Service Properties Trust(US:SVC)2020-08-10 13:11PART I Financial Information Item 1. Financial Statements Unaudited condensed consolidated financial statements for Service Properties Trust as of June 30, 2020, detail balance sheets, income, equity, and cash flows, with notes on accounting policies and significant events Condensed Consolidated Balance Sheets Balance Sheet Items | Balance Sheet Items | June 30, 2020 ($ in thousands) | December 31, 2019 ($ in thousands) | Change | | :--- | :--- | :--- | :--- | | Total real estate properties, net | 7,999,090 | 8,264,275 | (3.2%) | | Cash and cash equivalents | 20,206 | 27,633 | (26.9%) | | Total assets | 8,879,545 | 9,033,967 | (1.7%) | | Revolving credit facility | 33,127 | 377,000 | (91.2%) | | Senior unsecured notes, net | 5,732,018 | 5,287,658 | +8.4% | | Total liabilities | 6,533,824 | 6,528,089 | +0.1% | | Total shareholders' equity | 2,345,721 | 2,505,878 | (6.4%) | Condensed Consolidated Statements of Comprehensive Income Metric | Metric | Three Months Ended June 30, 2020 ($ in thousands) | Three Months Ended June 30, 2019 ($ in thousands) | Six Months Ended June 30, 2020 ($ in thousands) | Six Months Ended June 30, 2019 ($ in thousands) | | :--- | :--- | :--- | :--- | :--- | | Total revenues | 214,940 | 610,562 | 698,716 | 1,135,470 | | Hotel operating revenues | 117,356 | 541,215 | 500,859 | 996,078 | | Net income (loss) | (37,349) | 8,782 | (70,999) | 234,569 | | Net income (loss) per share | $(0.23) | $0.05 | $(0.43) | $1.43 | - The company experienced a significant decline in revenues, particularly from hotel operations, leading to a net loss in the second quarter and first half of 2020, a sharp reversal from the net income reported in the same periods of 2019, primarily driven by the COVID-19 pandemic's impact on the lodging industry11 - A gain on an insurance settlement of $62.4 million was recognized in Q2 2020, partially offsetting operating losses, while the company also recorded a $28.5 million loss on asset impairment in the same quarter11 Condensed Consolidated Statements of Shareholders' Equity - Total shareholders' equity decreased from $2.51 billion at year-end 2019 to $2.35 billion at June 30, 2020, primarily driven by a net loss of $71.0 million and common distributions of $90.5 million during the first six months of 202014 Condensed Consolidated Statements of Cash Flows Cash Flow Activity (Six Months Ended June 30) | Cash Flow Activity (Six Months Ended June 30) | 2020 ($ in thousands) | 2019 ($ in thousands) | | :--- | :--- | :--- | | Net cash provided by operating activities | 48,797 | 239,898 | | Net cash (used in) provided by investing activities | (74,760) | 531 | | Net cash used in financing activities | (5,438) | (262,952) | | Decrease in cash and cash equivalents | (31,401) | (22,523) | - Net cash from operating activities decreased significantly year-over-year, primarily due to the net loss and the application of $100.2 million in security deposits, which is a non-cash adjustment to reconcile net income18 - Financing activities in H1 2020 included issuing $800 million in senior notes, repurchasing $356 million of senior notes, and paying significantly lower distributions to shareholders ($90.5 million vs. $176.0 million in H1 2019)18 Notes to Condensed Consolidated Financial Statements - As of June 30, 2020, the company owned 329 hotels and 809 service-oriented retail properties, acquiring three net lease properties for $7.1 million and selling ten net lease properties for $64.0 million during the first six months343842 - The company's hotel agreements with major operators like IHG and Marriott faced significant stress, with the IHG security deposit depleted leading to a default and termination notice in July 2020, and the Marriott security deposit and limited guaranty fully exhausted515257 - In response to the COVID-19 pandemic, the company entered into rent deferral agreements with 80 net lease retail tenants, deferring an aggregate of $11.3 million of rent as of August 6, 202092 - To maintain liquidity, the company amended its credit agreement to waive certain financial covenants through March 31, 2021, issued $800 million of 7.50% senior notes due 2025, and