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Red Lion Hotels (NYSE:RLH)
Q3 2018 Earnings Conference Call
Nov. 5, 2018 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to RLH Corporation's third-quarter 2018 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Dan Redmond, vice president of financial planning and analysis. Please go ahead.

Dan Redmond -- Vice President of Financial Planning and Analysis

Thank you. Welcome to RLH Corporation's third-quarter earnings call. With us today are President and Chief Executive Officer Greg Mount and SVP and Chief Accounting Officer Nate Troup. Before we get started, I want to remind you that the company's remarks today contain forward-looking information that is subject to a number of risk factors that may cause actual results to differ materially from those expressed or implied.

For a discussion of important risk factors, please see our most recent Form 10-K and subsequent reports filed with the SEC. Our Form 10-K and other filings are available on our website, rlhco.com in the Investor Relations section or through the SEC website at sec.gov. These forward-looking statements speak as of today and we undertake no obligation to publicly update them to reflect subsequent events or circumstances. The company will also be referring to a number of non-GAAP measures.

The reconciliation of these measures to their comparable GAAP measure is provided in the tables of the press release today. That release is also available on the Investor Relations section of our website. I will now turn the call over to Greg Mount.

Greg Mount -- President and Chief Executive Officer

Hello, and thank you for joining today's call. Before I discuss our third-quarter 2018 results, I wanted to thank Doug Ludwig for his hard work during his time here at RLH. Everyone here wishes Doug a smooth recovery, and he and his family remain in our thoughts. In the interim, during our search for a new CFO, Nate Troup, our chief accounting officer, will assume the role of principal financial officer.

We have complete confidence in Nate's ability to handle the day-to-day responsibilities, along with our deep and experienced financial team as we search for a new CFO. Now let's turn to RLH's performance in the third quarter. RLH had a strong quarter on a number of fronts. Our hotel sales, franchise growth and technology initiatives are moving ahead, helping to accelerate RLH to a fully asset-light business model.

This year, as we have shared a number of times, would be highly fluid, given the number of sales transactions under way and the impact those would have due to unpredictable timing. We could not be more pleased with how successful the hotel sales initiative has been. Our most recent sales, Spokane and Port Angeles, closed early in the quarter as reported in our 8-K filings and had little contribution to this quarter's operational results. They did, however, generate gross sales proceeds of over $54 million.

With respect to the hotels we are marketing, we have added three to the queue and those hotels are moving ahead swiftly. Of course, we can't ensure that they will close, but we have a high degree of confidence, based on our discussions thus far and we anticipate Anaheim, Montana, Salt Lake and Atlanta will be sold in the first half of 2019. We estimate these four hotels will generate over $70 million in proceeds. With respect to Olympia, we have taken it off the market to allow for additional stabilization during this typically slow season.

But ultimately, we do expect to market again in 2019. No matter the timing, sales proceeds will be used for continued investment into our growing franchise network. In October, we made a decision to take full ownership of the strategic RL Baltimore for $300,000, having also paid off joint ventures $13 million loan during the third quarter. These actions have given us full control over the operations, refinancing and eventual sale of the asset.

Additional hotels will be added to the disposition pipeline when we believe they have reached stabilization and are positioned to maximize sales proceeds. Our divisional revenue mix over 2018 has mirrored the progress made in our hotel sales with franchise contribution becoming increasingly more dominant. Of the nine hotels sold to date, RLH will retain the flag on eight of these hotels. Beyond the value generated from these sales, we estimate these franchise agreements will result in royalty revenue with a net present value of $6 million.

To facilitate our asset-light strategy and focus more on our human resources and other assets on our core franchise business, we are working with our partners to move operations at the remaining owned or leased hotels to third-party hotel management. We will now have all of our people fully focused on our core business, our franchising division. The franchising division is performing exceptionally well. Operating margins increased to 39% in the quarter, a full 900 basis-point increase over last year, underscoring the emerging benefits of scale.

