SOTHERLY HOTELS LP Q4 FY2020 Earnings Call

Good day and welcome to the Sotherly Hotels’ fourth quarter 2020 earnings call and webcast. All participants will be in listen-only mode. Please note this event is being recorded. I would 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 ask on our website sotherlyhotels.com for 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 in this conference call that are not historical constitute forward-looking statements. Although we believe the expectations reflected in these 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’ll turn the call over to Scott.

Thanks, Mack. Good morning, everyone. Let’s start off today’s call with a review of our portfolio's key operating metrics in the quarter and the year. Looking at results for the composite portfolio, which remained fully open during the quarter, RevPAR decreased sixty-two point three percent over the prior year, reflecting a fifty-two point six percent decrease in occupancy and a twenty point four percent decrease in ADR for the year. Portfolio RevPAR decreased sixty point eight percent over the prior year, with a fifty-six point four percent decrease in occupancy and a ten point one percent decrease in ADR. These metrics were generally in line with our market competitors and ahead of the upper upscale U.S. lodging segment for the quarter and for the year. The lodging industry’s fourth-quarter performance continued to be firmly influenced by COVID-19 impacts on travel demand as well as macroeconomic factors. While the third quarter showed gradual improvement, the fourth quarter was choppier. October results were relatively strong, driven by leisure travel and a modest recovery in business and group travel. However, we experienced a decline in demand in November and December as a third wave of COVID-19 led to a record number of cases and hospitalizations, and the reimplementation of travel restrictions in some municipalities. Despite the challenges faced during the quarter, our strong sales efforts resulted in the highest level of group bookings since the outset of the pandemic, highlighted by the return of film industry crews at the Georgian Terrace in Atlanta. We were also able to close out the year on a high note as our warm-weather leisure destinations, including Savannah and our Florida properties in Jacksonville, Tampa, and Hollywood, all experienced strong pickups leading up to the New Year’s holiday. The improved group and leisure performance has carried through to the New Year, suggesting that the beginning of a sustained recovery is on the horizon. Looking at more detailed property highlights for the quarter, our DoubleTree in Jacksonville continued to outperform the market, achieving a RevPAR index of one hundred and forty-six for the quarter, gaining two thousand seven hundred basis points in share. The outperformance was due to small group business, an uptick in transient business travel, and weekend leisure. The Hilton Garden Inn in Tampa continues to ramp up following its renovation and conversion, achieving a RevPAR index of one hundred and twenty-five for the quarter, gaining four thousand nine hundred basis points this year from its competitors. We are optimistic this hotel has even more room to grow and firmly position itself as the market leader. During the quarter, the Georgian Terrace in Atlanta outperformed its competitive set, which consists exclusively of luxury properties, achieving a RevPAR index of one hundred and twenty-one percent, a gain of one thousand seven hundred basis points in share. This outperformance is due to the return of film groups and weekend leisure business, both of which were severely disrupted during the pandemic. Turning to corporate activity in November, we successfully transitioned the management of the Hyatt Centric Arlington to our Town Hospitality. With that transition, our Town now manages one hundred percent of our portfolio, which should continue to improve the efficiency and effectiveness of our day-to-day managerial efforts. We continue to work with our lenders and to date have successfully completed a variety of modification and forbearance agreements across the majority of our portfolio, generally allowing us to defer payments of principal and/or interest for periods starting from April 2020 and extending through various dates that end between February 2021 and December 2021. They also waive or modify covenants to keep the loans in compliance. To date, the only loan not in compliance with its covenants is the mortgage loan secured by the DoubleTree Resort Hollywood Beach. However, we are in active negotiations with that special servicer to finalize a forbearance agreement. During our last earnings call, we referenced our monthly cash burn rate and the need to address the company’s shrinking liquidity pool. At the end of the year, we announced that we entered into a loan agreement with affiliates of Kamins Wilson Hospitality LP and a co-investor, for an aggregate amount of twenty million dollars with an additional ten million dollars available to draw by year-end 2021. The loan matures in three years and will be payable on or before the maturity date at the rate of one point forty-seven times the principal amount borrowed during the initial three-year term, with a one-year extension option for the company. The loan also carries a six percent current interest rate payable quarterly during the initial three-year term, and includes certain covenants such as borrowing liquidity thresholds. We believe the loan satisfies our immediate need for liquidity and will provide us the bridge to a sustained recovery for the industry. I will now turn the call over to Tony.

