Sotherly Hotels Inc. (SOHON) Q3 2022 Earnings Call Transcript

Hello, and welcome to today's Sotherly Hotels Third Quarter 2022 Earnings Call and Webcast. My name is Bailey, and I'll be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to our host, Mack Sims, Vice President of Operations. 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'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 the third quarter results for the same-store composite portfolio, RevPAR was $103.42, driven by an occupancy of 62.7% and an ADR of $164.97. Third quarter RevPAR performance represents an increase of 12.3% over the same period in 2021. Looking at these figures versus the third quarter of 2019, RevPAR increased 2.7%, with occupancy down 7.2%, and ADR increasing 10.8%. Year-to-date RevPAR for the same-store composite portfolio was $110.65, with occupancy of 62.2% and an ADR of $177.88. Year-to-date RevPAR performance represents an increase of 31.4% over the same period in 2021. Looking at these figures for the comparable period in 2019, RevPAR was down 7.2%, with occupancy down 12.9% and ADR increasing 6.5%. Overall, we were pleased with our portfolio's third-quarter results, highlighted by sustained strength of demand for leisure travel during the summer months, coupled with strong growth in demand for group business travel. For September alone, RevPAR was up 9% over 2019, with ADR up nearly 11%, and occupancy only slightly off to pre-pandemic levels, a definitive indication that we are nearing a normalized operating environment. Examining our portfolio's recent booking trends for business and group travel further validates the thesis that demand from these segments is returning to normalized levels. For the group segment, our portfolio produced 86% of the group business in the third quarter 2022 compared to Q3 2019. However, in September, group business was 106% of group business in September 2019. For the business travel segment, our portfolio was at 67% of the business travel produced in Q3 2019. Though in September, business travel revenue increased to 78% of the business travel in September of 2019. These trends, which have shown further improvement thus far during the fourth quarter, are an encouraging sign for our company. The continued strengthening of the business travel and group segments came across our entire portfolio, but was most noteworthy at our heavily impacted urban hotels in Washington, D.C. and Houston, which experienced the best year-over-year improvement in performance. While contribution from group and business travel at these hotels was at its highest level since the start of the pandemic, we believe there is still significant upside potential for these assets as midweek occupancy continues to grow and forward bookings are trending positively for Q4 and next year. In addition, weekend performance at our urban properties was boosted during the quarter by demand drivers such as concerts, major sporting events, and citywide events that are now running at or near full capacity. Meanwhile, our portfolio’s leisure-focused hotels maintained their strong results during the quarter, as leisure demand was combined with a steady return of group demand to produce outstanding results. Rate growth at our leisure-focused hotels was especially strong during the quarter, with rates easily outperforming pre-pandemic levels. Looking at some highlights across the portfolio, the DeSoto Savannah continued its excellent results during the quarter as the property easily outpaced 2019 metrics with a 36.3% gain in RevPAR, fueled by significant rate growth of 27.8% and occupancy growth of 6.7% over 2019. The Hyatt Centric Arlington continues to show strong sequential improvement relative to 2019, fueled by the return of business travel to the hotel. Though, third quarter RevPAR was still off 10.1% compared to the same period in 2019, this was a significant improvement over the second quarter. Rate, which was up 8.6% compared to the third quarter of 2019, was the main driver of this improvement. The property continues to outperform its competitive set, and during the quarter, the hotel achieved a RevPAR index of nearly 124% and gained over 8% in RevPAR share, further solidifying its position as the leader in the market. Hotel Ballast in Wilmington, North Carolina posted exceptional results for the third quarter as the hotel drove strong demand from the leisure and group segments, improving RevPAR by 12.3% over 2019, fueled by a 3.2% increase in occupancy and an 8.9% increase in rate. The property continues to perform well versus the competitive set, gaining 7.4% in RevPAR share during the quarter. Management’s strategic cost control initiatives and revenue management strategies aimed at driving rate led to commendable profitability during the third quarter as we continue to experience margin expansion over pre-pandemic levels. Looking at hotel EBITDA margins, for the third quarter 2022 versus 2019, margins expanded 420 basis points to 25.1%. Year-to-date, margins have expanded 110 basis points over 2019 to 27.7%, the highest level in the company's history. While the labor markets are still challenging, this headwind appears to be easing, thus reducing our reliance on expensive contract labor while also improving the quality of service for our guests. In addition, guests at our hotels continue to show minimal price sensitivity to ancillary revenue drivers, such as food and beverage outlets, parking, banquet rentals, and resort fees. Following a period of greatly reduced offerings during the pandemic, our hotels' reconfigured food and beverage operations are nearing stabilization, providing additional revenue opportunities at our properties. As we navigate the post-pandemic operating environment, margin control will continue to be a crucial area of focus for our managers. All in all, we are pleased with the quarterly operating results for our portfolio and are encouraged by the trends we are seeing going forward. I will now turn the call over to Tony.

