Morgans Hotel Group Co. Q2 2009 Earnings Call Transcript

| About: Morgans Hotel (MHGC)
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Morgans Hotel Group Co. (NASDAQ:MHGC) Q2 2009 Earnings Call August 10, 2009 5:00 PM ET


Michelle Reddin –Investor Relations

Fred Kleisner – President and Chief Executive Officer

Marc Gordon – Chief Investment Officer

Rich Szymanski – Chief Financial Officer


David Katz – Oppenheimer & Co.

Will Marks – JMP Securities

Steve Altebrando – Sidoti & Company


Welcome to the Morgans Hotel Group Co.'s second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Michelle Redding of Morgans Hotel Group.

Michelle Reddin

Good afternoon. Thank you for joining us on our second quarter 2009 conference call. Joining me on today's conference call are: Fred Kleisner, President and Chief Executive Officer; Marc Gordon, Chief Investment Officer; and Rich Szymanski, Chief Financial Officer and 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 you to all 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 will pass the call to Fred.

Fred Kleisner

Good afternoon and thanks for joining us for our second quarter 2009 conference call. Once again, in the second quarter economic trends presented significant headwinds for the hotel industry. The ongoing pullback in demand led to continued declines in average daily rate across the industry with the urban and high-end segments being hit particularly hard.

While the operating environment remains difficult, revenue per available room declines are moderating somewhat, driven by a slight rebound in occupancy. Rates, however, remain under pressure.

These trends suggest to us that we are at or near the bottom of the down swing. The industry in general continues to show negative year-over-year comparisons, however, the declines are stabilizing.

As a further sign of relief, U.S. unemployment rate declined in July for the first time in over a year. The jobs report released by the U.S. Department of Labor on Friday is the least bad we've seen since August of 2008 and the trajectory of decline has slowed substantially. Furthermore, there was an actual year-over-year growth in leisure and hospitality sector where employment rose marginally.

Similarly, at Morgans the pace of decline appears to be stabilizing. Our second quarter results were on par with those we reported in the first quarter. For six successive months, from October 2008 to March 2009, we saw RevPAR declines expand month after month. We are no longer seeing this trend.

Adjusted EBITDA was down 59% in the second quarter and RevPAR from our comparable hotels was down 37% in constant dollars. Consistent with industry trends, occupancy across our hotels is generally improving, however the rates continue to be a challenge.

The booking windows remain short across our operations. Those who make decisions to book hotel accommodations continue to do so in a very short term.

We also continue to be effected in the second quarter by the slowdown in New York City. While average daily rate remained under pressure and mid-week corporate bookings continued to be a challenge, occupancy rates are beginning to improve. Leisure travelers from Europe continue to favor New York as a destination, particularly in the summertime. Our New York City hotels operated at 87% occupancy in the second quarter and that trend has continued, and even improved, in the third quarter. A return in occupancy is typically the first sign of a returning market.

In Miami, the summer business trends are challenging with leisure travelers hesitant to book discretionary travel. Miami has traditionally enjoyed high demand from South American countries in the summer. We have seen a moderation in that demand as well.

Having said all this, we do see pockets of promise emerging within our portfolio. Despite an L.A. market that is declining at roughly the same rate as other major markets, our Mondrian L.A. property has done very well. As a result of our renovation, we achieved a year-over-year increase in revenue per available room and our RevPAR index is in excess of our competitive set.

At Morgans' in New York, another recently renovated property, we are seeing results that are outperforming our competitive set. We are also seeing signs of stability in our London hotels. And in addition, the Hard Rock Hotel and Casino in Las Vegas, with its exciting new venues, go also down year-over-year as outperforming its peers on the Las Vegan strip.

On July 30, taking advantage of the high summer weekend demand, we opened our 490-unit Paradise Tower. This followed the successful opening in April of our 65,000 square foot convention center and Las Vegas' newest and best music venue, The Joint at Hard Rock.

