SOTHERLY HOTELS LP Q3 FY2020 Earnings Call

Good day, and welcome to the Sotherly Hotels Inc. Third Quarter 2020 Earnings Call. 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, Vice President. 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 the 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 the duty to update or revise any forward-looking statements. With that, I’ll turn the call over to Scott.

Thanks, Mack. Good morning, everyone. I'll start off today's call with a review of our portfolio's key operating metrics for the quarter. Looking at results for the composite portfolio which remained fully open during the quarter, RevPAR decreased 63.3% over the prior year reflecting a 59.8% decrease in occupancy and an 8.9% decrease in ADR. Year-to-date portfolio RevPAR decreased 60.4% over the prior year with a 57.6% decrease in occupancy and a 6.5% decrease in ADR. These metrics were generally in line with our comp sets in the upper-upscale of the US lodging segment and appear to be ahead of the majority of our REIT peers that have reported thus far. Similar to the second quarter, the industry's third quarter performance was firmly influenced by COVID-19’s impact on travel demand as a gradual improvement in traveler sentiment reflected the progress and performance in the industry. The relative improvement in performance was not without setbacks, however, as states and local jurisdictions struggled to strike a balance between curbing the spread of the virus and reopening their economies. During the quarter, several Northeastern states implemented new travel restrictions requiring travelers from states with high infection rates to quarantine after arriving; most of these have now been lifted. Several states rolled back reopening plans with restrictions on businesses and social gatherings while other states, such as Florida, are now operating without any significant restriction at all. Lastly, during the quarter, civil unrest in several of our markets led to further complications for hotel operations in those locations. Thankfully, this activity has now also subsided. Needless to say, it was a bumpy start to the recovery. Nonetheless, as the broader travel industry experienced incremental improvement in performance throughout the quarter as evidenced by the steady upward trajectory of airline passengers and hotel demand. Examining our composite portfolio's performance month by month, we saw solid incremental improvement as the quarter went on and more consumers felt comfortable traveling again. Looking at RevPAR results on an absolute basis for the portfolio highlights this gradual improvement as RevPAR was $36.27 in July, $40.28 in August, and $44.28 in September. These figures represent a deceleration in year-over-year declines which were 38.4% in July, 58.9% in August, and 57.5% in September. While certainly not attractive figures on their own, they do represent consistent and meaningful steps in the right direction month after month. Similar to the first part of the summer, this relative improvement in performance for our portfolio was led by our leisure drive-to destinations such as Wilmington, Savannah, and our Florida properties. In contrast, our properties located in CBD locations of more urban markets such as Washington, D.C., Raleigh, Atlanta, and Houston have continued to be impacted by the limited improvement in travel to those more densely populated locations. It's also noteworthy that our management teams have done a commendable job maintaining rates at our properties, which outperformed the competitive sets year-over-year results by maintaining rate integrity; our properties were able to control costs and improve flow-through during the quarter. Although the third quarter experienced a considerable improvement in performance over the second quarter, substantial challenges lie ahead for our portfolio in the lodging industry as a whole. Intense pricing competition is underway in certain markets, further threatening the profitability of our operations. The upper-upscale segment, which encompasses the majority of our properties, faces added headwinds due to its reliance on group and catering revenues, which have been severely limited due to social distancing measures, group gathering size limitations, and corporate travel restrictions. Furthermore, although the slight uptick in business travel is encouraging, this segment remains severely constrained as companies extend corporate travel restrictions into early 2021. Lastly, and perhaps more profound, we expect the government's response and the trajectory of the virus to be a primary driver in shaping the demand of the industry. Despite these challenges, we believe our corporate team and management partners have executed soundly on our strategic plan and will adapt to the evolving lodging environment moving forward. I would like to end by noting that this past month we began the process of transitioning the management of the Hyatt-centric Arlington to some of these dedicated managers, Our Town Hospitality. With this change, which is planned to be completed later this month, all of Sotherly’s properties will be managed by Our Town. We believe the change will result in improved workflow and efficiency at both the property and corporate levels, which we believe will in turn lead to improved results in the future. I will now turn the call over to Tony.

