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Morgans Hotel Group Co. (NASDAQ:MHGC)

Q2 2014 Earnings Conference Call

August 8, 2014 09:00 am ET

Executives

Jason Kalisman – Interim Chief Executive Officer

Richard Szymanski – Chief Financial Officer

Michelle Redden – Vice President, Finance

Analysts

Kim Opiatowski – Vertical Group

Amit Kapoor – Gabelli & Company

[David Bakra] – BBT Capital

Chris Agnew – MKM Partners

Matthew Stolzar – Pyrrho Capital Management

Operator

Good morning. My name is Deana and will be your conference facilitator today. I would like to welcome everyone to the Morgans Hotel Group Q2 2014 Earnings Conference Call. Today’s conference is being recorded. I would now like to introduce Ms. Michelle Redden, Vice President of Finance. Ms. Redden, you may begin your conference.

Michelle Redden

Thank you. Before we begin I need to remind you that certain comments made on this conference call may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve a number of factors that could cause actual results to differ materially.

A more detailed discussion of the risks that have a direct bearing on our operating results, performance and financial condition is contained in our filings with the SEC. Copies are available from the SEC or from the Morgans website under “Investors.” Morgans Hotel Group assumes no obligation to update any forward-looking statements or information which speak as of their respective dates.

On today’s call we will also discuss non-GAAP financial measures as we talk about the company’s performance. Reconciliations of these non-GAAP measures to the GAAP measures Morgans considers most comparable can be found on our corporate website, www.morganshotelgroup.com under Investors. Additionally, certain terms or abbreviations discussed on today’s call are defined in the earnings press release we issued earlier this morning.

On today’s call are Jason Kalisman, Interim Chief Executive Officer; and Rich Szymanski, Chief Financial Officer. I’ll now turn the call over to Jason.

Jason Kalisman

Thank you, Michelle. Good morning everyone and thanks for joining us. On the call today I will provide an update on our operations and discuss some highlights, after which Rich Szymanski, our Chief Financial Officer, will discuss our Q2 financials. And then we’ll turn the call over to the operator for a brief Q&A.

Over the past 18 months Morgans Hotel Group has experienced deep and profound change at all levels of the organization. We are pleased to have put many of the legacy issues behind us and to be in a position to communicate with you with a clearer sense of the business on a forward-looking basis. We greatly appreciate your patience during this period.

I would also like to take a brief moment to thank our Board and management who have worked tirelessly and put us in a position to make significant improvements to our financial and operational performance. To that end, since last addressing you here, we have restructured the company’s legacy balance sheet, reduced costs at our hotels and corporate offices, [dealt with] costly litigation and terminated a number of disadvantaged management contracts.

These actions were not easy and required a lot of difficult decisions along the way, but ultimately they were necessary for us to be able to successfully execute on the company’s asset-light, brand-focused strategy.

Today I am thrilled with the leadership team we have in place and are confident that our unique portfolio, pipeline, global footprint and continually improving financial position has Morgans Hotel Group well-positioned to compete effectively in every market where we operate.

I also fully recognize that this is only the start and that there is still work to be done. We come to work every day with the commitment, passion and dedication to create the best experience possible for our guests and maximize value for all of our stakeholders. We are focused for the future and determining the best path forward for the company, and our Board is confidently exploring all opportunities to do what is right for all stockholders.

I would also like to touch on the Board’s strategic review process. As the company disclosed back in May, our Board of Directors formed a special Transaction Committee at the beginning of the year to evaluate a full range of alternatives. The Committee also retained Morgan Stanley as its financial advisory to assist the company in this review. Not surprisingly I am unable to get into specifics about the review except to say that it is ongoing and that we will share any news once the review concludes.

Now I will walk you through some highlights during the quarter. Many of the initiatives I have just discussed are already bearing fruit and we are extremely pleased with our operational performance during Q2. One hotel in particular, The Delano in South Beach, performed extremely well during the quarter, generating significant increases in EBITDA, RevPar, occupancy and ADR versus the same period last year. Our team there has really done a remarkable job.