As we continue to navigate through this difficult operating environment, laser-focus on cost savings and liquidity remain our top priorities. With regard to cost savings, our team has implemented extensive and rigorous reductions in both corporate and property level over the last year. Most importantly, we've maintained those efficiencies through the second quarter and continue to do so.

On a run rate basis, we have reduced hotel operating expenses in excess of $20.0 million and corporate expenses by approximately $10.0 million annually. As we have told you previously, these cuts were executed carefully to insure there would be limited impact on the quality of our customers' experience. In fact, we have been successful.

We increased our customer satisfaction scores in the second quarter, continuing a three quarter trend of increased quality scores. This demonstrates that our highly-targeted approach to reductions in costs has worked and broadly produced the desired results.

Later in the call Rich will be discussing the effectiveness of our cost reductions, which have allowed us to maintain our targeted ratio of RevPAR decline to EBITDA decline, one that is well ahead of industry standards.

We have demonstrated over the past 18 months we can reduce operating costs swiftly and can sustain these levels without sacrificing quality. We will continue to review our operations and our corporate office costs for more efficiencies as we proceed through the year.

Moving to development, the company continues to grow, despite the difficult environment and our pipeline is strong. Marc Gordon will talk more about our development projects later in this call.

Before turning the call over to Marc for additional details on these development efforts, I want to take a minute and discuss the proactive and aggressive steps we continue to take to manage our balance sheet.

As we move through this economic environment, liquidity and the strength of our financial position remain our top priorities. To this end, our plan overall has been to limit capital commitments, reduce operating costs, and increase liquidity.

As a significant part of this, on August 5 we announced the broad amendment to the terms of our revolving line of credit. This is a very important and positive announcement for our company and clearly demonstrates the continued support of our lenders. The amendment provides us with significant liquidity and flexibility to accommodate our business needs through these challenging times.

Our team did a terrific job in executing this deal. And with thanks, I want to turn the call over to Marc for additional details.

Marc Gordon

As Fred mentioned, we announced last Wednesday an amendment to our line of credit that provides significant covenant relief and substantially improves our liquidity. While we reduced the nominal size of the facility to $125.0 million, it is important to note that prior to the amendment the availability under the facility was only approximately $150.0 million as of March 31, 2009, and was declining from there to zero.

With the amendment, today we have access to the full $125.0 million and we believe the amendment will provide access to substantial liquidity for the life of the loan.

Specifically, the amendment eliminates the corporate leverage test entirely, reduces the corporate debt service coverage test to .9x from 1.75x, amends the borrowing base test so that a minimum amount will be available regardless of income, and cleans up a variety of other provisions at the subsidiary level that could have triggered technical default.

The interest rate is increased to LIBOR plus 3.75% with a LIBOR floor of 1% and the maturity and most of the other terms remain the same.

We are proud of the expression of confidence from our lender group. We appreciate their support and we thank them for their belief in us.

We are optimistic that the line of credit amendment will be the first of a series of modifications to other loans that will strengthen our balance sheet and address other issues in our capital structure. We cannot promise you that every one of them will work out according to plan, as we are dealing with third parties whom we do not control, like lenders and equity partners. However, we view the line of credit as our top priority since the additional liquidity provides us another tool to use with other lenders. We remain proactive and are in dialogue with other of our lenders.

Most timely among these are Mondrian in Scottsdale and the joint venture that owns Mondrian in South Beach where the loans have matured. In both situations lenders have been accommodating. In Scottsdale interest is accruing and the lender is releasing cash to pay operating expenses. As we have said before, we do not intend to commit significant funds to this property. In South Beach, again, the lender is allowing interest to accrue. We intend to fund no more than a modest amount into Mondrian in South Beach that have already been built into the capital expenditures commitments, which we'll discuss shortly.

Of great importance are Hudson and Mondrian Illinois, both of which are due in July 2010, subject to extension options. There, too, we proactively engaged in conversations with lenders about extending these loans early, however, we do not have anything as definitive as a line of credit amendment to announce today. We look forward to announcing more about these efforts in the near term.