Thank you, Scott. Reviewing performance for the period ended September 30, 2020. For the third quarter, total revenue was approximately $14.4 million, representing a decrease of approximately $28.1 million or 66.1% over the same quarter a year ago. For the first nine months, total revenue was approximately $56.9 million, representing a decrease of $84.6 million or 59.8% over the prior period. Hotel EBITDA for the quarter was a deficit of approximately $1.2 million, representing a decrease of approximately $10.1 million or 113% over the same quarter a year ago. For the first nine months, hotel EBITDA was a deficit of approximately $1.3 million, representing a decrease of approximately $39 million or 103.5% over the prior period. And lastly, adjusted FFO for the quarter was a deficit of approximately $8.6 million, a decrease of approximately $12.8 million or 301% over the same quarter a year ago, and for the first nine months, adjusted FFO was a deficit of approximately $25.5 million representing a decrease of approximately $41.7 million or 257% over the prior period. As Scott mentioned, due to the incremental demand experienced during the third quarter, six of our 14 hotels achieved better than a breakeven EBITDA, including Philadelphia, Jacksonville, our hotels in Wilmington, Laurel, Louisville, and the Hyde Resort and residences. The company had total cash of approximately $23.2 million consisting of unrestricted cash and cash equivalents of approximately $15.5 million as well as approximately $7.7 million which was reserved for real estate taxes, capital improvements, and certain other items. Company estimates the average monthly cash used for hotel-level expenses for the fourth quarter to range between a small amount of cash generation in the month of October to no more than $0.45 million in the months of November and December. We expect corporate level general and administrative expenses to range between $0.45 million and $0.5 million per month and outlays for scheduled principal payments of scheduled payments of principal and interest to be approximately $1.3 million per month. At the end of the quarter, we had principal balances of approximately $369.7 million in outstanding debt at a weighted average interest rate of 4.64%; approximately 86% of the company's debt carries a fixed rate of interest. During the third quarter, we remained committed to our action plan in accordance with our management companies to reduce hotel operating expenses and mitigate the impact of loss of business. Although we reduced hotel operating expenses by approximately 61% from the same quarter a year ago, hotel operating expenses exceeded hotel revenue by approximately $1.2 million. We have significantly scaled back our capital projects and anticipate the capital expenditures for the remainder of the year will only relate to the replacements of systems critical to the operation of our hotels. We estimate total capital expenditures to be approximately $4.4 million for calendar year 2020, most of which were already completed or well underway at the onset of the pandemic. As a result, a majority of our wholly-owned guestrooms are undergoing renovation over the past five years; we feel our portfolio is in a good position with no required renovations through the end of 2021. At the corporate level, we reduced expenses by approximately 25% to a range of $1.2 million to $1.4 million per quarter. The savings resulted primarily from reductions in regular compensation, anticipated bonuses and benefits for 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 a deferral of payments of dividends announced for January. The suspension and deferral eliminated draw on the company's cash reserves of approximately $4.25 million per quarter. Since the onset of the pandemic, we've had continuing discussions with our lenders regarding forbearance of current payments of principal and interest required under our loan agreements. Existing and contemplated agreements provide for deferral of current payments of approximately $3.9 million that would have been payable in the third quarter and approximately $3 million that would have been payable in the fourth quarter. While some deferrals are required to be repaid or caught up in subsequent quarters, much of the deferral will be repaid upon maturity of the loans. The company has been engaged in productive discussions with its lenders regarding anticipated non-compliance with the 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; neither can we guarantee that obtaining such waivers will not come with incurring additional costs, increased interest rates, or additional restrictive covenants and lender protections related to such loans. And I will now turn the call over to Dave.

