Sotherly Hotels Inc. (SOHON) Q2 2023 Earnings Call Transcript

Hello, everyone, and welcome to Sotherly Hotels Second Quarter 2023 Earnings Call and Webcast. My name is Devi, and I will be coordinating your call today. I would now like to hand over to your host, Mack Sims, Vice President of Operations to begin. Mack, 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 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 the second quarter results for the same-store portfolio. RevPAR was $131.16 and driven by an occupancy of 70.6% and an ADR of $185.82. Second quarter RevPAR performance represents an increase of 5% over the same period in 2022, driven by a 1.6% increase in occupancy and a 3.4% increase in rate. Year-to-date, RevPAR for the same-store portfolio was $122.27 with occupancy of 65.6% and an ADR of $186.45. Year-to-date RevPAR performance represents an increase of 11.9% over the same period in 2022 driven by a 5.8% increase in occupancy and a 5.8% increase in rate. Overall, our portfolio's second quarter results were characterized by further recovery of group and corporate demand at our hotels, which were generally in line with our expectations. Despite softer-than-expected leisure demand at our South Florida properties on a year-over-year basis, our portfolio continued to shift to a more normalized mix of business with strong RevPAR growth from our group and corporate transient segments. Comparing to pre-pandemic metrics, RevPAR increased by 1.8% compared to the second quarter of 2019 despite occupancy being down by 8.7%, demonstrating there is still significant upside for the portfolio. Examining our portfolio's recent booking trends for business and group travel confirms our belief that demand in our hotels continues to progress towards a more normalized mix. For the group segment, our portfolio produced 8.7% more group business in the second quarter of 2023 compared to the same period in 2022, while business travel was slightly ahead of the second quarter of last year. These results were largely driven by our Washington, D.C. market hotels in Arlington, Virginia and Laurel, Maryland, which are now outperforming 2019 results. While the Washington, D.C. market is nearing a full recovery, our hotels in Houston, Philadelphia, and Atlanta have plenty of upside potential as corporate travel in those markets is still significantly below pre-pandemic levels. We expect demand at these hotels to continue to improve during the corporate and group-heavy fall travel season, which should help close the gap to pre-pandemic occupancy for those hotels. Meanwhile, leisure demand across the portfolio remained strong as a whole with encouraging booking trends moving forward. Looking at some highlights across the portfolio. The Hyatt Centric Arlington posted commendable performance during the quarter, fueled by a noteworthy recovery in group and business demand at the hotel. This property is hitting on all cylinders following the lagging recovery in the Washington, D.C. market, outperforming last year's RevPAR by nearly 25%. ADR, which was up 16.6% compared to the second quarter of last year, was the primary driver of this improvement while occupancy continues to grow as well. The property further solidified its position as the market leader among its competitive set, achieving a RevPAR index of over 121% during the quarter. Hotel Ballast in Wilmington, North Carolina, recorded excellent results during the quarter, beating prior year RevPAR by nearly 15%, fueled by an 11.1% improvement in occupancy and a 3% increase in rate. Results were driven by improved demand from the corporate group and transient business traveler segments and continued strength from leisure demand. The DeSoto Savannah continued to deliver a well-balanced mix of leisure and group business during the quarter. The property easily outpaced the comparable period in 2019 with RevPAR improving nearly 25%, fueled by significant rate growth of nearly 19%. The property continues to improve versus the competitive set, gaining 730 basis points in fair share during the quarter. During the second quarter, our management team achieved commendable profitability metrics by controlling variable costs and executing revenue management strategies aimed at driving higher rates. Hotel EBITDA margins for the second quarter of 2023 were slightly ahead of the comparable period in 2019. We are pleased with these metrics, especially considering increased expense pressures from restaffing our hotels, higher utility rates, increased insurance costs, and expanded food and beverage offerings that have been layered into our properties. Moving forward, we expect margins to stabilize as we have reached normalized staffing and amenity levels at our hotels following the lean operating model during the pandemic. I will now turn the call over to Tony.

