Ashford Hospitality Trust Q2 2009 Earnings Call Transcript

| About: Ashford Hospitality (AHT)

Ashford Hospitality Trust

Q2 2009 Earnings Call

August 6, 2009, 11:00 am ET


Monty Bennett - Chief Executive Officer

Doug Kessler - President

David Kimichik - Chief Financial Officer.


Cann Hoe - KeyBanc

Andrew Wittman - Robert W. Baird

Matthew Larson - Morgan Stanley


Ladies and gentlemen, thank you for standing by. Welcome to the Ashford Hospitality Trust second quarter 2009 earnings conference call. During the presentation, all participants will in be a listen-only mode. Afterwards we will conduct the question-and-answer session. (Operator Instructions).

It is now my pleasure to turn the conference over to [Jo Anderson]. Please go ahead, ma'am.

Unidentified Company Representative

Welcome to the Ashford Hospitality Trust conference call to review the company’s results for the second quarter of 2009. On the call today will be Monty Bennett, Chief Executive Officer; Doug Kessler, President; and David Kimichik, Chief Financial Officer.

The results as well as notice of the accessibility of this conference call on a listen-only basis over the internet were released yesterday afternoon in a press release that has been covered by the financial media.

As we start, let me remind you that certain statements and assumptions in this conference call contain or are based upon forward-looking information and are being made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous assumptions, uncertainties and known or unknown risks, which could cause actual results to differ materially from those anticipated. These risk factors are more fully discussed in the section entitled “Risk Factors” in Ashford’s Registration Statement on Form S-3 and other filings with the Securities and Exchange Commission.

The forward-looking statements included in this conference call are only made as of the date of this call, and the company is not obligated to publicly update or revise them. In addition, certain terms used in this call are non-GAAP financial measurements, reconciliations of which are provided in the company’s earnings release and accompanying tables or schedules, which has been filed on Form 8-K with the SEC on August 6, 2009 and maybe also accessed through the company’s website. Each listener is encouraged to review these reconciliations provided in the earnings release, together with all other information provided in the release.

I will now turn the call over to Monty Bennett. Please go ahead, sir.

Monty Bennett

Good morning and thank you for joining us. Our priorities during these challenging times for the lodging industry remain consistent. We are focused on operating margin preservation, interest expense reduction, debt maturities and share buybacks. We remain steadfast in our strategies, but are constantly analyzing changing market conditions and recognize the need to respond accordingly. As we have previous demonstrated in this unprecedented cycle, our capital markets and operational strategies are working simultaneously toward the goal of sustaining the company while creating shareholder value.

For the second quarter, our operating performance declined in step with the overall industry. Pro forma RevPAR for the hotels not under renovation was down 20.6% compared with the prior year. ADR was down 10.9% and occupancy was down 844 basis points. Our RevPAR Yield Index for the quarter was 118.9%, compared with 117.5% a year ago, reflecting a gain in market share of 140 basis points.

The accelerated drop-off in RevPAR has made it more challenging to maintain operating margins. Our hotel EBITDA margins dropped year-over-year by 599 basis points for hotels not under renovation and 612 basis points for all hotels. Our NOI flow-through at 51% is working to mitigate some of the impact of the RevPAR declines and our affiliate manager Remington continues to lead the charge. We have been and will continue to be very proactive with these property managers to reduce costs.

During the second quarter, our asset management team reexamined all phases of operations to further reduce costs and improve efficiency. We updated profit restructuring plans to achieve greater operating margins given the continued decline in revenues. An analysis of managerial and hourly staffing highlighted inefficiencies and led to further labor reductions.

We adjusted food and beverage operational hours and offerings to fit the scale of that hotel demand. Where appropriate, we implemented shared services of staffing between hotels proximate to one another. We anticipate further savings to be reflected in our year-over-year [GOP] flows and margins.

AFFO and CAD per diluted share for the quarter were $0.31 and $0.22 respectively. Given the magnitude of the RevPAR operating profit declines, this per share performance clearly demonstrates the benefits of our operating cost controls, interest rate swap strategy and share repurchase activity.

