Morgans Hotel Q3 2007 Earnings Call Transcript

Morgans Hotel Group Co. (MHGC)

Q3 2007 Earnings Call

November 7, 2007 5 pm ET

Executives

David Hamamoto - Chairman

Fred Kleisner - Interim President, CEO

Rich Szymanski - CFO

Analyst

Celeste Brown - Morgan Stanley

Jake Fuller from Thomas Weisel

David Katz - CIBC World Markets

William Marks - JMP Securities

Operator

Presentation

Good afternoon, and welcome to the Morgans Hotel Group Company's Third Quarter 2007 Earnings Call. My name is Mary and I will be your conference operator today. At this time I would like to inform all participants that your lines will be in a listen-only mode. After the speakers remarks there will be a question-and-answer period. (Operator Instructions). As a reminder ladies and gentlemen, this conference call is being recorded and your participation implies consent to our recording of this call.

I would now like to turn the call over to Jennifer Foley of Morgan Hotel Group. Please go ahead.

Jennifer Foley

Good afternoon. Thank you for joining us on the third quarter 2007 conference call. Participating on today's conference call are David Hamamoto, Fred Kleisner Interim President and Chief Executive Officer, and Rich Szymanski, Chief Financial 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 all of you to 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'll pass the call to David.

David Hamamoto

Thank you, Jen. I am glad to be with you all today. Before I turn the call over to Fred to discuss the Company's results, I wanted to make a few brief comments.

Given the management transition we experienced in September I wanted to emphasize that the company has not (inaudible). This quarter we continue to deliver outstanding results with our Comparable Hotels RevPAR rising well in excess of industry averages. We have significant underlying real estate value with fever irreplaceable assets in high profile market.

Today's announcement, by another hotel company, that it is developing a new hotel in New York City for $1.4 million per room, including $400,000 per room for land, further illustrates the value of our hotels in key markets. Our hotels are well positioned in the boutique luxury segment and we owned some of the most notable brands in the industry, such as Mondrian and Delano.

With targeted reposition such as Delano and Royalton, and six new hotels under development, we have a well defined growth plan. We've recently raised $143 million of capital, which puts us in a great position to capitalize on opportunities to grow our company. All of us, from the board level and down, focus on growing our brands and continuing to deliver outstanding results. Of course, the results speak for themselves, as you all read in our earnings release.

I want to thank Fred Kleisner for taking the helm so quickly and so well. As I said at the time of our announcement, we are extremely fortunate to have someone of Fred's caliber, step-up to lead this company. I have been actively involved working with Fred and the rest of the management team over the past several months. This experience has given me great confidence in the breath and depth of management talent in the organization. Team has focused on a common vision of growing our brands through new management contracts and minority ownership interest in hotel, in 24 hour gateway cities and select resort destination.

I am extremely proud of our strong operating results, strategic repositioning, solid financial position, and well defined growth plan, and I am highly optimistic about our prospects for the future. I firmly believe we have the management talent, brand value, and creative development expertise continue to deliver superior growth.

Allow me to say a few words about our executive search. The board of directors is the actively engaged in the search for permanent President and Chief Executive Officer. We have been working with Spencer Stuart and our meeting with both internal and external candidates with impressive leadership quality.

Let me assure that we are searching for a CEO with experience and qualities necessary to take this company to the next level for the benefit of all MHG shareholders.

With that I would like to turn the call over the Fred to discuss the results of the quarter.

Fred Kleisner

Thanks David and thanks everyone for joining us today to discuss our third quarter results. I will start off by reviewing some of the highlights of the quarter; then I will turn things over to Rich who will get into the details of our financial results. After that, David Rich and I will be happy to take your questions.

Before we begin, for those of you who may not have listened into the call we had in September, let me just say a few words to introduce myself. As David mentioned, I've served on the Morgan's Board of Directors since the company went public in early 2006, and also has substantial expertise in the boutique hotel sector from my prior positions with both Wyndham International and Starwood Hotels and Resorts.

I've spend my entire career in the hotel industry, and have the same passion today as I did when I started in this business over four decades ago. Since assuming this expanded role at Morgans Hotel Group, I've relocated to New York for full time working with the board and management to execute the strategy and vision of the company.