Turning to development, we have three projects that we expect to generate additional management fees in last 2009 and 2010. Ames in Boston is on track to open in November of this year, Mondrian in Soho is currently expected to open in mid-2010, and at Hard Rock in Las Vegas, a new guest-room tower, The Paradise Tower, consisting of just under 500 rooms, opened on July 30 following the recent openings of a new concert venue and convention center. The casino expansion and the other new guest-room tower, consisting of just under 400 suites and penthouses, are projected to open around the end of this year.

Importantly, our partner in this project, DLJ, continues to fund its commitments, having funded an additional $18.0 million in July.

With that, I will turn the call over to Rich for additional details on our performance and financial picture, after which Fred will provide some closing remarks.

Rich Szymanski

I would like to focus on second quarter earnings and a review of our liquidity position.

For the quarter, our adjusted EBITDA was $11.3 million compared to $27.8 million in the second quarter of 2008. Net income was a loss of $10.1 million compared to a loss of $1.1 million in the second quarter of 2008.

We recorded a tax benefit of $7.4 million and now have tax NOLs of approximately $100.0 million, which may be used to offset future income, including gains on asset sales.

RevPAR for our system-wide comparable hotels for the second quarter was $169.92, a decrease of 39.5%, or 36.8% in constant dollars, from the second quarter of 2008. The pace of decline has stabilized as these percentages are similar to the first quarter declines. The decrease was driven by a 30.9% decline in average rate.

As Fred mentioned, we are starting to see strong occupancies. As an example, occupancy rates at our three New York hotels averaged approximately 87% in the quarter. Unfortunately, due to the drop in mid-week corporate business and declines in consumer spending, pricing continues to be a challenge.

We did see some positive signs at our non-comparable hotels, Mondrian L.A. and Morgans, which were both under renovation in the second quarter of 2008. Both hotels exceeded their competitive sets as we are starting to realize the benefits of our extensive reimaging at these hotels.

We continue to focus on reducing operating costs without affecting the guest experience. For the quarter, operating costs at system-wide comparable hotels decreased by approximately 20%.

We measure our flow-through and cost control by the ratio of the percentage decline in EBITDA to the percentage of decline in RevPAR. Since we own and operate many of our hotels and have control of our brands, one of our core strengths is our ability to cut costs quickly.

During the quarter we achieved a 1.8x ratio of comparable EBITDA percentage decline to RevPAR percentage decline, the third consecutive quarter where the ration has been below 2x. This is significantly better than industry norms of 2x to 3x.

We have also taken a proactive approach to our corporate expenses, which declined by approximately 40% in the second quarter of 2009 from the comparable period in 2008.

Liquidity and the preservation of capital continue to be the company's number one priority and we are executing our plan. I would like to walk through a detailed analysis of our liquidity, focusing on our cash position, our credit facility, commitments, cash flow, and covenants.

We finished the second quarter with approximately $165.0 million in cash and cash equivalents and had $139.0 million in outstanding revolver borrowings. Upon closing the amended revolving credit facility, we reduced the outstanding balance under the credit line from $139.0 million to approximately $24.0 million. We currently have the full availability under the credit facility of $125.0 million, less the $24.0 million drawn and $11.0 million of letters of credit.

I would like to reiterate the key terms under the facility. Most importantly, we have eliminated the corporate leverage tax and we have reduced the fixed charge coverage ratio from 1.75x to .9 x for the life of the loan. As of June 2009, under the new amended agreement, the fixed charge coverage ratio was 2x.

The facility continues to be secured by three recently renovated hotels in great locations: Delano, Royalton, and Morgans.

The interest rate is LIBOR plus 3.75% with a 1% LIBOR floor, and the loan matures in October of 2011.

Our borrowing base is calculated at the lesser of a trailing EBITDA test, or 60% of appraised value, with a minimum of 35% of appraised value on the New York properties.

Another part of our liquidity plan was to reduce our capital commitments. In 2008 we took key steps to reduce our equity commitments on new projects. Today we have just approximately $13.0 million of commitments remaining to fund, which we expect to complete by year end.