Thank you, Scott. Reviewing performance for the period ended December 31st, 2020, for the fourth quarter, total revenue was approximately fourteen point six million dollars, representing a decrease of approximately twenty-nine point seven million dollars or sixty-seven point one percent over the same quarter a year ago. For the year, total revenue was approximately seventy-one and a half million dollars, representing a decrease of approximately one hundred and fourteen point three million dollars or sixty-one point five percent over the prior period. Hotel EBITDA for the quarter was a deficit of approximately one point nine million dollars, representing a decrease of approximately eleven point two million dollars or one hundred and twenty percent over the same quarter a year ago. For the year, Hotel EBITDA was a deficit of approximately three point two million dollars, representing a decrease of fifty point two million dollars or one hundred and seven percent over the prior period. Adjusted FFO for the quarter was a deficit of approximately ten point seven million dollars, a decrease of approximately eleven point seven million dollars over the same quarter a year ago. For the year, adjusted FFO was a deficit of approximately thirty-six point two million dollars, representing a decrease of approximately fifty-three point four million dollars, or over three hundred percent over the prior period. Please note that our adjusted FFO excludes charges related to the early extinguishment of debt, gains and losses on derivative instruments, charges related to an aborted or abandoned securities offering, costs related to the deferred portion of our income tax provision, as well as other items. Hotel EBITDA excluded these charges, as well as interest expense and income, corporate general and administrative expenses, and the cash portion of our income tax provision and other items. Please refer to our earnings release for additional detail. Looking at our balance sheet as of December 31st, the company had total cash of approximately thirty-five point three million dollars, consisting of unrestricted cash and cash equivalents of approximately twenty-five point three million dollars, as well as approximately ten million dollars which was reserved for real estate taxes, capital improvements and certain other items. The company estimates the average monthly cash generated at the hotel level for the first quarter to range between five hundred thousand and six hundred thousand dollars per month. Thus, we believe that this will be the first quarter our properties will achieve positive cash flow since the start of the pandemic. We expect corporate level expenses to range between five hundred and five hundred fifty thousand dollars per month. Capital expenditures are estimated to range between two hundred and fifty thousand and three hundred and fifty thousand dollars per month, and outlays for scheduled payments of principal and interest are expected to range between one point one and one point four five million dollars per month. Overall, we’re expecting a total cash burn of approximately four and a half million dollars for the first quarter. At the end of the quarter, we had principal balances of approximately three hundred and ninety point three million dollars in outstanding debt at a weighted average interest rate of four point sixty-six percent, with approximately eighty-seven percent of the company carrying a fixed rate of interest during the fourth quarter. We remain committed to our action plan in coordination with our management company to reduce hotel operating expenses and mitigate the impact of the loss of business. Although we reduced hotel operating expenses by approximately fifty-three percent from the same quarter a year ago, hotel operating expenses exceeded hotel revenue by approximately one point nine million dollars. We have also significantly scaled back our capital projects and anticipate the capital expenditures, which primarily represent the replacement of systems critical to the operation of our hotels, to amount to approximately four million dollars per calendar year. As a result of the majority of our wholly-owned guest rooms undergoing renovation over the last five years, we feel the portfolio is in a good position with no required renovations through the end of 2021. Last March, we announced the suspension of our dividend and deferral of payment of dividends. This suspension and deferral eliminate a draw on the company’s cash reserves of approximately four and a quarter million dollars per quarter. The company will continue to have discussions with its lenders regarding anticipated noncompliance with the financial covenants in the agreements that include them. Based on these discussions, the company believes it will continue to obtain waivers from its lenders under agreements that articulate noncompliance in the event of default. However, no guarantee can be made that such waivers will be obtained, nor can we guarantee that obtaining these waivers will not come at the expense of additional costs, increased interest rates, or additional restrictive covenants and other lender protections related to such loans. I’ll now turn the call over to Dave.

