Red Lion Hotels Corporation Q2 2008 Earnings Call Transcript

Red Lion Hotels Corporation (RLH) Q2 2008 Earnings Call Transcript August 7, 2008 2:00 PM ET

Executives

William Schmitt – Managing Director, ICR, Inc.
Anupam Narayan – President and CEO
Tony Dombrowik – SVP and CFO

Analysts

David Loeb – Robert W. Baird
Smedes Rose – Keefe, Bruyette & Woods
Will Marks – JMP Securities

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Red Lion Second Quarter Earnings Conference Call. At this time, all lines are in a listen-only mode. Later there will be a question-and-answer session and instructions will be given at that time (Operator instructions). As a reminder, today’s call is being recorded.

At this time then I would like to turn the conference over to Mr. William Schmitt, please go ahead sir.

William Schmitt

Thank you Ken. Hello and welcome to Red Lion Hotels Corporation second quarter 2008 earnings conference call. With us today are Red Lion Hotels President and Chief Executive Officer, Anupam Narayan and Chief Financial Officer Anthony Dombrowik.

Today’s call will follow the following format. Mr. Narayan will begin with a few introductory comments, give an overview of the core, highlight some recent accomplishments and discuss the overall outlook. Then Mr. Dombrowik will provide a discussion on the financial results and then we will open the call to Q-&-A.

Before I turn the call over to them, please remember that in this call, management’s remarks may contain forward-looking statements within the meaning of Federal Securities Law, including statements concerning plans, objectives, goals, strategies, projections of future events or performance and underlying assumptions, many of which are based in turn upon further assumptions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

These statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today, including but not limited to risks and uncertainties related to local conditions, such as an over supply of or reduction in demand for hotels, changes in travel time, extreme weather conditions and cancellation of or changes in events scheduled to occur in the company’s markets and the attractiveness of the company’s hotels to consumers and competition from other hotels.

Examples of forward-looking statements include statements related to Red Lion’s anticipated or projected revenues, gross margin, operating margin, RevPAR, EBITDA, expenditures and liquidity needs. We would like to encourage all of our listeners to review a more detailed discussion of the risks and uncertainties related to these forward-looking statements that is contained in the company’s filings with the Securities and Exchange Commission and in particular on its Form 10K.

Any projections as to the company’s future financial performance represent management’s estimates as of today, August 7, 2008. Red Lion assumes no obligation to update these projections in the future, due to changing market conditions or otherwise. I would now like to turn the call over to Mr. Narayan.

Anupam Narayan

Thank you Bill, and welcome everyone to Red Lion’s second quarter earnings call. Red Lion’s second quarter performance was another testament to our strength and our offerings in the face of a challenging economic environment. We grew RevPAR at owned and leased hotels by 3.2% during the quarter. Further, direct hotel operating margins improved by 150 basis points and EBITDA from continuing operations increased 3.5%.

Overall, we were pleased to once again deliver positive growth in our key metrics in the second quarter. The company’s central reservation system continued its strong contributions to Red Lion. In the second quarter of 2008, central reservations delivered an average 45% of room revenue to our systems hotels. Our brand website, RedLion.com also continues to deliver strong booking performance, with a 13.3% increase in revenues booked through the website during the quarter.

Our group booking pace is holding and in most cases are ahead of last year. However, we are seeing some softness in attendance. Business transient demand and leisure consumer demand has also shown some weakness especially at the end of the second quarter. The overall difficult economic climate is affecting our markets, though less so than many other regions of the country. Under this uncertain outlook, we will continue to manage our expenses and manage our mix of business to maximize revenues.

An example of our efforts to broaden our business was our announcement yesterday of our agreement with Preferred Hotel Group as a worldwide hotel redemption partner for members of our Red Lion R&R Club. We are excited about this relationship because it strengthens our loyalty program by offering our members redemption opportunities at hotels and resorts around the world.