We also have no significant capital commitments at our owned hotels. Given the excellent conditions of our own properties, we estimate maintenance capital at these hotels to be between $6.0 million to $8.0 million in total in 2009, of which approximately $3.0 million has been spent through the second quarter.

For the 12 months ended June 30 we generated approximately $7.0 million of operating cash flow, defined as EBITDA less cash interest, less maintenance capital. For the full year 2009, due to our extensive cost reduction program, we believe that we will be able to keep our operating cash flow around the break-even level.

Regarding financial covenants, the trust preferred notes contain a trailing 12-month EBITDA to interest ratio of 1.4x that we may not fall below for four consecutive quarters. We were in compliance with the trust preferred covenant, which was at 1.7x as of June 30, 2009.

As Marc mentioned, we are in active dialogue with our lenders about revising the loan terms on a number of our loans, one of which is the trust preferred.

Turning to our outlook for 2009, it goes without saying that it is very difficult for anyone to predict what will happen this year, given the short-term booking patterns and the transient nature of our business. In light of this, we will continue to manage our business and our capital position in a proactive and aggressive manner.

As we stated in prior calls, we are not comfortable defining a specific RevPAR target or range for the year because of the continuing uncertainly and volatility in the market. However, we are providing a framework for adjusted EBITDA, given certain RevPAR levels. We believe that if, for example, RevPAR for the year were to decline on average 25% to 30%, we would expect 2009 adjusted EBITDA to be between $40.0 million and $50.0 million.

This is based on a ration of comparable hotel EBITDA percentage decline to RevPAR percentage decline of 2-to-1. And we have achieved an average of 1.6x over the prior three quarters.

With that I will turn the call back over to Fred.

Fred Kleisner

While the economic and operating environment remains difficult, we are beginning to see trends stabilize. We saw some returns in occupancy in the second quarter, which has continued into the third quarter. This, I mentioned, is typical precursor to bottoming markets.

We also saw modes, but nevertheless meaningful, pockets of promise across our businesses. This occupancy and stabilization trend has continued in the third quarter.

As we move forward through this pressured economic and industry environment, we remain focused on maintaining cost controls, strengthening our financial position, and preserving an ultimately growing shareholder value.

The amendment we reached with lenders is a very positive step for the company and signifies our strong lender support and their confidence in us and our business.

We are comfortable with our liquidity position and believe we are well positioned to address our near-term commitments. We also continue to develop and build our businesses, both domestically and internationally.

Our management team and I are confident in the long-term potential of our business. We have been through difficult cycles in the past and we are taking all the necessary steps to get us through this current period.

At the same time, we are focused on maintaining our unique brands and the hotel experience contained in those brands so that we are well positioned for growth when the economy turns around.

I would now like to open the call for question.

Question-and-Answer Session


(Operator Instructions) Your first question comes from David Katz – Oppenheimer & Co.

David Katz – Oppenheimer & Co.

The Scottsdale property, I think there was some limiting commentary about it but I guess as we look at our models today, we are not sure exactly how to treat it going forward, whether it will be in or out. What help can you offer us?

Rich Szymanski

As far as modeling, we are in discussions with the lenders. We don't intend to really keep it on our balance sheet for a long period to time. We're just working things out with them now. We can't predict that time frame but as we said, it is not something we intend to retain as a consolidated liability.

David Katz – Oppenheimer & Co.

And if I can just ask about the rate environment in New York City and as a long a term of view as you might be able to share with us, are you in a position, or foresee yourself as being in a position soon, where you can start to maybe push rates back up a little bit, or are you seeing stability?

Fred Kleisner

Stability, yes. Let me just put this in context. When I say the booking curve has decreased, a year ago at this time it was approximately 75 days, where the broad base of our bookings occur. Today that number is more like 45 days. So it is a short-term view.

However, having said that, as you look at occupancy edging up the way it has, what we're seeing right now is the ability to begin to manage the market mix, restricting inventories dedicated to discounted rates and to programs that offer specials, including the opaque markets that operate on the Internet.