Thank you, Tony, and good morning everyone. I'd like to take this opportunity to recognize our corporate and hotel associates for their hard work and perseverance during this unprecedented time for our industry. Since the last earnings call in August, the lodging industry and our company have continued to face significant challenges as the country grapples with COVID-19 and its effect on economic activity. While we continue to see green shoots of recovery as a whole, the revenue recovery trajectory for the US lodging industry has been slower than originally projected by industry experts. Despite the challenging operating environment, we remain dedicated to effectively managing the factors that are within our control, including mitigating risk, minimizing losses, and capitalizing on available opportunities. During the quarter, the company made notable progress in realigning its strategy to the new normal market environment generated by COVID-19. First and foremost, we continue to prioritize the health and safety of our guests and our associates. The extensive hygiene protocols implemented at each of our hotels have been successful in protecting our guests while maintaining a welcoming guest experience. As the quarter progressed, we recognized and capitalized on new trends in traveler behavior which were a direct result of the COVID-19 pandemic. Most notably was the importance of capturing transient leisure business which was further amplified by the steep decline of group and business travel. Weekend leisure business quickly became the company's most valuable market segment influenced by pent-up demand and relaxed work from home policies. Our leisure destinations including Wilmington, Savannah, and Jacksonville performed well during the quarter due to their drivable coastal locations. In addition, several of our markets including Philadelphia and Hollywood became prime targets for local guests to take staycations. While we do not believe this will be a permanent source of revenue, it provided relatively healthy weekend business at certain locations during the quarter. The company also focused on mitigating the pandemic's financial impact by delivering on and adapting stringent property and corporate level cost reduction initiatives implemented during the first quarter. As Tony mentioned, the increased property level efficiencies reduced total operating expenses by more than 60% during the quarter. We managed to improve profitability during the quarter by increasing occupancy, maintaining rate integrity, and streamlining operations. In order to streamline ops, we focused on rightsizing property services and amenities. For example, in certain markets, we limited food and beverage offering hours, downsized menus, implemented just-in-time food shipments, and eliminated valet service. Shifting guest preferences, which included the desire to forgo daily service in order to minimize contact with staff, have allowed our operations to improve housekeeping cost efficiencies. The lodging industry faces a number of challenges both in the near and long-term. One of the primary concerns surrounding the upper-upscale lodging segment as well as our company is the timeline on the return of group business. Due to government mandates, group gatherings have been heavily restricted resulting in muted pickup from this segment during the quarter. In recent weeks, we've been encouraged by the modest return in smaller group functions and room blocks. However, we expect this segment to be severely limited until social gathering restrictions are lifted. The second area of concern for our industry I'd like to touch on is the return of business travel, which has been severely constrained since the outset of the pandemic due to ongoing corporate travel restrictions. While a portion of the workforce has adapted to virtual business, we expect that once travel resumes, the competitive nature of business will accelerate and in-person meetings and transit business demand will improve. Similar to group travel, we've seen a slight increase in demand from this segment in recent weeks albeit at a muted pace. The convergence of several macroeconomic factors has resulted in a volatile operating environment for hotels. Uncertainty surrounding the passing of a necessary stimulus bill and the development of a COVID-19 vaccine are continuously shifting consumer confidence and are directly impacting the travel industry. The resolution of these events should be a game changer for our industry. Although the timeline for its rollout is still uncertain, we believe today's encouraging news regarding Pfizer's vaccine and the eventual implementation of a COVID-19 vaccine program will spur consumer confidence and provide an immediate boost to traveler sentiment in the lodging industry. Until these critical macroeconomic events are resolved, the pace and magnitude of the recovery will remain uncertain. We expect 2021 to be a vast improvement over 2020 and expect to see a material improvement in demand which will initially be reflected in occupancy gains with subsequent increases in rates. Forecasting a full return of demand and profitability in the lodging industry remains elusive and the timeline for a full return to 2019 demand levels remains unclear. Regardless of the macroeconomic factors, we remain dedicated to making sound operational decisions to reduce losses and conserve liquidity while delivering long-term value for our shareholders. Strategically, our foremost concern heading into the end of the year is preserving and sourcing liquidity. As Tony mentioned, we still have a monthly cash burn rate and although this burn rate has slowed it still must be contended with. We are looking to all sources for additional liquidity including private capital and any government programs for which we may qualify and we believe we will be successful in this endeavor. And with that, operator, we will open the call to questions.

And our first question today will come from Tyler Batory with Janney Capital Markets. Please go ahead.

