Morgans Hotel Group Co. Q1 2009 Earnings Call Transcript

Morgans Hotel Group Co. (MHGC)

Q1 2009 Earnings Call

May 4, 2009 5:00 pm ET

Executives

Jennifer Foley -

Rich Szymanski – Chief Financial Officer

David Hamamoto – Chairman of the Board

Fred Kleisner – President and Chief Executive Officer

Marc Gordon – Chief Investment Officer

Analysts

Will Marks – JMP Securities

William Truelove – UBS

Steve Altebrando – Sidoti & Company

Maria [Slavens] – Oppenheimer & Co.

Presentation

Operator

Welcome to the Morgans Hotel Group Company's first quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Jennifer Foley of Morgans Hotel Group. Please go ahead.

Jennifer Foley

Good afternoon. Thank you for joining us on our first quarter 2009 conference call. Joining me on today's conference call are Fred Kleisner, President and Chief Executive Officer; Rich Szymanski, Chief Financial Officer and Marc Gordon, Chief Investment Officer of Morgans Hotel Group.

Before we begin, I need to remind everyone that part of our discussion this afternoon will include forward-looking statements. They are not guarantees of future performance and therefore undue reliance should not be placed upon them. We refer you to all the company's filings with the Securities and Exchange Commission for a more detailed discussion of the risks that may have a direct bearing on the company's operating results, performance and financial condition. With that, I will pass the call to Fred.

Fred Kleisner

Thanks Jen. Good afternoon everyone and thanks for joining us today. As you all know, the fourth quarter of 2008 began one of the most difficult operating environments the hotel industry has seen in a very long time. Unfortunately, industry results continued to decline in the first three months of 2009. Macro economic trends have presented significant headwinds to the lodging sector. March concluded six successive months of declining industry results driven primarily by declining average daily rates.

That has been true across the entire industry. This is particularly true in the luxury segment. While Morgans distinguishes itself far from traditional brand managed or franchised luxury hotels by our focus on lifestyle, distinctive lodging experiences, we are not immune to the downturn in our industry. Clearly we do not have much control over the large economic and industry environment. However, we do have control over how we manage our cost structure, sales and revenue generation and our balance sheet.

This allows us to preserve and enhance shareholder value and that is exactly where our management team has been acutely focused. Despite continued economic pressure we have demonstrated financial stability thanks to proactive steps and continued efforts we have taken to strengthen our position. Regarding costs, through a multi-phase contingency plan put in place in the beginning of 2008 we have reduced hotel operating expenses by approximately $20 million which resulted in a 21% decline in operating costs at system-wide comparable hotels for the first quarter 2009 compared to 2008.

Additionally we have reduced corporate expenses by approximately $10 million. We expect we will reduce corporate expenses by over a third on an annual run rate basis. I will discuss in a moment also how we implemented further reductions commensurate with market trends in the first quarter of this year.

Allow me to review the strategies we followed. Early in 2008 we began a strategy to reduce our exposure in Las Vegas. We have significantly reduced this exposure by eliminating commitments on the Echelon project in 2008 and we are progressively reducing our ownership percentage in Hard Rock from 33.3% to an expected 14% by the end of 2009. We have not entered into any future funding commitments at Hard Rock since February 2008 and have no intention to do so.

Regarding balance sheet management, maintaining solid and sustainable liquidity position continues to be our top priority in this environment. We have described on prior calls as Rick will further detail later on this call we are taking decisive action to ensure we have sufficient cash and financial flexibility. Despite the difficulties of the current environment we are confident in the long-term potential of this company. Morgans has some of the strongest and most distinctive brands in the industry, compelling assets and a differentiated approach.

Our management team has been through difficult cycles in the past and I know we are taking all the necessary steps to get us through this challenging period while at the same time maintaining our unique brands, our hotels and our customer experience so that we are well positioned when the economy turns around.

With that said, there are several topics I would like to discuss on today’s call. First, I would like to review our first quarter results. Then I would like to briefly touch on our liquidity and balance sheet initiatives. After that I will provide a little more detail on our recent expense reduction initiatives along with a status update on current development projects.