Overall, excluding a termination seen in 2013 related to The Ames, adjusted EBITDA increased 26.7% over the same period in last year, primarily driven by the strong operating performance at The Delano. At the same time, RevPar for system-wide comparable hotels increased by 6.4% on a year-over-year basis during Q2 2014.

Our managed hotels in London, the Sanderson and St. Martins Lane, are non-comparable due to a major room renovation that began in early 2014 resulting in a decrease in RevPar due to the rooms being out of service in Q2 this year. We expect the majority of renovations to be completed by the end of the year and we eagerly wait for these unique properties to return to full capacity. Once completed, we believe our boutique offerings in London including our new Mondrian London which I will touch upon shortly, will be unrivaled in the industry.

We have also been focused on improving our operations behind the scenes. Specifically we have upgraded our central reservations system to help us take our operations and distribution capacities to the next level. We have also enhanced the company’s website by streamlining the booking process, adding maps and content, and integrating social media. As a result, bookings through our website have nearly doubled since 2013.

We are working harder than ever to improve guest services, including continued work towards developing a loyalty program, bolstering our customer database, and developing new service standards and training programs that resulted in higher service scores. Importantly, these internal improvements have led to strengthened relationships with many of our property owners.

Also notable is our pipeline. We currently have signed agreements for six managed hotels as well as license or franchise agreements for two additional hotels. As I am about to discuss, three of these hotels are expected to open by the end of the year.

First, The Delano Las Vegas, a 1117 room hotel at Mandalay Bay is expected to open on September 1st and will be operated under a license agreement with MGM who has been a fantastic partner to us. With its all-suite boutique offering, Delano Las Vegas will bring the effortless style, luxury, and unparalleled service of the original Delano in South Beach to the Las Vegas Strip.

Later in the month the Mondrian London at Sea Containers is on track to open on September 30th. We could not be more excited about this project. The hotel is located in a vibrant and diverse neighborhood in London’s South Bank. The property has 359 guest rooms and is within walking distance of popular tourist attractions such as the Tate Modern and the Southbank Centre. The hotel will have more than 20,000 sq. ft. dedicated to food & beverage and spa services, as well as more than 5500 sq. ft. of meeting space and a 56-seat screening room.

We are eager about the openings this fall and have already started taking reservations. Additionally, we have a project in Istanbul, Turkey, that’s expected to open in late 2014 under a franchise agreement as well as a Mondrian project in Doha, Qatar, that is currently under construction and expected to open Q2 2015.

Furthermore we are making solid progress on expanding our development platform. We recently have signed two letters of intent for hotels located in the Middle East. Each of these projects contemplates long-term agreements with no investment needed from Morgans. We are also in advanced stages of negotiation for other new hotel opportunities located both domestically and abroad. We look forward to signing hotel management agreements for this properties currently under LOI and will update you with further development announcements at the appropriate times.

As you can see it has been a busy and productive year thus far. Our improving financials and operational achievements highlight the many ways in which we are benefiting from the changes we have put in place. We are doing everything we can to make smart, strategic decisions to capitalize on this momentum in order to deliver continued growth well into the future, and we look forward to discussing our progress with you on future calls.

With that I will turn the call over to Rich who will take you through the financial results.

Richard Szymanski

Thank you, Jason. For Q2 2014 adjusted EBITDA was $14.8 million versus $12.6 million in Q2 2013. The adjusted EBITDA increase of 18% is primarily due to a strong performance at Delano along with lower corporate expenses. Excluding termination fees in 2013, adjusted EBITDA increased by 27%.

RevPar for our system-wide comparable hotels for Q2 increased by 6.4% from Q2 2013. The increase was driven fairly evenly between occupancy and ADR with occupancy increasing by 3.4% and ADR rising by 2.9%.

Our New York hotels generated a 2.8% RevPar increase from Q2 2013. Occupancy in New York was very strong at 94%. The RevPar increase was primarily driven by Mondrian Soho which was up by 7.9%. A combination of strong transient business and leisure travel along with the opening of Mondrian SoHo’s rooftop bar Sonny’s were the primary drivers of growth.