Thank you, Scott. Reviewing performance for the period ended September 30, 2022. For the third quarter, total revenue was approximately $39.2 million, representing an increase of 10.5% over the same quarter in 2021. On a year-to-date basis, total revenue was approximately $124.7 million, representing an increase of 34.8% over the same period in 2021. Comparing current performance to pre-pandemic levels, total revenue for the third quarter increased to 92.2% of the level of total revenue for the same period in 2019. On a year-to-date basis, total revenue increased to 88.2% of the level of total revenue for the same period in 2019. Hotel EBITDA for the quarter was approximately $9.8 million, representing an increase of 10% over the same quarter in 2021. Year-to-date, hotel EBITDA was approximately $34.6 million, representing an increase of 51.7% over the same 9-month period in 2021. Comparing current performance to pre-pandemic levels, hotel EBITDA increased to 110.3% of hotel EBITDA for the same period in 2019. On a year-to-date basis, hotel EBITDA increased to 91.8% of the level of hotel EBITDA for that same 9-month period in 2019. For the quarter, adjusted FFO was approximately $2.4 million, representing an increase of $2.4 million over the same quarter in 2021. Year-to-date, adjusted FFO was approximately $9.8 million, representing an improvement of approximately $13.4 million over that same 9-month period in 2021. Comparing current performance to pre-pandemic levels, adjusted FFO increased to 217.5% of the level of adjusted FFO for the same period in 2019. Year-to-date, adjusted FFO increased to 81.1% of the level of adjusted FFO for that same 9-month period in 2019. Please note that our adjusted FFO excludes charges related to the early extinguishment of debt, gains and losses on derivative instruments, charges related to aborted or abandoned securities offerings, ESOP and stock compensation expense as well as other items. Hotel EBITDA excludes these charges as well as interest expense, interest income, corporate, general and administrative expenses, and our income tax provision as well as other items. Please refer to our earnings release for additional detail. Looking at our balance sheet. As of September 30, 2022, we ended the quarter with total cash of approximately $30 million, consisting of unrestricted cash and cash equivalents of approximately $23 million, as well as $7 million which was reserved for real estate taxes, capital improvements, and certain other items. Looking ahead to the fourth quarter, the company estimates cash generated at the hotel level to range between $10 million and $10.25 million. We expect corporate level G&A expenses of approximately $1.55 million. And capital expenditures are expected to be approximately $2.4 million to $2.65 million for the quarter. Outlays for scheduled payments of principal and interest are expected to be approximately $6.3 million for the quarter. Overall, we are expecting cash used by our portfolio to be no more than about $600,000. Since December 2020, we have removed $55.3 million of debt from the company's balance sheet using approximately $52.2 million generated in asset sales. During that period, we reduced deferred interest due to our lenders and deferred fees due to certain vendors, all of which was granted to us through various forbearance agreements. We reduced this by approximately $8.5 million over the period. We expect all such repayment of deferred interest and principal from forbearance granted during the pandemic, as well as forbearance granted by our vendors, to be complete by the end of 2022, ending another important chapter in the company's recovery from the pandemic financial impact. At the end of the quarter, we had principal balances of approximately $322.7 million in outstanding debt at a weighted average interest rate of 4.88%. Approximately 96% of the company's debt carried a fixed rate of interest after taking into account the company's interest rate swap agreements. As we enter a more normalized operating environment, we anticipate capital expenditures will be more aligned with historic norms, and we estimate capital expenditures will amount to approximately $7.2 million for calendar year 2022. And I'll now turn the call over to Dave.

