Sotherly Hotels Inc. (SOHON) Q4 2020 Earnings Call Transcript

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 in the release. The company has reconciled all non-GAAP financial measures, the most directly comparable GAAP measure in accordance with REG-G requirements. Any statements made in this conference call, which are not historical, constitute forward-looking statements. Although we believe the expectations reflected by 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 for the year. Looking at results for the composite portfolio, which remained fully open during the quarter, RevPAR decreased 62.3 percent over the prior year, reflecting a 52.6 percent decrease in occupancy and a 20.4 percent decrease in ADR for the year. Portfolio RevPAR decreased to 60.8 percent over the prior year, with a 56.4 percent decrease in occupancy and a 10.1 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's impact on travel demand as well as macroeconomic factors. While the third quarter showed gradual improvement, the fourth quarter was choppier. October's 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, hospitalizations, and the implementation of travel restrictions in some municipalities. Examining our results on an absolute basis for the portfolio highlights, of course, uneven performance as RevPAR was $43.78 in October and $35.67 in November and $36.56 in December. Despite the challenges we faced during the quarter and in December, our staff's 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 also closed 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 as indicators in these segments suggest 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 146 for the quarter, gaining 2700 basis points in share. The outperformance was due to a small group business, an uptick in transient business travel, and weekend leisure business. The photo album in Tampa continues to ramp up following its renovation and conversion, achieving a RevPAR index of 125 for the quarter, gaining 4900 basis points this year from its competitors. We are optimistic this hotel has even more room to grow in share and firmly positioned 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 121 percent, a gain of 1700 basis points in share. The outperformance is due to the return of film groups we mentioned, as well as weekend leisure business, both of which have been 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 100 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 the portfolio, generally allowing us to defer payments of principal and or interest for periods that began back in April 2020 and that extend through various dates ending between February 2021 and December 2021. They also waived or modified covenants in order 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 a loan agreement with affiliates of Kamins Wilson Hospitality LP and a co-investor for an aggregate amount of $20 million, with an additional $10 million 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 1.47 times the principal amount borrowed during the initial three-year term, with a one-year extension as a company option. The loan also carries a 6% current interest rate payable quarterly during the initial three-year term and includes certain covenants such as borrower one-year liquidity thresholds. We believe the loan satisfies our immediate need for liquidity that 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 31, 2020, for the fourth quarter, total revenue was approximately $14.6 billion, representing a decrease of approximately $29.7 million or 67.1 percent over the same quarter a year ago. For the year, total revenue was approximately $71.5 million, representing a decrease of approximately $114.3 million or 61.5 percent over the prior period. Hotel EBITDA for the quarter was a deficit of approximately $1.9 million, representing a decrease of approximately $11.2 million or 120 percent over the same quarter a year ago. For the year, hotel EBITDA was a deficit of approximately $3.2 million, representing a decrease of $50.2 million or 107 percent over the prior period. Adjusted FFO for the quarter was a deficit of approximately $10.7 million, a decrease of approximately $11.7 million over the same quarter a year ago. For the year, adjusted FFO was a deficit of approximately $36.2 million, representing a decrease of approximately $53.4 million, or over 300 percent over the prior period. Please note that our adjusted FFO excludes the charges related to the early extinguishment of debt, gains and losses on derivative instruments, charges related to an aborted or abandoned securities offering, costs changes 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 interest income, corporate, general and administrative expenses, and the current portion or the cash portion of our income tax provision and other items as well. Please refer to our earnings release for additional detail. Looking at our balance sheet as of December 31, the company had total cash of approximately $35.3 million, consisting of unrestricted cash and cash equivalents of approximately $25.3 million, and approximately $10 million 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 $500,000 and $600,000 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 $500,000 and $550,000 per month. Capital expenditures are estimated to range between $250,000 and $350,000 per month, and outlays for scheduled payments of principal and interest are expected to range between $1.1 and $1.4 million per month. Overall, we’re expecting a total cash burn of approximately $4.5 million for the first quarter. At the end of the quarter, we had principal balances of approximately $390.3 million in outstanding debt at a weighted average interest rate of 4.66 percent. Approximately 87 percent of the company’s debt carries 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 53 percent from the same quarter a year ago, hotel operating expenses exceeded hotel revenue by approximately $1.9 million. We have also significantly scaled back our capital projects and anticipate that capital expenditures, which primarily represent the replacement of systems critical to the operation of our hotels, will amount to approximately $4 million per calendar year 2021. 