Hotel Properties' Second Quarter 2012 Earnings Conference Call. Today, I'm joined by Dan Hansen, our President and Chief Executive Officer; and Stuart Becker, our Executive Vice President and Chief Financial Officer. Before we begin, I remind everyone that many of our comments today are not historical facts. They are considered forward-looking statements under federal securities laws. They may not be updated in the future. These statements are subject to risks and uncertainties described in our securities filings. Also, as we discuss certain non-GAAP financial measures, it may be helpful to review the reconciliation to GAAP in our earnings press release. To begin our discussion of our second quarter 2012 results, please welcome President and Chief Executive Officer, Dan Hansen.

Thanks, Dan. Our performance in the second quarter was solid across the board and reflects the steady pace of improvement and continued execution of our strategy. The embedded growth in our portfolio, our newly renovated hotels, our accretive acquisitions and aggressive asset management strategy are the key drivers of this success, and we see this trend continuing through 2012. I'll continue to reiterate our simple strategy, which is to realize the embedded growth in our existing portfolio and to grow value through accretive acquisitions of top brands in top markets at great cap rates. Despite a few hurdles early on, we have consistently delivered on that strategy. Our pro forma RevPAR growth of 11.7% for the second quarter was driven by a balanced mix of rate and occupancy. This compares to second quarter upscale RevPAR growth of 7.3% and upper midscale growth of 7.7% for the industry. We are seeing exceptional performance in our same-store properties, as well as the 12 properties we have acquired since our IPO. Our asset management team is doing a great job ensuring that our hotel management partners are maximizing the performance of our hotels everyday. Managing the mix of occupancy and rate is a key component to our outperformance. We currently have 6 managers operating our portfolio of 74 properties, and we continue to keep a tight rein on them. The success of our efforts is further evident in the margin growth we continue to show. We are extremely aggressive in our asset management and are seeing those efforts pay off. We manage a delicate balance between rate and occupancy, with multiple demand generators, and our revenue management strategies are best-in-class. We do push too hard on occasion and have a hotel or 2 that may lose some occupancy due to aggressive rate management, but those are short-term issues we are quick to act on. We continue to find attractive opportunities to acquire hotels, and the pipeline continues to be very favorable. We see many off-market deals direct from owners and franchise companies and expect that to continue. During the quarter ended June 30, 2012, we acquired a 103-room Courtyard by Marriott in the Dallas, Texas suburb of Arlington. This is a 2-year old property which requires minimal renovation capital. The hotel has strong demand generators, including several corporate offices such as Aetna, GE, Cardinal Health and Lockheed Martin, as well as leisure demand from destinations such as the Dallas Cowboys Stadium, Ameriquest Field at Rangers Ballpark and the Six Flags Over Texas theme park. We also acquired the 112-room Hilton Garden Inn and the 83-room Hampton Inn & Suites in the Nashville, Tennessee suburb of Smyrna. These hotels offer multiple demand generators also, including corporate offices of companies such as Bridgestone/Firestone, Whirlpool, Singer and Cardinal Health. The nearby state capital, the national convention center and the Grand Ole Opry also provide solid business and leisure demand for the city. Including these recent purchases, we now have 3 hotels and 273 rooms in the Nashville market. We believe this is a solid market for us to grow in and cultivate a cluster of hotels. On July 2, 2012, we purchased the 96-room Residence Inn by Marriott in Arlington, Texas. This is our second hotel acquired in Arlington, and we now have 7 hotels and nearly 700 rooms in the Dallas-Fort Worth market. Since our IPO in February 2011, these 12 acquisitions represent an increase in total rooms of nearly 20%. We've also been active in the recycling of capital. During second quarter of 2012, we sold 3 hotels in Twin Falls, Idaho for $16.5 million and 2 parcels of vacant ground in Boise and Twin Falls, Idaho for $1.7 million. We have identified 6 more candidates for disposition and have several parcels of land under letter of intent for purchase agreement. Our primary focus is to own a quality portfolio of premiere select service hotels in top 50 U.S. markets. And a key part of that strategy is to exit hotels in markets that don't meet our underwriting criteria. As you know, we completed renovations on 12 hotels and converted 11 since our IPO. Our renovated and converted properties illustrate our prudent use of capital. For example, the $2.3 million in capital we deployed on rebranding of 3 of the former Cambria Suites has resulted in EBITDA growth of over $1.1 million, which represents an increase of over 86%. Applying our current EBITDA multiple of 13x on the incremental EBITDA results in value creation of nearly $15 million. This clearly demonstrates the strength of the new brands of Holiday Inn, Springhill Suites by Marriott and Doubletree by Hilton, and the substantial value we created. We view the use of capital for renovation or conversion the same as use of our capital for acquisitions. We invest it wisely and expect the same returns we would get elsewhere. Otherwise, it's an asset we would consider for sale. Our dividend continues to be one of the highest in our space and it is well covered. This dividend, combined with the growth of our existing portfolio, our accretive acquisitions and our robust pipeline for future accretive acquisitions, presents an exceptional total return opportunity for investors. For further discussion on our performance and details on our balance sheet and financials for the second quarter 2012, please welcome our Executive Vice President and Chief Financial Officer, Stu Becker.

