Service Properties Trust (SVC) 2005 Q2 法說會逐字稿

Good day and welcome to the Hospitality Properties Trust second quarter 2005 financial results conference call. This call is being recorded. At this time for opening remarks and introductions I'd like it turn the conference over to Mr. Tim Bonang with Hospitality Properties Trust. Please go ahead, sir.

Thank you. Good afternoon, everyone and thanks for joining us on HPT's second quarter 2005 investor conference call. My name's Tim Bonang, I'm the Manager of Investor Relations for HPT. Joining me on today's call are John Murray, President and Chief Operating Officer and Mark Kleifges, Chief Financial Officer. The agenda for today's call includes a presentation by management followed by question-and-answer session. 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 Federal Securities laws. These forward-looking statements are based on HPT's present beliefs and expectations as of today August 4, 2005. The Company undertakes no obligation to revise or publicly release the results of any revisions to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this recording period. 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 Forms 10-K and 10-Q filed with the Securities and Exchange Commission and in our Q2 supplemental, operating, and financial data found on our website at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. With that I'd like to turn the call over to John Murray.

Thank you, Tim. Good afternoon and welcome to our second quarter 2005 investor conference call. Before I begin, I would like to point out that Tim's role as Manager of Investor Relation is a new position that we have recently created at the Company in order to better organize our investor relations efforts. In addition to this conference call we have prepared a comprehensive supplemental operating an d financial report for the second quarter. This report was released this morning and is currently available for download at our website.

I would also note that yesterday we launched a new website for HPT. In addition to a more user friendly design this new website provides investors with information about the Company's management, business strategies, and financial, and operating performance. A prominent feature of this redesigned website is a properties section with interactive maps that allow users to view individual hotels that HPT owns. We hope that Tim's position, this conference call, the supplemental report, and the new website will help investors better understand HPT.

Since this is our first conference call we thought it may be appropriate to cover a brief history of an overview of HPT before we get into the specifics of the quarter. Hospitality Properties Trust was founded in March 1995 and in August 1995 HPT shares were listed on the New York Stock Exchange. In 1998 HPT became the first and today remains the only hotel REIT to be rated investment grade by both Moody's and Standard and Poors. In 2000 HPT was added to S&P 400 mid-cap index which has been one factor which has led to increased institutional interest in our shares over the last few years.

From its inception HPT created a franchise by investing in portfolios of hotels managed by the brand ownership companies such as Marriott International and more recently Intercontinental Hotels Group. During the first five years of our operations HPT focussed on entering into triple net lease agreements with unaffiliated brand owners to operate the hotels. HPT's intent then as it remains today was to structure secure transactions that emphasized security of cash flow over upside growth. Base rents were set to provide returns that exceeded HPT's costs and percentage rents were set to allow HPT modest participation and improving performance by capturing a percentage of revenue increases over threshold amounts. However the majority of HPT's growth in cash flow was derived from acquisitions of additional hotel portfolios.

In 2001 congress passed what became known as the REIT Modernization Act or RMA. One feature of the RMA was that hotel REITs were no longer required to lease hotels to third party tenants. The RMA allows hotel REITs to set up their own taxable REIT subsidiary or TRS to be their tenant and the TRS engages a third party manager. Once the RMA became effective the large hotel companies like Marriott and Intercontinental, Hyatt, and Carlson largely stopped signing leases. In order to be competitive HPT set up a TRS to be its tenant and now we generally enter long term management agreements with brand owner management companies rather than leases.

Another advantage of transitioning to management agreements is we have been able to make subtle changes to our agreements which allow us to share in a greater amount of the potential cash flow growth at our hotels. As a result we expect over time this may add a greater level of same store growth to HPTs FFO than was the case when we only entered lease agreements. As we have moved from leases to management contracts we have tried to maintain the features that secure the long-term predictability of our cash flow, and therefore the safety of our dividend. We believe we have been successful at achieving this objective, because HPT is the only mature hotel REIT of material size that did not reduce or eliminate its dividend or have to renegotiate its credit facilities during the difficult 2001 to 2003 period.