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 the deferral of payment of dividends announced in January. The suspension and deferral eliminate a draw on the company’s cash reserves of approximately $4.25 million per quarter. The company continues and will continue to have discussions with its lenders regarding anticipated noncompliance with the financial covenants and 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. Neither can we guarantee that obtaining these waivers will not incur 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 in 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 that 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. Despite the difficult operating environment, 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 for 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, including the layoff of over 90 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 and defer all non-essential capital expenditures. As Tony mentioned, the increased property level efficiencies reduced hotel operating expenses by more than 50 percent, 53 percent during the quarter. At the corporate level, the company implemented several cash conservation efforts, which included the layoff of over 20 percent of the staff, a reduction in salaries and benefits for all remaining staff, ceasing all cash incentive compensation, and waiving the quarterly director’s 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 CPA’s paycheck protection program. As we adjusted our strategy to fit the operating environment shaped by COVID-19, we managed our margins to meet the pandemic's demand by preserving occupancy, maintaining rate integrity, and streamlining our operations. We recognized and capitalized on new trends in traveler behavior that were a direct result of the pandemic, highlighted 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 $20 million, which includes an option to draw an initial $10 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. Focusing on the impending recovery, we manage our balance sheet, our obligations, and preserve our asset base. With the completion of this transaction, we accomplished our number one objective for the fourth quarter and better positioned the company to take advantage of the recovery. Although a number of 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 not fully materialized, the vaccine is a fundamental game changer for the travel industry, as it provides confidence in the ability to travel safely and serves as the catalyst needed to lift corporate travel restrictions and hold in-person events. Still, the primary contributing factor in 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 and what we believe will be a subsequent relaxation of travel restrictions. In the meantime, COVID-19 positivity rates and hospitalizations continue to decline. While TSA airline data has shown significant improvements in recent weeks, our Recovery Index, which tracks a number of leading and trailing indicators, including website visits, bookings, future bookings, and achieved occupancy, 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 for the return of group business at our properties during the start of the New Year. We’ve been encouraged by the return of smaller groups and room blocks as the vaccine has become 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 back half of the year should be characterized by larger corporate and perhaps city-wide events entering 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. Additionally, we believe there is a substantial amount of pent-up travel demand. Both business and leisure travel segments consumers have amassed significant savings since the outset of the pandemic, which should support strong leisure travel once the vaccine is more widely distributed. Recent 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 corrects itself, we believe prospects will arise for seasoned hotel companies like Sotherly to take advantage of acquisitions and asset management opportunities. Additionally, a number of capital providers have expressed interest in partnerships and joint ventures or other structures in the lodging space. We continue to pursue such opportunities. In closing, there is a great deal of work yet to be done, 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 attractive, and we frankly exceeded our budgets in January. February is looking pretty good as well. I think we will be on track. So it’s portfolio-wide. We did have some government pickup in some of our markets in Northern Virginia in January, which was also beneficial. As Tony mentioned, the hotels achieving positive hotel EBITDA is where we are as a company right now. Hopefully, we’re going to continue in a positive direction. I will tell you that as close as eight weeks ago, we were probably seeing $40,000 – $50,000 a night in bookings. Now we’re seeing $150,000 a night in bookings portfolio-wide. Most of it is 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, people are more confident; they are getting out on the road, and they’re getting into airplanes. Anecdotally, from airport information I’ve discussed with our board of directors and others, airports were packed this past weekend. So all those are good indicators. I don’t know if that fully answers your question or not, but that’s what we’re seeing.