Thanks, Dan. The second quarter ended June 30, 2012, was a solid quarter for our company. Revenue for the quarter was up 27.8%. The revenue increase was a result of several positive events during the past 12 months, including the acquisition of the 12 hotels, which now totals 1,336 additional rooms; completion of major renovations on 12 hotels; rebranding of 11 former Choice-branded hotels; and overall RevPAR improvement at the balance of our hotels. Pro forma RevPAR likewise improved substantially. For the quarter ending June 30, 2012, our pro forma RevPAR increased 11.7% as compared to the same quarter in 2011. The positive pro forma RevPAR growth was distributed relatively evenly between a 6.3% increase in occupancy and a 5.1% increase in ADR when compared to the same period in 2011. We are pleased with both the occupancy and ADR increases and the mix of the 2 components. Over the short and medium term, we remain bullish about the muted hotel supply in our markets. With a steady or improving macroeconomic environment, we maintain a positive outlook on our ability to drive ADR and, thus, RevPAR increases. Revenue increases positively affected our Hotel EBITDA. Pro forma Hotel EBITDA was $16.3 million for the second quarter, an increase of 16.2% over second quarter 2011. Pro forma hotel EBITDA margin for the second quarter was 33.5%, an improvement of 134 basis points over the comparable period in 2011. The company's pro forma hotel EBITDA margin expansion was 264 basis points when adjusting for the $565,000 one-time management fee concession agreed to by Interstate Hotels & Resorts during second quarter 2011. The overall efforts of our team are reflected in our EBITDA growth. Adjusted EBITDA was $14.9 million, an increase of 35.6% as compared to second quarter 2011. Adjustments to EBITDA include: Noncash equity-based compensation, hotel property acquisition costs, loan transaction expense not capitalized during the quarter, small loss on derivatives and a prepayment incurred relating to the refinancing of debt on our properties in Scottsdale, Arizona. We anticipate a payback period of about 24 months on that prepayment fee. Included in adjusted Hotel EBITDA is approximately $298,000 award resulting from the favorable decision in our arbitration with Choice Hotels and a reversal of approximately $131,000 of expense accruals related to that arbitration. We were far less active with deployment of capital for renovations during the second quarter. We generally tend to undertake hotel and expenditure during the seasonally slow periods for our hotels. Second quarter, historically, is one of our stronger quarters. During the quarter, we deployed $4.4 million for renovations. Major improvement and capital invested during the second quarter includes: $1.1 million on our Fairfield Inn & Suites in Fort Worth, Texas; $700,000 on our Hampton Inn in Fort Wayne, Indiana; $400,000 on our Fairfield Inn & Suites in Denver, Colorado; $400,000 on our Hampton Inn in Provo, Utah; and $400,000 on our Hilton Garden Inn in Atlanta, Georgia. Varying in scope, the major improvements listed above include renovation to guest rooms, common areas and exteriors of the hotels. We feel very good about our balance sheet. Managing our leverage is a core value and key in generating strong returns for our shareholders. During second quarter, we were active in the debt markets, having refinanced or financed $150 million in debt. We were particularly pleased with the terms we were able to secure with our syndicate on the refinancing of our $125 million senior credit facility. We were able to extend the loan date, significantly reduce our borrowing costs, received increased flexibility with advanced rates and received flexibility with maximum leverage and fixed charge coverage restrictions. Our outlook for the remainder of the year is positive, and we are initiating guidance for third quarter. Regarding third quarter, we're expecting RevPAR growth on a pro forma and same-store basis to be in the range of 6.5% to 8.5%. Our third quarter AFFO outlook on a fully diluted per share basis is $0.24 to $0.26. On our full year outlook, we are increasing our pro forma and same-store RevPAR growth guidance to a range of 6.5% to 8.5%. Additionally, we are tightening our guidance range on AFFO per fully diluted share for the year to $0.77 to $0.80.