RevPar at Hudson increased by 0.5%. Hudson achieved 95% occupancy but ADR declined as a major nearby competitor returned to full operations in 2014 after undergoing a renovation in 2013. Food & beverage revenues at Hudson were up 19%, reflecting the continued success of Hudson Commons and the opening of a new bar Henry in September, 2013. Year-to-date, food & beverage operating profit is $0.5 million versus a loss of $0.3 million last year.

We expect to add ten new rooms at Hudson in Q3 and two new rooms in Q4 primarily from SRO conversions at a cost of approximately $190,000 per room, a significant discount to market value. After these rooms are in service Hudson will still have 60 SRO units remaining which we plan to convert into guest rooms as they become available. Additionally we’re constantly looking at other areas of the hotel that we can convert into revenue producing spaces.

Miami’s comparable RevPar rose by 11.8% in the quarter as compared to the same period in 2013. Our wholly-owned Miami hotel Delano generated a 14.0% increase in RevPar with occupancy rising by 9.5% and ADR increasing by 4.2% to $468 for the quarter. Miami continues to grow as an international destination and Delano remains one of the premier hotels in the market.

Our West Coast hotels generated 10.2% RevPar growth in the quarter compared to Q2 2013, driven by a favorable demand-to-supply growth ratio in both the San Francisco and Los Angeles markets. RevPar at Clift in San Francisco, a leased hotel, was up 11.2% while RevPar at Mondrian L.A., a managed hotel, was up 9.0%.

The strong top line trends translated into excellent bottom line results in Q2. Due to cost saving initiatives implemented in May, owned hotel operating expenses rose by just 0.7% on a 5.2% increase in revenues. As a result, owned hotel operating margins increased by 320 basis points. We’re pleased to see positive results from this new cost structure which hasn’t even been in place for a full quarter yet, and we look forward to realizing continued margin growth at both our owned hotels and the hotels owned by third parties.

Management and other fees were down $2 million for Q2 compared to last year of which $900,000 related to the termination fee at Ames. Fees also decreased due to a change in the [like] group fee structure to a lower base and higher incentive model, and the renovations in London. We expect our run rate fees to be positively impacted by the openings of Delano Las Vegas, Mondrian London, and The Original in Istanbul which we anticipate this year.

Corporate expenses for the quarter decreased by $1.8 million or 26% compared to the same period last year due to the cost saving initiatives implemented in March this year. We are still transitioning some employees and are on track to achieve the $8 million of expected annual run rate corporate savings we had previously disclosed.

At June 30, 2014, we had $616 million of consolidated debt excluding capital leases and $133 million of cash. We expect to utilize our cash primarily to retire our convertible notes which had a balance of $84.5 million at June 30th. Since the end of Q2 we have purchased $11.7 million of these notes at a small discount to their face value.

In addition, the dividend rate on our preferred securities, which has a balance of $113 million at June 30th including accrued dividends decreased to 8% on the election of the Yucaipa representative to our Board in May. The rate increases to 10% in October.

We currently have $391 million of federal tax NOL carry forwards to offset future income including gains on future asset sales. We estimate our tax bases at Hudson and Delano to be approximately $200 million combined.

In summary, our financial picture is improving. The refinancing of Hudson and Delano earlier this year provided us with the cash to cover our near-term maturities. With strong operating results and cost-saving initiatives we are generating positive cash flow from operations. Our streamlined cost structure along with the additional rooms at Hudson and new hotel contracts coming online this year make us well-positioned to generate strong incremental cash flow as revenues increase.

I’ll return it now to Jason.

Jason Kalisman

Thank you, Rich. Operator, you may now open the line up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions.) Thank you, we’ll go first to Kim Opiatowski of Vertical Group.

Kim Opiatowski – Vertical Group

Thank you for taking my call. One question with regards to, you know, right now you’re doing a lot of things within the operation of the hotel that are improving it over time, as far as upgrading the reservations systems. At what quarter do you think we’ll be at a point where most of this restructuring and reservations upgrade and structural changes are kind of at a constant steady state and we have it all behind us? What do you think the timing is as far as the rollout of that?

