FelCor Lodging Trust's (FCH) CEO Richard Smith on Q2 2014 Results - Earnings Call Transcript

Jul.31.14 | About: FelCor Lodging (FCH)

FelCor Lodging Trust Incorporated (NYSE:FCH)

Q2 2014 Earnings Conference Call

July 31, 2014 11:00 AM ET

Executives

Steve Schafer – IR

Richard Smith – President and CEO

Michael Hughes – SVP, CFO and Treasurer

Analysts

Patrick Scholes – SunTrust Robinson Humphrey

Nikhil Bhalla – FBR Capital Markets & Co.

Chris Woronka – Deutsche Bank

Anto Savarirajan – Goldman Sachs

Operator

Good morning, my name is Kim and I’ll be your conference operator today. At this time, I would like to welcome everyone to the FelCor Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there’ll be a question-and-answer session. (Operator instructions) Thank you.

Mr. Steve Schafer, you may begin your conference.

Steve Schafer

Thank you and good morning. I want to thank you for joining us for our second quarter earnings conference call. With me today are members of our management team, including Rick Smith, President and CEO and Michael Hughes, Chief Financial Officer.

Following their remarks today, we will take your questions.

Before I turn the call over to Rick, let me remind you that with the exception of historical information, the matters discussed on this conference call may include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are expressions of current expectations and are not guarantees of future performance. Numerous risks and uncertainties and the occurrence of future events may cause actual results to differ materially from those currently expected.

These risks and uncertainties are described in our filings with the SEC. Although we believe our current expectations to be based upon reasonable assumptions, we cannot assure you that our expectations will be attained or that actual results will not differ materially.

And with that, I will turn the call over to Rick.

Richard Smith

Thanks, Steve, and good morning everyone. We had another very strong quarter from every perspective and accomplished or progressed on all of our goals for the year. We exceeded the high end of our expectations for RevPAR and EBITDA growth and have increased our full-year operational guidance by approximately $2 million at the midpoint. The improvement is largely driven by the increase in group pace which is running 7.1% higher in ‘14 and it’s adding known compression for the GMs.

Once again, our comparable portfolio outperformed the industry with a 9.2% RevPAR increase. Our six acquired and recently redeveloped hotels again outperformed our expectations with a 23% increase in EBITDA and the win of hotels grew RevPAR more than 20%. We made good progress on asset sales, including completing the swap with Hilton. As we announced last week, we completed the term loan and will pay off the 10% senior notes on August 15th and we are making good progress on the Knickerbocker redevelopment.

Our primary focus for ‘14 remains the same, simply to complete the plan, including the following items. Complete the remaining asset sales and use proceeds to repay debt and finalize the balance sheet restructuring; open the Knickerbocker and effectively position that in the market; focus on a continued ramp up of the acquired recently redeveloped hotels; continue to aggressively attack ADR index and flowthrough; and complete the next phase of our investor relations program.

Now a little more detail on each of these points. First asset sales in the balance sheet. At January 1st, we had 21 non-strategic hotels remaining to sell. We sold four hotels during the first half of the year. We completed the swap of interest and 10 hotels with Hilton, retaining five. That leaves 12 hotels remaining to sell.

We have agreed to sell five hotels, including four with non-refundable deposits. We have hired brokers and informally started the marketing process on the five hotels retained in our swap with Hilton. Full scale marketing will begin in early September and we expect the first call for offers near the end of September.

We will bring the remaining two hotels to market later this year or early ‘15. Therefore, we expect to have 19 of the 21 hotels sold or marketed for sale by the end of the third quarter. Pricing continues to be within our expectations at 11 times prior year EBITDA.

I’m very pleased with our progress this year. For all intents and purposes, the asset sale program and the balance sheet restructuring will be complete by the end of this year.

After redeeming our 10% notes, our weighted average cost of borrowing will be below 6% and our next significant debt maturity other than the line of credit occurs in 2019. Furthermore, we remain on track to achieve our target leverage in 2015.

Now let’s turn to the Knickerbocker. We have made steady progress on the projects since the last earnings call. Our net project cost remains $240 million and we expect the hotel to open this fall.

Overall, we feel good about the process, both from a development and operational perspective. Recent development milestones include – we have increased construction and project management staffing to ensure we stay on schedule. Sheetrock walls are now being completed on the 16th and final floor, ceilings are complete through the 14th floor and tile is complete through the 12th floor with painting and wall covering in process on the 10th floor.

