Sotherly Hotels Inc (SOHO) 2011 Q2 法說會逐字稿

Good day, and welcome to the MHI Hospitality Corporation's second-quarter 2011 earnings conference call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Scott Kucinski, Director of Investor Relations. Please go ahead.

Thank you, Sue, and good morning, everyone. Welcome to MHI Hospitality Corporation's second-quarter earnings call and webcast. Dave Folsom, our President and COO, will begin today's call with a review of the Company's quarterly activities and a review of portfolio performance. Bill Zaiser, our CFO, will provide our key financial results for the quarter and update our 2011 guidance. Drew Sims, our Chairman and CEO, will conclude with his perspectives on the industry and an update of our strategic objectives. We will then take questions.

If you did not receive a copy of the earnings release, you may access it on our website at www.mhihospitality.com. In the release, the Company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg. G requirements.

Any statements made during this conference call, which are not historical, may constitute forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurances that these expectations will be attained. Factors and risks that can cause actual results to differ materially from those expressed or implied by forward-looking statements are detailed in today's press release, and from time to time in the Company's filings with the SEC. The Company does not undertake a duty to update or revise any forward-looking statements.

With that, I'll turn the call over to Dave.

Thanks, Scott. I'm pleased to report that we had another productive quarter, as we continue to restructure our balance sheet, see strong result from our portfolio, and we've announced the resumption of common dividend distributions. We believe the Company is in a strong position to take full advantage of the ongoing lodging recovery.

I'd like to begin by discussing our transaction activity for the quarter. As we first announced on last quarter's earnings call in April, we completed a series of transactions related to our credit facility and the new preferred stock investor. In summary, these transactions resulted in the issuance of $25 million of the Company's Series A cumulative redeemable preferred stock to Richmond Hill Investment Company; the paydown of our senior credit facility by a similar amount to a balance of $52.5 million; the extension of our credit facility to May 2014; and a $10 million bridge facility from a related entity of Richmond Hill available until the end of this year.

At the end of June, we exercised the one-year extension on the mortgage on our Crowne Plaza Hampton Hotel. The mortgage now matures in June 2012. As part of the extension, we agreed to increase the floating-rate floor on the loan by 25 basis points to 5.0%. We also agreed to begin making principal payments in the amount of $16,000 per month. And further, we placed $750,000 into a deposit account as additional cash collateral, which the lender may use to pay down the principal amount in the event the hotel does not achieve certain debt coverage hurdles.

After the close of the quarter, we also extended the mortgage maturity on the Crowne Plaza Jacksonville Hotel to January 2013. As part of that extension, we paid down the principal by $4.0 million. The outstanding balance on the loan is now $14 million. We accessed our bridge facility to fund this paydown. The other terms of the loan remain the same, except that the lender waived provisions in the loan that might trigger additional principal curtailments. These transactions addressed the majority of our near-term debt maturity risk, and provided us with some additional liquidity. We are very pleased with these results.

Lastly, as we announced yesterday, we refinanced our Holiday Inn Laurel Hotel for $7.5 million at a fixed rate of 5.25% for a 10-year term with the Bank of Georgetown. We are pleased with the terms of this loan. The Hotel was part of the collateral pool in our credit facility. And, as part of the refinancing, the lending syndicate accepted the proceeds of the new loan and released the collateral. The outstanding balance on the credit facility is now approximately $45.1 million. This is the first step in the second phase of our balance sheet restructuring, which is to replace our corporate line of credit with permanent fixed-rate financing on individual assets.

Turning to our portfolio's performance, we had another strong quarter, achieving RevPAR growth of 8.1% over the prior-year period. This growth was a result of a 1% increase in occupancy and a 7% increase in average daily rate. If you include the Crowne Plaza Hollywood Beach, our joint venture asset, RevPAR growth was 9.9%, resulting from a 1.5% increase in occupancy and an 8.3% increase in rate. Rate growth has helped to increase operating margins once again, with our hotel EBITDA margin gaining 40 basis points over the prior-year period to 28.8%. Hotel margins have increased for six consecutive quarters.

