SOTHERLY HOTELS LP Q2 FY2020 Earnings Call

Good morning and welcome to the Sotherly Hotels' Second Quarter 2020 Earnings Call and Webcast. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mack Sims. Please go ahead.

Thank you and good morning everyone. If you did not receive 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 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 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 will turn the call over to Scott.

Thanks Mack. Good morning everyone. I'll start off today's call to review our portfolio key operating measures in the quarter, which, as we all know, was the worst quarter on record for our industry during the COVID-19 pandemic. All the company's hotels remain open during the quarter, with the exception of our two rental programs with a Hyde Resort and Hyde Beach and Condominium Hotels, which were temporarily suspended during the month of April and May as a result of government mandates. Looking at results for the wholly owned portfolio, RevPar decreased 89.3% year-over-year, reflecting an 85.1% decrease in occupancy and a 28.1% decrease in ADR. Year-to-date portfolio RevPar decreased 58.9% over the prior year for the 55.3% decrease in occupancy and an 8.1% decrease in ADR. These metrics were in line with our concepts in the upper upscale US lodging segment and appear to be ahead of the majority of our weaker peers that have reported thus far. Our portfolio's performance was clearly driven by COVID-19's impact on travel demand and the uphill battle we're now fighting as our industry tries to gain some traction. While our operators have worked to maintain rate integrity as demand returns, pricing wars are inevitable in some markets where non-institutional owner operators are simply trying to fill rooms at any cost. Our operators have done a commendable job of staying the course. The full-service segment, which all of our hotels sit in, currently has some added headwinds due to our reliance on group catering revenues, which are very limited due to social distancing measures, group gathering size limitations, and corporate travel restrictions. Until these restrictions on events are further lifted, this portion of our business will be in question. It is important to note that our reliance on the road warrior individual business traveler has been reduced over the past few years as we transition our property to lifestyle concepts. This should be a benefit to us during the recovery as we don't see that segment coming back for some time. Lastly, our properties located in CBD locations and more densely populated urban markets, such as Washington D.C., Raleigh, Atlanta, and Houston, have underperformed national averages as consumers have understandably been avoiding travel to more densely populated areas. We expect the quarter to show month-by-month improvement as the quarter progressed and phase re-openings commenced. Like most of our portfolio, it bottomed out in April with a 95.7% decline in RevPar year-over-year. This increased slightly in May, with a portfolio RevPar decline of 90.1% from last year, as government restrictions began to be lifted in the latter half of the month around the Memorial Day holiday. As the phase re-openings continued, we saw RevPar further improve with a decline of 80.5% year-over-year, highlighting this relative performance where our leisure drive-to locations such as Wilmington, Jacksonville, and Savannah outperformed broader US market trends, particularly in terms of ADR, primarily driven by weekend leisure business. Unfortunately, we've seen these trends and improvements begin to stall due to surging coronavirus cases in some southern states in the latter half of June, with several of our markets reimplementing restrictions to flatten the curve. Specifically, Florida, Texas, and the city of Atlanta are taking actions to pause reopening, which has directly impacted the operations of our properties located in these destinations. As we continue on our path to recovery, we expect the government's response to the trajectory of the virus to be a primary driver in shaping demand in the industry. I'll now turn the call over to Tony.