All of the millwork for the guest rooms has either been delivered or is in transit and is tracking on schedule and installation is complete on floors five through eight. Rooms on the fifth through ninth floors will be guest ready by the end of August.

The public spaces that is the lobby, fourth floor and rooftop continue to progress. The ME&P is complete, the majority of the lobby sheetrock is complete and stone flooring and wall installation has started. The majority of the FF&E has been delivered.

We have continued to assert ourselves aggressively in the preopening operations and sales and marketing efforts to ensure a successful opening. And we remain ahead of all critical path items.

Recent operation milestones include – additional management team hires in human resources, front office, revenue management, housekeeping and finance. We are currently finalizing food and beverage programming concepts and menus with the local team and Charlie Palmer, website frontend design is complete and the site is ready to be launched in tandem with the booking engine. The sales team completed a total of 2,500 activities throughout the second quarter, both domestically and internationally. And corporate and group interest is high.

As I mentioned earlier, our six acquired and recently redeveloped hotels continue to pace ahead of our expectations operationally with hotel EBITDA increasing 23% during the quarter. The performance of the eight Wyndham hotels continues to improve, growing RevPAR 20.4% during the quarter.

As the disruption subsides from the transition and we complete the renovation on the remaining hotel, we expect continued strong RevPAR growth. Importantly, the guarantee steps up more than 20% this year. So EBITDA at these hotels is expected to be about $43 million in 2014, or about $8 million higher than ‘13, and will step up another 20%-plus in 2015.

Please note that our guidance reflects the guarantee level as to mitigate any remaining transition risk.

Starting in late August, we will begin our next phase of investor meetings. The front end of the schedule will take us to the Midwest in Canada and will be focused on new investors. After the Knickerbocker is opened and the asset sales have progressed, the schedule will become more extensive and focused on new and existing investors. This will also entail an analyst day at the Knickerbocker.

The feedback continues to be very positive. And as we continue to progress on the asset sales, the Knick and further ramp up, we will stay out in front of investors to update them throughout next year.

Just a few comments before I turn the call over to Michael – a few additional comments.

We remain committed to delivering on our strategic objectives. We are making great progress on the portfolio transformation which should be virtually complete by year-end. We are reducing our leverage and cost of borrowing to strengthen our balance sheet and we are achieving desired returns collectively on our acquired, recently redeveloped hotels.

This commitment is paying off. We have assembled a high quality and world diversified portfolio that continues to outperform the industry. We should continue to deliver sustainable growth as our portfolio is in excellent shape, is well-insulated from new supply and is experiencing lower supply growth in the industry.

We will continue to deliver superior stockholder value as we complete the plan and build a strong balance sheet to provide flexibility throughout the lodging cycle enabling us to seize strategic opportunities while providing a meaningful common dividend.

And with that, I will turn the call over to Michael.

Michael Hughes

Thanks, Rick, and good morning. We’ve made significant progress on the balance sheet to extend [ph] maturities and lower our weighted average cost of debt. During the first half of the year, we repaid $63 million of non-cross mortgage loans secured by five hotels, otherwise scheduled to mature between June and August which bore interest at a weighted average rate of 6.7%.

Earlier this month, we posted $140 million term loan, borrowings under the facility bear interest at LIBOR with no floor, plus 2.5%. And the loan is freely pre-payable.

We’re also paying off our 10% notes on August 15. Proceeds from the term loan, cash on hand and line of credit borrowings will be used to retire the $234 million of outstanding principal. We anticipate generating $280 million of proceeds from the 12 remaining asset sales which we’ll use to repay the term loan, they’re the only [ph] outstanding line of credit, and the mortgages of the sold hotels.

We feel very good about the progress and pace of our asset sales. And as we discussed on prior earnings calls, we expect to have the new term loan outstanding for only a short period of time.

As Rick mentioned, we had another good quarter with RevPAR for our comparable hotels increasing 9.2%. Occupancy increased 2.9% mostly from an increase in group demand. ADR increased 6.6% through the combination of higher absolute rates and a continued remixing away from lower rated segments such as government and the higher rated corporate segments. We also had strong margin improvement of 175 basis points.

So far this year, corporate transient room nights which make up the largest concentration of demand for our hotels increased 6% while group increased 8%. Conversely, room nights for lower rated segments declined 5%. Hotel EBITDA increased 17% which was ahead of our expectations.