Thank you, Stu. To wrap up, I'd say we had a solid quarter, we see stability for the balance of the year in demand, more opportunity to raise rates, opportunities to recycle capital, a robust pipeline and capacity to continue to execute. As always, we welcome your questions, so let's open the lines.

[Operator Instructions] And your first question comes from the line of Ryan Meliker with MLV & Co.

Just a couple of quick questions. First, with regards to RevPAR, basically same store up 12.9%. Can you give us some more color on really what drove that growth, whether it was specific brands, specific properties, some renovations, et cetera? Any more detail would be helpful.

Sure. I think the -- a big engine of the outsized growth was the renovated -- or rebranded hotels, I should say, from Choice. We said early on, if we expected to get back to even, we would need approximately 22% RevPAR growth for the year, and we're on pace for that. Also, our acquired hotels are performing very well, above the market as a whole. So I think it was an easy comparison due to the rebranded hotels, but to also strong performance across the board from our acquisitions and same-store hotels.

So aside from the Choice rebrandings, because obviously you have some property-specific things going on there, were your properties outperforming your markets this quarter, or was it just that your submarkets are performing that strongly?

If you look at the chains -- the upscale chain scale of 7.3%, we beat that as a metric for our same-store, for our hotels that x Choice and acquisitions. I think it's just strong outperformance across the board.

And do you think there's a lot more opportunity for outperformance going forward relative to your markets? Or do you think this was more of a one-time blip in the quarter as you guys are doing a little catch up, I guess?

Yes, one way to think about it, Ryan, is we talked about, really over the last year, that we saw the gateway markets had really strong push over the last year. And our portfolio is more a top 50 market than a broader across the economy as a whole. And we talked about we tend to lag both coming out of recession and actually heading into recession. We tend to be more of a lagging portfolio. And I think you're seeing results of that as you kind of head through the balance of '12. We see more performance kind of a -- for improving as a combination of those renovation and the Choice deal, but also just the performance of the portfolio as a whole.

Yes, we -- if you -- important to note that we did raise full year guidance from -- to 6.5% to 8.5%. So we do see continued strength, although the -- a big part of the strength in second quarter was the rebranded hotels having outsized performance.

No, that's helpful. Now as we look at guidance into 3Q and 4Q, I mean, you guys obviously raised guidance for the full year, but up 6.5% to 8.5% is obviously a material deceleration from what we saw in 2Q, and then it actually implies further deceleration in 4Q from 3Q. Are you seeing anything that makes you think that your fundamentals are slowing? Was 2Q kind of extreme in nature? Or can you give us some color as to whether you're just being conservative and taking things more prudently, or you're seeing something that makes us think that maybe 2Q is more of an extreme on the high end?