Thank you, Scott. Reviewing performance for the period ended June 30, 2020. For the second quarter, which represents the first full quarter since the pandemic began, total revenue was approximately $5.3 million, representing a decrease of approximately $46.2 million, or 89.7% over the same quarter a year ago. Hotels EBITDA for the quarter was a deficit of approximately $5.2 million, representing a decrease of $20.8 million, or 133.4% over the same quarter a year ago, and adjusted AFFO for the quarter was a deficit of approximately $11.1 million, a decrease of $18.3 million or 254.8% over the same quarter a year ago. The company had total cash of approximately $24.9 million, consisting of unrestricted cash and cash equivalents of approximately $18.5 million, as well as approximately $6.4 million which was reserved for real estate taxes, capital improvements, and certain other items. At the end of the quarter, we had principal balances of approximately $369.9 million in outstanding debt at a weighted average interest rate of 4.59%. Approximately 86% of the company's debt carries a fixed rate of interest. As previously mentioned with the onset of the pandemic, we reacted swiftly in coordination with our management companies to reduce hotel operating expenses and mitigate the impact of the loss of business. Although we reduced hotel operating expenses approximately 71% from the same quarter a year ago, hotel operating expenses exceeded hotel revenue by approximately $5.2 million. Due to the anticipated increase in customer traffic and continued cost containment, we expect a narrowing of that gap in the third quarter, with hotel operating expenses exceeding hotel revenue by no more than $1.2 million per month, aiming for breakeven performance before the end of the quarter. We have also reduced capital projects and anticipate that capital expenditures for the remainder of the year will only relate to the replacement of critical systems reaching the end of their useful life. We estimate total capital expenditures will amount to approximately $4.4 million for the calendar year 2020. Most of those were already completed or well underway at the onset of the pandemic. With a majority of our wholly-owned guestrooms undergoing renovation over the last five years, we feel our portfolio is in a good position with no required renovations for the balance of the year. At the corporate level, we reduced expenses by approximately 25% to a range of $1.1 million to $1.3 million per quarter. The savings are primarily from reductions in regular compensation, anticipated bonuses, benefits for the members of the Board, the company's executive officers and employees, as well as the elimination of discretionary expenses. In March, we announced the suspension of our dividends and the deferral of payments for dividends announced in January. The suspension and deferral eliminated a draw on the company's cash reserves of approximately $4.25 million per quarter. Since the onset of the pandemic, we've had ongoing discussions with our lenders regarding forbearance of current payments of principal and interest required under our loan agreements. Existing and contemplated agreements provide for the deferral of payments of approximately $4.7 million that would have been payable in the second quarter, and approximately $3.1 million that would have been payable in the third quarter. While some deferrals are required to be repaid, or caught up in subsequent quarters, most of the deferrals will be repaid upon the maturity of the loan. Notwithstanding, the company has been in discussions with its lenders regarding anticipated non-compliance with financial covenants under the agreements that include them. Based on these discussions, the company believes it will obtain waivers from its lenders under agreements that articulate non-compliance as an event of default. However, no guarantee can be made that we will obtain such waivers, nor can we guarantee that obtaining such waivers will not incur additional costs, increased interest rates, or additional restrictive covenants and other lender protections related to such loans. As previously stated during the second quarter, the company made applications through its banks under the SBA Paycheck Protection Program and received proceeds of approximately $10.7 million. Pursuant to the terms of the CARES Act, the proceeds of each PPP loan may be used for payroll costs, mortgage interest, rent, or utility costs, and the company anticipates a significant portion of the loan to qualify for loan forgiveness.