Yes. No, that’s very helpful color. I appreciate that. And then just a 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. But I can tell you last year, you know, corporate group bookings were rolling forward, so you’d have a cancellation, and then they would book 90 days out and 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 we 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. A lot of big companies still have not really opened the door, but their meeting planners and group bookers are already looking around; they’re putting what I would call shadow bookings at the hotels in anticipation of being able to do so for real. So that demand, I think, is there. You’ll 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 JVs taking advantage of acquisition opportunities that are out there. Just curious what you’re seeing and, you know, in your target markets, you know, on the acquisition side, in terms of potential opportunities, interest if you’re seeing any distress as well.

Yeah, I mean, I think there’s more of it to come, but we’ve seen a few bankruptcy filings, we’ve seen some meaningful sales, and we’ve seen some outright marketing for hotels. So the activity is definitely picking up. I think what we would say is 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; I see quite a bit every week. The bow wave is definitely getting a little bigger, and I think in 2021, we’re going to see a lot more activity with assets trading hands.

Okay, great. And just last question for me. More housekeeping interested, but the latest is on the negotiations with special services for the Doubletree down in Hollywood. Just interested in how those are progressing and how you see that situation potentially playing out.

Yeah, hey, Tyler. Scott, it’s going well. We’ve made comments before that the special servicing process for this one in particular is just very slow moving; it’s a complete logjam. We’ve been in continual, although inconsistent communication. We do have forbearance terms that we could accept, but they’re currently continuing to go through the approval process on that. The short answer is it’s all positive; it’s just a matter of trying to get the best deal that we can at this point.

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 you have in deferral where you reach resolution. I think you said, apart from the Hollywood hotel, that you can defer payments from February or at the latest one until December. I guess two parts to that. What are the changes you guys have seen in interest rates or covenants or any of the terms? What are the changes you’re seeing as the lenders agree to the differences?

Yes, there has not been any change in interest rates at this point. That hasn’t been something we've asked for. Covenants: luckily for us, almost half of our portfolio is covenant-free in terms of not having any debt service coverage ratio (DCR) covenants as part of the loan agreements. The ones that do have DCR covenants or other covenants, they just continue to modify them. They are waiving them for a period of time or now we’re starting to set them in a ramped-up fashion so that they’re achievable. I mean, no lender is coming to us and saying we need to meet a DCR test; they understand that that’s just not achievable. We’re just continuing to modify them in a way that they can be achieved and kept in good standing on their books.

Okay? And then, given what you’ve outlined as far as the potential for the second half for corporate travel to come back, obviously, it’s great to see the pent-up demand. Up north, we’re seeing everyone head down to Florida or down south to get out of the restrictions. But it seems like you’re going to need to defer these loans into 2022. Based on Scott's comments about the lenders' receptiveness on making any covenant adjustments to reflect the environment, should we take it that it’s not a problem for you to extend these loans or defer them into 2022? Or do you sense that special servicers or lenders are going to start to play hardball if you can’t start to do something by later this year?

Yes, we’re obviously dealing with it loan by loan, and property performance is the focus for lenders. As Tony mentioned, some of our properties are cash flow positive in the first quarter; as a portfolio, we expect them to be cash flow positive. Lenders are going to be looking at that as these properties with loans become cash flow positive—they become less inclined to defer payments. Most lenders have gone from deferring principal and interest to deferring just principal. As we get to the end of the forbearance agreements, we continue to ask for more; however, I think at a certain point if the property is generating cash flow, we’re going to see less and less receptivity from lenders to give forbearance.

Okay, that’s fine. And then the last question is, if you rebound on the business obviously, you’ve cut a lot of jobs, which is very difficult as an employer. Not easy to do. You’ve made the business more efficient, you know, whether it’s blocking out floors or limiting the amenities and services, et cetera. As you guys reopen, do you envision a point where you’re going to have to re-add staff or re-add amenities before this sort of revenue picks back up just because of competitiveness? Or do you believe you can maintain this more efficient business model that you’ve adopted further into the recovery before needing to restore some of the amenities or staffing?

Yes, I tell you, every two weeks, I look at the payroll numbers as a percentage of revenue, and that percentage is plummeting. Our flow-through continues to improve, because as we get more occupancy and more rate, more revenue, we are not layering on additional expenses. Our internal policy with our manager—we can touch all the hotels—is that we’re not going to front-load expenses or payroll in anticipation of increased demand. It will have to match as we get additional bookings; that’s when we think about opening up amenities, food, beverage services, and additional staffing. So what you’re concerned about is what we’ve been concerned about for 12 months: we’ve got to match fund our revenues with our costs on a very marginally profitable basis. We’re just not going to declare the pandemic over and then re-hire everybody. It’s a very sensitive process, and you really have to have onsite personnel with their finger on the pulse of the business to ensure we do not overload the assets with expenses too early.

Okay, thank you very much. Thanks. And 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.