Today HPT is one of the largest REITs with a total market capitalization of $4.2 billion including $3.2 billion of common equity. As of the end of the second quarter we owned 298 hotels with over 42,000 guest rooms located in 38 states, Puerto Rico, and Ontario, Canada. Each of our 298 hotels is included in one of ten combination agreements which include between 76 hotels in our largest agreements and 12 hotels in our smallest agreements. We have four lease agreements including 109 hotels that were entered into before the passage of the REIT Modernization Act and we also have six agreements which include 189 hotels with our taxable REIT subsidiaries that are managed by independent hotel operating companies. These agreements were entered into after the passage of the RMA.

Our hotels are managed by Marriott International, Intercontinental Hotels Group, Hyatt Corp., Carlson Hotels worldwide, and Homestead. These are some of the largest and most experienced hotel management companies in the world. Two of the world's strongest hotel operators Marriott and Intercontinental manage hotels responsible for 87% of HPT's minimum rents or returns. Our Marriott properties are operated under such brands as Marriott Hotels and Resorts, Residence inn, Courtyard, TownePlace Suites, and SpringHill Suites. The Intercontinental properties are operated under the Intercontinental Hotels and Resorts, Crown Plaza, Holiday Inn, Staybridge Suites, and Candlewood Suites brands. The Hyatt properties are operated under the AmeriSuites brand and the Carlson properties are operated under the Radisson, Country Inn and Suites, and Park Plaza Flags. Homestead operates Homestead Studio Suites hotels.

The defining business characteristic of HPT is its strong agreement terms. First we have pulled agreements with each of our operators. The obligations that are due HPT for all hotels in each combination agreement across the fault and each combination is geographically diverse. We only allow renewals on a combination basis for all hotels in each of the agreement pools.

Second our agreements require minimum returns or rents from our operators that cover HPTs capital costs including debt service and dividends. HPT is not dependent upon percentage rents or returns to pay dividends or debt service and therefore, is not as susceptible to industry cyclicality as other hotel REITs.

Third, we enter into long term agreements with hotel operators. Generally, new agreements have durations in the range of 15 to 30 years. We have no near term lease expirations on the horizon. We also believe renewals are likely because HPTs hotels represent significant percentages of our operators brands. Fourth we require FF&E reserves into which generally hotel operators are required to escrow 5 to 6% of gross revenues for periodic renovations. We think that this helps ensure that the high quality of our properties are maintained and leads to our hotels regularly outperforming industry averages in occupancy and RevPAR.

I would now like to review our operating agreements in more detail with a focus on HPTs minimum rents and returns. As I mentioned earlier, each of our 298 hotels is included in one of ten combinations of hotels. First I'd like to review our four lease agreements. Approximately 23% of HPTs minimum returns or rents come from hotels leased to host Marriott which are operated by Marriott International. There are two leases. The first lease is for 53 Courtyard by Marriott hotels located in 24 states. The minimum rent on these hotels is $55.7 million per year. The second host related lease is for 18 Residence Inn by Marriott hotels located in 14 states. The minimum rent on these hotels is $18.7 million. Approximately 9% of HPTs minimum rents or returns come from hotels leased to Barcelo Crestline which are managed by Marriott International. There's one lease for 19 Marriott hotels including ten Courtyards, six Residence Inns, two TownePlace Suites and one SpringHill Suites hotel which are located in 14 states. The minimum rate on these hotels is $28.5 million per year.

HPTs lease to Homestead provides approximately 5% of HPTs minimum rates or returns. There is one lease for 18 Homestead Studio Suites which are located in five states. The minimum rate on these hotels is $16 million per year. In addition to minimum rents each of our four lease agreements provide for percentage rents based on a percentage of revenue increases over a threshold amount. Also from time to time HPT may fund capital improvements in addition to amounts funded from the FF&E reserves. To the extent this occurs HPTs rents are increased.

Next I'd like to discuss our six management contracts, properties leased to our taxable REIT subsidiaries. Hotels operated by Marriott International account for approximately 15% of HPTs minimum returns. There is one management agreement for 35 Marriott hotels including three full service Marriotts, eight Courtyards, 13 Residence Inns, 10 TownePlace Suites and a SpringHill Suites hotel which are located in 15 states. The minimum owners priority return on these hotels is $47.3 million per year. Hotels operated by Intercontinental Hotels Group, or IHG, account for approximately 41% of HPTs minimum rents or returns.