We also continue to invest in our owned and leased hotels and we believe these continued investments are strengthening the brand. The majority of our franchise hotels have also completed their renovations and we are monitoring the progress of the remaining franchise hotels. In July, we terminated the license of one franchise hotel for non-performance, and we may terminate additional hotels if progress is not satisfactory.

Having a strong and consistent product across our system whether franchised or owned, is a key goal because it will drive higher performance for all Red Lions in the system. Now as you know in May we closed on the acquisition of the 478 room Red Lion Hotel Denver Southeast for $25.3 million. Now we plan to spend over $8 million to renovate the hotel, primarily on guest rooms and public spaces with renovations starting after the busy summer season, which includes hosting the Texas and American Samoa delegations to the Democratic National Convention in August.

We expect to complete the renovation of the hotel by the end of the first quarter 2009. With regard to our Anaheim hotel, renovations are continuing and we are on track to substantially complete all renovations by the end of this year.

Now building on our organic growth and in spite of a difficult industry environment, we continue to look at various opportunities for acquisitions in additional key markets. Our balance sheet is strong and we have the cash and current line availability to execute on any acquisition.

Now for those of you who did not see it, we provided a public update Tuesday on the company’s review of strategic alternatives and announced that as part of that review, the company has entered into confidentiality agreements with several parties, including Columbia Pacific Opportunity Fund. I would also add that our Board of Directors has made no decisions to pursue any transaction. We appreciate your patience on this matter and expect that you would understand that it would not be appropriate for me to make any further comment on this topic during this call.

With that, I’d like to turn this call over to Tony Dombrowik, our Chief Financial Officer.

Tony Dombrowik

Thank you Anupam. I’m going to take a few minutes to cover the financial results in greater detail, but before I do I’d like to remind you that as in past quarters, the financial results I will be discussing will focus on our continuing operations because we feel those results are more meaningful to investors.

I will also discuss certain financial results before a special item incurred during the first quarter 2008, related to the retirement of our previous CEO. Again, we feel this gives us a more relevant presentation of our activities. Please refer to the exhibit in our press release issued later yesterday for a reconciliation of our results discussed here, to GAAP measures disclosed in our financial statements.

Turning to our second quarter results, total revenue for the quarter increased 1.7% to $49.8 million. Hotel revenue which accounted for 94% of total revenue increased 4.1% in the second quarter to $46.7 million. Keep in mind that the results for the second quarter of 2008 included revenue from the Anaheim hotel acquired in October 2007 and the Red Lion Hotel Denver Southeast, acquired in May 2008.

Also, the second quarter 2008 results did not include revenues from the Red Lion Hotel Sacramento which was subleased to a franchisee in July 2007. So on a comparable basis, hotel revenues increased 3.2%.

As Anupam mentioned, the hotel revenue increase was driven by a 3.2% growth in RevPAR at owned and leased hotels. That was achieved with a combination of a 1.4% increase in average daily rate and 120 basis point increase in occupancy. As with many in the hotel industry, we have seen weakness and transient demand, but our group business and the overall strength of our revenue management strategies helped us grow in difficult economic circumstances.

On a system-wide basis, RevPAR increased 2.0% on a quarter-over-quarter basis, driven by a 2% growth in ADR. As they were last quarter, the system-wide results were negatively impacted by rooms out of service for renovation at a number of our franchised hotels. Franchise and management revenue declined 445,000 from 782,000 in the prior year period, primarily due to having fewer franchises in the system as well as the receipt of a $200,000 franchise termination fee in the prior year comparative period.

As of June 30, there were 50 hotels in the Red Lion system, 31 owned, 18 franchised and our Anaheim hotel which is in the process of being repositioned as a Red Lion Hotel. The high quality of our hotels is a significant focus for us and we continue to monitor our franchise business closely for the continued health of the brand. We are in frequent contact with our franchisees, focusing on quality and service and delivering to them our same key brand initiatives.