Hotel EBITDA was approximately $6.6 million for the quarter, an increase of 9.2% over the prior-year period. We believe our quarterly results are better than industry norms. Even with such solid performance, several markets in which our hotels are located have lagged the overall lodging recovery, especially when compared with top gateway markets. We think this actually works in our favor, as we still have quite a bit of runway remaining in certain markets that should result in sustained RevPAR growth, albeit later in the cycle.

And with that, I'll turn the call over to Bill Zaiser.

Thank you, Dave. Reviewing performance for the quarter ended June 30, 2011, total revenue was $23.1 million for the second quarter, an increase of 7.5% over the comparable period in 2010. Adjusted EBITDA was $6.1 million for the quarter, an increase of 12.9% over the prior period in 2010. Adjusted FFO was $3.3 million for the second quarter or $0.25 a share, an increase of 12.8% over the prior-year period.

Please note that both our adjusted FFO and adjusted EBITDA exclude unrealized gains or losses on hedging activities, unrealized gains or losses on warrant derivatives, and changes to our deferred income tax provision. You should refer to our earnings release for additional details.

The Company recorded a consolidated net loss of $183,000 or $0.02 a share as compared to a consolidated net income of approximately $256,000 or $0.03 a share for the prior-year period. As of June 30, 2011, total assets were approximately $213.2 million. This includes approximately $182.9 million of net investment in hotel properties plus approximately $9.4 million for the Company's joint venture investment in the Crowne Plaza Hollywood Beach Resort. The Company had approximately $7.7 million of available cash and cash equivalents, of which approximately $3.3 million was reserved for real estate taxes, insurance, capital improvements, and certain other expenses.

As of June 30, the Company had approximately $153.8 million in outstanding debt at a weighted average interest rate of 6.32%. This includes $71.8 million in mortgage debt; $52.5 million on our line of credit; $25.1 million in Series A cumulative redeemable preferred stock; as well as $4.4 million in the loan related to our joint venture with the Carlyle Group. Total shareholder and unitholder equity was $49.3 million at the end of the quarter. Shareholder equity was $38.3 million, with approximately 9.7 million shares outstanding. Unitholder equity was $11 million, with approximately 3.2 million limited partnership units outstanding.

At the end of the second quarter, our interest-bearing debt to total capitalization, which we define as the gross market value of our properties plus cash and other current assets, was 52.6% or approximately $70,300 per room. Excluding preferred stock, debt to total capitalization is currently 44%, or approximately $58,800 per room.

Turning to our 2011 guidance, we are updating and revising our forecast for 2011 financial performance. Due to the distortions created by previously mentioned non-cash charges such as swaps and warrants, we have decided to present a wider range of metrics, both in our quarterly earnings and in our forward-looking projections, that focuses more on the metrics that, in our opinion, more accurately reflect the Company's operating performance.

For the year, we are projecting adjusted FFO in the range of $5.8 million to $7.7 million, or $0.45 to $0.60 per share, as opposed to our previously announced FFO guidance of $0.50 to $0.60 per share. Additional details can be found in the Outlook section of our earnings release.

With that, I'll turn the call over to Drew Sims.

Thank you, Bill. I'd like to start off by discussing the strategic objectives of the Company. Our goals for the near-term are to restructure our balance sheet, reinstate the dividend, and restart growth. First, I would like to discuss our efforts and achievements related to the balance sheet.

With the amendment and extension of our credit agreement, the issuance of preferred stock, and the establishment of a $10 million unsecured line of credit, combined with the recent extensions of the Hampton and Jacksonville mortgages, we've addressed all of our near-term debt maturity risk while enhancing the Company's liquidity position.

The next step in restructuring our balance sheet is to replace our corporate line of credit, which carries restrictive covenants and a floating rate, with a series of fixed rate, long-term loans on individual assets. As Dave said, the Laurel refinancing is the first asset in the credit facility borrowing base to be refinanced. We are eager to take advantage of the historically low interest rate environment and have seen the hotel debt markets open substantially over the past six months.

We believe that attractive interest rates will be available for the foreseeable future, as more players, specifically the balance sheet lenders, enter the markets. This is good news for us, and should provide us with the ability to secure more financing with attractive terms similar to the Laurel loan. We have targeted our Raleigh and Louisville assets to close in the third quarter of this year.