Turning to our capital expenditures for a moment, we have previously mentioned expenditures of $130 million for 2009, of this amount approximately $43 million will come from the CapEx reserve, $44 million will be owner-funded and $43 million will be funded from insurance or loan proceeds. Through the first half of the year, we have completed approximately $33.5 million in total capital expenditures, $23.8 million of which has been owner-funded. Going forward, we expect that a portion of the expenditures will rollover into 2010.

Our mezzanine loan portfolio consisting of $234.9 million in book value at the end of the last quarter, weakened progressively and resulted in our taking several write-offs totaling $129.5 million. When we implemented our mezzanine investment strategy, we anticipated that in the market downturn, the loan portfolio would outperform equity investments given the interest expense coverage cushion.

To be conservative, our original loan underwriting even stress tested, performance based upon scenarios similar to the downturn the hotel industry experienced post 9/11. However, the magnitude of this current downturn far exceeds our underwriting sensitivities. Similar to many other lenders in the mezzanine lending business, loan write-offs are unfortunately becoming more common.

Our most notable write-down is the loan involved in the Extended Stay Hotel bankruptcy. We fully wrote down our investment which equated to a charge of $109.4 million or $1.18 per diluted share. Although there were Extended Stay bankruptcy rumors, the borrower had been current on interest payments up to the filing.

Ashford has been actively involved in a negotiated restructure of the loan which fell apart just prior to the company electing to seek bankruptcy protection. We are member of the Unsecured Creditors Committee and will be actively working to protect our investment as much as possible.

During the quarter, we also wrote-off half of our $18.2 million first mortgage participation in the Four Seasons Nevis. Concurrent with the original loan maturity base of October 2008, Hurricane Omar hit the island and forced the hotel to close. While work to rebuild the hotel continues, the project is six months or more behind schedule and the total amount of uninsured costs continue to escalate.

Additionally we wrote off the $7.0 million mezzanine loan secured by the Le Meridien Dallas. While this loan is current, it matures next month, and the borrower will most likely fail the debt yield test for an extension. Another write-off for the quarter pertains to the $4.0 million mezzanine loan secured by interest in the Sheraton Dallas. The loan matured and we are working with the borrower as well the first mortgage holder to restructure. We wrote off the entire amount of the loan in the second quarter, but continue to pursue negotiations.

We continue to monitor our loan portfolio and take aggressive action where appropriate and feasible to protect our position. Further declines and write-downs are certainly a possibility as industry fundamentals worsen. We are planning for what we expect will be a difficult second half of the year for the hotel industry and as well as the soft beginning to 2010. Our focus remains in creating value via operations, capital markets activity and share repurchases. We believe these efforts will yield the highest shareholder returns over the long term. I would now like to turn the call over to David Kimichik to review our financial results.

David Kimichik

Thanks, Monty. Good morning. For the second quarter, we reported a net loss to common shareholders of $165,890,000, adjusted EBITDA of $67,679,000, and AFFO of $28,214,000 or $0.31 per diluted share. We reported a CAD of $20,350,000 or $0.22 per diluted share.

At quarter’s end, Ashford had total assets of $4.1 billion including $236.6 million of unrestricted cash. We had $2.8 billion of mortgage debt, a blended average interest rate of 3.3%, including the $1.8 billion interest rate swap, 97% of our debt is now floating.

Since the length of the swap does not match the term of the swap fixed-rate debt, for GAAP purposes the swap is not considered an effective hedge. The result of this is that the changes in the market value of these instruments must be run through our P&L each quarter as unrealized gains or losses on derivatives. These are non-cash entries that will affect our net income, but we added back for purposes of calculating our AFFO and CAD

And for the second quarter, net income was a loss of $37,723,000. Year-to-date it's a loss of $19,691,000. At quarter's end our portfolio consisted of 103 hotels in continuing operations containing 22,913 rooms. During the quarter, we booked an impairment loss for the Hyatt Dearborn of $10.9 million. The auto industry woes and general Detroit market conditions weigh heavily on this property and cash flow is currently negative.