As Anupam mentioned, the majority of our franchisees have completed renovations to meet the Red Lion brand standards, or making acceptable progress towards meeting the requirements. However, at the end of July, we terminated the franchise at the 186-room hotel in Modesto, California for failure to meet our requirements. We are monitoring progress at a few of our smaller franchise hotels to ensure continued satisfactory progress on their improvements.

Also impacting total revenues for the quarter, our entertainment segment revenue declined by $0.7 million to $1.9 million in the second quarter of 2008, primarily due to the difference in the number and types of shows presented between comparative periods.

Now turning to the profit side of the equation. Operating expenses in aggregate for the second quarter of 2008 increased $1.3 million to $44.5 million driven primarily by depreciation and higher corporate expenses, this resulted in $5.3 million of operating income for the quarter, compared to $5.8 million during the second quarter of 2007.

Operations of the hotels continued to improve. Our direct hotels division margin for the second quarter 2008 was 28.4%, up 150 basis points from the second quarter of 2007. I would also like to note that as we have mentioned before, early in 2008 we began to review all of our cost structures and activities, recommitting to our efforts to maintain or improve margins. We have also strongly focused on promotions and other revenue-generating activities.

All of those plans are in motion and have positively impacted our results for the quarter, while maintaining our service and quality standards. We will continue in those efforts. Direct costs for the franchise and management segment were lower for the quarter, consistent with our focus instead on acquisitions. Entertainment expenses fell by $0.5million to $2.1 million, again primarily due to the lower number of shows presented during the quarter.

Depreciation and amortization increased by $636,000 to $4.6 million, mainly related to our capital additions, including the Anaheim hotel and our new Denver hotel. You can expect a similar level of depreciation amortization throughout 2008. Undistributed corporate expenses for the quarter were $1.9 million, up $0.4 million compared to the same period last year.

So for the second quarter of 2008, EBITDA from continuing operations increased 3.5% to $10.4 million and the overall net income from continuing operations during the quarter was $2.3 million, or $0.12 per fully diluted share. This compares to $0.13 per fully diluted share for the second quarter of 2007.

Looking at liquidity and capital resources, as of June 30, 2008, our cash position was $7.9 million. We believe that our current cash position, cash from operations and the remaining $28 million of availability under our credit facility provides us with sufficient resources to meet our existing needs, as well as to fund our long-term growth strategy.

For the second half of 2008, we expect hotel improvement capital expenditures to be approximately $8.8 million and $8.5 million for the renovations at the Anaheim and Denver hotels. During the quarter, we drew down $23 million on our primary credit facility to fund part of the Denver hotel acquisition, but have since repaired $1 million of that total.

We’ve also engaged a broker to help us secure term financing on the Denver property and are reviewing potential commitments consistent with our capital recycle plans. In terms of forward-looking guidance, we recognize the generally weak national trends. As we’ve noted in our press release and consistent with others in the industry, we are taking a more cautious view to the rest of 2008, we’ve revised our guidance for the year as follows; RevPAR growth for the company owned and leased hotels in the range of 0% to 3%; direct hotel operating margins to improve between 25 and 100 basis points from 2007; and 2008 EBITDA from continuing operations to be in the range of $33 million to $35 million, up 0% to 4% from 2007.

Please note that we have excluded the aforementioned $3.7 million in separation costs incurred during the first quarter 2008 from our EBITDA guidance.

With that, I will turn the call back over to Anupam.

Anupam Narayan

Thank you Tony. In spite of a difficult economy, we remain confident in our overall business and remain committed to our long-term strategy, and we believe that our second quarter results show that Red Lion is solid financially and has a strong and seasoned team in place to manage our business. As such, we continue to pay close attention to changing economic conditions and will continue to adjust our cost structure accordingly.

However, our long-term growth strategy has not changed. It is my belief that good companies distinguish themselves in difficult times and I think we are well positioned to prove that through our performance in coming months.

With that, we will now open up the call for questions. Operator.