Prior to the recession, we prided ourselves on our ability to pay an above-market stable dividend to our shareholders, and we are pleased to reinstate the dividend at this early stage of our industry's recovery. At current pricing, our $0.02 per share quarterly dividend represents an annual yield of approximately 3%. This puts us in line with our peers and, we believe, provides room to grow the dividend, as the portfolio continues to stabilize and our industry continues to recover.

The final objective is to restart growth. Let me first state that our primary focus is to continue our organic growth by effectively managing our current portfolio of recently renovated, high-quality assets. As Dave mentioned, while our portfolio is performing better than the overall industry trends, the majority of our assets are out-performing their respective markets. This is an enviable situation to be in and provides us a platform for a prolonged period of growth. We believe we are still in the early stages of the recovery and supply growth is muted, and demand and pricing are on the upswing.

We continue to monitor the acquisition market and have ongoing discussions related to several assets. While we have not allocated significant cash assets for growth, we have options, such as JV partnerships and recycling our capital out of existing assets, that would allow us to structure an acquisition in the near-term. That said, the target markets we are focused on have experienced little transaction activity to date. We continue to take a conservative strategic approach to growth, and are prepared to take advantage of the right opportunities when they present themselves.

Lastly, we continue to see a disconnect between the inherent value of our portfolio and the current market value of our stock. As of August 5, our stock has produced a total return of 23.2% year-to-date, which is a very favorable return as compared to our peer group. While we are encouraged by the upward movement in our stock price, we believe our Company is still significantly undervalued. We believe the growing value of our portfolio within this current environment harbors an attractive opportunity for investment.

With that, we'll now open the call up for questions.

(Operator Instructions). Carol Kemple, Hilliard Lyons.

With your new preferred shares on the balance sheet, why did you put those under liabilities instead of under equity?

Bill, I'll let you answer that question. It's because it has a defined term.

It does have a -- it has a defined term and it is redeemable. And therefore, we are required to place it there as opposed under the equity section.

Okay. And then (multiple speakers) --

(multiple speakers) If it had an unlimited term, then it could be considered equity.

Okay. And so in the second quarter in interest expense, was there some preferred dividends included in that?

Yes.

Okay, so that's how it will look on the income statement going forward -- there's not going to be a separate line item that says preferred dividend?

That is correct.

Okay. And then, when we look at forecasting in the future with that -- in the quarter, there was unrealized loss on warrants derivatives. How should we look at that going forward?

Well, (laughter) --

Good question.

-- that's a very good question. If you have the answer, call me. It basically tied to our stock. As our stock price goes up, the value of the warrants goes up and that creates the loss or gain. If the price of the stock were to go down, the value of the warrants would decline and, therefore, it would have -- you'd actually show a gain on the warrants for the quarter.

It's just like a derivative. That's why we're excluding that. That's why we have the AFFO calculations, because that number can effectively distort some of the computations and metrics we had been using in the past.

So when you look at your forecast for this year, do you have -- do you assume that's going to be similar to second quarter numbers in the third and the fourth?

You mean the value of the warrants?

Yes.

If our stock price continues to increase at the same rate it increased in the second quarter, yes.

Okay.

It's totally tied to the stock price.

Okay. And then your equity and earnings of joint venture -- that looks like that was a bigger loss than it was last year. Was there anything specific going on there?

(multiple speakers) No.

No, we actually had a very strong -- exceptionally strong quarter in Hollywood. So I don't know what the variance is, other than it could be non-cash items.

Are you looking at it at a quarter-to-quarter?

Yes, I'm looking on the income statement, yes. Second quarter to second (multiple speakers) --

(multiple speakers) From the third quarter to the second quarter, I mean?

No, I'm looking from second quarter of this year to second quarter of '10.

I can't think of anything right off the top of my head that would have a significant change there. You've got your depreciation would be about the same -- be about the same.

Okay. Will you all have your 10-Q out later today with that information in it?

I'm sorry, I didn't hear that.

Will you all have the 10-Q out later with the breakdown of Hollywood in it -- kind of figure out where that is coming from?

We plan to file that in the morning, Carol.

Okay, thanks.

Dan Donlan, Janney.