In June, we stopped paying interest on the $29.1 million mortgage that matures in April 2010 and are currently negotiating with the lender for a consensual deed in lieu or foreclosure. Additionally after adjusting for the aforementioned loan write-offs we have total principal outstanding of $106 million with an average annual unleveraged yield of 8.8%.

Hotel operating profit for the entire portfolio was down by $35.8 million or 36.6% for the quarter. Our hotel operating profit margin decreased by 599 basis points for the hotels not under renovation, and our flow through from lost revenue to net operating income for the quarter was 51%.

Our quarter end adjusted EBTIDA at a fixed charge ratio now stands at 1.63 times versus the required minimum of 1.25 times, and Ashford's net debt to gross assets is at 57.3%, versus not to exceed a level of 65% for our credit facility covenants. I would now like to turn it over to Douglas to discuss our capital allocation strategies.

Doug Kessler

Thanks, and good morning. Our capital allocation decisions continue to support the goal of sustainability against further deterioration in the lodging industry. In addition, we believe that stock repurchases at certain share price ranges, greatly exceed the returns of future investment in new hotel assets. Maintaining an appropriate cash level has been at the core of each decision we have made, and it is evident in our liquidity.

We ended the quarter with $236.6 million of unrestricted cash. For the quarter we had $20.4 million of cash available for distribution. Through the first half of the year, we have generated approximately $44.1 million of cash available for distribution. A significant contributor to cash flow is the interest-rate swap and floor doors we previously put in place.

We use floor doors to help further ensure against the impact of the lodging market downturn. A floor door is the purchase and sale of interest rate floors at different stock prices. The floor doors do not expose Ashford to any additional cost apart from the upfront purchase price.

If interest rates stay low as one would expect in the soft economy, we benefit by receiving a net payment from our counter party. Subsequent to the end of the second quarter, we purchased two floor doors at a combined cost of $22.3 million to work in concert with our interest rate swap. The first floor door with a notional amount of $1.8 billion commences on December 14th, 2009, and is from 1.75%, to 1.25%, and lasts for one year.

The second floor door with a notional amount of $1.8 billion commences on December 13, 2010, and it's from 2.75% to 0.5% and lasts for one year. The combination of the swap and existing floor doors in place have generated life to date income of $32.1 million, and year-to-date of $21.9 million. This income has more than paid for the initial cost of those matched-period hedges of $8.8 million.

Based upon the current LIBOR of 0.29%, remaining at the same level through the end of the year, Ashford would receive $44.3 million and proceeds for the entire year 2009. In the event the economy remains soft, lodging recovers more slowly, and rates remain low for sometime as the Fed is suggesting, Ashford will benefit from the added protection of these transactions. If not, the higher interest rates should correlate to an improvement in the economy and RevPAR, which would mean the latest floor door transactions were an insurance policy. Turning to near-term maturities, we eliminated a 2010 soft maturity, by agreeing with the lender to extend the $55 million loan on JW Marriott San Francisco to March 2011 with two one-year extensions remaining.

We also paid down the loan by $2.5 million. With the exception of the aforementioned Hyatt Regency Dearborn, the only other 2010 hard maturity is a $75 million loan on a five hotel portfolio that comes due in March 2010. We are currently in discussions with the existing lender and other prospects to obtain a new loan.

In 2010, we have $294.7 million of hard maturity debt due and have already begun to work to refinance some of these loans. During the quarter, we acquired $5.7 million common shares at an average price of $3.08, reducing our fully diluted share count to 92, 284,000 shares. We witnessed numerous REITs raising equity in the second quarter.

Based on our analysis, it appears that those equity raises were mostly related to solving for upcoming maturities, covenants or other short-term capital events and future dry powder. Fortunately, we took the steps late last year to address the covenants on our credit facility, and have been proactive on upcoming maturities.

Regarding dry powder for future acquisitions, we believe share repurchases in our own company offer the best returns at select share prices. Moreover, the opportunity to buy hotels is always off, and we believe the time to issue equity for this opportunity is not when share prices are scraping along the bottom.