Question-and-Answer Session

Operator

Great, thank you. (Operator instructions) And our first question then today comes from the line of David Loeb, please go ahead.

David Loeb – Robert W. Baird

Anupam, I know this is somewhat sensitive, but can you talk about how the strategic alternative review process impacts your ability to make changes in your capital structure or buy hotels? I understand that the non-binding indication of interest indicated that they requested no major capital structure changes, or buying or selling during that process.

But given what you are doing, how does that affect your ability to continue to execute on your strategy?

Anupam Narayan

Well David, we will continue to execute on our long-term strategy and a lot of that has to do with managing our hotels most efficiently and managing our businesses the best way we can. So none of the operational side of the business has changed, and I cannot comment a lot on the specifics about the transactions and the strategic review process. Obviously that’s part of what we will consider as we look at any transaction or any, I guess transaction in the future. So we are right now just managing our business the best way we are.

David Loeb – Robert W. Baird

Does that mean that if you were in process looking at an acquisition or in your ongoing search for the right acquisitions, that you might continue that process and go ahead and execute the transaction?

Anupam Narayan

I think that certainly is possible. As you know, as Tony mentioned we are also in the market right now looking at financing for our hotel in Denver. So we are continuing our business. We obviously have to keep an eye on any future transaction that may occur.

David Loeb – Robert W. Baird

And in terms of the hotel acquisition market, what kind of trends are you seeing? How has that changed in the last few months?

Anupam Narayan

Overall David, there are fewer transactions out there, fewer product out there. We are seeing a reduction in the number of hotels for sell; however we are seeing actually a better pricing of those hotels. I’m sure you’ve seen some of the fliers from the brokers; occasionally you’re actually seeing fliers for reduced prices, which we never saw before. We are seeing also hotels being marketed for sale with a specific listing price, which we didn’t see before. It was always the call for offers, so we are seeing some reduction, we are seeing a reduction. I think that one study indicated that there were a number of hotels available for sale were down, about 18%, but there are also fewer buyers out there. So I think it’s just getting better in terms of pricing.

David Loeb – Robert W. Baird

Okay. That’s very helpful. Tony you mentioned Modesto leaving the system. How many more franchisees are there that you’re still waiting to see whether they are going to embrace the brand changes?

Tony Dombrowik

David, we generally don’t comment on the individual franchise, the status of any individual franchise. As I mentioned in the press release and my comments earlier, there are several of the smaller ones that we continue to monitor to make sure they are making sufficient progress, and if we decide that that isn’t sufficient, we’ll take action, but right now I’m not able to comment on any individual ones.

David Loeb – Robert W. Baird

I guess I was hoping you would quantify several.

Tony Dombrowik

There are right now, I think 18 franchises in the system and I would say it’s a smaller portion of that number. How about that?

David Loeb – Robert W. Baird

I would hope it’s a smaller portion because I think you’ve said in the past that a large number have actually already embraced this and made renovations. I think that’s fair.

Anupam Narayan

I think David, one of the things that you should remember is, our focus is make sure we have a strong consistent brand, and we are working with our franchisees and embracing them and helping them sort of get there. Obviously at some point we want to make sure that everybody has the same process and the same standards, same requirements, so we want everybody to succeed and be there.

Unfortunately sometimes, some people for whatever reason are not able to.

Tony Dombrowik

The biggest part of our franchise drive right now is delivering to them the same strategies and revenue management and all the programs that we offer to our owned and leased hotels and making sure that they’re successful in this tough market too. So that’s kind of our focus right now.

David Loeb – Robert W. Baird

Okay, one kind of housekeeping. Can you talk a little bit about the CapEx needed for Denver and how that splits between this year and next year? I guess on top of that, kind of what you think the total CapEx is likely to be for next year?

Tony Dombrowik

Yes. For the Denver property, we’re looking at a little over $8 million in renovations to really make it a high-quality flagship property for the brand. The split between years, it’s sort of fluid. It depends on delivery of things, but I would estimate about half and half between the two periods.