Now let's move to financial results: The third quarter was yet another outstanding quarter for our company and we are pleased with our results. We've had another quarter of industry leading RevPAR growth in our comparable hotels, up 11.5% over the third quarter 2006. This is the fifth consecutive quarter of double-digit comparable hotel RevPAR growth. We operate in favorable markets, where we continue to see supply-demand fundamentals strong. Our hotels have benefited from a strong business and leisure demand, including an increase in foreign travel to these key gateway markets in our third quarter.

At new hotels, we achieved significant average daily rate increases with Hard Rock's ADR increase at 13.5% and Scottsdale ADR at almost 10%. We continue to demonstrate our strong revenue management capabilities and believe this is a key strength we bring to future projects. As a result of the strong year-over-year growth at our comparable hotels, and the impact of renovations and new hotels, adjusted EBITDA increased by 34% than the prior year period to $24 million. Excluding Royalton, which was closed for renovation during the quarter, this increase was 46% driven by a 100 basis point increase in comparable hotel margins and the execution of our growth plan.

Now, I would like to discuss some of the important events of the quarter. We have a robust pipeline of announced projects with new hotels under developments in Southeast Miami, New York SoHo, Chicago and Las Vegas. We're on track to open Mondrian South Beach in Miami early next year. Despite difficult market conditions, we've secured over 200 non-refundable deposits for condominium units. That's a strong endorsement for our brand.

Relative to the recent activities in our existing hotels, we've said before that it's not only by expanding into key markets with developments of new projects, but also reinvigorating our existing properties, that keeps us in the forefront of the boutique hotel sector.

Our goal is to consistently create an unparallel guest experience, creating a vibe that inspires our guest to live each visit more intensely. We have seen that by renovating our existing projects and keeping our brands fresh and on a cutting edge, we are able to directly increase RevPAR for individual hotels.

Recently on October 23rd, we unveiled our newly redesigned Royalton here in New York City, which has been under renovation since June. We partnered with Roman & Williams to re-image and redesign Royalton's vibrant lobby, bar, restaurant and penthouses. We have set out to bring life to one of New York's most iconic properties and are pleased to say, we've given New York back its preeminent living room.

We've already received extremely positive responses from our guests, which is further and even more demonstrated by the fact during the first two weeks of October, when all rooms were back in service, average daily rate was up 20.5% over the comparable year, a period in October 2006.

Likewise, last fall we announced the completion of the first phase of renovation at Delano at South Beach Miami with 70% of the rooms completed. We are now completing the renovation of the remaining 30% of all of our guest rooms this month and completing the upgrade of the spa and gym, as well as building a new nightclub designed by Lenny Kravitz and Kravitz Design.

Our customers have reacted very favorably and, as a result of these renovations, Delano has achieved consistently high RevPAR growth, increasing approximately 16%, both in the third quarter and year-to-date.

As we previously announced, we have begun renovating Mondrian in Los Angeles in September, with a targeted completion date for the second quarter of 2008. We're doing complete room renovations including, a total redesign of our guest rooms, brand new bathrooms, re-imaging public spaces to enhance the modern chick Hollywood feel of that hotel.

With the track record of strong results this year from Delano, and positive returns from the Royalton, we are confident in our expectation that Mondrian LA will be our next RevPAR growth story.

In September, we opened a new Bungalow 8 nightclub in London's St Martins Lane. That was in partnership with nightlife expert Amy Sacco. This is an exciting project that has brought significant notoriety and publicity to their hotel. We will continue to focus on opportunities to add value to our existing hotels with planned renovations for 2008 at Morgan's in New York and planned utilization of excess space at Hudson in New York City, as well as the conversion of residential units to hotel unit at Hudson in New York.

As I mentioned earlier, our Hard Rock investment continues to make a significant contribution to our EBITDA driven by the quality of our management. We are proceeding with design plans for the expansion project of that resort in Casino and that is expected to double the size of the hotel in Casino and add much needed meeting space.

Construction is expected to start this December with an expected completion date in 2009.

With that I would like to turn the call over to Rich to run though our financial results greater detail.

Richard Szymanski

Thank you, Fred. We are very pleased with our third operating result. Our adjusted EBITDA of 24 million reflects strong year-over-year growth and significant contribution from new and renovated hotel. As Fred mentioned, quarter adjusted EBITDA rose by 34% and excluding Royalton, which was closed for renovation, adjusted EBIDTA increased by 46%.