We have a very clear plan to work our way through this environment that involves a series of steps that we expect will enhance shareholder value. Bring in mind that insiders own 14.6% of the company. We take these strategic decisions very seriously given our strong alignment with shareholders. That concludes our prepared remarks, and now we'll open it up to any questions you may have.

Question-and-Answer Session

(Operator instructions). Our first question will come from the line of Cann Hoe with KeyBanc. Please proceed with your question.

Cann Hoe - KeyBanc

Can you talk a little bit about the trends that you are seeing in July and August with the booking windows and the Transit group pace?

Monty Bennett

We don't give specific guidance, but typically our performance tracks the overall industry, and I'm sure you have seen the macro statistics, the same that we have. It seems like, the past few weeks the overall industry has been a little bit better than most of the second quarter, maybe down 16% 17% instead of 20% 21%, so we're seeing that trend. It's hard to see how it -- how it holds up.

The biggest falloff initially was a transient and then group started to falloff and we're not seeing group return in any meaningful fashion, although transit seems a little firmer, but it's as much of easy comparison compared to last year as anything. No, I don't know that the rate of transit has picked up as much as the comparisons are easy as far as the prior year, but booking windows are still very short.

Even when there is a book grouping, we have great skepticism about how much of that group is actually going to show up, and even the meeting planners themselves have great skepticism about how much is going to show up? So it's a guessing game.

Cann Hoe - KeyBanc

A question the Extended Stay negotiations. Can you talk a little bit about how far those discussions are and what your position in the tranche is and maybe if you do expect any recovery, how much you do expect?

Monty Bennett

Doug during his section talked about the debt maturities and he stated the year 2010 instead of 2011. So in other words, a part of his script should have read in 2011, we have $294.7 million of hard maturity debt due. And have already begun to work to refinance some of those loans. I think he said 2010.

Regarding Extended Stay, it is in bankruptcy. We are on the Creditors Committee. It's just hard to say how this all is going to work out. Every day that we wait, valuation of this portfolio will increase. And so the longer it can be stretched out, the better for us, since we're in a relatively [junior] piece.

However in bankruptcy court, typically the settlement or the rework involves a current valuation, and to the extent that we're out of the money on that current valuation, then we can get light much easier.

So there will be no doubt competing plans between some of the first mortgage holders, the bondholders, the borrower, and the mezzanine group, the borrower may be teamed up with one of those two groups or may have his own plan. As far as how much we can recover, it's just a guessing game.

We have been through a lot of these. And in our experience, we did a lot of this in RTC days, and it's just hard to say, but, I wouldn't count on too much being recovered. If we had to guess, as far as us recovering something from the bankruptcy itself, I would say there's a 20% chance we'll achieve or recover something, and the net amount is a big question mark. So, it doesn't look good.


Our next question will come from the line of Andrew Wittman with Baird. Please proceed with your question.

Andrew Wittman - Robert W. Baird

I wanted to just dig a little bit more on the remaining loan portfolio that's outstanding, could you give us a little bit more color on some of the larger loans, maybe [Farrellsun] or the (inaudible) gained, just in terms what trailing 12-month coverage looks like or what you are tracking there

Monty Bennett

We'll give you some general color. We don't get in to the specifics too much usually, but portfolios loans like [Farrellsun] and the JER Highland loan have a positive coverage and are hanging in there.

They have got maturities coming up that will have to be dealt with, but because those loans were LIBOR based, their coverage is better and they seem to be hanging in there better.

All of the rest of the loans with the exception of the Westminster loan which we defeased are just in tougher situations because they have got fixed payments or because they are single assets or against a resort and all of those have question marks around them about what's going to happen in the future.

Andrew Wittman - Robert W. Baird

I just wanted to try to understand the floor door strategy a little bit better. Obviously it's pretty complex here. My understanding is basically for 2009, you have got a notional balance of $1.8 million, so that kind of matches the swap, and kind of matches the chunk of debt that you are trying to go fixed or floating with.

But starting in 2010, it looks like your notional value is more than the $1.8 million. It is even $5.4 million, if I'm not mistaken. How should we think about that? Should we think about an interest rate swap? Or is that more of an operational hedge, or is that an interest hedge, or what's the approach there? Can you just give us some clarity?