Thank you, Tony, and good morning, everyone. Filled with unprecedented challenges, 2020 was the most difficult year in history for the modern lodging industry as well as our company. The COVID-19 pandemic caused the most severe contraction for the lodging industry ever recorded, including the financial crisis of a decade ago, the Great Depression, and any number of other economic recessions or downturns over the past century. While we recognize the challenges facing our industry are far from over, we are happy to say that 2020 is behind us and feel it is important to review the accomplishments of our committed property and corporate-level teams during the year. In the difficult operating environment of 2020, we remained dedicated to effectively managing the factors within our control, including mitigating risk, minimizing losses, and capitalizing on available opportunities. First, we prioritized the health and safety of our guests and associates by implementing extensive sanitation protocols in each of our hotels, which have been successful in keeping our guests and associates safe while maintaining a pleasant and welcoming lodging experience. Our stay-open strategy proved successful as it enabled a quicker ramp up following the pandemic’s initial demand shock and allowed a continuous sales effort throughout the course of the year. The company focused on mitigating the pandemic’s financial impact by delivering on stringent property and corporate-level cost reduction initiatives implemented during the first quarter. This included the layoff of over ninety percent of hotel staff, the closure of food and beverage outlets, and other non-essential guest amenities in order to shrink the cost structure of the properties, as well as the deferral of all non-essential capital expenditures. As Tony mentioned, the increased property-level efficiencies reduced hotel operating expenses by more than fifty-three percent during the quarter. At the corporate level, the company implemented several cash conservation efforts, which included the layoff of over twenty percent of the staff, a reduction in salaries and benefits for all remaining staff, ceasing all cash incentive compensation, and waiving the quarterly directors' cash fees by the company’s board. In addition, common dividends were suspended, preferred dividends were deferred, and our balance sheet was bolstered during the second quarter by securing proceeds through the Paycheck Protection Program. As we adjusted our strategy to fit the operating environment shaped by COVID-19, we managed our margins to meet the press demand by preserving occupancy, maintaining rate integrity, and streamlining our operations. We recognized and capitalized on new trends in traveler behavior, spotlighted by the importance of capturing transient leisure business, which was amplified by the steep decline of group and business travel. As a result of management’s quick and decisive actions during the year, we believe we are on the right course to endure the waning impacts of the pandemic and to preserve the company’s future success. As Scott mentioned, during the fourth quarter, we addressed our near-term liquidity concerns by securing a loan in the amount of twenty million dollars, which includes an option to draw an initial ten million by year-end. The loan greatly improves the company’s liquidity position and enables us to navigate the ongoing negative impacts of the pandemic. Focused on the impending recovery, we are managing our balance sheet, our obligations, and aiming to preserve our asset base. With the completion of this transaction, we've accomplished our number one objective for the fourth quarter and are better positioned to take advantage of the recovery. Although various events shaped the lodging business climate during the fourth quarter, none was as significant for our industry as the approval of the vaccine. While its positive impact has yet to fully materialize, the vaccine is a fundamental game changer for the travel industry. It provides confidence in traveling safely and serves as the catalyst needed to lift corporate travel restrictions and hold in-person events. The primary contributing factor to the industry’s recovery in the near term is the rate at which the vaccine program is rolled out. While the program experienced a slow start in December and January due to strict guidelines for eligible recipients, the U.S. coronavirus vaccine supply is poised to double in the coming weeks, allowing for a broad expansion of vaccination efforts. This should lead to the subsequent relaxation of travel restrictions. Meanwhile, COVID-19 positivity rates and hospitalizations continue to trend downward. TSA airline data has shown significant improvements in recent weeks. The Skift Recovery Index, which tracks a number of leading and trailing indicators, including website visits, bookings, future bookings, and achieved occupancies, reported a travel environment in January that was the best since the outset of the pandemic. A successful rollout of the vaccine is also a primary contributor to the timeline of the return of group business at our properties at the start of the New Year. We’ve been encouraged by the return of smaller groups and room blocks. As the vaccine becomes more widely available, corporations and meeting planners have expressed greater confidence in the ability to safely hold larger events during the second half of the year. In January, our sales team booked more group business than during the entire fourth quarter of 2020. Social groups represent a majority of our near-term group bookings, while the latter half of the year should be characterized by larger corporate and perhaps city-wide events as we enter the next phase of the business cycle. We have plenty of reasons for optimism. In addition to the improving vaccine rollout, we believe the concentration of our properties in the southern U.S. with limited exposure to large gateway markets positions the company well for outsized returns. Moreover, we believe there is substantial pent-up travel demand. Both business and leisure travel segments have consumers who have amassed significant savings since the onset of the pandemic, which should support strong leisure travel once the vaccine is more widely distributed. Recent Smith Travel data reported that industry-wide occupancy hit its highest level since October. We are cautiously optimistic that the combination of these factors will lead to a sharp increase in travel and a strong recovery for the industry in the coming months. Looking ahead, as the industry stabilizes, we believe prospects will arise for seasoned hotel companies like Sotherly to take advantage of acquisition and asset management opportunities. Additionally, several capital providers have expressed interest in partnerships and joint ventures in the lodging space. We continue to pursue such opportunities. In closing, a great deal of work remains, but we believe our strong efforts during 2020 have positioned us well entering the recovery. We remain dedicated to making sound operational decisions to reduce losses and conserve liquidity in the near term while delivering long-term value for our shareholders. We will now open the call for questions.