Adjusted EBITDA was down 67% for the first quarter and rev par from our comparable hotels was down 36% in constant dollars driven by a continued slow down in key markets, particularly New York City. The pull back in demand across the industry led to a drop in average daily rate. We felt the effects of this pricing erosion in each of our New York Hotels, particularly at our Hudson in Mid-Town.

Given the environment these results were by no means unique within the sector. In this recession, high end hotels in major urban areas have fared far worse than the national average and Morgans is no exception. We have seen these trends before, most recently in the aftermath of 9/11. Inevitably the trends reverse and the category rebounds. Over the long term, owning or having investments in our unique lifestyle hotels in limited supply gateway markets has been and we believe will continue to be a compelling business proposition.

Additionally, despite the turmoil within the category we continued to out perform our competitive sets when you compare our individual hotels to similarly priced hotels in similar locations in the aggregate our hotels’ rev par out performed our competitors.

We attribute this to our unique position as a lifestyle or boutique hotel group and our commitment to high quality and personalized service.

We were able to achieve a ratio of EBITDA percentage decline to rev par percentage decline of 1.6 to 1 due to rigorous cost reductions and both revenue and expense contingency plans we have continued to implement in the first quarter. Notwithstanding that, first quarter rev par trends were incrementally worse in the first quarter period, I do want to note that in April we did and have seen some indications of moderation in that decline which may suggest a reversal of the sequential downward trends we have seen in the quarter. It is important to mention however that due to the transit nature of our business and short-term bookings it is difficult to say with certainty whether this reflects a meaningful trend or an anomaly.

Clearly the first quarter of 2009 was a difficult period for the hotel industry and as I said Morgans was no exception. In this regard I would like to review with you the offensive and proactive tactics we have executed to combat the difficult operating economic environment and ensure survivability of our compelling assets over the long-term.

Let’s look at liquidity and balance sheet initiatives first. At the end of the first quarter we had over $87 million in cash. As Rich will discuss in a few minutes we drew down on our revolver to further enhance our liquidity and preserve flexibility going forward. We now have just $15 million of capital commitments remaining on new projects and with recent renovations complete and behind us we expect maintenance capital will be minimal for the foreseeable future at our owned hotels. Last but not least, we have no consolidated near-term maturities other than Mondrian Scottsdale and as we have said on prior quarter calls we do not intend to invest significant additional capital at this property.

Turning to efficiency initiatives, we implemented $5 million of additional annualized cost savings in January and another $5 million in March both at our corporate office and at the property level. We continue to look at all lines of business and monitoring the trends at each of our properties so we can manage efficiencies and revenue to the greatest extent possible.

Before I turn the call over to Rich, let me spend a few minutes providing a status report on our project development. We have three projects coming up. Mondrian Soho in New York City, Ames in Boston and the expansion of the Hard Rock. All projects are fully financed and in the case of Hard Rock Hotel and Casino ahead of schedule. More importantly, we expect to generate additional management fees from all of these projects starting late 2009 and early 2010. One small benefit of the downturn we have seen in Las Vegas is the ability to lower construction costs and accelerate construction given the decreased activity in the building industry.

In April we opened a new and expanded concert venue, the Hard Rock; the joint concert hall and also added 65,000 square feet of meeting space. The Joint opened to sold-out performances by Beatles legend Paul McCartney and the Killers. Opening weekend was a huge success and marked the first of many exciting performances by legendary artists we plan to showcase in this new venue. On Sunday, April 19^th, Hard Rock generated the highest one-day gross revenue of its entire 14-year history. This is quite an achievement given the hotel is still under full construction. With the Hard Rock’s niche position in the Las Vegas market as well as its off-strip location, we believe this property will continue to out perform the market as it has for the last year.

The North Tower, consisting of 490 rooms is scheduled to open this summer. The casino expansion and the all-suite south tower consisting of 374 suites is projected to open late this year or early 2010 along with a dozen new penthouse suites. Importantly, our partner in this project, DLJ, continues to fund all of their expansion commitments on this project.