You guys talked a little bit about the debt markets opening up. Just kind of curious in the last -- really in the last week we're hearing the debt markets -- last, actually two or three weeks, the debt markets have closed substantially to a lot of different borrowers, particularly the CMBS market. Just kind of curious what you've seen in the last two weeks? And if you can maybe quantify, as you guys continue to pull out mortgages from the credit facility, where you think rates are right now versus maybe where they were a year or a month ago -- or anything you can offer there would be helpful.

Well, I guess, we're -- we've been looking at various options in the debt markets and CMBS was one of them. And certainly, that's closed. I mean, we don't see that as an opportunity at this point. I mean, it's -- things have gone south.

But some of the smaller banks are starved for loans, especially higher quality loans that have strict underwriting standards that are CMBS-like. And really, that's where our focus is. Bank of Georgetown is a relatively small bank, a D.C. bank-based. We're working with another small -- relatively small lender to do a similar transaction on our Raleigh asset. And so that's going to be our focus.

Now, whether that -- the problems with the CMBS market and the overall markets affect the smaller lenders, I don't know at this point. We haven't seen that yet but that doesn't mean it won't happen. But at this point, we're moving forward. I mean, we have commitments and we're trying to get -- working towards closing.

And then -- and sorry if I missed this in your prepared remarks; got on a little bit late -- but is the intention to bring the credit facility down from -- on a nominal basis and to maybe make it unsecured? Or as you fast-forward maybe a year to two years from now, what do you want your capital structure to look like?

Well, what we're trying to do is we've got four remaining assets on the borrowing base after the Laurel closing. We think that we can refinance three of the four, and pay off the line of credit, and put that to bed. And our goal is to do that by the end of the year if we can -- if the markets will behave themselves. Now I don't know -- that's a big if at this point, what's gone on in the last two days. But that was our goal last week. Hopefully, it's still our goal this week.

And that will free up one of our assets, which we believe will be Tampa, which will be free and clear. And what we'd like to do is then refinance that asset and pay down or pay off our unsecured line of credit with Richmond Hill, which has a fairly high interest rate on it. And also we have a provision in our preferred where we can actually pay down up to $5 million of the preferred with no penalty at par.

So, we'd also like to do that, so that we would be, hopefully, at the end of next quarter -- end of the first quarter next year have one-off mortgages on our assets that are conservatively underwritten; each and every hotel will have a positive cash flow. The loans aren't cross-collateralized so that they cause some sort of contagion for us. If you have a problem at one hotel, it doesn't have to affect all the other hotels, which was obviously a problem with our line of credit. And then go out and probably find a lender that is willing to lend us money on an unsecured basis at that point. So we just have that as reserve capital.

Okay. Thanks. That's very helpful.

(Operator Instructions). Jon Evans, Edmund White Partners.

Can you help me understand a little bit better your direct -- indirect expenses in the quarter and just the growth of those?

Indirect expenses. Bill, I'm going to defer to you on that one.

All right. I mean, I just -- just before we get -- before I answer, where in particular are you -- you looking on the earnings release?

Correct. So you have total hotel operating expenses and you break them down between room department, food and beverage, other operating departments and indirect.

Correct. And you're looking at the growth of the indirect sector? (multiple speakers) They grew by about $600,000.

Yes, it was up 7.32% year-over-year.

Yes, it's an increase of about $600,000. These are the -- for lack of a better -- I'm going to call them the expenses related to the things that are not allocated to specific departments. For example, our general managers' salaries, room maintenance, that sort of thing. I could -- I can go -- I will go through, if you want, with you probably better offline, and find the exact place where it occurred. I can give you some idea --.

Jon, it's Dave Folsom. Those line items are property level, overhead, in terms of SG&A. It's sales and marketing expenses. It is the franchise fees, and the operation and maintenance expenses of the property, and the property managers' management fees. And then some of our assets, especially our renovation projects, some of our royalty fees with the franchise companies who are step-laddered-up. As we came out of renovation, the royalty fees increased to more market-driven levels. Usually, when you do a renovation project, the royalty fees from the franchise start out a little bit lower than normal and they ramp up.

And the same is true with the management fees at the property level. The management company charges a discounted management fee at the beginning of the tenure of the property. And that, over a period of three years, increases. So what we saw at some of the properties was the combination of the franchise fees and the management fees, and just some of the given SG&A and sales and marketing just drove that up. But that's commensurate, I think, with some of the improvements in our RevPAR as well.