Monty Bennett

The concept is the same for all of them. And the concept is that when short-term interest rates are high, typically RevPAR is high and when RevPAR is low, then short-term interest rates such LIBOR are low. And that correlation is held not with an art squared of about 0.9 over the past 20 years. Back when we originally swapped, and we thought that RevPAR might start into decline, and we had no idea that the decline would be this much.

We wanted to protect ourselves somehow, we wanted to protect our cash flow, and whether you see it as an offset to declining operating cash flow or some offset to fixed interest expense, it's really kind of academic. We're just looking to offset the downturn in cash flows.

Well, the challenge that we have got is not unlike the challenge that the Fed has spoken about here recently, and some governors of the Federal Reserve said that if they had the power, they would be lowering LIBOR, not down to 26 basis points, but to negative 500 basis points. That's how severe this recession is, and how much their rule of thumb, called the tailor rule tells them that they should lower interest rates.

Well obviously, they can't lower interest rates down that far. You can only lower them down to zero and so they are struggling in order to how to help the economy, since they can't take the interest rates down any lower. That's why the Fed had gone into the market and done some of these other unusual activities.

The hedge on our part is the same. That in order for this to work, completely I should say, we need short-term interest rates to go down to negative 0.5 or or negative 5% and then we would get the offset that we're looking for because this downturn is so severe. But, obviously that doesn't happen, so what we were looking to do is to continue to hedge in ways, so that we could get more help if the economy stays this bad.

So how you do that is you just increase your notional amount in the amount of the hedge, so instead of $1.8 billion, we ticked it up to $3.6 billion. Then added the $1.8 billion to it for 2010. So, the way you should look at it is, we're just looking for cash flow offsets, should LIBOR stay real low, which we think correlates to a continued bad economy.

So that's kind of the thought behind it. Does that answer your question?

Andrew Wittman - Robert W. Baird

Obviously, Remington and really all of your operators for the last couple of quarters have done a pretty good job. This quarter we are starting to see the margin degradation hitting a little bit harder. Are we into the point now where we're kind of lapping some of the cuts that were made, and this is kind of expected and probably will continue a little bit more into the future.

Monty Bennett

I don't think that's the answer as much as we had kind of a few unusual things happen this quarter. First of all, you go in to a quarter where your margins are traditionally higher. I think our margins are the highest in the second quarter. We try to cut 50% of the revenue impact, what we call 50 % flow or better. So if the top line is down $100,000 we don’t want the bottom line to be down anymore than $50,000.

Well, we achieved that 56% in the first quarter, but only 51% in the second quarter. That's not too much different, but when you consider the fact that revenue drop was more in the second quarter, and the margins were higher to begin with, that just translates into bigger margin drops.

Added to that, was the fact that we had some other expenses like legal expenses pile up, more or so in the second quarter and we had an incentive fee that was working to our benefits in the first quarter, but we had one property, the Marriott Crystal Gateway that earned substantial incentive fees in the second quarter of this year which offset the downturn incentive fees for all the other properties.

So, you had a few interesting or disparate factors come together, but we continued to shoot for that 50% flow margin, and hope to be able to achieve that, and certainly that's our expectation going forward. We will see if we are able to actually achieve it.


(Operator instructions). Our next question will come from the line of Matthew Larson with Morgan Stanley. Please proceed with your question.

Matthew Larson - Morgan Stanley

Any reason why you didn't favor buying back any of the high coupon, highly discounted preferred this quarter?

Doug Kessler

Sure the price ran up on it a little bit. We were a buyer when it was in the 5 to 7 to 8 range and it's kind of jumped up to 10 plus range. So, the benefits are just not as strong. We look at a few things. Buying that preferred helps us on a current basis, as far as a current cash flow, but the accretion in the long term benefit is much lower than buying common. So we just felt like the trade off moved in the direction of the common over the past quarter.


Mr. Bennett, there are no further questions at this time. I'll turn the call back to you. Please continue with your presentation or closing remarks.

Monty Bennett

That concludes our prepared remarks. Thanks for joining us in the call today. And we look forward to speaking with you next quarter.


Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.

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