Thank you, Tony, and good morning, everyone. During the third quarter, we experienced encouraging trends across our portfolio as business and group travel continue to improve, while leisure travel maintained its robust demand and exceptionally strong rate growth. The improvement in operating fundamentals was reflected in the quarter's profitability metrics with hotel EBITDA and adjusted FFO per share easily outpacing the same period in 2019. Our portfolio's continued recovery during the quarter demonstrates the ideal location of our southern coastal markets as well as management’s ability to navigate the lodging environment with a flexible operating model. Our portfolio sustained no material damage from Hurricane Ian, which swept through Florida and up the East Coast at the end of the quarter. This major storm caused only a nominal impact on revenues for the portfolio in the quarter as our sales managers did a commendable job in seeking out replacement business from hurricane-related response personnel and rebooking group business for future dates. Leisure demand at our hotels remained particularly strong during the quarter, especially at our coastal properties such as Hotel Ballast and the DeSoto, which posted historically strong room rates during the period. Rates were especially strong during high demand periods in the quarter, such as the July 4, Labor Day weekend and other citywide events. Notably, ADR at the DeSoto increased nearly 28% over the third quarter of 2019, translating to excellent profitability. While the pace of the recovery has been uneven across segments and markets, we are progressively witnessing signs that traditional travel patterns are normalizing. Demand at our urban locations experienced the most profound year-over-year increases during the quarter, a trend which clearly reflects the improving group and business travel segments in those markets. Much of this improvement was driven by post-Labor Day demand, suggesting a more normalized corporate travel calendar, one which the industry has not experienced since before the start of the pandemic. The market improvement at the Hyatt Centric in Arlington highlights this trend as RevPAR steadily pushes towards 2019 levels. Notably, RevPAR at this property improved approximately 1,000 basis points quarter-over-quarter relative to 2019. Group demand at the property sold during the period actually outpacing 2019 by nearly 20%. While year-over-year occupancy growth for our portfolio is impressive, we believe there is still significant room for improvement as occupancy was still 7.2% below 2019 during the third quarter. We expect the momentum gained during the third quarter to continue as corporate travel trends are improving and site visits, leads, and group bookings remain strong for the fourth quarter of next year. In fact, fourth quarter group bookings are pacing 12% ahead of 2019 levels, representing a significant improvement over the third quarter's group bookings. In addition to the improvements in group, we anticipate closing out the year with a robust holiday travel season driven by high rated leisure travel, especially in our warm weather markets. Overall, we are forecasting fourth quarter RevPAR to be approximately 6.5% above the same period in 2019. We are closely monitoring macroeconomic data, consumer behavior, and corporate travel policies and have not seen any pullback in demand or in the future booking pace of room rates. We believe these encouraging trends and tailwinds for our industry and our portfolio will fuel our growth prospects for the remainder of 2022 and beyond. And with that, operator, we can open the call up for questions.

The first question today comes from Alexander Goldfarb from Piper Sandler.

It's encouraging to see the leisure business returning and to hear about the strong group bookings and holiday travel. However, according to your press release and cash usage estimates, even with these positives, you are still projected to use a few hundred thousand dollars in cash due to the $6.3 million debt service. I recall you mentioning that you're at about 92% of previous revenue levels. How do you view the company's potential to achieve meaningful cash flow positivity? Are there strategies to reduce debt service while continuing to grow revenue or cutting additional expenses? Could you elaborate on this?

Alex, this is Scott. Tony and I will follow up with you on that. There are a couple of points to consider. First, regarding cash usage in the fourth quarter that Tony mentioned, there are still approximately $300,000 to $600,000 in forbearance catch-up payments. On a normalized basis, we are at least cash neutral when excluding those one-time forbearance payments we are completing by the year's end. Additionally, our capital expenditure forecast for the fourth quarter is heavily weighted towards the end of the period. We have had delays throughout the year, so we did not spend as much earlier on, and we anticipate higher spending in the fourth quarter as it takes longer to complete tasks and receive product deliveries. Therefore, we expect a larger expenditure in the fourth quarter.

I think to that, Alex, this is Tony. I would add that ours is a seasonal business, a really strong second quarter, a good first quarter, and the latter half of the year is generally good, but not nearly as strong as the first half of the year. Therefore, the company generates most of its cash flow on a quarterly basis during those first two quarters of the year.

Okay. Considering the current position of the company and looking ahead to next year based on existing trends, it’s important to note that things can change. However, as of now, do you expect that for the full year 2023, the company will be cash flow positive, breakeven, or significantly cash flow positive? I'm just trying to gauge where things stand after accounting for debt service and capital expenditures.

Yes. I think on a CAD basis, we're definitely going to be positive. We're in the budget cycle right now, Alex. And I think the data that we're receiving is pretty robust in terms of where we think the market is going to be next year.

Okay. It seems that the $6.3 million is actually $5.7 million. Are there ways to further lower that debt service? I understand that refinancing may not be an option, so I'm wondering if there are any principal pay downs or other strategies you can implement to reduce the debt service, allowing cash flow to grow and eventually lead to dividend restoration.

Yes, Alex. I mean all of our debt is amortizing, so we make principal payments on all of that on a scheduled basis. So it's by nature, the principal balance is reducing every single quarter, every single month. Beyond those scheduled payments to use excess cash to reduce the debt could be a possibility, but it's not going to be a meaningful pay down. We're not sitting on a ton of excess cash to reduce our debt in that manner.

Yes, this is Tony. I would like to mention that we have several loans, such as some CMBS debt, that we cannot pay down, or there are significant prepayment penalties associated with that debt. Therefore, we have limited options for paying down mortgage debt, aside from a few pieces maturing next year. I also want to point out that for the calendar year 2022, we mentioned we have about $7.5 million to $8.5 million in forbearance payments. This cash has been utilized to catch up on deferred interest, principal, and vendor payments, which will not reoccur next year. We consider this as a source of liquidity and free cash flow for the coming year.

You said $8.5 million of forbearance and catch-up payments that we're in '22 that won't be in '23, correct?

That's correct.

Right.

There are no additional questions waiting at this time. So I will turn the conference back over to Dave Folsom for any closing remarks. Please go ahead.

Thank you, everyone, for joining us on our call, and we look forward to speaking with you again on our fourth quarter earnings release. Thank you.

This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.