Sotherly Hotels Inc.
Q2 2017 Earnings Call Transcript

Published: 12 Aug 2017

[Operator:]

Good day and welcome to the Sotherly Hotels Inc. Conference Call and Webcast. All participants will be in a listen-only mode [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Scott Kucinski. Please go ahead.

[Scott Kucinski:]

Thank you, and good morning, everyone. Welcome to Sotherly Hotels' 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. Tony Domalski, our CFO will provide our key financial results for the quarter and update our 2017 guidance. Drew Sims, our Chairman and CEO will conclude with an update on our strategic objectives. We will then take questions. If you've not received a copy of the earnings release you may access it on our website at sotherlyhotels.com. In the release, the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measures 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 give no assurance 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.

[Dave Folsom:]

Thank you, Scott and good morning everyone. I'd like to start today's call by discussing some of the portfolio's key operating metrics, looking at quarterly results for the composite portfolio which represents the company's wholly owned properties and the participating condominium hotel rooms from the Hyde Resort & Residences. RevPAR was $110.67 in the second quarter, an increase of 1.4% over prior year with a 4.0% increase in rate and a 2.5% decrease in occupancy. Year-to-date RevPAR was $107.93, an increase of 3.3% over prior year with a 3.8% increase in rate and a 0.4% decrease in occupancy. Excluding our hotels in Hollywood, Savannah and Wilmington which all were under renovation in the period and negatively impacted results due to rooms being out of service, composite RevPAR increased 4.1% for the quarter with a 5.1% increase in rate and a 1% decrease in occupancy. Year-to-date RevPAR increased 7.5% driven by a 6% increase in rate and a 1.4% increase in occupancy. Primarily due to this renovation impact, hotel EBITDA for the portfolio decreased 7.7% to approximately $11.5 million for the quarter and hotel EBITDA margins decreased 150 basis points. However, year-to-date, hotel EBITDA increased 2% over prior year and hotel EBITDA margins have increased 70 basis points. We attribute much of the second quarter decreases to the highly impactful renovations and the Easter holiday calendar shift. Looking at some of the individual property and market highlights. The DoubleTree by Hilton Jacksonville Riverfront continues its exceptional performance with RevPAR increasing 5.7% in the quarter, driven by a 6.7% rate increase. This property continues to hold its position as the market leader with a fair share index of 120% -- 121% in the quarter. The Georgian Terrace in Atlanta had a strong quarter with RevPAR increasing 4.5% against a soft market, which was down 1%. The property is achieving an ADR share index of 105% as it continues to benefit from the guestroom renovations, which were completed late last year. The Whitehall in Houston continues to ramp up while the market struggles to gain stability. In the quarter, the hotel's RevPAR increased 17.5% against the market's decline of 11%. The market achieved flat occupancy, but rate continued to suffer. In Savannah, the $9.4 million renovation is now complete. And last week, the hotel converted to the DeSoto by Sotherly, an independent boutique associated with preferred hotels and resorts. In Hollywood, the $7 million renovation of the Crowne Plaza is more than halfway finished as we work towards a conversion to the DoubleTree Resort by Hilton in the fourth quarter of this year. Public spaces are nearing completion, while the guest rooms are approximately 50% renovated. In Wilmington, North Carolina, we have commenced an $8.5 million renovation of that hotel, which is scheduled to be completed in March 2018 and includes a re-branding of the asset to the Hotel Ballast, an independent boutique associated with Preferred Hotels & Resorts. Today, approximately 35% of the room inventory has been fully renovated. We continue to ramp up operations of the Hyde Resort & Residences, with approximately 250 units now in our reno program. We anticipate a stabilized inventory pool and continued ramp-up of operations heading into the South Florida high season. Looking at some of our corporate activity for the quarter. In June, we entered into an agreement to purchase the commercial unit of the planned Hyde Beach House, a condominium hotel under development in Hollywood, Florida, for a price of $5.1 million. Expected to open in the second quarter of 2019, this property is located adjacent to the company's Crowne Plaza Hollywood Beach Resort and directly across from the Hyde Resort & Residences. This 342-unit condominium hotel consists of 265 use-restricted resort units and 77 residences that feature 1-, 2- and 3-bedroom layouts. The property will feature amenities that include an expansive pool deck with an infinity edge pool, a sports club and an aqua club offering watersports on the Intracoastal Waterway. Drew will offer additional comments on this transaction in a moment. Also in June, we refinanced the DoubleTree by Hilton Jacksonville Riverfront with a new $35.5 million nonrecourse CMBS loan. The loan carries a 7-year term amortized on a 30-year schedule and has a fixed interest rate of 4.88%. Net proceeds from the refinancing were approximately $15.8 million after repayment of the existing first mortgage. We consider this refinancing the capstone on a 3-year conversion of value creation strategy consisting of a $7.2 million renovation, brand conversion and rapid revenue, profit and market share growth of the property, all resulting in the creation of over $30 million of asset value over this time period. We are very pleased with this overall effort and result. And finally, last month, we announced that we increased our quarterly dividend by approximately 5% to $0.11 per share, representing an annualized dividend of $0.44 per share and a yield of approximately 6.8% based on yesterday's closing price. Now I will turn over the call to Tony Domalski, the company's Chief Financial Officer.