David Loeb – Robert W. Baird

Any kind of thoughts on the total budget for ’09?

Tony Dombrowik

The total budget for ’09, I think we’re going to be consistent with what we’ve done in the past as far as, what I’ll call project capital which is about 6$ to 7% of revenues, and then we’ll look at individual projects that are delivering returns on a separate basis.

David Loeb – Robert W. Baird

Great. Thank you very much.

Tony Dombrowik

Thanks David.

Operator

And out next question comes from the line of Smedes Rose. Please go ahead.

Smedes Rose – Keefe, Bruyette & Woods

Hi, I just wanted to go back to the franchising. Can you – may be you won’t answer this, but how many of your franchisees now have completed the renovation program, of the 17 or whatever that you have left?

Anupam Narayan

Well, everybody has – the majority of them have completed the program, Smedes. There are few franchisees that are still completing the program that may have various elements left, they may have a wing of the hotel remaining at this point, or they may have more than that, and one of the challenges as you can imagine right now, is simply many of these people are having a very busy summer.

So we are working with them to make sure that we have a specific clear plan to get the hotels renovated and they live up to the commitments that have been made.

Smedes Rose – Keefe, Bruyette & Woods

So had the Modesto hotel indicated to you that they would be onboard with the renovation program, or had they sort of been dragging their feet during the process and you decided to terminate them?

Anupam Narayan

I really don’t want to get into specifics as to the rationale, but clearly we’ve made a decision that they were not in compliance with our requirements.

Smedes Rose – Keefe, Bruyette & Woods

Okay. And then last quarter you talked about a few that you did expect to drop out, I guess Modesto is one of them. Are there still any more that you would expect to come out of the system over the next quarter or two?

Anupam Narayan

It’s very possible.

Smedes Rose – Keefe, Bruyette & Woods

Okay. Can you quantify it a little bit? I mean are you looking at like five or I mean at this point…?

Anupam Narayan

No, let me just say it would be probably less than five. It could be, let’s say maybe a couple of handfuls.

Smedes Rose – Keefe, Bruyette & Woods

Okay, and then have you received termination fees, I guess to date? I mean you mentioned some that were in the quarter a year ago. I’m just wondering if you can break out any that are in your numbers for this year in the franchising fees?

Anupam Narayan

I’ll let Tony answer that.

Tony Dombrowik

In this, 2008 numbers to date there are no termination fees. In the prior year comparative period, we did have about 200,000 that flowed through in the second quarter. So there isn’t any coming through in the second quarter of 2008 or in the first quarter of 2008.

Smedes Rose – Keefe, Bruyette & Woods

Okay, but were there any in the balance of 2007?

Tony Dombrowik

Yes there were, but I honestly don’t have that number, that statistic with me right now.

Smedes Rose – Keefe, Bruyette & Woods

Okay. All right, thanks.

Anupam Narayan

Smedes, just one thing, just to follow-up on that. I think there have been two questions on franchising. I think we’ve indicated earlier that our focus right now, from a strategic long-term plan was to focus on acquisitions and establishing a presence in some of the key markets, and our franchising would sort of follow after that. So we have not put a lot of effort right now into the franchising of new hotels in these markets, until we start establishing some of our presence with our owned assets in markets like San Francisco area or Phoenix or Texas.

So I think what you’re seeing is in the meantime we are sort of making sure that our system, our brand system is strong and it’s consistent and that’s what you’re seeing in some of the changes in our franchises, so to come. I want to use that as a necessarily, as an indicator of the health of the system to say.

Smedes Rose – Keefe, Bruyette & Woods

Okay.

Tony Dombrowik

And as a follow-up, Smedes , I just did look it up, we did not have any termination fees in the second half of the year last year, in 2007.

Smedes Rose – Keefe, Bruyette & Woods

Okay, thank you.

Anupam Narayan

Thank you.

Operator

Thanks. Then we have a question then from the line of Will Marks, please go ahead.