Thank you, Tony. Good morning, everyone. First, I'd like to recognize our hotel associates for their dedication and resilience during this unprecedented time. Their efforts have been integral in preserving the company's liquidity and protecting the health and safety of guests in our hotels. The second-quarter operating environment was unlike anything we've experienced in our 63 years in business, as the COVID-19 pandemic resulted in government-mandated closures and severe travel restrictions, causing significant cancellations and revenue declines for the lodging industry. To put things in context, the lodging industry is closely tied to GDP and general economic conditions. In the second quarter, the US Commerce Department reported GDP plunging 32.9% on an annualized basis. This is the most severe economic contraction over such a short period ever recorded, even more significant than the financial crisis of a decade ago, the Great Depression, and numerous other economic recessions or downturns over the past century. Challenged with this environment, we took immediate action to cut costs and preserve liquidity. As described on our first-quarter earnings call, our action plan contains several key objectives, including prioritizing the safety of our staff and guests, mitigating the pandemic’s financial impact through stringent property and corporate level cost-reduction initiatives, strengthening our balance sheet with alternative sources of capital, and capitalizing on new opportunities presented by the industry's evolving landscape. We believe the progress we have made on each of these key objectives has positioned the company to persevere as demand recovers in the months and years ahead. More specifically, during the second quarter, we addressed concerns surrounding the safety of our staff and guests by implementing extensive hygiene protocols at every property in our portfolio. These standard operating procedures encompass changes to service standards at every level of the guest experience. During the quarter, we were successful in working with our management partners to optimize our operations to achieve maximum property-level efficiency. We effectively managed property staffing levels by implementing cross-training programs and adjusting personnel levels relative to the growth in demand. We believe our stay-open strategy proved successful as revenue exceeded variable expenses for the quarter and enabled a quicker ramp-up process as demand grew in the latter part of the quarter. Additionally, we bolstered our balance sheet during the quarter by securing proceeds through the SBA’s Paycheck Protection Program. We continue to evaluate alternative sources of capital, whether through government-sponsored programs or private equity partners, to provide immediate liquidity to the company. The macroeconomic environment has shown mixed indicators in recent weeks, as increased case counts across a number of states are shifting market sentiment and could negatively impact summer travel demand. While the uptick in cases is concerning, an uneven recovery was not unexpected due to the inconsistent reopening plans among state and local jurisdictions. Questions remain about the pace of reopening, the election, the fall school calendar, and a return to the workplace, all of which directly impact the travel industry and our portfolio’s performance. On the positive side, data from the US Department of Labor shows the economy added a combined 6.6 million jobs during June and July, dropping the unemployment rate to 10.2%. News surrounding a potential vaccine has been encouraging, although the timeline for its rollout is still uncertain. While we continue to see some signs of recovery, including reasonably solid leisure demand and consumer spending, the pace of recovery moderated from the spike over the July 4 holiday week. We do not believe, however, that our industry will retrace the gains made since early April in terms of revenue losses. We've seen slow and gradual demand increases since that time. Regardless of macroeconomic factors, we believe our diversified portfolio, which includes in-demand leisure and drive-to destinations, along with our renewed focus on streamlined operations, has positioned the company to withstand the current environment. We remain dedicated to making sound operational decisions to reduce losses and conserve liquidity while delivering long-term value for our shareholders. And with that, operator, we can open the call for questions.

We will now begin the question-and-answer session. Our first question will come from Tyler Batory of Janney. Please go ahead.

Hi. Good morning. This is Jonathan on for Tyler. Thanks for taking our questions. First one from me. I was just wondering if you guys could provide some additional color on your revenue management strategy broadly. How much competitive discounting are you seeing in some of your markets currently?

Yes, I mean, we're seeing a lot of that, especially in some of the CBD locations. But I think many hotels, including ours in those locations, are trying to retain some rate integrity; it really doesn't serve a purpose to drop the rate down to a point where we're simply trying to get occupancy that's very limited in the first place. So, we've actually been able to maintain some rates, as you can see from Scott's comments. The rate has gone down but not as significantly as occupancy in these markets. So there are travelers, albeit a few in the second quarter, and they were willing to pay rates that were not rock-bottom. But nonetheless, we think as demand emerges, we'll regain both the rate and occupancy. But yes, there has been some discounting.

Okay, great. That's very helpful. And then turning to the markets, Louisville seems to have quite strong occupancy. So, can you just provide some color on what you've seen there in the second quarter what was driving that?

Yes, we have a large UPS contract and counterparty in the hotel, which has actually been very fortunate. Their consumption of room demand has increased during the second quarter, because the UPS schedule out of the air hub in Louisville actually increased. So, that's been a good outcome for us. Our fair share index in that market is over 200%, so it's all contract business.

Okay, great. I appreciate the detail, that's all for me. Thank you.

The next question will come from Alexander Goldfarb with Piper Sandler. Please go ahead.

Hey, morning, going down there and good to hear you guys. Glad you guys are holding up. Just some quick questions here really about cash management. One, if you can just give us an update on how the forbearance and mortgage restructuring conversations are going? Are lenders being accommodating, or do you feel like they're not being reasonable in how they're looking at either the recovery and the ability for you guys to once again become current on the properties?