repurchased $350 million of 4.25% senior notes due 2021105108109 - The quarterly common share distribution was drastically reduced from $0.54 per share in Q1 2020 to $0.01 per share in Q2 2020 to preserve cash110 Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the severe COVID-19 impact on lodging and retail properties, detailing operational and financial responses, including revenue declines, cost reductions, credit waivers, capital raising, and distribution cuts, alongside liquidity and portfolio performance Impact of COVID-19 - The COVID-19 pandemic has had, and is expected to continue to have, a substantial and materially adverse impact on the company's business, operations, financial results, and liquidity due to its severe effect on the travel, entertainment, and retail industries148 - Hotel occupancy plummeted to lows in Q2 2020 (21.0% in April, 26.8% in May, 35.5% in June), though it showed gradual improvement to 42.4% for the 28 days ended July 25, 2020, with 19 hotels suspending operations and 9 having resumed by August 6, 2020149 - Rent collection from non-TA net lease tenants was 58.7% in Q2 2020, and the company entered into rent deferral agreements for $11.3 million with 80 tenants154 - To preserve liquidity, the company reduced its quarterly dividend to $0.01/share, raised $788 million from a notes offering, repurchased $350 million of notes due 2021, and secured a waiver on certain financial covenants for its credit facility159 Results of Operations Metric (Q2 2020 vs Q2 2019) | Metric (Q2 2020 vs Q2 2019) | Q2 2020 ($ in thousands) | Q2 2019 ($ in thousands) | % Change | | :--- | :--- | :--- | :--- | | Hotel operating revenues | 117,356 | 541,215 | (78.3)% | | Total rental income | 97,584 | 68,217 | +43.0% | | Hotel operating expenses | 46,957 | 380,431 | (87.7)% | | Net income (loss) | (37,349) | 8,782 | (525.3)% | - The decrease in hotel operating revenues for Q2 2020 was primarily due to lower occupancies caused by the COVID-19 pandemic173 - The increase in rental income from the net lease portfolio was primarily due to properties acquired in the SMTA Transaction in late 2019176 - Hotel operating expenses decreased sharply in Q2 2020 due to lower occupancy and a $121.2 million reduction from the utilization of security deposits and guarantees from hotel operators97178 Liquidity and Capital Resources - As of August 6, 2020, the company had $967.9 million available under its revolving credit facility, with a limited waiver of compliance with certain financial covenants secured to ensure access to this facility159234 - In July 2020, the company sent a notice of default and termination to IHG for non-payment of minimum returns after exhausting its security deposit, with plans to transition these 103 hotels to Sonesta if the default is not cured210 - During Q2 2020, the company advanced $80.5 million in working capital to its hotel operators (IHG, Marriott, Sonesta, Wyndham, Hyatt) to cover projected operating losses212 - The company issued $800 million of 7.50% senior notes due 2025 in June 2020 and used proceeds to repay borrowings under its revolving credit facility, also repurchasing $350 million of its 4.25% senior notes due 2021229230 Portfolio Performance Hotel Portfolio Key Metrics | Hotel Portfolio Key Metrics | Q2 2020 | Q2 2019 | Change | | :--- | :--- | :--- | :--- | | ADR | $84.34 | $132.55 | (36.4%) | | Occupancy | 27.8% | 77.2% | (49.4) Pts | | RevPAR | $23.45 | $102.33 | (77.1%) | - For the twelve months ended June 30, 2020, all six of the company's hotel operating agreements generated rent/return coverage of less than 1.0x, with a range from 0.04x to 0.52x, indicating severe cash flow shortfalls at the property level214259 - The net lease portfolio was 99% occupied as of June 30, 2020, with a weighted average remaining lease term of 11.1 years, and generated an aggregate coverage of 2.16x169215277 - TravelCenters of America (TA) is the largest tenant, accounting for 66.6% of annualized minimum rent from the net lease portfolio281 Non-GAAP Financial Measures Metric (per share) | Metric (per share) | Q2 2020 | Q2 2019 | H1 2020 | H1 2019 | | :--- | :--- | :--- | :--- | :--- | | Net income (loss) | $(0.23) | $0.05 | $(0.43) | $1.43 | | FFO | $0.72 | $1.03 | $1.47 | $1.91 | | Normalized FFO | $0.48 | $1.03 | $1.22 | $1.91 | - Normalized FFO for Q2 2020 was $78.2 million, or $0.48 per share, a significant decrease from $168.8 million, or $1.03 per share, in Q2 2019, reflecting the severe impact of the pandemic on operations298 - Adjustments to calculate Normalized FFO from FFO in Q2 2020 included adding back a $7.0 million loss on early extinguishment of debt and subtracting a $46.7 million net gain on an insurance settlement298301302 Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate exposure, with $5.8 billion in fixed-rate senior notes and $433.1 million in floating-rate debt, where a 1% rate increase would raise annual interest expense by $4.3 million - As of June 30, 2020, the company had $5.8 billion in fixed-rate senior notes, which mitigates the impact of rising interest rates on interest expense for this portion of its debt305 - The company had $433.1 million in floating-rate debt outstanding, consisting of $33.1 million on its revolving credit facility and a $400.0 million term loan, where a hypothetical 1% increase in interest rates would increase annual interest expense by approximately $4.3 million308309 - The company acknowledges the expected phase-out of LIBOR in 2021 and anticipates its credit agreements will be amended to provide for an alternative interest rate benchmark313 Controls and Procedures Management concluded that disclosure controls and procedures were effective as of June 30, 2020, with no material changes to internal control over financial reporting during the quarter - Based on an evaluation as of June 30, 2020, the President and Chief Executive Officer and the Chief Financial Officer and Treasurer concluded that the company's disclosure controls and procedures are effective314 - There were no changes in internal control over financial reporting during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, internal controls315 PART II Other Information Risk Factors Significant risks include the material adverse impact of COVID-19 on operations, financial results, and liquidity, exhaustion of hotel operator security deposits, potential for low share prices, tenant defaults, and restrictions on distributions and asset sales - The COVID-19 pandemic has had, and is expected to continue to have, a substantial and materially adverse impact on the company's business, operations, financial results, and liquidity due to its severe effect on the travel, entertainment, and retail industries330331 - A significant risk is the exhaustion of security deposits and guarantees from the company's two largest hotel operators, IHG and Marriott, which reduces the security of minimum returns, increases the variability of operating results, and has led to a payment default and termination notice for IHG343 - The company's ability to pay distributions is restricted by its credit agreement waiver and may remain at the reduced rate of $0.01 per share for an indefinite period or be eliminated entirely341344 - Plans to sell hotels and reduce debt leverage are expected to be delayed due to market conditions, and there is no assurance that sales will be completed or at expected prices346350 Unregistered Sales of Equity Securities and Use of Proceeds During Q2 2020, the company purchased 3,808 common shares at $7.09 per share to satisfy tax obligations related to vested share awards for a former officer and employee Calendar Month | Calendar Month | Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | April 2020 | — | $— | | May 2020 | — | $— | | June 2020 | 3,808 | $7.09 | | Total | 3,808 | $7.09 | Exhibits This section lists exhibits filed with the Form 10-Q, including corporate governance documents, senior note indentures, credit agreement amendments, IHG default correspondence, and required SEC certifications - Key exhibits filed include the Notice of Event of Default and Termination sent to InterContinental Hotels Group (IHG) on July 23, 2020, and a subsequent Notice of Additional Event of Default sent on August 4, 2020355 - The filing includes certifications by the CEO and CFO as required by Rule 13a-14(a) and Section 1350 of the Sarbanes-Oxley Act355357