We will now begin the question and answer session. The first question will be from Tyler Batory from Janney Montgomery.

Thank you. Good morning. I hope everyone is doing well. A few questions for me and I wanted to start with the comments on the positive cash flow at the property level in the first quarter. Just wondering if we could unpack that a little bit more and if you could talk about some of the assumptions broadly behind that, whether it be your occupancy levels or rates, and then also how many hotels potentially are driving that number specifically?

I would tell you that so far in the quarter, Tyler, we’ve seen a broad-based positive environment. Our January numbers were very, very attractive and we frankly blew by our budgets in January. It was very attractive. February is going to be pretty good as well. I think we will be on track and I think it’s portfolio-wide. We did have some government pick up in some of our markets in Northern Virginia in January, which was beneficial to what Tony mentioned as the hotels reaching positive hotel EBITDA as well. Hopefully, we’re going to continue in a positive direction. I will tell you, as early as you know, as close as eight weeks ago, we were probably seeing forty to fifty thousand dollars a night in bookings. Now we’re seeing one hundred and fifty thousand dollars a night in bookings portfolio-wide. So most of it’s transient. We’re getting smaller groups here and there, but most of it is simply pent-up leisure demand. Now that restrictions are being lifted and people are more confident in getting out on the road and into airplanes. Anecdotally, airport information, I’ve talked to from our board of directors and other sources, indicates that airports are packed. All this is positive news.

Yes. No, that’s very helpful color. I appreciate that. And then just follow up. I wanted to go back to the comments earlier on bookings, especially for the back half of 2021. How many of those are rescheduled business that was canceled in 2020 that has been pushed out? And how much of that is incremental bookings that are coming through as well?

Well, I’ll let our team answer as well. I can tell you that last year corporate group bookings were rolling forward—so you’d have a cancellation and then they would book ninety days out and then rebook and rebook, because no one knew where the bottom was at the end of the pandemic. I would say some of that has rolled forward. But as you go into the new year, a lot of it went away, but now it’s automatically coming back in the second half of the year in terms of the demand. The big question mark really is corporate travel restrictions. You see a lot of big companies that still have not really opened the door, but all their meeting planners and group bookers are already looking around and putting what I would call shadow bookings at the hotels in anticipation of being able to do so for real. That demand, I think, is there. You’re going to have to see the final unwinding of restrictions both in localities and at corporations to see those things actually become definite group bookings. Do you guys have anything to add?

Okay, and then in the prepared remarks, you talked about potentially some joint ventures taking advantage of acquisition opportunities that are out there. Just curious what you’re seeing in your target markets on the acquisition side and if you’re seeing any distress as well.

Yeah, I mean, I think there’s more of it to come. We’ve seen a few bankruptcy filings, some distressed sales, and some outright marketing for hotels. So the activity is definitely picking up. I think there is a lot of capital out there on the sidelines waiting for the right time, the right transaction, and the right hotel partner to come in and make some of these transactions happen. I see quite a bit of activity every week. So the bow wave is definitely getting larger, and I think in twenty twenty-one we’re going to see a lot more activity with assets trading hands.