Thank you, Scott. Reviewing performance for the period ended June 30, 2023. For the second quarter, total revenue was approximately $49 million, representing an increase of 3.9% over the same quarter in 2022. Year-to-date, total revenue was approximately $92.5 million, representing an 8.2% increase over the same period last year. Hotel EBITDA for the quarter was approximately $14.8 million, representing an increase of 0.5% over the same quarter in 2022. Year-to-date, hotel EBITDA was approximately $26.9 million, representing an increase of 8.8% over the same period last year. For the quarter, adjusted FFO was approximately $7 million, representing an increase of 12.9% over the same quarter in 2022, and year-to-date adjusted FFO was approximately $11.7 million, representing an improvement of 56.5% over the same period last year. 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 expenses as well as other items. Hotel EBITDA excludes these charges as well as interest expenses, interest income, corporate G&A expenses, the current 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 June 30, 2023, the company had total cash of approximately $32.2 million, consisting of unrestricted cash and cash equivalents of approximately $24.2 million as well as approximately $8 million, which was reserved for real estate taxes, capital improvements, and certain other items. At the end of the quarter, we had principal balances of approximately $322.7 million in outstanding debt at a weighted average interest rate of 5.11%. Approximately 96% of the company's debt carried a fixed rate of interest after taking into account the company's interest rate swap agreements. During the second quarter, we announced the refinance of the mortgage on the DoubleTree by Hilton Hotel in Laurel, Maryland, with City Real Estate Funding. The interest-only loan, which has a principal balance of $10 million, has a 5-year term maturing in May 2028 and maintains a fixed rate of interest of 7.35%. Given the challenges in the current lending environment, we were pleased with the execution of this transaction, which netted cash proceeds of approximately $2.5 million to the company. As we enter a more normalized operating environment, we anticipate capital expenditures to be more in line with historical norms and estimate capital expenditures will amount to approximately $7.4 million for calendar year 2023. Issuing guidance with a forecast of anticipated results for the third quarter. Our guidance considers market conditions and accounts for current and expected performance within the portfolio. We're projecting total revenue in the range of $39.1 million to $41 million for the third quarter. Hotel EBITDA is projected in the range of $8.5 million to $9 million. The year-over-year decrease in hotel EBITDA is largely due to a benefit received last year related to successful real estate tax appeals of approximately $434,000 as well as an increase in the quarter for the costs related to the renewal of our property and casualty policies of approximately $560,000. Adjusted FFO is projected in the range of $0.6 million to $1.1 million or $0.03 to $0.06 per share. Now I'll turn the call over to Dave.

Thank you, Tony. Our portfolio delivered solid results in the quarter. We outpaced prior year operating metrics despite moderate market-related headwinds faced in Atlanta and South Florida. Our portfolio's results benefited from the continued improvement of fundamentals at our urban hotels, which saw further recovery from the corporate and group segments as well as weekend leisure travel. In addition, our coastal leisure-focused hotels in Tampa, Savannah, and Wilmington continue to perform well due to continued strength in leisure demand coupled with strong group pickup. Overall, the strength in both group and business traveler bookings is reflected in the market's continued demand normalization for these revenue segments. In the quarter, we saw demand soften in our South Florida markets, which followed the period of pent-up demand that benefited and characterized these markets immediately following the pandemic. Increased competition from international destinations and cruise lines were major contributors to this moderation in demand. We also faced a material reduction in demand via group bookings at our Atlanta location related to the ongoing Hollywood writers' and actors' strike. Revenues from film and television crew productions, which have been a mainstay source of revenue for many years at this hotel, were negatively impacted by approximately $300,000 during the second quarter and $900,000 year-to-date. Despite these headwinds, our portfolio achieved commendable hotel EBITDA outperforming the same period last year, which at the time saw hotel operating expenses well below stabilized levels as full-service hotel amenities and services had not yet been fully reintroduced. Strong rates continue to be a critical factor in both RevPAR growth and overall profitability. During the quarter, our portfolio outpaced prior year's ADR by 3.4% and 2019's ADR by 11.5%. Meanwhile, occupancy showed sequential improvement, an important factor that validates the continued recovery of the group and business travel segments at our hotels. As Scott mentioned, the most notable improvement in RevPAR occurred at our group and corporate-focused hotels and markets where return-to-office rates continue to climb following the pandemic. Our hotel in Arlington continues to surprise to the upside, easily outperforming its competitive set with a well-balanced mix of business that includes strong group, weekend leisure, and corporate travel revenue, which surpassed pre-pandemic levels during the quarter. Moving forward, we believe there is still significant potential to be unlocked at our urban locations, which have historically been more dependent on corporate transient and group demand. Previously, we announced the reinstatement of quarterly dividend payments for our preferred shareholders. During the second quarter, we also announced an additional catch-up payment for our three series of preferred stock, decreasing the amount owed on the unpaid cumulative preferred dividend by approximately $1.9 million. Reducing the unpaid dividend represents an ongoing priority for the company. Forward bookings for our portfolio continue to trend positively despite uncertainty surrounding a potential recession. We believe a decline in the rate of inflation, coupled with the possibility of a soft landing by the Fed, will provide an environment for ongoing demand growth. Our portfolio's outlook is pacing well for the balance of the year, with 2023's group revenue pacing 24% ahead of last year, while the business transient segment is pacing 18% ahead of last year. We believe this segment still has plenty of opportunity for growth in the back half of the year. Overall, we are encouraged by the progress we are seeing in our operations with Q3 RevPAR forecasted to range between 103% and 109% of Q3 2022's RevPAR. We remain optimistic that improved market conditions and encouraging booking trends will continue to fuel growth prospects for our well-positioned portfolio. We will now open the call up for questions, operator.