There are three separate management agreements. The minimum returns on each of these contracts are guaranteed by IHG pursuant to a limited guarantee. The first agreement with IHG is for 30 Staybridge Suites hotels located in 16 states. The minimum owners priority return to HPT from these hotel is $36.1 million annually. The second agreement with IHG is for 76 Candlewood hotels located in 29 states. The minimum owners priority return to HPT from these hotels is $60 million annually.

The third agreement with IHG is for 13 hotels, including 4 Intercontinental hotels, 4 Crown Plazas, 3 Holiday Inns, and 2 Staybridge Suites. The minimum owners priority return to HPT from these hotels is $37.8 million annually. This increases to $40.7 million in 2006, $41.6 million in 2007 and $42 million thereafter. Unlike our lease agreements our management contacts with Marriott and Intercontinental tend to be more complex with multi-tiered cash flow water falls and varying degrees of management fee subordinations and minimum return guarantee levels. For example pursuant to the Candlewood management agreement, first, the cash flow from these hotels after paying operating expenses and funding CapEx reserves pays HPT a $50 million annual owners priority. IHGs parent company guarantees this first property under a limited guarantee agreement.

The remaining cash flow is currently distributed as follows. To IHG to pay a management fee of 4% of revenues then to HPT to pay a second owners priority of $10 million, then to IHG to pay them a second management fee of 3% of revenues then to HPT beginning in 2007 to pay a percentage priority equal to 7.5% of revenue increases over 2006. Then to IHG to reimburse any guarantee advances, and finally any remaining cash flow is split 20% to IHG and 80% to HPT.

While these added complexities may result in HPT sharing in a higher percentage of hotel cash flows in excess of our minimum returns, compared with our triple net leases, they may also add some modest variability to our quarterly earnings and FFO. Our final two management contracts with Hyatt and Carlson are much less complex. Hotels operated by Hyatt Corp. represent approximately 5% of HPTs minimum rents or returns. There is one management agreement with Hyatt for 24 Amerisuites which are located in 14 states. The minimum annual owners priority return on these hotels is $18 million per year in 2005, $17 million in 2006, $16.7 million in 2007, and $15.7 million thereafter. The decline in owners priority in this management contract is matched by increases in the owners priority under the cost of management contract which I'll discuss next. HPT gets 50% participation in the hotel cash flow after the payment of the priority return.

Hotels operated by Carlson Hotels Worldwide account for approximately 2% of HPTs minimum rents or returns. There is one management agreement for 12 hotels which include four Radisson, hotels, four Country Inn and Suites and three Park Plaza hotels and resorts located in eight states. There is a minimum owners priority return of $8 million per year in 2005 which increases to $9 million in 2006, $9.3 million in 2007, and $10.3 million thereafter. HPT gets 50% participation in the hotel cash flow after the payment of the priority return.

I would now like to focus on some of the specifics regarding the second quarter results. In summary the second quarter was a solid one for HPT. Second quarter FFO per share was $0.98 compared to FFO per share of $0.89 a year ago. This 10% increase in FFO per share shows the increasingly positive trends that are present throughout the lodging industry generally and our portfolio of 298 hotels specifically. Revpar for our 298 hotels was up 8.7% this quarter and is up 8.2% year to date. Excluding the former Prime hotels which we're in the process of rebranding to Carlson brands revpar was up 9.9% this quarter and year to date. Approximately 78% of our revpar gains this quarter and year to date were driven by rate increases. Our gross operating margins year to date are at 44.1% on average up from 43.1% last year. As a result of these improving operating results of our hotels HPTs minimum return and rent coverage ratios have generally continued to improve during the second quarter.

Our hotels are also doing well in their markets. Our average revpar yield index was 124 for the second quarter and is at 119.1 year to date. Year to date HTPs occupancy is 17.4% better than the industry average while revpar is 15% better than the industry average based on data provided by Smith Travel. We believe all of these are indicative of well located, well branded, well managed, and well maintained hotels.