The unique guest experience, strong and distinctive brands, compelling assets and a differentiated approach are the foundations of this company. Each of our hotels is designed and specifically tailored to reflect the local market environment which we believe is a crucial component of our value proposition to our guests. As a result, despite the current trends in the economy we are confident in this unique approach and the long-term potential of our business.

With that I will turn the call over to Rich for additional details on our financial picture.

Rich Szymanski

Thank you Fred. I would like to focus on our first quarter earnings and a detailed review of our liquidity position as well as our funding for 2009. Our adjusted EBITDA for the first quarter was $7.1 million compared to $21.6 million in the first quarter of 2008. Rev par for our system-wide comparable hotels for the first quarter was $170, a decrease of 39% or 36% in constant dollars from the first quarter of 2008.

The decline reflects the weak global economy and was driven by a 26% decrease in average daily rate. We continue to keep a close watch on our operating costs given these revenue declines. For the quarter operating costs for system-wide comparable hotels decreased by 21.3%. We measure our flow through and cost control by the ratio of the percent of decline in EBITDA to the percentage decline in rev par. We believe industry averages are typically two to three times at the hotel level but since we have ownership interest in our properties we operate all of our hotels and we have control of our brands, one of our core strengths is our ability to swiftly reduce our operating expenses.

As Fred already mentioned during the quarter we achieved a 1.5 times ratio of EBITDA percentage of decline to rev par percentage of decline and this was the second consecutive quarter where the ratio has been below two times which is far better than industry norm. We have also taken a proactive approach to our corporate expenses which declined by 15.8% in the first quarter of 2009 from the comparable period in 2008.

The reductions in hotel and corporate expenses were achieved without the full quarter benefit of restructuring initiatives implemented in January and later in March of this year. We will continue to review our operations and our corporate office for more efficiencies as we proceed throughout the year.

Similar to our approach to cost control we are taking a proactive approach to liquidity which is our number one priority. I would now like to walk through a detailed analysis of our liquidity focusing on our cash position, commitment, cash flow, covenants and maturities of our debt.

We finished the first quarter with approximately $87 million in cash and cash equivalents. In March we borrowed $52 million under our revolving credit facility which we have invested in cash and cash equivalents. The revolver debt has an interest rate of LIBOR plus 135 or a current rate of less than 2%. Given the current market conditions and the importance of liquidity in these challenging times we felt it was prudent to put our cash on our balance sheet especially given the relatively inexpensive cost of the debt.

Additionally, one of our line providers was taken over by the FDIC and dropped out of the line during the quarter. They represented only 2% of the facility but the risks this highlighted influenced our decision to take down the line. This cash remains in an interest bearing account where it is available to us as needed. There are a variety of ways which we may ultimately utilize the cash including property level or other corporate debt. If and when we make a determination to utilize this cash it will be based on a strict evaluation to preserve and ultimately increase shareholder value.

During the quarter we funded $4.2 million of our equity commitment at Ames Boston. As a result our total commitments for new projects have been reduced to approximately $15 million as of March 31. With the completion of Mondrian L.A. and Morgans renovation projects in 2008 we have no significant capital commitments on our owned hotels. Given the excellent condition of our owned properties we estimate maintenance capital to be between $6-8 million in total in 2009 of which approximately $1.5 million has been spent through the first quarter.

For the 12-months ended March 31, 2009, we generated approximately $14 million of operating cash flow defined as EBITDA less interest less maintenance capital. For the full year 2009 we believe our operating cash flow will be around a break-even level.

Regarding financial covenants, the trust preferred notes contain the trailing 12-month EBITDA to interest ratio of 1.4 times that we may not fall below for four consecutive quarters. We were in compliance with the trust preferred covenant which was at two times ratio as of March 31. We also have financial covenants associated with our line of credit. The credit facility has an interest coverage of 1.75 times and a debt to EBITDA covenant of six times. Under these covenants, debt is net of cash and excludes the convertible notes, the trust preferred and the [Clift] capitalized lease.