That has already begun to, if you look at, in New York City as an example, on Monday and Tuesday, on Friday and Saturday, it's already begun to work. An interesting trend that we see beyond that is city-wides are once again beginning to pick up. We are seeing that far enough in advance that we're prepared to take risks to tighten up rates.

A specific example is we were unprepared for the success of the Fancy Food Show in the month of April. I believe the entire city could have done better on rate. As we got into the Accessory Show just last week, we once again saw rates beginning to move up through the entire period of that show. That was evidence to me that our operators within the company were prepared as they set availability to take some risks and pull back some of those commitments to discounted rate areas.

I saw rates back that I haven't seen for over ten months. That was reassuring. However, I will just emphasize, that's a temporal point. We're seeing that begin to inch forward. And I like the feel of that. In each market we are seeing the ability to manage day of the week, month of the year, and season of the year, is beginning to come back. City-wides are starting, in certain cases, to pick up their full commitments. All of that falls in to that zone of saying stabilization is what we're seeing.

David Katz – Oppenheimer & Co.

We're searching for new words and stabilization was the one cue word; we need a new one. But a very complete answer.


Your next question comes from Will Marks – JMP Securities.

Will Marks – JMP Securities

Rich, on the balance sheet, I just wanted to make sure I'm adding all the parts correctly. Maybe you could run through each item, maybe starting with the converts and the trust preferred, how much we should be including for each one.

Rich Szymanski

The converts have a balance of $172.5 million, the trust preferreds have a balance of $50.0 million.

Will Marks – JMP Securities

And the credit facility changed after the quarter, right?

Rich Szymanski

At the end of the quarter we had borrowed $139.0 million but upon closing we have $24.0 million borrowed.

Will Marks – JMP Securities

And your mortgage nets haven't changed.

Rich Szymanski


Will Marks – JMP Securities

And on Mondrian Scottsdale is there anything new? I mean, anything else in terms of debt?

Rich Szymanski

We have some small pieces of debt. $10.0 million on the Gale property and maybe $5.0 million to $6.0 million of small capitalized leases. That's it for our debt portfolio.

Will Marks – JMP Securities

In looking at the overall structure, a few other things related to the balance sheet. On the Hard Rock, what is the update as to what we should be including there in terms of off-balance-sheet debt?

Rich Szymanski

The total debt on Hard Rock, when the project is complete, will be in a range of about $1.3 billion and our percentage interest will be something between 10% and 15% we believe, at this point.

Will Marks – JMP Securities

And what about current debt at that Mondrian South Beach?

Rich Szymanski

It's about $96.0 million or so.

Will Marks – JMP Securities

And on projects that are unopened, how much have you spent at Soho, as well as at the Ames? And then finally on the Hudson rooms?

Rich Szymanski

Our equity commitments, we've spent about $10.0 million to $11.0 million in Boston, something a little south of $10.0 million at Soho, so our equity is in on those projects. And then on the project for the SRO rooms, the total cost was about $4.0 million to $5.0 million, and most of that's in. We have maybe another $1.0 million to spend on that.

Will Marks – JMP Securities

You give some joint ventures, that number is for Sanderson, St. Martin's Lane and Shore Club. Is there any offsetting cash that we should be aware of or is it nominal?

Rich Szymanski

It's nominal. There is some cash at those joint ventures but nothing significant.

Will Marks – JMP Securities

On Mondrian South Beach, any update on sales, what you expect the progress of that project to be.

Marc Gordon

With respect to the sales, sales have actually continued but closings have slowed. We have closed about 110 of the units. As I think we've talked about on previous calls, it's difficult for the buyers to get financing. And we believe that's the primary cause of the slowness in sales, in addition to, of course, the market there, generally there has been a lot of bad news about it.

As I think Rich answered with respect to the previous question, terms of the negotiation, as he said with respect to Scottsdale, negotiations are ongoing with the lenders so it's a little hard to predict exactly how it will come out, but at least thus far, our lenders are pretty accommodating and we will tell you more when we have something definitive.