Yeah. Let me just generally speak to that, Alex. Our lenders have been very accommodating. I think we all understand the situation we're in. It sort of went in phases. The initial phase we saw in March and April, when we got out in front of this, and the entire market just basically gave every lender every borrower sort of a 90-day standstill, it was kind of a phase one event. Then everybody was hoping to see the smoke clear a little bit, and we entered what we call sort of Phase 2 of our forbearance and modifications. Essentially, we've been able to get decent terms from balance sheet lenders, life company lenders, and even in some instances, some terms from the CMBS guys, even though they're constrained by the structure of that loan type. So, those results were good and will take us pretty much into the fourth quarter generally speaking. If demand returns in the marketplace, we probably see sort of a catch-up period where we will be current on loans and address the forbearance measures. I believe that most lenders we've talked to will accommodate us further as borrowers because they have to.

Yeah. I wanted to add that of our individual loans that we're dealing with, we either have agreements in place or we’re in active negotiations and pending approvals for forbearance or modifications that have been noted as a default, which we're discussing with the special servicer and approval is pending their committee. Philadelphia has noted that we received an initial forbearance from them, and we’ve been in ongoing conversation, working to finalize the documents for additional terms there. Essentially, we expect every loan to continue to be addressed with lenders moving forward for the foreseeable future.

Okay. And then just looking at your cash needs, it looks like basically you have nine months of cash on your balance sheet, based on just under $2 million a month, and basically $2 million of cash. It's fair to say that, through year-end, you guys are fine, but really you need the markets to improve in the first quarter. And regarding the deferred dividend, that's accruing yet, I guess that's right, $900,000 a quarter. So that's something additional that would also have to be caught up. So, my thinking about it is right, that basically you guys are fine with the balance of this year and really, beginning of 2021 is when, I guess, sort of rubber needs to hit the road. Is that a fair way to think about it, both from an operations and from a debt agreement restructuring?

Yes, that's a fair statement as a worst-case scenario. I mean, we're seeing improvement just in the last two weeks across our portfolio. But I understand that the news we all see is tempered by a variety of factors. I just saw last week that the State Department and the CDC lifted the four-month-old level four travel ban internationally. So, despite the negative news, we're also seeing good things. The things we're observing are clear on our financials with changes to forecasts and certain results. So yes, your statement is accurate as a worst-case scenario, that markets don’t improve. However, if we achieve some reasonable level of recovery in the fourth quarter and the first half of next year, you can extend that timeline further. But at the same time, I think we all understand that a company like ours, with the amount of real estate that we own and the operations we manage, we're going to need some additional liquidity, and we are currently in the marketplace looking for that.

Okay, so maybe I'll just finish with that last question there. Can you just fill us in on what you're thinking regarding additional capital? Is that equity? Is that a private investment? Is that maybe a joint venture? Maybe just share a little bit about what you're considering?

I think the answer to that is yes to all. I mean, we continue to look at government programs, version 2.0. The PPP excludes public companies, but that may not be the end of the SBA PPP program. The main street program was not really suitable for real estate investors, but that may change. If you follow some news from Congress, there was a Private Equity Line being sponsored by a congressman out of Texas, which is geared towards the CMBS universe and real estate lenders; that’s a very good program. I don't know if any of those will come to pass, but we continue to monitor them. We already took advantage of one of them, the PPP program, back in the quarter. Regarding the private side, yes, we're looking at solutions that would provide liquidity to the company. We're also exploring joint venture partners, as we believe there's a once-in-a-century opportunity here. So, we are considering partnership opportunities that can help position us to buy properties in the future.

Okay. All right. Thank you for your time.

Thanks, Alex.

This will conclude our question-and-answer session. I'd like to turn the conference back over to Dave Folsom for any closing remarks.

Thanks, everyone for participating in our call, and we look forward to speaking with everyone again in our next quarter. Thanks.

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