In the first quarter we were in compliance with these covenants at ratios as of March of two times for interest coverage and 5.2 times for debt. The revolver is secured by our three hotels in premier locations; Delano South Beach, Royalton and Morgans in New York. Additionally we have approximately $80 million of net operating loss tax carry forward which can be used to offset taxes on future income including gains on asset values.

With regard to consolidated debt maturities we are in discussions regarding our non-recourse mortgage on Mondrian Scottsdale which is due in June of this year. As we have said before, we do not intend to invest significant additional capital into this hotel. We also have $370 million of mortgages on Hudson and Mondrian in L.A. due in July 2010. These mortgages may be extended through October 2011 if the applicable hotel has a 1.55 debt service coverage ratio for the first half of 2010. If we do not meet the extension test we have the ability to prepay a portion of the mortgages to qualify for the extension. We have had preliminary discussions with the servicer regarding the extension of these loans and we will continue to take a proactive approach towards these loans while at the same time focusing on maximizing the cash flow at the hotels.

In summary, we have taken positive steps in recent months to limit capital commitments, ensure cash availability, reduce our operating costs and work towards extending our maturities.

Turning to our outlook for 2009 it goes without saying it is very difficult for anyone to predict what will happen this year given the dramatic shift in demand that we continue to witness and the short-term booking patterns and transient nature of our business. In light of this we will continue to manage our business and our capital position in a proactive and aggressive manner. As we stated on our year-end earnings call we are not comfortable defining a specific rev par target or range for the year because of the continuing uncertainty and volatility in the market.

However, we are providing a framework for adjusted EBITDA given certain rev par levels. For example, if rev par for the year was to decline on average 20-25% we would expect 2009 adjusted EBITDA to be between $45-60 million. This is based on a ratio of comparable hotel EBITDA percentage decline to rev par percentage decline of 2 to 1. We have achieved an average of 1.5 to 1 in the prior two quarters.

With that I will turn the call back over to Fred.

Fred Kleisner

Thanks Rich. We want you to know our team is laser focused on managing our costs and capital structure to ensure financial stability in this company and to ensure we preserve and ultimately grow shareholder value. Our management team and I remain confident in the long-term potential of our business. We have been through difficult cycles in the past. We have taken and will continue to take all necessary steps to get us through this current period.

At the same time we are focused on maintaining our unique brands, our hotels and the hotel experience so that we are well positioned for growth when the economy turns around again. With that I would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Will Marks – JMP Securities.

Will Marks – JMP Securities

My first question and I think you pretty much covered it but on borrowing from the credit facility which forces you to I guess comply with covenants it seems like the benefits outweigh the burden but 2 to 1 back exiting and having cash available it is kind of as simple as that?

Fred Kleisner

Yes. We though that given the risks we wanted access and we wanted flexibility. By drawing the money now and keeping it on the balance sheet we have that.

Will Marks – JMP Securities

Second question, some numbers on Hard Rock. Where do you stand right now in terms of debt associated with that project?

Rich Szymanski

The debt is being drawn down as the construction is being completed. I don’t know exactly where we are today. Combined it is probably over $1 billion. I think ultimately it will get to some range of close to between $1.2 billion and $1.3 billion.

Will Marks – JMP Securities

Should we estimate where you will end up with about 14% of that figure?

Rich Szymanski

Yes, by the end of the year as the letters of credit that DLJ have posted as they are drawn our ownership interest for accounting purposes is based on cash and as those letters of credit are converted into cash our current position ownership interest of 20% will be reduced down to 14%.

Will Marks – JMP Securities

That actually does take your debt level down over time because it is your percentage or your dollar amount was over $200 million?

Rich Szymanski

That is absolutely true. That has been our plan all along. As we have taken the ownership interest down initially from 33% down to 14% we are focused again more on the management and that effect.

Fred Kleisner

Coincident to that you will see a rather significant increase in our management fee income from Hard Rock.

Will Marks – JMP Securities

I understand. I also would think your actual debt level was going to stay the same you just weren’t going to be increasing it for the project. How has your total been reduced? Because you haven’t taken additional equity?