Will Marks – JMP Securities

And can you remind me, you closed approximately 110, how many does that leave then?

Marc Gordon

There were about 330 rooms in the building, of which 110 have closed.

Will Marks – JMP Securities

And you are actively renting them all out as hotel rooms at times, right?

Marc Gordon

All the unsold one are being rented as hotel rooms and in fact, the majority of the units that have had sales closed have been put back into a rental program and are also being sold out as hotel rooms.

Will Marks – JMP Securities

The $96.0 million or so of debt on that project, and your share of that is, I guess, 50%, but that does get paid down as projects close, is that correct?

Marc Gordon

That's right. There's a minimum lease price and all of that obviously goes to amortize the debt and moneys in excess of the minimum lease price, sometimes there's some splitting of that between amortization and other uses, but the simpler answer is the vast majority of the net sales proceeds goes to amortize that debt. That's correct.


Your next question comes from Steve Altebrando – Sidoti & Company.

Steve Altebrando – Sidoti & Company

You mentioned the possibility of free cash flow neutral. I'm having a bit of a tough time getting to that but would you essentially have to be at the high end of the EBITDA framework you provided, the $40.0 million to $50.0 million?

Rich Szymanski

I think for the year, if you actually took the limited amount of maintenance capital that we have, which is in the range of $6.0 million and you took our cash interest, excluding amortization, then I think we'd be somewhere in the middle of that range. We could be around break-even.

Steve Altebrando – Sidoti & Company

What's the non-cash interest? Do you have a rough break down?

Rich Szymanski

Yes, our amortization is in the range of $3.0+ million per year.

Steve Altebrando – Sidoti & Company

Could you give a little color on the distribution losses and excess investment on the liability side?

Rich Szymanski

Sure. What we did is, at the Hard Rock, back in December, we had written down our investment basically to zero but since we had a funding obligation of $11.0 million, we actually wrote it down to a negative $11.0 million, a liability of $11.0 million, and as we fund that $11.0 million, that number will be reduced to zero. So ultimately at the end of the year, our investment in Hard Rock will be at zero.

Steve Altebrando – Sidoti & Company

You have given some guidance in terms of where you thought management fees would be with the Hard Rock. That was obviously a ways back, but any color on that going forward? Do you want to readdress that?

Rich Szymanski

Over the past 12 months we've been in the range of about $7.0 million that we've actually earned at Hard Rock and with the addition and the new venues it will be some number north of that. I don’t want to actually predict an exact amount, but it will be something north of $7.0 million, of course.


Your next question is a follow-up from Will Marks – JMP Securities.

Will Marks – JMP Securities

On Soho and Ames, what do you expect your total share—I guess at Soho 20% is total cost of about $190.0 million?

Rich Szymanski

The debt? Yes. Yes.

Will Marks – JMP Securities

And then at the Ames, I know previously it was in the $40.0 million to $50.0 million range. Can you narrow that?

Rich Szymanski

I think it's about $45.0 million to $46.0 million and we have about a 30% to 35% interest.

Will Marks – JMP Securities

And on capital remaining to spend, I had asked you before what you had spent already. I guess you're pretty much done on all these projects, and you mentioned in the press release, is there anything—I gather you're to going to be starting anything new but you did have some projects that appear to be on hold. The Gale, obviously the Echelon, the Mondrian Chicago, shall we still assume that they're on hold?

Marc Gordon

It's a different story for different for different assets. The one that I think that we've announced that we have formally terminated is Chicago. With respect to most of the others, we still like a lot of them. A number of them are very exciting projects, attractive to Morgans and its guest and the real estate owners. However, other than Boston, Soho, and Hard Rock, these other ones we're talking about now are not financed so that the timing of them is going to be pushed out, at a minimum, if they haven't.


There are no further questions in the queue.

Fred Kleisner

Thank you, we appreciate your being with us here in the summertime. We look forward to speaking to you again in the fall where we report our Q3 results.


This concludes today’s conference call.

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