Richard Szymanski

Yeah, I think from the operational side the restructuring costs this quarter, unlike last quarter, do not have a lot of the restructuring costs related to the cost reductions. They’re mostly related to the proxy contests. So we think that we’re kind of at a run rate right now and we think that the guidance we gave with regards to both the corporate and hotel-level cost savings are accurate.

Kim Opiatowski – Vertical Group

Okay great, thank you. And just one more question: the food & beverage, there’s a notable trend as far as there’s a continuous positive ramp in that segment. Can you give us some highlights on why that’s outperforming and what the future plans are as far as potential expansion on that segment as well?

Jason Kalisman

Sure. I think a lot of it has to do with just opening up new venues. I think that last year at this time really the Hudson venues had not been opened or had just opened, and now they’ve been great performers. We also revamped in Q2 a lot of our offering in the summer at Mondrian SoHo with Sonny’s Soda Shoppe. So I think it’s just been rolling out these new food & beverage venue has helped boost food & beverage revenues.

Kim Opiatowski – Vertical Group

Okay, thank you. I’ll jump back in the queue.

Jason Kalisman

Thank you, Kim.

Operator

Thank you. We’ll take our next question from Amit Kapoor of Gabelli & Company.

Amit Kapoor – Gabelli & Company

Hey, good morning Jason, Rich. Two questions: in terms of the pipeline or the thought process about expanding the pipeline, are there geographies that you guys have on the map that you would like to focus on? And are there partnerships there or potential partnerships that you feel would be more fertile in terms of expanding the pipeline? And I have a second question after that.

Jason Kalisman

Sure. With regards to the pipeline we’re focused on major markets in North America, Europe and the Middle East where we can take advantage of markets where we have scale. We’re primarily focused on management agreements but we’d also consider license or franchise agreements depending on the brand, market and operator. Beyond that we would with the right partner look to expand into other areas, but I think as we’ve found in the past if you don’t have the right partner and you don’t have the right scale it’s not very profitable to do that.

Amit Kapoor – Gabelli & Company

Great, thank you. And then I know you mentioned in your scripted remarks about the strategic review that’s ongoing and you’re unable to comment on specifics. But as part of the framework for the review do you, is there a sense that the lodging asset market is, in terms of its depth, what is the sense there – is it deep enough, is it active enough right now? And how does that frame the overall review process itself, depth of asset sales, buyers out there – could you comment on that generally speaking, please?

Richard Szymanski

Yeah, I will comment on the market; I’m not going to comment on how that impacts the Strategic Transaction Committee’s activities if that’s okay. So in terms of the market we are still seeing a robust market. I mean as you saw from the improvements at Delano which Miami is a market that we thought was maturing and we’re still seeing strong growth there now. Hudson in New York has a little bit been impacted by new supply coming online at the end of last year but I think demand has still outpaced supply. In terms of asset transactions I think in the low-yield environment we’re in we’re continuing to see very strong pricing for hotel assets that are trading in the market.

Amit Kapoor – Gabelli & Company

Terrific, thank you.

Operator

Thank you. (Operator instructions.) We’ll go next to [David Bakra] of BBT Capital.

[David Bakra] – BBT Capital

Yes, good morning Richard and Jason, thanks for taking the question. Following on the remark you just made about strong asset prices and not getting into the details of the review, however you talked about the model, the asset-light model of the company. And given the prices of assets as you just mentioned what can you tell us about selling the Delano and the Hudson as far as the hotels go to really become 100% asset-light as the model would suggest? What can you tell us about that at this point?

Richard Szymanski

Yeah, I can’t. We’re not going to comment on the timing or plans of any possible asset sales.

[David Bakra] – BBT Capital

Okay. Well fair enough for the timing of the plan but how does it fit into how you see the company down the line? Irrespective of some strategic action or not, does it makes sense to sell those assets and reduce the debt?

Richard Szymanski

Our long-term goal is to be asset-light and I believe that whenever the right time as determined by the Committee to make asset sales or other types of transactions the Board will make that decision.

[David Bakra] – BBT Capital

Okay. And another quick question on the [like] group: there was some thinking I believe at one point that you might want to dispose of that. How are you thinking on that front?