[Tony Domalski:]

Thank you, Dave. Reviewing performance for the period ended June 30, 2017. Total revenue for the quarter was approximately $40.6 million, representing a decrease of 2.8% over the same quarter a year ago. Year-to-date, total revenue was approximately $79.3 million, a decrease of 0.4% over the same period a year ago. For the quarter, hotel EBITDA was approximately $11.5 million, representing a 7.7% decrease over the same quarter a year ago. And year-to-date, hotel EBITDA was approximately $23 million, an increase of 2% over the same period a year ago. For the quarter, adjusted FFO was approximately $5 million, representing a decrease of 23.8% over the same quarter a year ago. And adjusted FFO was approximately $10.1 million on a year-to-date basis, a decrease of 1.7% over the same period a year ago. Please note that our adjusted FFO excludes charges related to the early extinguishment of debt, gains and losses on derivative instruments, charges related to aborted or abandoned offering costs, changes to the deferred portion of our income tax provision as well as other items. Hotel EBITDA excludes these charges as well as interest expense, interest income, corporate, general and administrative expenses, the current portion of our income tax provision as well as other items. Please refer to our earnings release for additional detail. Looking at our balance sheet. As of June 30, 2017 the total book value of our assets was approximately $413 million which includes net investment in hotel properties of approximately $357.4 million. The company had total cash of approximately $39 million, consisting of unrestricted cash and cash equivalents of approximately $34.4 million as well as approximately $4.7 million which was reserved for real estate taxes, capital improvements and certain other expenses. As of the end of the quarter, the company had principal balances of approximately $321.7 million in outstanding debt at a weighted average interest rate of 4.79% which is a 28 basis point improvement over the same period a year ago. With the refinance of the mortgage on our Jacksonville property, approximately 80% of the company's debt carries a fixed rate of interest. Total stockholder and unitholder equity was approximately $75.9 million at the end of the quarter of which stockholder equity was approximately $73.7 million and unitholder equity was approximately $2.2 million. At the end of the quarter, there were approximately 13.8 million common shares and approximately 1.8 million limited partnership units outstanding. At the end of the quarter, the principal balance on our interest-bearing debt was approximately $113,350 per room. Also, the ratio of debt to total asset value, as defined in the indenture agreement to our senior unsecured notes was 54% based on a total asset value of approximately $594.5 million at the end of the quarter. Turning to guidance. We're updating our previous guidance for 2017 which accounts for current and expected performance within our portfolio as well as other factors. For the year, we're projecting total revenue in the range of $152.7 million to $156.5 million. At the midpoint of the range, this represents a 1.1% increase over last year's total revenue. Hotel EBITDA is projected in the range of $41.3 million to $42.5 million. At the midpoint of the range, this represents a 4.8% increase over last year's hotel EBITDA. And adjusted FFO is projected in the range of $16 million to $17.2 million or $1.02 to $1.10 per share. At the midpoint of the range, this represents a 17.8% increase over last year's adjusted FFO per share. Additional details can be found in the outlook section of our earnings release. And I will now turn the call over to Drew.