Hi, good morning. This is Jonathan on for Tyler. Thanks for taking our questions. You know, obviously the industry got some positive news this morning. Can you just provide us with some thoughts on the recovery of your business and which segments, or if that changes, which segments may return first?

Well, I think as I said in my remarks and what we've alluded to in the call is that we think there's a lot of pent-up leisure demand and with the rollout of a vaccine program, I think we'll see some group business and some corporate business return. What we've seen, Jonathan, over the months prior to this is that the group and the business travel, the corporate group has pushed its reservations constantly into the future. So we'll have a booking, the booking will be canceled, and it will roll into the future and on and on and on. At some point, I think that has become a function of confidence in whether or not these groups can actually materialize at our hotels. I think with a good vaccine program implementation by the government and the private sector, then that certainty will be quite clear for these groups and those bookings will become definite. So that's the thesis we have, going into the first quarter next year.

Okay, great. I appreciate that color. And then switching gears toward REIT. Scott touched on this in his opening remarks, but obviously relatively strong in the quarter given the environment. Can you just provide some color on some of the revenue management initiatives that you’ve taken?

Yeah, I mean, obviously we’re big believers in revenue quality and revenue quantity. We think a race to the bottom is not necessarily a good idea for any of our hotels or any hotel in general. You get into these environments there are operators that just crash rates to give what little occupancy they can in the deals. We have tried to avoid that; sometimes it's unavoidable in this environment where rates do decline, but we've taken steps to ensure that we preserve as much rate integrity as we can. And we think that positions us well when we start to get a real recovery.

The only thing I'll add to that, Jonathan, is obviously, as we've said, the recovery in the demand we've seen in leisure business predominantly on the weekends in certain markets. And the pricing power is there. But there isn't anything once the weekend's over; you get to midweek, there isn't a whole world of demand. So we don't see the thought process behind dropping your rates midweek just to get a couple of rooms in the hotel. So that's really where we've seen overall our rates be fairly strong at those hotels where we just keep some good rate integrity on a consistent seven-day-a-week basis. There are some markets, as we mentioned, that are starting to really see challenges. Philadelphia airport being one of them; you’ll just see year-over-year rates. I mean, there are some battles that we're fighting. And I think we'll be fighting those for a while coming out of this. But overall, I think we've seen our managers do a pretty good job of holding firm.

Okay, thank you; that's very helpful. And then last one for me. Could you just provide some additional color on the occupancy trends and how they've moved into October?

Well, Scott gave in his opening remarks, I mean we've seen these incremental increases since the April lows week-by-week, month-by-month. We had a good spike in early September over the holiday. Leading into the election, things sort of tempered off a little bit, but we're still seeing gradual increases. And we're still seeing that. I think now we're going to start to see those trends accelerate. A lot of those occupancy trends were a function of decisions made at the local jurisdictional level. In Florida, when you saw the governor or mayors or counties relax their restrictions during the summer, we would see a big bump in occupancy. And then if those restrictions were reinstated, then you have a muted occupancy trend that follows. So I think what we're going to see now with this current news and some clarity with respect to the vaccine rollout is just continued incremental increases in occupancy, but this may be the news that everyone has been waiting for to start to relax travel restrictions once the rollout starts.

Okay, great. Thank you for all the color. And that’s all from me.

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

Hey, how are you? So, just a few questions here. One, just looking at your cash balance from last quarter, and I'm doing this in aggregate both the restricted and unrestricted. You had only gone down by about $2 million; you are still about the same $2 million burn rate. So I am guessing that the reason that it didn’t go down more is that all the loans that were in deferment or discussion, you made no payment on any of these. So, when these get settled out, will there be a catch-up on these loans or will you just start payment from that date forward and the missed payments won't have to be caught up all at once?

I will let Tony discuss the cash situation specifically, but I want to clarify that our mortgage loans, whether in forbearance or not, are all up to date. We have not simply neglected our mortgage payments. We have implemented various forbearance and modification agreements and initiatives since April, and we are current on all of them.