Richard Szymanski

Again, we’re not commenting on plans for any of our assets but Las Vegas is a strong market. We’re opening the Delano Las Vegas there now and we’ll continue to seek to maximize the performance and cash flow of the [like] group however we can.

[David Bakra] – BBT Capital

Okay, thank you.

Operator

Thank you. We’ll go next to Chris Agnew of MKM Partners.

Chris Agnew – MKM Partners

Thanks very much, good morning. First question really on the CEO search, any update there and just the thought process behind how you’re going about the search, thanks.

Jason Kalisman

Sure. The search is in progress. We have hired Spencer Stewart who as I’m sure you know is the leading executive search firm and we’ll update you when there’s something to announce. There’s no set timing. Due to recent events such as the proxy contests I think there was a feeling that it was important for the business for me to remain in the CEO position but now that we have made progress on many legacy issues facing the company I believe we are in a better position to find the best possible candidate.

Chris Agnew – MKM Partners

Gotcha, thanks. And the management fee decline, I think you said $1 million from the [like] group, the change in the fee structure. Should we assume it’s a similar sort of pace, quarterly pace through the rest of this year? And how do we think about potential upside from, as you’ve shifted to the incentive fee or if there is any at all? Thanks.

Richard Szymanski

Yeah, just to be clear – of the $2 million, 0.9% is related to the Ames termination and we didn’t mean to say that the rest is related to the [like] group. The [like] group is one portion of the rest. Also the fact that we have the London assets out of service is another portion, so the [like] group is only a portion of that. So it’s not the full $1 million. But les, I think in told the London assets come online; I think that all-in about $1 million is probably good for the next quarter or two.

Chris Agnew – MKM Partners

Okay. And did you mention when the Sanderson and St. Martins Lane are back fully online? And also just for the Mondrian London, you’ve outlined before the way to think about sort of fees coming in. What should our expectation on fees be for 2015? Thanks.

Jason Kalisman

Sure. So for the other London hotels we expect the rooms to be coming online by the end of the year. With regards to the Mondrian London, I think that in the past, we don’t disclose fees on individual hotels but in the past we have given guidance on average. We receive approximately $750,000 to $1 million per year in fees for every 100 rooms.

Chris Agnew – MKM Partners

Great, thank you so much.

Jason Kalisman

Thank you, Chris.

Operator

Thank you. We’ll take our next question from Matthew Stolzar of Pyrrho Capital Management.

Matthew Stolzar – Pyrrho Capital Management

Hi guys. We’re seeing a lot of brand birth across the competitive landscape, and we believe as I’m sure you do that there’s a lot of value in your brand especially at this point in the cycle. However, to realize that value there needs to be scale to build them out properly which this company doesn’t really have. You’ve had two unsolicited bids, both above where the stock closed yesterday. Your assets seemed to have performed well since those bids were announced, but by not engaging in these discussions and limiting the brand growth due to your scale we’re concerned that these brands which we think are great assets will deteriorate over time. As you mentioned, you engaged Morgan Stanley three months ago for a strategic review. When can we expect an update on their initial valuation and their strategic recommendations?

Richard Szymanski

So Matt, as I mentioned before we’re not going to comment on the Special Transaction Committee’s activities or timing.

Matthew Stolzar – Pyrrho Capital Management

So no timing in terms of the initial valuation, just when you’d expect to have any updates?

Richard Szymanski

As I said, Matt, we’re not going to comment on the process or timing.

Matthew Stolzar – Pyrrho Capital Management

Okay. Well we would strongly urge you to pursue a sale of the company which we believe is the only path to realizing the full value of these assets and you know, we look forward to an update on this process in the coming weeks and months and we’re hoping that that’s weeks. So thank you for your time.

Richard Szymanski

Thank you, Matt.

Operator

Thank you. At this time I’d like to turn the conference back over to Mr. Jason Kalisman for any additional or closing remarks.

Jason Kalisman

Great. Thank you everyone again for joining today’s conference call. We’re always available offline to answer any additional questions you may have. We look forward to speaking with you again next quarter. Take care.

Operator

That does conclude today’s conference. Thank you for your participation.

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