That said their remains some notable challenges and opportunities in our portfolio, which you might expect when you own 298 hotels. This quarter Carlson rebranded 11 of the 12 former Prime hotels that they are now managing for us. We have committed 25 to $35 million towards various rebranding and renovation programs at these hotels which are now Radissons, Country Inn and Suites and Park Plaza hotels. As part of this process we are offering our Atlanta hotel for sale. In connection with this decision HPT recorded a non-cash charge of $7.3 million during the second quarter. With an upgraded brand strategy, a strong management company and a comprehensive capital plan in place we expect these hotels to begin showing improvement later this year and to perform more strongly in 2006. We expect this will turn out to be a very positive transaction for both Carlson and HPT.

Another challenge in opportunity lies with our 24 Amerisuites. Hyatt acquired this brand from Blackstone near the beginning of 2005 and has been busy working on brand name, marketing, and capital initiatives for the brand. Today there is a revpar gap of roughly 20 to $25 between Amerisuites and the better known brands they want to compete against such as Courtyard and Hilton Garden Inn. It is clear to us that Hyatt is committed to closing and ultimately eliminating or reversing this gap. I believe this is good news for the Amerisuites brand, for Hyatt and HPTs 24 hotels in particular.

Before I turn the call over to Mark I want to briefly comment on acquisitions. To date this year we have acquired 13 hotels for $450 million. In February we acquired 12 hotels including 3 Intercontinentals, 4 Crown Plazas, 3 Holiday Inns, and 2 Staybridge Suites. These hotels are located in the U.S., Puerto Rico and Ontario, Canada. In May we acquired the Intercontinental hotel in Austin, Texas. These acquisitions represent an average purchase price of $108,000 per key and are meaningful for us because they increase he number of full service hotels that we own and include our first investments outside the United States. Our minimum guaranteed cash on cash return after FF&E reserves on this portfolio is 8% growing to 8.5% next year.

The market for acquisitions remains highly competitive. Recently private equity firms have seen more success completing acquisitions than the public hotel REITs. Nonetheless, we are currently evaluating several large portfolios of branded hotels as well as a couple of significant rebranding portfolio opportunities. In addition we are working equally diligently on several smaller opportunities that may make attractive additions to portfolios of hotels we currently own. I will now turn the presentation over to Mark Kleifges our Chief Financial Officer to provide some more details regarding our second quarter results.

Thank you, John. Revenues for the quarter ended June 30, 2005 were $218.1 million which is a $54.9 million increase over 2004 revenues for the comparable period. This increase was due primarily to the 8.5% revpar increase at our managed hotels and our acquisition of 13 hotels during the first six months of 2005. Net income available for common shareholders was $20.5 million or $0.30 per share for the second quarter, compared to $28.8 million or $0.43 per share for the same quarter last year. Net income available for common shareholders for the quarter ended June 30, 2005 includes a $7.3 million or $0.11 per share loss on asset impairment resulting from the decision to share our Prime hotels located in Atlanta, Georgia. The weighted average number of common shares outstanding totaled 68.4 million in the 2005 second quarter compared with 67.2 million for the second quarter of 2004.

Funds from operations for the second quarter were $67.2 million, or $0.98 per share. This compares to FFO for the second quarter in 2004 of $59.5 million or $0.89 per share. In calculating 2005 FFO we have added back the $7.3 million loss on asset impairment recorded in the second quarter. The 10% increase in FFO per share was driven by our 2005 acquisition activity and the improved operating performance of our hotel portfolio. FFO for the second quarter included $7.3 million of deferred percentage rent and deferred hotel operating income compared to $1.7 million for the 2004 second quarter. The largest contributor to this $5.6 million was our Candlewood Suites portfolio which produced a 16.6% RevPAR increase in the second quarter.