Will Marks – JMP Securities

Thanks, hello everyone.

Anupam Narayan

Hi Will.

Will Marks – JMP Securities

So Anaheim, all the CapEx should be completed this year it looks like, right?

Anupam Narayan

I think all the VapEx will be – all the work will be done or substantially all the work will be done. Some of the payments may spill over into 2009, just because of the timing of bills, etc.

Will Marks – JMP Securities

And any early indication of the performance of that in ’09, how profitable could it be?

Anupam Narayan

I think the team is going to be working on their budgets shortly and based on the completion of the hotels, and I think Anaheim as you know is a good market. This year I think it has some shortfalls in convention or citywide conventions, but I believe that next year convention center is projected to do very well. So we’re very optimistic about that.

Will Marks – JMP Securities

And is it profitable at all right now during this renovation? On an EBITDA basis?

Anupam Narayan

No, no it’s not. I think we’d indicated, will that we expect to be after the lease payment which is I think $1.8 million, we expect to have essentially a negative EBITDA for about $1 million to maybe a little bit more than a $1million during the renovations.

Will Marks – JMP Securities

On the guidance for the rest of the year, $17.3 million of spending, does that include maintenance CapEx?

Tony Dombrowik

What that includes is all the ongoing hotel improvement projects that we have and it also includes the expected spend for the remainder of the work in Anaheim and what will get accomplished for Denver in 2008.

Will Marks – JMP Securities

So it is, it’s basically…?

Tony Dombrowik

It’s an all-in number.

Will Marks – JMP Securities

And then you mentioned that the project capital of 6% to 7% of revenue next year, is that the same kind of thing that would include the maintenance as well?

Tony Dombrowik

Yes.

Will Marks – JMP Securities

And then bigger picture stuff. Can you talk a little bit about the difference you’re seeing in the various markets, where your strength is, Seattle out-performing Portland or vice versa?

Anupam Narayan

Sure, will I mean I think you’ve probably seen with some of the Smith Travel information that comes out. As you know, the Seattle market for the first half of this year did under-perform and I think it’s mostly because of the bookings, the convention center bookings was kind of low, but all the data that we have right now

is that the convention center is booked pretty solidly in the second half, so we do expect to see significant improvement from the second half.

The economy in this market in the Washington State, as well as Oregon, is certainly affected by what’s happening in the national economy, but we are in general there is some offsetting factors, so we expect to see at least some, let’s say our performance will be better than the national, but it is also, I would tell you that this economy is a lagging indicator, so it does sort of catch up eventually.

The Portland market continues to be relatively strong too. I haven’t seen any significant changes in the Portland market. So we’re pretty optimistic about what’s happening in our marketplace, which is why we feel pretty comfortable with our guidance for the future.

Will Marks – JMP Securities

Thank you very much.

Anupam Narayan

Thank you, Will.

Operator

Thanks, and we do have a question now from the line of David Braid [ph]. Please go ahead. Sir, if your line is muted, we are unable to hear you. Mr. Braid, we’re still unable to hear you. (Operator instructions) And at this point, gentlemen I’m showing no further questions in queue.

Anupam Narayan

Well, thank you all for your questions and thank you for your interest in Red Lion Hotels. As we said, we continue to work to deliver strong financial results and increase shareholder value, and I look forward to speaking with you again on our next earnings call. Thank you.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay starting today Thursday, August 7 at 1:30 p.m. Pacific Time and it will be available through Sunday, September 7 at midnight Pacific Time. You may access the AT&T executive playback service by dialing 1-800-475-6701 from within the United States or Canada, or from outside the United States or Canada, please dial 320-365-3844 and then enter the access code of 954084. Those numbers once again are 1-800-475-6701 from within the U.S. or Canada or 320-365-3844 from outside the U.S. or Canada and again, enter the access code of 954084.

That does conclude our conference for today. Thanks for your participation and for using AT&T’s executive teleconference. You may now disconnect.