The increase in our annual guidance has resulted in better than expected hotel operating performance during the second quarter and our updated asset sale timing. We forecast 7.5% to 8% full-year RevPAR growth for our 46 comparable hotels and 8.75% to 9.25% for our 54 same-store hotels, which is a midpoint increase of 75 basis points.

We expect to sell majority of our non-strategic hotels this year. However, for the purposes of EBITDA and FFO guidance, our outlook reflects selling all 12 remaining non-strategic hotels. The low end of our outlook assumes that five hotels are sold in the third quarter and seven hotels are sold in the fourth quarter. The high end assumes that four hotels are sold in the third quarter and eight hotels are sold during the fourth quarter.

As Rick said earlier, our full-year outlook continues to assume NOI from our Wyndham hotels equal to the 2014 guaranteed amount. We have increased the midpoint of our EBITDA guidance by $2 million for operational performance and another $1 million for updated asset sale timing. We now forecast full-year adjusted FFO per share to be between $0.56 and $0.60 and adjusted EBITDA between $211.5 million and $217.5 million.

And with that, we’re ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Patrick Scholes from SunTrust. Your line is open.

Patrick Scholes – SunTrust Robinson Humphrey

Good morning.

Richard Smith

Good morning, Patrick.

Patrick Scholes – SunTrust Robinson Humphrey

Good morning. Question for you on the Morgans Royalton and the question is, I don’t think it’s been much of a secret that obviously Morgans group is having some challenges and the hotels have been underperforming. How long does your management contract with them go? Are you able to get out of that now if you should want to?

Richard Smith

Well, there’s various answers to that question. From a contractual standpoint, we have a ways to go. There are performance issues at the end of five years or performance standards at the end of five years. And they are our agent. I hate to be cryptic about that, Patrick, but that’s kind of the lay of the land on that right now.

Patrick Scholes – SunTrust Robinson Humphrey

So not likely up for discussion in the next 12 months, is that a fair –?

Richard Smith

I don’t know but I wouldn’t say that. I wouldn’t go that far. I mean we’re certainly looking at every alternative available to us. With regard to those two hotels, that includes a lot of things. We’re in the process of their analysis now.

Patrick Scholes – SunTrust Robinson Humphrey

Okay.

Richard Smith

When we are ready to discuss that publicly, we will absolutely do so.

Patrick Scholes – SunTrust Robinson Humphrey

Got you. When I hear about Hilton having the new – they’re a new conversion brand and you folks being [ph] very large over [ph] with Hilton, just in my mind, it initially seems like it would be a good match and I’m sure you folks are probably considering that, so I’ll leave it at that.

Richard Smith

Thank you.

Steve Schafer

Operator?

Operator

– line is open. You’re on mute. Please unmute. And your next question comes from the line of Nikhil Bhalla from FBR. Your line is open.

Nikhil Bhalla – FBR Capital Markets & Co.

Yes, hi, good morning, Rick and Mike. Just a question on the sale of the five hotels that you expect to bring in September. Is there a way to think about what the sales proceeds might be from those sales?

Richard Smith

You’re talking not the five that [indiscernible], you’re talking about the five that we are going to start marketing that we retained in the Hilton swap?

Nikhil Bhalla – FBR Capital Markets & Co.

Yes, correct.

Richard Smith

Well, I mean the whole thing for the 12 is about 2.75. I think that number is around 130 to 140, Nikhil.

Nikhil Bhalla – FBR Capital Markets & Co.

Okay, that helps a lot. And then finally, it seems like – so two hotels may carry over into 2015 like 1Q, is that a fair assessment?

Richard Smith

Yes, absolutely. One of them we are in a joint venture with and we have made a determination based on the kind of the current market, what the hotel is doing this year and how that will improve things. So it would be better to – I mean from the JV standpoint, it’s better to bring that to market at the beginning of next year.

The final hotel we are currently reevaluating that based on some work that has been done based on the year that they’re having, et cetera. There is a chance that would come out in the second half of this year. And I think the latest is going to be first of next year.

Nikhil Bhalla – FBR Capital Markets & Co.

Got it. And just a final question on the ramp across your hotels. I remember last time when you guys did your analyst day presentation, you talked about the ramp up in sort of the different segments of your hotels, the ones that you’ve renovated like the Union Square in San Fran and some of the other ones. Could you just update us on how you think about ramp maybe in 2015 versus 2014? And what’s your latest expectation?