Well, that's a fair question, Ryan. I -- not increasing the upper end of guidance is really our conservative approach to predominantly the fourth quarter, which is always a bit of a challenge to predict around the holidays, and also some addition of some expenses over the next couple of quarters associated with our expectation of accelerating growth. We're very confident in our portfolio, our execution, and at this point, we see nothing slowing us down. I think you should view our tightening of the range really as a positive signal. We're executing and we're confident on what we can deliver.

Okay, that's helpful. And then just one last quick question on the margins. Obviously, you guys talked about the 130 bps impact that you had on margins this quarter related to, I guess, the reimbursement from Interstate less in 2Q '11. Do we have any other things like that going on through the rest of this year? Are we going to see more challenging margin comps as a result of those onetime-oriented fees in the -- or I think it's not fees, but reversal of fees in the back half of the year?

Yes, Ryan, specifically regarding that Interstate concession, they earned that back in the fourth quarter of 2011, fully earned that back. So you can think about that as a tough comp relative to fourth quarter, or at least something you want to keep an eye on in your modeling. As we talked about, we've got -- in the second half of the year, we are sort of -- we'll start to build a little bit on G&A in anticipation of continued acquisition growth into '13. And so there'll be a slight increase, but nothing else that jumps out that's material.

Okay, that's helpful. And then real quickly, you guys obviously -- you put 1 property held for sale, I think it's the AmericInn in Montana. Is that under contract? Can you give us any color on what's going on there and why that property is under -- moved into, I guess, moved into just Canadian operations, whatever assets you guys are -- you talked about marketing or not yet?

We expect the Missoula transaction to close very shortly, within the next 30 days. There's never a high degree of certainty until the closing actually takes place, but we feel that's the transaction that will happen. As far as the other hotels we have identified, we've received quite a few inquiries in some of these markets from some local hoteliers, some small, somewhat regional sophisticated buyers. So we've got some flexibility around those, but you can look at some of our smaller hotels and smaller markets, and those are predominantly the ones that we'd be recycling capital out of.

And your next question comes from the line of Wes Golladay with RBC Capital Markets.

Dan, you had mentioned you were pushing the rate and you had, I guess, some properties where you weren't able to do that. How is it looking for the balance of the year? Will we look for more, I guess, ADR growth to the back half?

Yes, I think we fully expect this trend of rate growth in the markets outside the gateways to continue. As we've continued to get through the quarter, we see that blend of rate and occupancy being something we anticipate having through the balance of the year.

Okay. So for modeling purposes, an even mix, I guess?

Yes.

I think it's fair.

Okay. We talked about the rebranded hotels, how they're doing on a RevPAR performance. How much EBITDA is left, I guess, to gain? Taking it back to the, I guess, prior performance level?

Yes, if you think about it, on a -- when we had the rebranding event last year, we probably lost about $3.5 million all-in of EBITDA, both from hotel operations as well as just cost, legal cost to fight the arbitration. And I would say, just to give you a metrics, in first quarter of 2012, we probably saw just south of $1 million lift in EBITDA in comparing those hotels from where they were 1 year ago. Somewhere between 3/4 and a 1/2 earned $1 million. So on a run rate like that, if we're trying to get all the way back, we're probably -- a year's time, we should be able to earn that EBITDA lost from those rebranded hotels.

Okay. And looking at the acquisitions, you guys bought some assets ahead, a little bit north of a 70% loan to cost. Are you seeing a lot of opportunities like that where you have to put a little bit of equity in, a nonrecourse? And I mean, what are the opportunities for those type of properties?

Yes, great question. We were really pleased with the acquisitions we did this year because we were able to, in most cases, bring some pretty solid debt with it. We will continue to look at that. I think it's been -- we perceive, at least for the balance of this year, more of that sort of scenario, where the lenders on those transactions, different than maybe 1 year ago, where 1 year ago or 18 months ago, I think lenders were just trying to get out of deals. And so you had to buy hotels and probably find a debt co with it. We've just seen a lot more push where the lenders seem to be receptive, that typically, they're looking for a better sponsor, but they're not looking to completely get loans off their books. And so we anticipate a little bit more activity regarding friendliness with lenders in acquisition opportunities.