In early July we declared a common dividend of $0.72 per share which represents 73% of our FFO for the quarter. This compares favorably to an FFO payout ratio of 81% in the 2004 second quarter. Hotel operating expenses for our managed hotels in 2005 were $132 million which is a $46 million increase over 2004. This increase is primarily due to our 2005 hotel acquisitions. Interest expense in 2005 increased over 2004 by $5.2 million which is primarily due to higher average borrowings only partially offset by a lower weighted average interest rate during the three months ended June 30, 2005. Our weighted average outstanding debt balance and interest rate was $1.1 billion and 6.3% and $692 million and 6.8% for the three months ended June 30, 2005 and 2004 respectively. General and administrative expenses increased in 2005 by $2 million over 2004. This is principally due to the impact of additional hotel investments during 2005 and an increase in accrued management incentive fees in 2005.

Turning to the asset side of the balance sheet cash and cash equivalents totaled $47.5 million at June 30, 2005 which includes $37.4 million of cash escrowed for future improvements to our hotels. Real estate investments increased during the quarter by a net $24 million which represents the $30.5 million acquisition of the Intercontinental hotel in Austin, Texas and $11.4 million of capital improvements to our hotel during the quarter offset by asset retirements and the write-down of the carrying value of the Prime Atlanta hotel during the second quarter. On the liability side HPT has $925 million of unsecured senior notes and only one $3.8 million mortgage. Our senior unsecured notes are rated BAA3 by Moody's and BBB minus by Standard and Poors and we've been investment grade rated since 1998. Our first term debt maturity is 2008.

In June, 2005 we completed an offering of 4.7 million common shares raising approximately $200 million in proceeds. Due to strong demand the size of the offering was increased from the originally announced 4 million common shares. Net proceeds from the sale were used to reduce borrowings outstanding under our resolving credit facility. In May we amended our existing $350 million revolving bank credit facility to increase the maximum borrowing amount to $750 million and to extend the maturity date to June 2009. The interest rate on borrowings was lowered from LIBOR plus 135 to LIBOR plus 80 basis points and the annual facility fee was reduced by 10 basis points. The maximum borrowing on the line may be expanded to up to $1.5 billion in certain circumstances. This transaction was significantly oversubscribed and we believe this new facility expands our financial flexibility as we look at acquisitions in this competitive market. As of June 30, 2005 we had no borrowings outstanding on the facility.

On a book basis today debt to total capital is approximately 33% which falls within our target range of 30 to 40%. On a market basis debt to total capital is approximately 22%. In the second quarter of 2005 our EBITDA to total fixed charges coverage ratio was 4.4 times and we are currently comfortably within the requirements of our public debt covenants. We expect to use cash balances, borrowings under our resolving facility, and net proceeds from offerings of equity or debt securities to fund future property acquisitions. That includes our prepared remarks. Operator, we are now ready to take questions.

[OPERATOR INSTRUCTIONS] First we'll hear from William Truelove from UBS.

Good quarter. Hopefully there's not a quiz on all those portfolio things you talked about John. Mark, maybe you can help me with the deferred hotel operating income jump from 6 million versus 1 million last year. You mentioned in your comments it was Candlewood who had a 16% revpar growth and that's great but that Candlewood portfolio just had a coverage ratio of the minimum of 1.1 times in the second quarter and didn't meet the minimum requirement in the first quarter so how can that portfolio be the primary reason for the jump in that payment.

Sure, well, let me maybe step back and spend a little bit of time making certain everyone has a thorough understanding of what exactly ends up in that line we call deferred hotel operating income. There's really three components to that line. One, to the extent that we're earning percentage returns under any of our management agreements it would be included in that line. To the extent that we are being paid minimum returns in excess of the guaranteed minimum amount it would be included in that line and last to the extent that we are participating in the remaining net cash flow from our hotels after all the waterfalls have been met. It would also end up in that particular line item and the reason those three items are deferred during the first, second, and third quarters of each year is because under the terms of our management agreements all of those revenue streams to us are based on annual calculations. And as a result under generally accepted accounting principles we're required to defer recognition of those amounts in our financial statements during the first three quarters of the year even though the agreements require that we be paid those amounts currently and then in the fourth quarter we get to recognize all those amounts in our GAAP financial statements.