[Drew Sims:]

Thank you, Tony. The domestic lodging industry continues to experience lackluster performance as positive indicators for the U.S. economy and corporate profits have not served as catalysts for an increase in lodging demand. In the second quarter, there was an impact due to the holiday shift with Easter occurring in April versus March in 2016. But even with that considered, demand was still below expectations. In the quarter, 8 of our 11 markets had negative RevPAR growth. However, our portfolio took 350 basis points in share, outperforming our competitors as a whole. We also experienced planned negative impact in the quarter as we had 3 of our largest hotels under renovation. Hollywood and Wilmington both have rooms out of service, while Savannah felt the impact of having its food and beverage outlets out of service for an extended period of time as these outlets are converted to new concepts, which caused additional impact as increased operational expenses were incurred. In addition to the renovations, we have experienced a slower ramp-up with the Hyde Resort as developer unit closeouts were slower than anticipated. All that taken into account, our portfolio's performance year-to-date remains in line with our expectations and our forecasts for the balance of the year remain as originally planned. Our expectation is that we will perform within our guidance range, which represents significant year-over-year growth across key profitability metrics. We remain focused on completing our repositioning in Savannah, Hollywood and Wilmington, which we believe will serve as growth catalysts for the portfolio in the near future as those properties ramp up. Of note, The DeSoto in Savannah converted last week, with the renovation now substantially complete. The finished product has received rave reviews from our guests and the media, and we are confident in its performance going forward. In terms of acquisitions, as Dave previously mentioned, we entered into an agreement to purchase the commercial unit at the Hyde Beach House condominium hotel in Hollywood, Florida, last month. Another project by the related group, this property is located directly across the street from the Hyde Resort & Residences, which opened in February and adjacent to our Crowne Plaza, which are, we are converting to the DoubleTree flag in the fourth quarter. This transaction represents the final phase of the value creation strategy we have envisioned since we originally commenced our investment into the South Florida market. Once completed, this will be a unique complex that offers a tremendous variety of product offerings and amenities for our guests while providing the ability to fully implement and take advantage of operational efficiencies, and sales and marketing synergies. We also continue to seek out other acquisition opportunities that fit our long-term strategy. There have been dozens of hotels in the market this year that fit the mold. However, the environment, in our view, is overheated and we continue our long-held approach of conservative and diligent underwriting. So far, finding the right value has been a challenge. We intend to continue with this approach, and we'll act only when we believe we have found value we can unlock for our shareholders. With that, we'll open the call up for questions.

[Operator:]

We will now begin the question-and-answer session [Operator Instructions]. The first question comes from Tyler Batory of Janney Capital Markets. Please go ahead.

[Tyler Batory:]

Good morning. Thanks for taking my questions. Maybe the first, can you guys talk a little bit about Houston? Just kind of wondering what you saw in the second quarter there. I'm not sure if you have any high-level thoughts on that market that property for the rest of the year.

[Drew Sims:]

Well, I mean, Houston continues to be a challenged market. Market was down significantly double digits again in the quarter. We took tremendous amounts of market share from our competitors. But even with that, we're not performing at a level that we'd like to be at. In terms of the property, it's certainly cash flow positive. We don't have any issues with a loan or anything like that. So we're positive on the project. We think that long term, we're positioned well. In terms of Houston at large, every quarter we think we've hit bottom and then we haven't hit bottom. So there's been a lot of new product introduced into the market this year and I think there's another two hotels coming into the downtown market later this year. So until all that product gets presented and starts to stabilize, I think we're probably in for a pretty rough ride for the next 12 to 18 months.

[Tyler Batory:]

Okay, great. And then just maybe on Jacksonville and Laurel, I mean, those continue to be very strong properties for you guys post the conversions. How much room or how much upside do you think you have left at both of those hotels?