I was going to echo what Dave just said. I think first off, if we look back at what happened in the third quarter, we ended up realizing forbearance from a number of lenders that we couldn't have projected three months ago when we truly made our disclosures. I think we also performed better from our hotel EBITDA perspective than what we were forecasting. As far as what happens in the future, you know, we have ongoing discussions with our lenders. When we first began talking to them back in April, everybody thought this was maybe a three-month problem or a six-month problem, and every three months we’re on the phone with our lenders updating them as to what our outlook is for each of our properties and the kind of forbearance that we would like to have.

Okay, so just so we're all clear, and we're all using, I guess, simple English, just so we're on the same page, all of the loans that you have against all of your hotels, all those loans are current on payments or some of those have been, you’d been paying at a lesser rate, whether it be at interest or modified principal. I just want to make sure that I'm clear on everything that way we can sort of forecast how you guys are going to emerge from this?

I think what Dave was saying is that we're within the terms of our agreements as they've been modified with the lenders. So if, if the agreement was in place a year ago called for monthly payments of principal and interest listed at $100,000 a month, we may not have paid that. But as we've been able to negotiate a forbearance agreement with the lender, we're in compliance and within terms of that forbearance agreement.

Okay, so we're clear that you've gone to the lenders, you've gotten waivers, adjustments, and with those new terms, you're now current.

I think that's right. We're on the phone every week with lenders basically.

So whatever was the original versus now, that delta, that's an individual discussion whether it gets tacked on to the end, whether you make accelerated to try and cover that. But the point is that...

You’re correct.

Once you've modified the loans, you're now paying. That's helpful. My second question is, what is your breakdown of CMBS versus individual hotel loans? Specifically, how many of your hotels have individual loans and how many are part of CMBS pools?

We have three CMBS loans of the 12 mortgages.

Okay, so there are no individual loans; they're all pooled into CMBS?

No, no, there are three individual CMBS loans on three individual hotels with 12 individual mortgages on 12 assets; three of which are CMBS loans. None of our hotels, none of our mortgages are pooled or cross-collateralized; everything's solid individually on each hotel asset.

Okay, so there's no cross-collateralized. Okay. That's good. That's important. And then just a final thing and we'll put today's announcement aside. But you know, it definitely has seen that the Sun Belt has been just doing a lot better than the coasts. You mentioned some of your hotels were impacted by some of the social unrest. But then you also mentioned that Philly was breakeven. Certainly, I would think, would fall into the latter category. So can you just comment a little bit more on the hotel performance, especially with some of your breakeven hotels? Has it been just in general economic improvement in the area, or are there certain dynamics that are going on that are specific to some of your hotel locations that have been more the driver?

In some locations, as Scott mentioned in the outset, we've got leisure destinations in Wilmington, Savannah; those types of locations have been the catalyst for the improvement at or above a breakeven level because in some of those states and locations where there are minimal restrictions on activities. Leisure destinations in Wilmington and Savannah has been the catalyst for the improvement at or above a breakeven level; and in some of those states and locations where there are minimal restrictions on activities, that has been a dynamic qualifier, I guess if you want to term it that way; and in some other markets it's been far more restrictive from a government standpoint and if you're in a center city urban core location with an upper-upscale full-service hotel, that hasn't been a good equation for the last six months.

In Georgia, Savannah is attracting a lot of weekend leisure demand from Atlanta and nearby areas. However, people from Savannah are not traveling to Atlanta during the week for business. This highlights our current situation. Regarding Philadelphia, our hotel is not located in the central business district; it's near the airport. We have seen some airport-related business at the property, but we've also attracted leisure guests from the local community. Many locals opted for staycations at our hotel, which features an indoor pool, adding to its appeal. This influx of local guests has contributed positively to the property's performance over the summer, which is unusual compared to its typical demand.

Like, it really had a lot of downtown hotels that were closed; some of which carry Hilton flags. So we were actually getting a small amount of business that otherwise would have gone downtown through the Hilton reservation system; a nominal amount, but, you know, when everything is closed downtown and we're open, it does help.

And this will conclude our question-and-answer session. I'd like to turn the conference back over to the management team for any closing remarks.

Thank you, operator. Thank you all for dialing in this morning, and everyone have a good day. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.