So with that background going back to your question and specifically as it relates to Candle -- I'll use Candlewood as an example. In the first quarter of 2005, if you recall the Candlewood agreement, it's a $60 million minimum return, 15 million of that 60 is subject to a guarantee from Intercontinental. In the first quarter of 2005 the hotels generated cash flow sufficient to pay $936,000 of the $2.5 million unguaranteed minimum return due for the quarter so we recognize as deferred hotel operating income $936,000 in the first quarter. At the end of the second quarter we had earned all -- the hotels had produced cash flow sufficient to pay all $5 million of that second $10 million priority we were due at June 30, so we recognized in the second quarter an additional $4.064 million worth of deferred hotel operating income to bring the total for the year up to $5 million.

Okay. Maybe I'll just ask you offline. One other question and this is probably for John. You mentioned that Hyatt would be trying to eliminate the gap on the Amerisuites you own, I believe 24 Amerisuites. Do you believe this program that Hyatt is going to do is going to require a significant amount of CapEx on -- from the owner's standpoint?

Yes, we do believe that it will require CapEx. They're going to be changing -- they're still working on the plans and it's best that they make the announcement of those specific plans because they are evolving still. There are going to be some changes to the exterior of the building and there's going to be changes to the lobby and the food and beverage offerings and there's going to be changes to the furnishings and design of the rooms. The actual shape of the room is going to remain the same but there's going to be some switches to flat screen TVs that will open the room up and make them more roomy and vanities will be upgraded to granite countertops and various things like that to improve the richness of the properties and so long story short, yes, there will be capital required to continue to comply with brand standards as they're changed by Hyatt. We've gotten projections from Hyatt. We believe that even though as we fund those capital improvements our returns will increase and they believe that they'll continue to cover -- the owners priority will continue to be covered by the cash flow and our returns will increase by 10% of the amounts we fund as we fund them.

So your minimum agreements are going to change with the addition to the CapEx.

Yes.

Thanks so much. Good quarter.

[OPERATOR INSTRUCTIONS] We'll now go to Jeff Donnelly with Wachovia Securities.

Good afternoon, guys. A couple of questions, First, actually, I do want to applaud you on hosting a conference call and providing a good level of disclosure in your supplementals. It's a great improvement. First off is actually just on lease coverage continued to improve, I think right now you still have seven leases operating at or below 1.0 coverage on a trailing 12 month basis. Can you guys look into your crystal ball and give us your gut, and how many of those leases might be at or below 1.0 coverage at year end '05 or even at some point in '06 just as past quarters begin to burn off?

Well, we've taken a big step forward in doing this conference call and providing the supplemental data. We haven't taken the leap to providing forward guidance, Jeff. I would say though, that if you look at some of the other statistics in terms of our margins and flow throughs and if you look at the fact that the economy is continuing to improve that the rate of new supply growth is pretty anemic still. The general expectation industry-wide is that revpar will continue to grow and we don't have very high fixed costs in our hotels so we would expect that as that continues and assuming it does continue that you'll continue to see this trend of improvement. It's important to note that we cater to business travelers and the second and third quarters are always for HPTs hotels the strongest quarters, the fourth quarter is often one of the weakest quarters so I guess long story short is if you look at the trends on a rolling quarterly basis the coverage for the most part is improving with the exception of the Carlson portfolio which is just in the process of going through the rebranding and capital improvement process and so we expect that trend will continue for all the portfolios.

Maybe this falls under the same category about looking forward. Do you guys intend to seek a dividend increase from the Board? It's been a little while since the last one for various reasons in the industry and wasn't sure what your thinking might be there.

Our Board considers the dividend every quarter. We want to make sure that we have a sufficient cushion cash flow and although the cushion was as Mark indicated in the 70% range which is pretty healthy and something the Board is very comfortable with again there's fluctuations quarter to quarter in our cash flow and we want to be in a position where we can go through any cycle both good and bad without having to make any dividend reductions. I guess the only guidance I can give you is that every quarter it gets a serious look from our Board and as results improve and acquisitions get completed it gets a more serious look.

And then just a few questions actually on your acquisition pipeline. First, historically you guys have thought on a deal structure that had something of a preferred return. Should we be surprised if HPT makes hotel investments in the future without preferred return structure?