Our operating results were driven by our high RevPAR level, which was $260.13 for the quarter and that is among the highest in the industry. This reflects an increase of 11.5% or 9.6% excluding the effects of currency fluctuation and our comparable system-wide hotel. Given our high occupancy level, we were able to achieve most of growth through ADR increase. For the quarter, comparable hotel ADR rose by 9% to $322 and occupancy grew by 2.3% to 81%.

As you know ADR increases had a significant impact on EBITDA margin, and this drove the increase of approximately 100 basis points at comparable hotels.

At new hotels we achieved significant ADR increases in both, due to the implementation of revenue management strategies. In the third quarter, Hard Rock achieved a 96.1% occupancy rate and a $226 ADR. This represents a 13.5% increase in ADR, and an 11.6% increase in RevPAR over the comparable period last year, when it was operated by prior management.

We recorded a net loss of $10 million for the third quarter of 2007, compared to a net loss of $700,000 for the third quarter of 2006. Results included a non-cash charge for stock compensation expenses of $7.3 million, and other cost of $2.5 million in connection with the resignation of our former CEO.

In the past few months we have completed new financings, which have raised over $200 million of new proceeds, and positioned the company for further growth. In July we completed a stock offering of 12.2 million shares at a price of $22.50, which included 2.8 million shares sold by the company and 9.4 million shares sold by certain selling stock holders. We've realized $59.5 million in net proceeds.

In October we issued 172.5 million of our [2 and 3A] Senior Subordinated Convertible Notes in a private offering. The notes are Senior Subordinated Unsecured Obligations of the Company and can be converted into shares of the company's common stock under certain circumstances, and upon the occurrence of specified events.

Interest on the notes is payable semi-annually in arrears in April and October of each year, beginning next April. In connection with the issuance of the notes, we entered into a convertible note hedge and warrant transactions, which generally have the effect of increasing the conversion price from the initial level of $26.89 to $40, and net proceeds of $142.7 million after fees and expenses and the net cost of the hedged transaction, utilized $25 million to repay all outstanding borrowing under the revolving credit facility.

As of September 30 we had approximately $236 million invested in non- EBITDA producing assets including consolidated assets, equity investment and joint ventures, and our proportionate share of joint venture debt.

Our future committed equity funding on these projects are approximately $80 million and include approximately $50 million on Echelon, $15 million for Mondrian Chicago and $15 million for the Delano expansion. With a cash balance today of approximately a $150 million and undrawn $225 million revolving credit facility in place through 2011, we have significant liquidity to execute these and other future projects.

Looking ahead, we reiterate our guidance for the full year of 9% to 11% RevPAR growth in our comparable hotels. Total revenue in excess of $300 million and adjusted EBITDA in excess of a $110 million. Due to the ramp up in Hard Rock and Mondrian Scottsdale and the renovation at existing hotels, we believe that the projected 2007 adjusted EBITDA level is not indicative of the normalized run rate adjusted EBITDA of the portfolio.

So in conclusion, it was a very good quarter from a financial perspective. We continue to deliver outstanding operating results and our recent financing has provided us with the liquidity to grow. We believe our business model of growing through minority equity investment with partners, coupled with long-term management agreements, should generate high returns on investment with management fees alone, having the potential to yield a significant return on invested capital.

I would like to turn it now over to Fred for some closing remarks.

Fred Kleisner

Thanks Rich. Since taking on the role of interim CEO, I've had the opportunity to work closely with an incredible team of talented and dedicated employees and one of the strongest management team in our industry. We've already accomplished a lot together.

We believe there is more to come. Our outstanding results over the last several quarters reflect the strength of our brands in our markets. We will continue to distinguish ourselves in the marketplace by redefining the guest experience through cutting edge design, renowned bars and restaurants and outstanding personalized service.

We have a well defined growth plan and are focus solely on the luxury boutique sector, the fastest growing segment of the hotel industry.

I have been here now for six weeks. And while I am impressed with the quality of our locations in hotels, I have always had that, I am equally impressed with our management talent, our operating systems and our ability to deliver and generate high margins.