Okay. So you guys are doing a little bit of a deal, so the loan to cost is -- loan to value is probably a little bit south of that?

That's fair.

And your next question comes from the line of Tim Wengerd with Deutsche Bank.

Can you touch a little bit on the incremental expenses you expect in the second half as you continue to grow?

Yes. A couple of things. We've recently announced that we're bringing on a new Chief Accounting Officer and SEC reporting person. Jolynn Sorum will continue to be in a controller role. We've -- as we anticipate a substantial growth in our company the next couple of years, we think that we need to add in a little bit resources there, probably an analyst or 2 is also probably on the agenda, probably asset managers. As we anticipate 2013 and '14 growth, we will start to stage those sort of employee acquisitions in. In addition, I think we reported in June, we got a -- in our proxy, we acknowledged that we have a new incentive plan for our management team that could be impactful if we hit some budget numbers in the second half of this year. Those would be the 2 items that would, I think, have an impact to the G&A.

Okay. And then we've seen RevPAR decelerate a little bit in July and in recent weeks. And I'm wondering if you've seen any signs of deceleration at all.

Tim, we really haven't. Our -- we don't have concerns about European travelers. We had a very small part of our business from government travelers, government employees. So our business traveler has been solid. Our rate increases have been solid. We have no indications of any slowing in our portfolio and feel very confident for third quarter.

Tim, if it helps you a little bit, just looking at April, May and June, and just looking at a trend line on a pro forma RevPAR basis, we did not see any small -- a falloff and maybe slight uptick from April to May and then into June. And I know folks have talked about June and was there a little bit of outsized growth of RevPAR in June relative to that first week in July. That may or may not be an impact. But certainly, our trend line was still headed north in that -- the full run of that quarter.

Okay, that's helpful. And then on the balance sheet, I guess, what -- are there opportunities for you to bring down rates a little more? I know you just reworked your line of credit. Are there other opportunities for mortgages that are in place now?

Yes, we're in pretty good shape with our balance sheet. We do have some, maybe $25 million of debt that'll be addressed in the next 6 months, that are existing loans with hotels that we'll probably -- we'll hold and we'll want to do some refinancings. And certainly, rates have continued to migrate down even since first quarter when we were doing -- first and second quarter, we were doing some financing, we've seen rates headed down. So there's a potential there. And then we'll always continue to look at just refinancing existing mortgages, but we feel like we're in pretty good shape. And I think our overall cost of funding is just north of 5%, our interest rate cost, the mix of the fixed and the variable. So we'll always continue to look at that. We feel pretty good about where we're at.

Okay. And the $25 million that you'll look to refi, I guess, roughly where is that now? Where is the cost of funds now for the $25 million, and where do you think it will be able to be refinanced?

I think that pricing is 5.5-ish. 5.25, 5.5 is where that debt's at. And so maybe an opportunity with refinancing that. I'd love that we would get in the 4s, but I'm not sure that's -- we'll see. But certainly, we're in decent shape at that rate. I don't see a huge ability to reduce our funding costs when we refinance that debt, but we'll certainly look hard at that.

[Operator Instructions] And your next question comes from the line of Michael Bellisario with Baird.

Could we go back to the acquisition pipeline, kind of give us some color on what you're seeing? Still one-off deals? Are there portfolio deals out there? How do you guys think about financing that? Are OP units a part of the discussion?

Yes. We continue to see opportunities in the 8 to 10 cap rate range of IHG and Hyatt, Marriott, Hilton. And we've got a full pipeline with assets in various stages of due diligence. We do see some opportunities in some portfolios, but we can really create our own portfolio with our pipeline. So I would say that, obviously, a portfolio doesn't come at quite the pricing that you can do one-offs, which is something we're keen to get at the best pricing. So I wouldn't -- I would say that it's continuing to be very favorable and the outlook is very good.