[Drew Sims:]

We're nearing the end of our ramp-up period. I think Laurel has got more room to run than Jacksonville. Jacksonville has kind of stabilized at this point. I mean, we had a really, really good quarter, but -- and we got off to a good quarter this -- in the third quarter as well. But I think Laurel has got some upside, especially on the margin side. We're still working with our manager. We've worked very diligently to be one of the top-performing DoubleTrees in the system so that we can capture that top line revenue. And to do that, we've spent more in the expense line than we would typically do on a stabilized asset. And at this point, we're now refocusing our efforts on the profitability of the asset. So I think we got the top line problem solved and that now we need to focus on the profitability of the hotel.

[Tyler Batory:]

Great. And then maybe talk about Atlanta as well. That property continued to outperform in the market there. Are there any more details you can share on what's been driving that strength?

[Drew Sims:]

We're really proud of what we've done in Atlanta, not only from a product standpoint but from a branding standpoint. It was the first independent boutique that we did. We've introduced all our kind of independent brand hallmarks there and they've just been very, very well received. And so we just continue to take share. The people who stay there love staying there and we get nothing but rave reviews about their experience and -- and that's really what it's all about in the independent boutique space. We want to make sure that it's more of an experience, not just a stay. And I think that's where we've been successful.

[Dave Folsom:]

We've got a lot of demand generators right near the hotel that are really experiencing a lot of the same growth characteristics that Atlanta at large has experienced. There's a lot of movement, economic movement from Fortune 5 companies and other business ventures that are moving to areas like Atlanta, and we're seeing that right around the hotel, the Midtown section, where 4 years ago, there were empty office buildings that are now fully leased. We're seeing things that, frankly, for example, at Emory University, their medical center with their cancer treatment facilities, all sorts of demand generators that are both emerging and expanding and stabilizing in the market. And we've got the best product in the market, and it's just a very harmonious and beneficial loop that we're experiencing where we continue to profit. So as Drew said, we've created a lot of value for our shareholders at that hotel, and it just continues to do very well.

[Drew Sims:]

Yes. I mean, just a little, to drill down that just a little bit. Within a block or 2 of us there, Honeywell is just taking a 200,000 square foot building that sat empty for the last 5 years. And they aren't, they haven't even fully occupied yet, so we haven't seen the full benefit of that. The Proton center that Dave referenced that Emory University has built is nearing opening. Their expectation is it's going to be 10,000 to 20,000 room nights generated from that facility. And then we've had Mercedes-Benz move their North American operations out of New Jersey. They're moving 1,000 employees to Midtown in Atlanta. So these are just 3 things that are happening in our neighborhood, and there's a lot more. It's just, it's a very dynamic market.

[Tyler Batory:]

Great. It's very helpful. Appreciate that color. And then maybe a last question quick on the portfolio. I think you guys said you gained 350 basis points of market share. So I just want to make sure that I heard that number correct and then just confirm that was referring to the entire portfolio.

[Drew Sims:]

Yes, that's correct.

[Tyler Batory:]

And then the last question, circle back a little bit on acquisitions. Could you just remind us maybe target markets you guys are looking at and how you're thinking about maybe the source of funds to do a deal?

[Drew Sims:]

Yes. I mean, we wrote offers in, on 3 hotels in D.C. this last quarter

[Dave Folsom:]

Charlotte.

[Drew Sims:]

Where? Yes, Charlotte, North Carolina. So we've been active. There's still a lot of private equity money out there chasing deals and driving down cap rates. And we're just trying to be disciplined about what we do, and we're not going to buy a hotel just to buy it. And we're more worried about making money for our shareholders than just increasing the size of the company.

[Operator:]

Next question comes from the line of Carol Kemple of Hilliard Lyons.

[Carol Kemple:]

Did you all do any share buybacks in the quarter? And if you did, can you quantify that and tell us the average price at which those were done?

[Drew Sims:]

We did not buy back any shares. We had an extensive blackout period during the quarter, so we didn't do that. We are intending to reinitiate that sometime in the second half of the year, but I can't give you any specifics on that.

[Carol Kemple:]

And then can you give any guidance to what you expect interest expense to be for the full year? It looked like it ticked up a little this quarter. So would this be a good run rate? Or how are you looking at it for the whole year?