Yes. We're long-term investors and our focus as I indicated is to make investments where there's a favoritism given towards predictability of cash flow and we're going to continue to try and structure portfolio transactions in that way and we do it by having good relationships throughout the cycles. We are a hotel REIT that has great capital access, we are one of the few hotel buyers and one of the few hotel REITs that enters into transactions for the long-term without seeking very overtly to have opportunities to change management, to take the flag down, to sell hotels after very short hold periods which creates tension at the hotel operating level, and that's why we've been able to attract strong relationships with companies like Marriott and Intercontinental Hotels and why we think we are going to be able to grow the relationships we have with Hyatt and Carlson. Our plan today is to stick to that general strategy.

Okay. And building on that -- normally -- or looking at the deals you are looking at now, larger portfolio deals again historically they have involved a brand owner. Do the deals you're looking at now still involve a brand owner and I guess if not would you need to seek some form of credit support for your preferred returns?

We're looking at some portfolios as we speak that have brand owners with our brand owners who own portfolios of hotels who are seeking to reduce their capital exposure to the bricks and sticks. We have a couple of portfolios that we are looking at where the brand is likely to be changed and where we've been approached in one case by more than one of our existing operators to pursue those transactions with them to rebrand the hotels, with us acquiring the hotels, and the other party acquiring the management component of the transaction, and we are also looking at individual hotel transactions. One offs where the hotel might be strategic to the operator and could be added to one of our existing hotel portfolios. That is one thing that will be different, not only are we pursuing just portfolios as we have in the past. We're now more actively looking at larger hotels that could be by themselves nice additions to existing portfolios.

One last question, right now I'd say most of your portfolio is kind of a mid-scale orientation. Are some of the larger portfolios you're looking at more upscale or in that price line I guess?

Yes. We've always looked at larger full service hotels in the past but haven't always been a successful bidder, as we develop more relationships we've been able to achieve more success in that segment. We still like the select service, the upscale select service hotels like Courtyards and Residence Inns and Staybridge Suites, but we recognize there's greater barriers to entry in some of the urban markets with larger full service hotels. So we're going to to look at a variety of opportunities that way.

Thanks, guys.

[OPERATOR INSTRUCTIONS] We'll hear from William Acheson with Merrill Lynch.

Congrats on the disclosure. It's very helpful. Just jump back to the preferred hotel operating income. If I heard you correctly it sounded like there's sort of catch-up involved here and I was wondering if that means that going forward there's going to be a more normalized level not trying to get you to go towards guidance.

This is Mark. It's really you have to look at it contract by contract. The example I gave you Candlewood what's included in deferred hotel operating income related to the Candlewood management contract relates to the unguaranteed portion, the $10 million unguaranteed portion of the minimum return that we're required under GAAP to defer, recognizing during the interim quarters. The maximum we can recognize per quarter is 2.5 million of that $10 million because after that IHG starts sharing in cash flow above that $2.5 million amount each quarter so at the end of the second quarter we could, our share of the cash flow was $5 million and after that IHG started to earn additional fees. Looking to the third quarter we would have the opportunity to share in another $2.5 million of cash flow under that contract and obviously that's less than the $4 million we recorded this quarter.

And then turning to the the IHG acquisition properties, they seem to be doing okay. Coverage is up, the performance is a little bit under portfolio if you exclude Carlson, I was wondering if there were any operating changes or improvements under way there?

We've -- as part of the $425 million -- well, we've acquired the hotels for 450 million. 425 million was the purchase price for the IHG hotels and 25 million was going to go towards various capital projects and they cover a variety of different items. Improving meeting space in White Plains, improving some of the restaurant and other offerings at -- in Hilton Head, redoing some restaurant space and the Lobby Lounge at the Intercontinental in Toronto so we have a number of projects that are underway and that we hope will lead to better rates and stronger revenues besides just room revenues.

Thank you.

And that's all the time we have for questions. Mr. Murray, I'll turn the conference back over to you for any additional or closing remarks.

I thank everybody for joining us today in our first conference call. I don't have any further comments. Thank you very much.

Thank you. That does conclude today's conference. We thank you for your participation and have a great day.