Rich Szymanski

That is true. In doing the math we initially started out with a $760 million loan of which we had 33%. We will end up somewhere between $1.2 billion and $1.3 billion and we will only have 14% of that. So the dollar amount has been decreased and it has been decreased by the fact that the equity has been funded by DLJ.

Will Marks – JMP Securities

On the $15 million of capital commitments going forward can you pinpoint them? I know it is not a lot of projects.

Rich Szymanski

It is an $11 million letter of credit that we posted back in February of 2008 for Hard Rock. Then a few small pieces, a few residual amounts on the other projects.

Will Marks – JMP Securities

What about the other Miami projects?

Rich Szymanski

The Gale project?

Will Marks – JMP Securities

Yes.

Rich Szymanski

That is on hold. We have not commenced any construction. We had gone to the point where we had drawn up the plans but given the economy we have put that on hold.

Will Marks – JMP Securities

On the Mondrian South Beach, what is the balance of that account essentially?

Marc Gordon

When you say the balance are you talking about the debt that is outstanding on that? As sales close, that debt gets amortized and I believe the total capital spend now is approaching $90 million.

Will Marks – JMP Securities

So your share would be half that essentially?

Marc Gordon

Yes.

Will Marks – JMP Securities

Maybe an update on sales would be helpful. Is it possible to sell anything in this environment?

Marc Gordon

It is difficult but we have continued to sell and close units. At this point in time there are over 100 units that have closed and there are another 100 additional purchase agreements with firm deposits that are outstanding. We believe there is interest in the bulk of the buyers to close on their units but the unit buyers have great difficulty in financing their purchases. There have been some buyers who have failed to close. The developer joint venture of which we are half has taken some deposits.

I think despite the issue we talk about on these calls all the time that relate to the difficulty of the buyers financing their purchases, the Mondrian South Beach should still be viewed as a nice success for the company. We have been able to sell units when others in the market have not. We have been able to close units when others in the market have not. I think we have also proven that the company continues to be able to create the hottest venues with great design, great restaurant, great bar, and great operations, all highly regarded.

In fact, just a recent issue of the Conde Nast Traveler Magazine has a picture of the Mondrian South Beach on its cover on its “Hot List” issue.

Operator

The next question comes from William Truelove – UBS.

William Truelove – UBS

Could you provide, I’m sure you disclosed it somewhere I just can’t see it quickly, the unconsolidated debt portion that is yours, how much is that amount?

Rich Szymanski

We didn’t put that in the release in total because some of these projects are like Hard Rock are under construction and the number isn’t finalized yet. On the properties that are open, the London property and Shore Club, our share of that debt is approximately $80 million, our proportionate share.

As we talked about you would ultimately when it is opened we would add Hard Rock which would be 14% of somewhere between $1.2 billion and $1.3 billion. Then of course as Marc mentioned $90 or so million of the Mondrian South Beach we have 50% of that.

William Truelove – UBS

I’ll get my calculator later. Secondly, with the changes in the credit facility and the fact you took the money there is still no restrictions if you so chose that you wanted to monetize those assets on how, there is nothing really that prevents you from doing that? I mean you could quickly pay down the line of credit right because it is sitting in cash?

Rich Szymanski

That is exactly the terms of the line of credit. We can pay that down at any time.

William Truelove – UBS

Is there any update you can provide on potential interest in those three hotels or any change in plans with what you want to do with them?

Fred Kleisner

We are still in the market talking on a selective basis about selling an asset, an interest in an asset or potentially financing an asset. With respect to the financing of the assets, we will access the mortgage market when the terms and the timing are right. Currently the cost of mortgage financing for any type of real estate are pretty extreme particularly compared to some of our alternatives like drawing on the line of credit. With respect to property sale or a sale of interest in a property similarly because it is difficult to finance an asset we actually view it as two challenging transactions to accomplish at the same time, one of which is selling an asset in a market like today when there are so few transactions occurring that it is hard to pinpoint value. Secondly, as I just said the buyer has to get his or herself financed and I would not counsel you to wait to see a transaction like that in the near-term.

Operator

The next question comes from Steve Altebrando – Sidoti & Company.