Lastly, let me say I have already met with a number of you since coming on board. I look forward to meeting more of you.

With that, David and Rich and I are pleased to take any and all questions.

Question-and-Answer-Session

Operator

(Operator Instructions). And our first question comes from Celeste Brown from Morgan Stanley. Please go ahead.

Celeste Brown - Morgan Stanley

Hi guys, good afternoon.

David Hamamoto

Hi Celeste.

Celeste Brown - Morgan Stanley

Few questions for you; one just a minor question: The $2.5 million of other costs related to severance to Ed's departure. I understand the stock comp, I thought there wasn’t any severance associated with his departure. Can you just give a little there?

Rich Szymanski

Yeah, the $2.5 million does not have severances. It is legal. Its search accrued for the search cost and items like that.

Celeste Brown - Morgan Stanley

Okay. And then in terms of your guidance, I know that you don't want to answer this, but you guys have trended ahead I think of expectations all year, with one quarter elapse. Is there any reason in particular you are not raising guidance at this point or you just concerned generally about the broader economy?

Rich Szymanski

There is no reason for not raising it. We want to just reiterate what we previously said.

Celeste Brown - Morgan Stanley

Okay. And then I know you guys have talked about assets sales in the past, tough credit markets right now, but are you guys out in the market or are you seeing anything that would stop you from selling any of them?

Fred Kleisner

Well, it is still part of our strategy and as far as what we are seeing in the market, of course banks are now requiring more equity and it's not necessarily a bad thing. This will get back to better underwriting standards and so there are changes in the market certainly, but we haven't seen anything drastic so far.

Rich Szymanski

Again, I think for last week, obliviously there are a lot of offshore buyers that are extremely aggressive today and not really impacted by the credit market, and I think you saw the announcement today of [OEH] deal at 1.4 million a key to build it and that’s two years out, but still its a huge number in terms of what that implies for replacement cost in New York City. And I think that the extent that there are aggressive buyers that are offshore, that want to buy our assets on an encumbered basis, that's probably our cheapest source to capital and so we will continue to evaluate how to access that capital and an employed time in order to fuel the growth of our brands by buying minority interest in new projects and getting long-term management contracts.

Celeste Brown - Morgan Stanley

Okay, great. Thank you.

Operator

Our next question comes from Jake Fuller from Thomas Weisel. Please go ahead.

Jake Fuller from Thomas Weisel

Yeah, good afternoon guys. Have you made a decision yet as to whether or not you're going to co-invest in the Hard Rock expansion?

David Hamamoto

We're looking at each progressive capital call individually. Thus far we've made them all and we remain very pleased with the results from our current operations at Hard Rock and enthused about the additions.

Jake Fuller from Thomas Weisel

Make sure I understand what you're saying: You've met all the capital calls so far. How much has been put into the project so far? Have you maintained your stake and how much does that mean you've put into the Hard Rock so far?

Rich Szymanski

Yes Jake, we have maintained our stake, we've posted letters of credit for about $5 million, which is our proportionate one-third share of the money that have been spend so far.

Jake Fuller from Thomas Weisel

And what's the total? Refresh me: what's the total budget for the Hard Rock expansion?

Rich Szymanski

Roughly about $750 million, of which financing will cover about $600 million, so total equity requirement we estimate is about $150 million.

Jake Fuller from Thomas Weisel

So, for you to maintain your stake, that would require you to put in what amount?

Rich Szymanski

50

Jake Fuller from Thomas Weisel

Okay. Based on the financing that you've done to date, do you have the capacity to make that investment, should you decide to?

Rich Szymanski

Certainly, yes.

Jake Fuller from Thomas Weisel

Okay. Thank you very much guys.

Operator

Our next question comes from David Katz from CIBC World Markets. Please go ahead.

David Katz - CIBC World Markets

Hi, good afternoon.

Fred Kleisner

Hey David.

David Katz - CIBC World Markets

Names changing all the time. Rich, do you have an average in an ending quarter share count for us?

Rich Szymanski

Ending of the quarter pure share count was $34.7 million. We used for our fully diluted calculation $34.1 million.

David Katz - CIBC World Markets

Got it. And just a follow up last question earlier, the $2.5 million, as I look at through P&L, I see, sort of any other line item, I see $3.2 to $9 million, its quite a bit higher year-over-year. We do assume that a $2.5 million is baked into that number and what else is in there, in your adjusted EBITDA calculation?