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

I guess the first question is sort of a big picture. Do you guys feel that the portfolio is now back to sort of a normalized level? Or do you feel that there's more meaningful catch-up to occur from now versus what the level was before the pandemic?

Well, Alex, it's Dave. I think there's still some growth out there on a macro, what I'd call, macro pre-pandemic level. And both Scott and I, and our remarks, there's still some room to grow in some of our markets from both the group and business travel segment. Some of these markets still have some opportunity to improve, the Philadelphia market, the Houston market, the Atlanta market. These markets are not yet in the shape they need to be to get a fully normalized set of revenue for the hotel industry. So I think there is some opportunity there. And then on a property-by-property basis, there is definitely opportunity for improvement. As you may or may not recall, last year, we had a significant casualty in Atlanta that has since been resolved and repaired. It was a water issue. Our year-over-year results are very, very good there because we had a problem last year with the hotel. So there are both selective hotel upsides, and I think there's some market upside at some of these locations, especially when we look at the group and the business travel customer.

Okay. That's helpful. And then on the insurance, can you just remind us how much your premiums went up. And I believe, when we met at NAREIT, you said second quarter would include the full impact of the new insurance. So can you just contrast how much the premiums are now versus previous? And then do you anticipate sort of a similar increase next year or from when you met with the insurance companies and brokers they were indicating that this year is probably the biggest one, hopefully, next year, maybe the reserves that insurance companies and the reinsurers have is a little bit better. Just trying to get a sense if we're going to be in a multiyear substantial increase environment? Or if maybe you got some light at the end of the tunnel when you spoke to the brokers and the insurance companies?

We are a company that renews on April 1. I'll let Tony share the before and after numbers. The changes in property and casualty premiums were largely influenced by developments in Florida, which significantly affected property premiums. As for next year, we will have a clearer understanding after November when hurricane season concludes. The market is currently waiting to see if there is excess capacity and the extent of any losses. If I had to make a prediction, I would say that our agents might indicate there won’t be a significant decrease in premiums. However, we also aren’t expecting another doubling or a 50% increase like some insureds experienced this year. Tony, would you like to add anything?

Yes. Year-over-year, our insurance premiums went up a little over $2 million, so it's about $500,000 to $550,000 a quarter. A small bit of that is just the normal increase in general liability, auto, cyber, and other policies; however, the bulk of the increase was property coverage. As you know, we have a lot of coastal properties there, Wilmington, Savannah, Jacksonville, South Florida, and Tampa and even Houston. And so that's a large exposure for us and hence, a large increase in premium.

What was the percentage?

What's the percentage, the $2 million as a percentage?

The total premiums increased by about $2 million, which represents a 50% change. Overall, our insurance costs are now approximately $6 million a year, up from $4 million.

Okay. Okay. And then the final question is, can you just update us on where you stand on the preferred for the still accrued but unpaid balance?

Yes, we made one catch-up payment in the last quarter. As shareholders, we're just as eager as everyone else to receive a common dividend, so we're focused on making those catch-up payments. Currently, we are being a bit more cautious and prudent. I can't provide a timeline for when everything will be completed. As you noted in your recent interview with Bloomberg, a lot of our caution depends on the lending markets, how we handle mortgage refinancings, and what assumptions we are making about the future of the lodging industry over the next 4 to 8 quarters. If market conditions allow, we will make additional payments, but I can't specify when those will occur.

Right. But what's the current balance that you still have?

The unpaid balance is $20 million.

$29 million. Okay. Great.

We have no questions at this time. I would like to turn it back to the management team for any closing statements.

Thank you, operator, and thanks to everyone listening in today. We look forward to speaking with you at the next quarterly review.

Thank you, everyone, for joining today's call. You may now disconnect your lines, and have a lovely day.