[Drew Sims:]

Well, I can answer partly, and then I'm going to let Tony answer. But we increased the size of the loan on the Jacksonville asset significantly, $15 million. So that interest has to be paid. Our intention is to put that money to work here in the not-too-distant future and create some return on that debt. But Tony, I'll let you take it from here.

[Tony Domalski:]

Yes. I would say if you take the second quarter there and add the extra $15 million that we borrowed on Jacksonville at 4.88%, then you get a good run rate for the third and the fourth quarter of the year.

[Drew Sims:]

Tony, can you address for everyone on the phone, the charge-off on the ATM?

[Tony Domalski:]

Sure. You'll notice that our corporate G&A expenses jumped up significantly this quarter. About three years ago, we had filed an S-3 and started an ATM offering. We had found other opportunities to raise capital through another S-3 that we did a baby bond offering, common stock offering and a preferred offering. And we had about $0.5 million or more of costs associated with that first filing of the S-3 related to the ATM offering that expired during the quarter and we wrote those charges off to corporate G&A expense. So you'll see them there in that blip of an increase in G&A expenses and added back to adjusted FFO.

[Drew Sims:]

Those are noncash charges. And just to expand on that a little bit, it doesn't make sense for us to have an ATM if we're buying back stock, right?

[Tony Domalski:]

Exactly.

[Drew Sims:]

So we had to terminate that and we've had -- we had to charge off those expenses which we paid for many years ago.

[Operator:]

Next question comes from the line of Daniel Santos of Sandler O'Neill. Please go ahead.

[Daniel Santos:]

Good morning, everyone and thanks for taking my question. Two questions for me. The one -- the first one is, generally speaking, over the last year, you guys have come in below expectations and have cut guidance. Could you talk a bit more about what's driving the disparity? Would you say that the renovations have proven to be more impactful than you previously thought or the market softer?

[Drew Sims:]

I would say it's two things. One, it's certainly the latter in terms of our expectations and market conditions. It has been significantly softer than we anticipated at the beginning of the year. However, I would say that our expectations on AFFO at the end of the year have not changed since the beginning of the year. We had built in some cushion there and we anticipated that we may see some softening later in the year. So we've -- I don't think -- we had a fantastic first quarter. I mean, it was fantastic and that was a result of some of the things we're getting from the second quarter moving in the first quarter and vice versa, things moving back and forth. And then the second quarter was a little disappointing. But when you add them together, we're kind of right where we thought we were going to be. So I don't know that I agree that we changed the guidance. We've changed the guidance on some of the metrics, the sales metrics and some of those things. But in terms of AFFO, I think we maintain our range exactly where we said it was going to be.

[Tony Domalski:]

Exactly. I think we've lowered our guidance for revenue but increased our guidance for margin which brings us to approximately the same point when you're looking at hotel EBITDA. I think, secondly, we were disappointed in the quarter at the way that Hyde Beach property ramped up. The owner was, or the developer was a lot slower in selling those units. And so we were a lot slower in getting those units enrolled into our program and available for rent.

[Drew Sims:]

Yes. When he says sales, we actually mean closing. All the units have been sold for quite some time, so it's just a matter of getting to the closing table. The problem has been that 90% of the owners of this building are South Americans, and we haven't been able to get them to the closing table. So now is the season for that. We had a really, really strong July at the Hyde, and things seem to be ramping up nicely in the last 45 days.

[Daniel Santos:]

My second question is actually on Hyde Beach. I saw that the seller is paying the company $750,000 for preopening services. Just wondering if you could give a little more color on that, whether that was something the seller was supposed to do and just didn't get around to it or this was always part of the agreement.

[Drew Sims:]

It's always been part of the agreement. There are significant expenses that we have to incur to get a hotel opened. And we felt like that, those expenses should be paid by the developer, not by the resort operator. And we got them to agree to that. And we got the same, basically, the same kind of deal on Hyde House as well. So both of those follow that model, both these projects have followed that model.