Right, but (multiple speakers) --

(multiple speakers) And particularly -- for example, Jacksonville in the case of the franchise fees from when we converted over to a Crowne Plaza, it has accelerated up, and some of the newer properties like Tampa and Hampton. Specifically those three.

Okay. I guess can you talk a little bit about -- you guys did a great job driving RevPAR. Your occupancy was up but you did a great job driving rate. I guess the thing that surprised me is you didn't get more flowthrough on your rate. And I guess, is that because of these franchise fees that stepped up? And if you can continue to grow rate at this level, shouldn't you get better flowthrough? Or help me understand that.

Actually, the flowthrough for the -- for example, at the GOP level before these indirect costs, was about 8%, which is reasonably at the same percentage level as the other increases in, say, RevPAR. [So I'd say] what happens if you're looking at, say, margin rates or something like that, these indirect costs come in and they distort it.

Got it. So let me ask you this -- if we're, at this time next year, and you've continued to grow your RevPAR and it's been by rate, would you get a better flowthrough from rate? Because most people (multiple speakers) --

Yes, we would expect to. We would expect to because we do not -- at this point, those indirect cost increases are not going to occur again because they've reached their level.

Yes, Jon, this is Drew Sims. More specifically, we negotiated hard with the franchise companies when we did these conversions. And what we did was we said, we're not going to pay you the full royalty rate because we're putting X millions of dollars into these hotels. And when we open, we need what they call marketing assistance, is how they term it, but it's basically a credit on your royalty fee. And we negotiated these credits so that we didn't have to pay the full royalty fee right out of the gate.

We also did the same thing with our management company. Whereas stabilized management fee is typically around 3%, we said, we're not going to pay you the full management fee until these hotels are stabilized. So we have a three-year ramp-up on these assets where -- and it's a fairly significant amount. It's 150 -- 100 to 150 basis points ramp-up when you combine the two. And so when you apply that to the topline sales number, it's a significant amount of money. So that -- I mean, that's the essence of the changes.

We've also seen some creep in our utility bills, I have to say that. I mean, they're -- the utilities, in almost all of the localities that we operate, have increased their rates. And there's not a whole lot we can do about that. I mean, we have tried to negotiate some contracts on gas. We also negotiated with the utility in Philadelphia to try to stabilize those rate increases, which I think -- you're going to see some benefit of that a little later in the year, but it's been a little bit of an uphill battle. I mean, the utilities are what they are. We obviously have to have them included in our expense formula there.

So -- but that's the vast majority of it. It's not, for the most part, items that are under our control like salaries, wages and those kinds of things. It's just some of these big items. And as Bill said, we're now capped out on those. So we're at the stabilized level, I believe, on all assets except for maybe Hampton and maybe Tampa. So -- and the rest of them are -- we're paying the full fare now.

And the other thing is that we still get -- we continue to see expense creep from all brands. They just nickel and dime us to death on all kinds of little items. And it all adds up. I mean, it's a little disturbing that -- when I started in the business 30 years ago, your all-in franchise fees were about 5% of your room sales. Now it's upwards of 11% to 12%. And every year, every quarter, they just seem to ding us a little bit more on the expense line.

Got it. Can you talk a little bit about what you've seen or what you saw in July and how the trends are there?

I have to tell you, the last three weeks of June, the transient leisure traveler disappeared. And I don't know if that's -- and that's pretty much in every market that we have. When you combine that with there's just been a hold put on all government and military travel in the last six, eight weeks. We've seen a real reduction in the transient phase. I mean, we've -- real strong group bookings going into the summer, and we were a little bit taken aback by how the last three weeks of June ended up. Then the first three weeks of July were equally soft. And then the last couple of weeks have been pretty good.

So, it's hard to predict. Transient travel is, for the most part, last-minute bookings and you really don't know what to expect. But certainly, I think probably the gas prices as much as anything had a negative effect on our summertime leisure traveler. So we were -- I have to say, we were disappointed the way the quarter ended and we were disappointed the way the third quarter started.

Okay, got it. Great. Thank you.

This concludes our question-and-answer session. I would now like to turn the conference back over to Drew Sims for any closing remarks.

Well, I'd just like to thank everyone for participating today and we look forward to talking to you next quarter.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Okay. Thanks.