Okay, great. And just last question for me. More housekeeping interested, what’s the latest on the negotiations with special servicers for the DoubleTree down in Hollywood?

Yeah, hey, Tyler. Scott here. It's going well. We’ve made comments before. The special servicer for this one, in particular, is just very slow-moving. I mean, it’s a complete logjam. We’ve had continual, though inconsistent communication. We do have forbearance terms that we could accept, but they’re currently going through the approval process on that. So, the short answer is it’s all positive. It’s just a matter of trying to get the best deal we can right now.

I appreciate all that detail. That’s all for me. Thank you.

The next question will be from Alexander Goldfarb of Piper Sandler.

Hey, good morning. Just a few questions here, sort of picking up on the loans that you have in deferral where you reached a resolution. I think you said that, apart from the Hollywood hotel, you can defer payments from February or at the latest one until December. I guess two parts to that. First, what are the changes that you guys have seen in interest rates or covenants or any of the terms as the lenders agree to these deferrals?

Yes, there has not been any change in interest rates at this point. That hasn’t been an issue. Regarding covenants, luckily for us, almost half of our portfolio is covenant-free in terms of not having any DCR covenants as part of the loan agreements. So there hasn't been a requirement to do any waivers. The loans that do have debt service coverage ratio covenants haven’t needed to be modified significantly. Lenders have been understanding of the situation. They modify covenants or set them in a ramped-up fashion so that they are achievable. No lender is coming to us and saying we need to meet a debt service coverage ratio test. They understand that’s just not feasible. So, we continue to modify them in a way that keeps us in good standing on their books.

Okay. And then, given what you’ve outlined regarding the potential for the second half of corporate travel to come back, it’s great to see the pent-up demand. We can see everyone heading down to Florida or down south to escape the restrictions to the north. But it would seem like you guys are going to need to defer these loans into 2022. Based on Scott’s comments about the lenders' receptiveness towards making any covenant adjustments reflective of current circumstances, are we to understand that it’s not a problem for you to extend these loans or defer them into twenty twenty-two? Or is your sense that the special servicers or the lenders may start to play hardball?

Yes, I mean, we’re obviously dealing with it on a loan-by-loan basis and based on property performance. That’s what lenders are focused on. Obviously, as Tony mentioned, some of our properties are cash flow positive in the first quarter, and as a portfolio, we expect them to be cash flow positive. Lenders will be looking at that performance. If the properties are generating cash flow, they become less inclined to defer their payments. What we’ve seen is most lenders have shifted from deferring principal and interest to deferring just principal. Eventually, that’s going to burn off, so as we reach the end of forbearance agreements, we will ask for more, but I think at some point, as properties generate cash flow, lenders will be less receptive to granting forbearance.

Okay, that’s fine. And then the last question is on, you know, if you guys rebound on the business. Obviously, you’ve cut a lot of jobs, which is always difficult as an employer. But as you guys reopen, do you envision a point where you will need to re-add staff or reintroduce amenities before revenue picks back up due to competitiveness? Or is your view that you can maintain this more efficient business model that you’ve adopted further into the recovery before the need to start restoring some amenities, staffing, or things like that?

Yes, I will tell you that every two weeks I look at the payroll numbers as a percentage of revenues, and that percentage is plummeting. Our flow-through continues to improve because as we get more occupancy and rate increase, we are not layering on additional expenses. Our internal policy with our manager is that we’re not going to front-load expenses or payroll in anticipation of increased demand. It will have to go in lockstep with additional bookings as the climate improves. That’s when we think about reopening amenities, food and beverage services, and additional staffing. It’s a very sensitive process, and it’s critical to have onsite personnel with a finger on the pulse of the business to ensure we don’t overload the assets with expenses too early.

Thank you very much. This concludes our question-and-answer session. I would now like to turn the conference back over to Dave Folsom for any closing remarks.

Thank you for joining us on our call, and we look forward to talking with everybody in a few months.

Thank you. The conference is now concluded. Thank you all for attending today’s presentation. You may now disconnect your lines. Have a great day.