[Operator:]

[Operator Instructions] We have a question from Michael Fies, and he's a Private Investor.

[Unidentified Analyst:]

Want to thank you guys for all the hard work that you're doing and that you've done. I much appreciate it. Two quick questions. The first one was if I heard it correctly, it sounded like that the debt relative to what you guys value the assets is about 54%, if I heard that correctly. What is your long-term goal for that rate?

[Drew Sims:]

That's about where our goal is. We'd like to keep it around 50%. We will lever up if we see an acquisition that we like. But we want to come back and stabilize somewhere in that 50% to 55% range. That's kind of where we've been for several years, and that's our strategy.

[Tony Domalski:]

This is Tony. I was going to add that we model that metric out, and we'll see it, we did a refinancing of the Jacksonville property there a few days before the end of the quarter. And so we saw that, that number was going to spike up a little bit. But as we forecast out into the future, we do see that, that number coming down to where it's been the last couple of years at 52%, 53%.

[Unidentified Analyst:]

And then following up on Carol's question from earlier regarding stock buybacks, I'm assuming that you guys feel, I don't want to put words in your mouth, just based on previous conversations and previous quarterly calls that the stock is significantly undervalued. And put it in more basic terms, that the cost of the hotels vis-à-vis the market price of the stock, there's a big discount. And it sounds like from what you described that the marketplace is quite competitive. I think you mentioned you bid on some things in D.C. as well as other places. If the stock price represents a meaningful, a large discount to what you guys think the value of the holdings are and the marketplace is quite competitive, how do you sort of jive that with that you haven't bought back stock and then it seems that your efforts are focused on making bids and looking for new investment opportunities when at least, on the surface, to a naive investor like me, it seems like the stock is trading at a massive discount? So I don't understand why you don't focus the energy on buying stock back which in essence is buying hotels at a very meaningful discount. Or do you feel the discount is not that big and that buying new things represents better investment opportunities?

[Drew Sims:]

Well, I guess our view is we can walk and chew gum at the same time. And we need to continue to grow the company and we've obviously done it at a very measured pace. But that's been our strategy since we started the REIT, since we went public. So we do think there's an opportunity to buy back our stock. I think we said -- I said earlier in this question-and-answer session that we are planning to do that. We will continue to do that. But we think there's limits to both. There's limits to how much we can buy back and there's limits to how much we can lever up the company and expand through property acquisitions. So we think there's a balanced approach that'll work for everyone and we'll continue down that road.

[Dave Folsom:]

Let me add one thing. This is Dave. I'm not sure I picked up on your question exactly right, but we have bought back stock. And this has been an initiative that -- where we answered the demands of the shareholders by doing that in the fourth quarter last year when we bought back several million dollars' worth of stock in both conventional share buyback program and through an ESOP program that we initiated in the first quarter. So as Drew said, we've -- we still have a bias to do that at the appropriate time and place in the future. And we've done it in the past, even though, as we've mentioned in prior earnings calls and in the annual meeting, we're in the business of owning hotels. And I understand your logic, but there are great deals out there that we can buy and that we can create value for our shareholders and we've proved that over 12, 13 years of continuous operations as a public company and 61 years as an owner operator in the private domain. So we think there's a time and place to do both and we'll continue to do that.

[Unidentified Analyst:]

I appreciate that. And again, this is just my two cents. But I don't care if you grow the company. I disagree that you need to grow the company. And it's sort of -- if you feel your stock is deeply undervalued, I just don't get it. And if you don't feel it's deeply undervalued, then that's fine, I do get it. But I don't think you can have it both ways. So I guess there's no question there, but it's just one small shareholder's point of view. But I'll just reiterate it I could care less if you grow the company, right? I just want you to allocate capital as prudently as possible. And if you feel your stock is trading at half price and it's competitive new market, just buy the hotels at half price. And when there's an opportunity and the market values your stock fully or overvalues it, then issue shares. I don't quite get it, but I definitely appreciate your time and thoughts.

[Operator:]

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

[Drew Sims:]

Okay. Thank you all for joining us this quarter and look forward to talking to you all in October.

[Operator:]

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