Steve Altebrando – Sidoti & Company

Can you remind me the restricted cash is that made up of the funding obligation and maintenance CapEx?

Rich Szymanski

The restricted cash which is about $20 million is primarily money set aside for maintenance capital. It is also money set aside for debt service, insurance, real estate taxes, rent on certain properties, those types of items. Basically pursuant to debt or lease agreements.

Steve Altebrando – Sidoti & Company

The interest coverage covenant on the bank facility is that similar you can’t fall behind for four consecutive quarters. Is that true or is that the trust preferred?

Rich Szymanski

No the trust preferred is four consecutive quarters. The revolver is quarter-by-quarter.

Steve Altebrando – Sidoti & Company

On the trailing previous quarter?

Rich Szymanski

On the trailing previous 12 months. Yes.

Steve Altebrando – Sidoti & Company

So essentially given the guidance you have out there, what you have drawn is going to need to be paid back likely over the next maybe six months or so?

Rich Szymanski

I don’t want to speculate on timing. We will monitor it very carefully. There are a number of factors to where EBITDA goes. It is also what we ultimately may do with the cash. That is something we are monitoring very carefully.

Steve Altebrando – Sidoti & Company

What is the capacity remaining on the revolver? I know the total line is…are you constricted by anything versus the total line?

Rich Szymanski

There is a borrowing base test and roughly according to that test we could have a total availability of $150 million. We have some letters of credit against that so we probably could borrow another up to about $135-140 million.

Steve Altebrando – Sidoti & Company

The corporate expense sequentially it looks like it doubled. Can you give us what a run rate will be for that roughly?

Rich Szymanski

Actually the corporate expense decreased. It went down about 16%. With the changes we just made in March, again the numbers we reported for the first quarter do not include or really includes a very small portion of what we just implemented at the end of March. We think the run rate of corporate expenses will be under $20 million for the year.

Steve Altebrando – Sidoti & Company

It looks sequentially though from fourth quarter to first it looks like it was significantly higher. I don’t know if there was something in consumer reversal in the fourth or one time in the first, but under $20 million?

Rich Szymanski

Yes. There were some year-end adjustments in the fourth quarter.

Operator

The next question comes from Maria [Slavens] – Oppenheimer & Co.

Maria [Slavens] – Oppenheimer & Co.

I have just two questions. The first is on your EBITDA adjustments was for $5.4 million from a loss from [inaudible] joint venture not recorded due to negative investment balances. Could you just talk about what that is and which property that is from?

Rich Szymanski

Here is where I bore everyone on the call. So you might hear everybody hanging up. What happened is in the fourth quarter at Hard Rock we had written down the investment. Accounting rules state that you really can’t go below your funding obligation when there are losses. So even though the property generated some book losses in the quarter we did not record those book losses.

Maria [Slavens] – Oppenheimer & Co.

The second question is your food and beverage business appears to be declining sort of a slower pace than your hotel business. Is there anything to that and is that actually performing better?

Fred Kleisner

It is particularly led by the beverage segment of our food and beverage business. The cover counts actually have remained stable in our restaurants. The average check has gone down a little bit but not at the pace that room rates have gone down particularly in New York City. I wouldn’t say there is anything recession proof but if there is anything close to stable during any economic cycle it is beverage consumption.

Operator

The next question is a follow-up question from Will Marks – JMP Securities.

Will Marks – JMP Securities

Rich, what do you expect the final debt amounts to be for Soho and Ames?

Rich Szymanski

Ames the borrowing is somewhere between $45-50 million of which we will have roughly 1/3. Our ownership interest in Soho is about 20% and the debt there is about $190 million.

Operator

There are no further questions at this time. I would now like to turn the floor back over to Mr. Fred Kleisner for any final comments.

Fred Kleisner

Thank you very much. We appreciate your attention in hearing the story of our first quarter. We will look forward to speaking to you again next quarter and updating you in particular as to the trends we referenced in April. Thank you.

Operator

Thank you all for participating in today’s Morgans Hotel Group Company’s first quarter 2009 earnings conference call. You may now disconnect.

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