Rich Szymanski

Yes, the $2.5 million is baked into there, the other piece are litigation cost, primarily on the Shore Club.

David Katz - CIBC World Markets

Okay. And I'm not sure, if we missed in the press release or in your comments, but Hard Rock fees for the quarter?

Rich Szymanski

Hard Rock fees for the quarter were about $2.4 million.

David Katz - CIBC World Markets

Okay. And last one, we are looking at the impact of the Los Angeles renovation, can you help us try and quantify the impact of that will be next year?

Fred Kleisner

Well, I don't want to give forward looking statements or make projections, but we were very encouraged by the first two weeks at Royalton, and our expectations are that, we should get a significant rate increase at Mondrian LA, to compete more with the Beverly Hills properties where we are both significantly below them. So we are looking for significant rate increases there. Then, also one thing I want to point out to the numbers even that we generated in the quarter, they include the long-term of renovation in the Mondrian in LA. So we did begin the renovation in September.

David Hamamoto

I emphasize, this is a total renovation. These are guest rooms that really had not had a 100% renovation of the bath, they are being gutted out. Full replacement of all case goods and soft goods, since the hotel opened in 1984. This is an extraordinary change in the quality of our accommodation. And for those of you who know Mondrian LA, it's terrific square footage. We have significantly oversized rooms that are going to be welcome in this market. Our projection is to absolutely hit this market head on.

David Katz - CIBC World Markets

If I can just follow that up for one quick second: It looks like ADR was still up during the quarter and occupancy was down only slightly, and it sounds like one of the months and I assume the month of September was -- there was under-renovation and I guess what we were trying to get out is how far occupancy really falls during that period? And perhaps some thoughts about how you're going about the renovation? How many rooms we would consider, perhaps taking at a service at a time or those kinds of details would help us figure out the impact, the negative impact?

Fred Kleisner

Yeah, we are basically taking out about quarter at a time or so it does not impact the guest experience significantly and I don’t exactly have the renovation schedule in front me to tell you where it would fall, but we're probably taking out 10% to 15% of the rooms for a period of times. So that's a rough gauge.

David Hamamoto

It's clearly a: “do no disturb strategy” for implementation. We are operating during the period of each day that is not during customer use periods that are typical. We are avoiding weekends that are major event periods and we will shutdown the project during the award season in 2008, which is so lucrative to that hotel. I do believe, we've taken the every precaution to minimize revenue displacement and prepare a product that will maximize revenue increment, as we present a new product.

David Katz - CIBC World Markets

Right. And one last one and then, I promise, I will get out of the way. Stock-based comp was up dramatically year-over-year. Could you just talk about what's in that $10.6 million this year versus last year, in corporate expenses?

Rich Szymanski

Sure, the $7.3 million related to the vesting of option or it is a expensing of options related to the resignation of our former CEO.

David Katz - CIBC World Markets

7.3, is what that number is. Thank you.

Operator

And we have time for one more question and that will be coming from William Marks from JMP Securities. Please go ahead.

William Marks - JMP Securities

Great, thanks. On the last question, then expanded to several, but: can you just discuss the CapEx? And one: is there any additional CapeEx from the Royalton in the fourth quarter? And then talk about CapEx needs in fourth quarter and also '08 including for Morgans Hotel?

Rich Szymanski

Sure. For CapEx, there is very little left on Royalton; most of money was spent in the third quarter. Fourth quarter CapEx for renovations, we think will be in the range of about 10 million. Next year we are projecting about $35 million or so, and that includes the Mondrian LA, it includes the Morgans, and it also includes the utilization of the excess space at the Hudson.

William Marks - JMP Securities

And can you give us any indication with the Hudson versus just between the approximately?

Rich Szymanski

Roughly the majority, the higher percentage would be from Mondrian LA. Hudson rough number, we kind of estimated at about $10 million for build out, but we don't costing on that one because we don't have all the plans and we are still exploring that and Morgans will be relatively minor.

Fred Kleisner

Note that at Hudson we have 25,000 square feet of space we have yet to utilize as revenue producing space that can be significant meeting and entertainment space. We also have residential units that with the replacement value of individual units at Midtown in Manhattan, that we have churned up our plans to convert those units to hotel use as quickly as possible.