Richard Smith

Yes. I think everything except for Morgans and Royalton of the six is going to be about where we expected it to by the end of ‘15 and closer to stabilization, and certainly increasing as we go into ‘15. So we’re getting there, I know. And obviously you have the Knick still to open and ramp up as well.

Nikhil Bhalla – FBR Capital Markets & Co.

Okay. That’s all for me. Thank you.

Richard Smith

Thanks.

Operator

And your next question comes from the line of Chris Woronka from Deutsche Bank. Your line is now open.

Chris Woronka – Deutsche Bank

Hi. Good morning guys.

Richard Smith

Good morning.

Chris Woronka – Deutsche Bank

Just a quick question on the guidance, does that – I see in the footnote that it includes the Knick. But are you guys expecting much of a contribution in ‘14 or can you tell us what the number is that you’re including in that?

Richard Smith

No, Chris. We started out the year thinking when we had a $1 million in our guidance, that’s actually reduced. So the fact that our guidance continues to go up each quarter is more of a strength of the rest of the portfolio perspective, just given the push out and the ramp up time required, that number is reduced. But we’re still working through kind of exactly when it opens what we think that number will be. But it certainly – it will be – it’s going to be less than a $1 million.

Chris Woronka – Deutsche Bank

Okay. That’s helpful. And then I guess, Rick, as you guys – you bring the asset sale program completion, you open the Knick and you de-lever, I guess the natural question is kind of what’s next for you guys? Do you really looking at acquisitions at this point in the cycle, it’s where we think pricing is or how do you see the cycle evolving for FelCor after this year?

Richard Smith

Yes. Good question, it’s been – there has been a lot of work to get through all of the transformation of this company. And that will kind of signal the end of the transformational period which will be great. And what it does is open up some real opportunity for us to be more opportunistic and more offensive [ph], et cetera.

And so, as we get through the next step, asset sales will occur. There will be a good portion of capacity created. And we have a number of opportunities to take advantage of to look at that. We have a number of redevelopment opportunities as I’ve expressed in the past such as Santa Monica which is huge and some lesser ones, there’s six or seven really good redevelopment opportunities. We’re very good at that. We’ve proven that in the past.

We have the preferred stocks sitting out there which post August 15, will be the highest cost piece of paper in our cash stock [ph], outside of common equity of course. And we have potential for growth.

So we’ll be getting the leverage where we need to. We’ll have plenty of capacity. And we’ll have opportunities to look at each one of those and determine based on the underwriting and vetting the assumptions very thoroughly, what will drive shareholder value the greatest?

And so, we’re going to have some real good opportunity on a next steps portion of our plan in addition to the remaining value to be created by finalizing this plan. So the future looks good.

Chris Woronka – Deutsche Bank

Okay. That’s a good color. And then just finally for me, hypothetically, if you sold Morgans and Royalton, does that – is there any change in the management contract on a change in ownership or would it theoretically kind of carry over as is?

Richard Smith

Well, I mean, if we sold them currently, it would be – it would be encumbered. If it was as it is, right? That’s all I can really say about that. And so, like I said, we’re looking at every alternative on those two hotels as to what are the best ways to move forward.

One thing I should say, they have another reorganization in March. But we’ve been working very well with them. And there’s been some new systems implemented which are helping. And helping manage mix, et cetera, a lot better, and to be more efficient from a mix management standpoint.

So things are improving a little. And so, we will continue to work very directly with them, very closely with the properties. Our asset management team, Troy, Michele [ph]. And so, things are looking better.

Chris Woronka – Deutsche Bank

Okay.

Richard Smith

And also – I mean, just one last note. I mean, Morgans Hotel doing a much better kind of post opening of reserve and so forth. It’s really back on track from a market share stand point. So that’s starting to hedge the right way. There’s still some mix opportunity there without question. Just like there isn’t at Royalton and we continue to pursue that. But again, just to close the book, we will continue to look at every alternative available to us. And when we make a decision moving forward and really – ready to state that publicly, we will.

Chris Woronka – Deutsche Bank

Okay, very good. Thanks.

Richard Smith

Thanks.

Operator

And your next question comes from the line of Steven Kent from Goldman Sachs. Your line is now open.

Anto Savarirajan – Goldman Sachs

Hi, good morning, this is Anto Savarirajan on for Steve.

Richard Smith

Good morning.

Anto Savarirajan – Goldman Sachs

Good morning. This is Anto on for Steve Kent. When you mentioned that transactions have been at close to your expectations, did I hear it right when you said, they were at 11 times prior year EBITDA? And so, can you give us some perspective on what would have been on a camp rate [ph] basis? And further, if you could give us the range of the overall transactions? That would helpful as well. It is the fact that FelCor is on the market to sell assets in any way, weighing on the pricing you’re getting for these assets?