Okay. And then the second question I had was, just hoping you could provide some color on kind of the supply growth and the development outlook in your markets. Have you seen any uptick or are things pretty status quo since you guys went public last February? And then also a little bit on replacement costs for select service properties in your types of markets.

Sure. We -- it's been -- obviously, came to a screeching halt. There's a lot of projects in the pipeline, not a lot of progress on them. A lot of them keep getting delayed. We see a few interesting deals, but really no indication that development has picked up in a meaningful amount. Good projects from well-capitalized developers will get done, but I think the real issue, and I have yet to see anyone really address, is what I refer to as the great flush, which is the major brands not renewing franchises on older properties that are coming due. There could actually end up being very little net room growth in upscale and upper midscale due to increasing brand standards and guest expectations. That's why we like our space. Now the gen-1 Residence Inn is not the only example of a -- that is -- has a short life span. Hilton's done a nice job at identifying some select service assets that don't represent the brand and are not renewing contracts. And don't forget, IHG kicked out many hotels already as part of their refreshing program. So I think it's a real positive thing for upscale and upper midscale, as our offering really competes very well with most full service assets. You really need to go to the luxury chain scale to get meaningful differentiation, in my view. As far as replacement cost, I think nothing's much changed. It's $100,000 a key plus land to build select service assets in an average market in America. And it's real tough to get it done much cheaper than that. And depending upon the market, it could be significantly higher, whether you're in a market where there's a lack of land and higher barriers to entry. So we look at replacement cost as really a check and balance. For us, it's really a yield or cap rate on our invested capital.

And your next question comes from the line of Dan Donlan with Janney Capital Markets.

It's Elizabeth Bland here with Dan. Can you just talk about what is involved in your hotel renovations and how those improvements allow you to push rate in the renovated assets after they're completed?

Sure. Each hotel is going to have a different scope based on its age and its life cycle and the brand. Most of the renovations we're undertaking are pretty significant with lobbies, rooms, some hardgoods. So I think TVs have been done across the board in most hotels, but the true refresh, which is a complete change in guest experience, takes some time, but allows the guest to have essentially a new product. So if you look at our performance in -- on a go-forward basis, we expect great things and great performance on that invested capital.

And your next question comes from -- is a follow-up question from the line of Wes Golladay with RBC Capital Markets.

Dan, you mentioned the great flush. I mean, are you seeing that in your markets right now? Would you look to acquire some of these assets?

That's a -- we get a lot of looks at them, but when you dig in and talk to the brands, without 12 to 15 years of franchise term, they just don't have much interest to us. It's hard to justify these type of renovations that they all need without term on the franchises. So a lot of them that you see floating around have that 10-year or less franchise term. If it's a high-barriered entry market and we can get term, we're willing to go through the brain damage if we see the upside in return. So we look at some of them, but we've looked at enough now that we can size them up pretty quick and make a pretty good assessment of which ones the brands will extend, which ones are material and which ones aren't. So I wouldn't say we wouldn't take a look at them, but it would be a special situation where we were able to get term and saw some consistent or considerable upside.

Okay. And once you do, I guess, lose your brand, I mean, I guess you guys had a little bit of experience last year with it, but I mean, how -- I guess, when does it become terminal for the hotel?

It depends upon the market and whether it's an upscale going to a midscale or an upper midscale going to an economy. There are a lot of different variables in there, but without a premium brand like IHG, Hyatt, Hilton or Marriott, there's a considerable loss in value when you go to sell that. If there's not enough term, it's just -- you just -- there's a big trail-off when you lose that franchise. It's really the strength of the brand and why nearly 90% of our portfolio is with IHG, Hyatt, Marriott and Hilton.

And with no further questions in queue, I'd like to turn the call back over to Mr. Dan Hansen, President and CEO, for closing remarks.

Well, thank you, again, to all who participated on today's call. We're very proud of our asset management team that's delivered a solid quarter. And we're confident that our disciplined strategy will continue to prove itself throughout 2012 and beyond. Thanks, everybody. And as always, please reach out to us if you have any further questions.

Ladies and gentlemen...