William Marks - JMP Securities

And how can the Morgans be relatively minor if you may be shutting the hotel for a period of time? When you say: “minor”, is it?

Rich Szymanski

That’s in: “minor” in terms of: “CapEx”, because we don’t its something like Royalton renovation we did a major lobby renovation, it’s a very small lobby of Morgans, and it’s primarily room renovations. So, the thought of shutting would be, if we did, would be not to impact the guest, to get it done quicker because New York is such a hot market. But the actual work we're doing in the rooms is not significant, and we are not touching the lobby and open the public space like we did at Royalton.

William Marks - JMP Securities

Okay. Clear the things hopefully. At the Clift, are you making money on the lease right now; I understand the lease payment may have gone up this year?

Fred Kleisner

Yeah, through three quarters we are at about, almost $5 million and the lease payment is $6 million. So, we're pleased with the results there, the results have gone up fairly significantly this year, and we are on track to cover the lease payment for the year.

William Marks - JMP Securities

Okay. And then just a general comment on flow-through: I know that the total EBITDA number was strong, but it looks like your EBITDA growth, if you look at the owned hotels, really matched about the RevPAR growth, and any comment common on if you felt the flow-through was weak, if there's improvement there or any related comments?

Rich Szymanski

We think generally the flow-through was pretty strong. Of course you know -- I think what you need to look at is total revenue growth, which also includes food and beverage and other revenues but, we think if you look at all the properties, you look at them individually, they all grew fairly well, plus, we had some promotional events during the quarter, we had some unusual repair and maintenance expenses in the quarter and, that was probably the only property that didn't have a really strong flow-through, but we think that they are right placed events.

David Hamamoto

Let me comment, I've been looking at hotels, individual hotel results for a long time, the flow-through individual hotel by hotel, Rich and I and David Weidlich, of EVP, Operations; went through each hotel, at the end of the quarter, the flow-though hotel-by- hotel, with the exception of some one time events at Hudson, was very strong, I'm very pleased. That drove a 100 basis point increase in our margins and its interesting to look, our margins were already strong.

William Marks - JMP Securities

Okay, great. And I'm going to ask one final question and that is just related to Hard Rock and any update on what you're doing with the land there, as well as the Hard Rock brand?

Marc Gordon

This is Marc Gordon. As you know, we've been marketing the land for central sale or joint venture. We have found a number of parties interested in doing something along the line in one of two categories of transaction, nothing defensive, nothing ready to announce, but nice interest with, probably those options.

William Marks - JMP Securities

And the brand?

Marc Gordon

In term of growing, their brands in the territory where we own right?

William Marks - JMP Securities

Yes

Marc Gordon

Similarly we've looked at a number of transactions in those territories, the western part of United States of America, the selected number of countries where we own the rights outside of United States. Again, nothing to announce, but certainly “interest” and it looks very parallel.

William Marks - JMP Securities

Great, that's all from me. Thank you.

Operator

Gentlemen, there is actually one more question and it’s our last question and its a follow up question from Celeste Brown from Morgan Stanley. Please go ahead.

Celeste Brown - Morgan Stanley

Hi, guys. Sorry to hit you again. Rich, with the acceleration of the stock-based comp with Ed's departure, will your run rate be lower than $2 million to $3 million we've seen in the past couple of quarters?

Rich Szymanski

I think if you took Ed's effect out of quarter even the normal amortization, we're probably are still, we are probably in about to $2.5 million range.

Celeste Brown - Morgan Stanley

Okay. And then in terms of the Royalton, there are clearly some or I assumed didn't get rid of all of your employees where the cost associated with keeping your employees and everything else capitalized?

Rich Szymanski

Yes, because under accounting rule if the hotel is closed, you can capitalize that.

Celeste Brown - Morgan Stanley

Thank you.

Operator

This ends our Q&A session. I would like turn the floor back over to Mr. Kleisner for any closing comments.

Fred Kleisner

Thank you all, again for joining us today. Have a great evening. We look forward to speaking to you again next quarter.

Operator

Thank you everyone. This concludes today's conference call. You may disconnect your lines at this time and please have a wonderful day.

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