Richard Smith

7% – around 7% cap on average for the first ones [ph]. But no, I mean, I think the answer to the second or the last piece – there might have been a middle piece in there [indiscernible] I have to ask you to reiterate or restate. But the – on the last piece, I don’t think the fact that we have assets on the market is forcing pressure down.

We have walked a number of deals where people have tried to re-trade us. And thinking that we need to finish selling the assets, we’re not going to give them away. We’re going to sell them when you look at the markets, look at the overall plan, look at the capital, future capital needed for the assets and what is in the best interest of shareholders from a global perspective going forward, that’s where we’ll sell the assets. Everyone knows that. And we are not – it’s not affecting that at all. By the end of the day, we’re going to end up selling 85 to 90 hotels from the first phase and the second phase of asset sales. And we haven’t had to deal with that really at all.

So maybe the fact that we brought hotels out on a staggered basis, and now, once has helped that [ph]? I’m not sure. We’re not going to deal with that.

Anto Savarirajan – Goldman Sachs

Understood. Now, when we look at the occupancy across the portfolio, FelCor maybe running in the low 70, some of the other REIT peers [ph] maybe running a few points, say hey, can you talk to us about the occupancy potential for FelCor maybe over the next couple of years? And how do you usually think of how much RevPAR [ph] can be driven by rate. And how much can be – how much of a benefit you can get from occupancy?

Richard Smith

Well, I think we still have some room on occupancy. I think as we will be able to solidify that, as we finish and finalized all the mix changes at the hotel that are currently going on. I think that – I certainly think we’re going to get back to prior peaks, 76%, 77% from an occupancy stand point.

So yes, there is some room. There are certainly some room from a rate stand point, both from an absolutely rate perspective as well as the finalization of the remix. So I feel pretty good about that. And the occupancy gain is likely to come on shorter periods as well as kind of building in after we finish the remix.

Anto Savarirajan – Goldman Sachs

Thank you very much.

Michael Hughes

You’re welcome.

Operator

(Operator instructions) And your next question comes from the line of Sue Berliner from JP Morgan. Your line is now open.

Unidentified Analyst

Yes. Hi, guys. This is actually Wade [ph] calling in for Sue.

Richard Smith

Hey, Wade.

Unidentified Analyst

Hey. Just had a question on encumbered [ph] hotels, just understanding is this 10% volume has been taken out? And then also future other sales proceeds [ph], is it correct that there are still going to be six unencumbered hotels?

Michael Hughes

Well, there are seven today. And post paying off the bonds are going to be ‘14 of the unencumbered [ph].

Unidentified Analyst

Got it. The pro forma for that is going to be ‘14 [ph]? And then pro forma for in the future, this $140 million loan been paid off.

Michael Hughes

Yes. We go into the future paying off $140 million term loan, selling our main assets in rents in hotels [ph].

Unidentified Analyst

Got that. Okay. And then just second question, just any kind of update on a New York market, overall it sounds like it’s been okay despite all new supply. So just I was wondering if you guys had any color on your properties generally.

Richard Smith

Well, the second quarter is certainly a lot better than the first quarter. The market is improving. There’s a number of things going on. It really depends on where you are. Third quarter is looking very strong. It depends on where you are. I mean, there has been a lot of this supply in New York. It’s been well documented and lamented. But my feeling is the market, the submarket that we’re in, in the midtown area, Time Square area is always the best at absorbing that.

And so, you’ve had – a lot of the supply has been thought [ph] on the island or has been in the out boroughs [ph], and as far as this year’s concern. So we think that the market is in very good shape. We love New York long-term. And there’s actually been a lot of talk recently about contraction. The housing market is extraordinarily strong. There’s been a number of discussions going on. I don’t think any deals announced yet [ph], but a lot of conversation going on about conversion from hotel to residential.

So I mean, from a long-term perspective, we love it. April, May, were very strong and also in – June is actually pretty strong, but we had BI [ph] last year in June at our properties. So it made for a kind of bad comp. But April, May, were very strong, third quarter look strong.

Unidentified Analyst

All right, awesome, that’s very helpful. Thanks.

Richard Smith

Thanks. Okay. Finally there [ph] – we are done for the day. So thank you all for joining. And we will talk to you next time.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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