The Knights Inn acquisition is performing in line with our expectations as it added $1.7 million to franchise revenue during the quarter. We continue to expect this acquisition to add more than $5 million to the adjusted EBITDA on an annualized basis. We are still implementing our brand review of the 350 franchise agreements and are pleased with the performance and long-term growth opportunities for the brand. We have worked hard to build a scalable architecture at RLH.

We have targeted highly talented professionals from the franchise hospitality space, gifted marketeers and innovative technology professionals, all of which who have been instrumental in our evolution as we -- as an emerging franchise company. We have been nimble in providing our owners with cutting-edge tools, such as RevPak to improve their return on invested capital. In October, we launched the redesigned redlion.com and it has been received positively by our guests and our owners. Guests enjoy the seamless use of the website, which allows them to make reservations in as little as three clicks, customize their stay, interact with the hotel and make last-minute changes to find the best deal available.

The dynamic features of the website provide a wider range of ways to drive revenue to our franchisees. Complementing the launch of the new website, we've upgraded our Hello Rewards currency to give members faster access to rewards, while driving down overall cost of sales for franchisees and the programming operating cost for RLH. The new currency Hello Bucks works like cash with one Hello Buck equaling CAD 1 or USD. Members can apply Hello Bucks to their next reservation booked on redlion.com or save for a free night.

Early feedback from owners of the new currency has been positive. All our actions have been deliberate and focused on transforming RLH into a dynamic high-margin, non-capital-intensive franchise-fee business model. I'm proud of what we have accomplished thus far in 2018 and foresee RLH being fully asset-light franchise company as we move to 2019. In the meantime, we will continue to identify and pursue accretive franchise acquisitions like Knights Inn, in our quest to grow our franchise business, our operating cash flow and shareholder value for our investors.

We appreciate the patience and support of our shareholders in this highly fluid and dynamic year. I would like to now turn the call over to Nate to discuss our financial performance and outlook for the remainder of 2018.

Nate Troup -- Senior Vice President and Chief Accounting Officer

Thank you, Greg. For the quarter ended September 30, 2018, RLH reported $8.9 million in net income or $0.35 per diluted share as compared to net income of $2.8 million or $0.11 per diluted share in the third quarter of 2017. The increase year over year was driven by the $26 million gain on the sale of the Hotel RL Spokane and the Red Lion Hotel Port Angeles and strong improvement in the franchise division. Our franchise division growth was due to both organic growth, as well as the incremental contribution from the Knights Inn acquisition.

The increases were offset by a $7.1 million noncash impairment on RL Baltimore. Lower contributions from our hotel division as a result of the success of our hotel sale initiative and an increase in G&A as resources previously dedicated to the hotel division are moved to support the overall growth of our company. We reported adjusted EBITDA from continuing operations of $4.6 million in the third quarter, compared to $11.4 million last year. The decrease over the prior year is almost entirely attributable to the impact of the hotels sold during the year.

The hotel sales initiative will continue to impact adjusted EBITDA, while we replace this lost income with additional franchise contributions. For the third quarter of 2018, our franchise division delivered revenue of $15.1 million, an increase of $2.4 million or 19% over the $12.7 million in revenue for the same period in 2017. This strong double-digit franchise revenue growth was driven both by contributions from our Knights Inn acquisition, as well as through sustained organic growth in our franchise base. As a result of the scalability of our franchise division model, we expect this top-line growth to contribute significantly to adjusted EBITDA expansion.

As we continue to execute on our hotel sales initiative, sales proceeds in excess of debt pay down will provide us with the capital to accelerate franchise growth. Furthermore, our transition to an asset-light model will provide the benefit of limited CAPEX spend as well as savings from various other hotel-related expenses. Turning to our outlook for 2018. We are refining our guidance on franchise divisional profits to a range of between $18 million and $19 million and have adjusted our expected full-year franchise profit margin to a range of 33% to 35% to reflect the timing of additions to our franchise portfolio.

This reflects an increase of $4 million to $5 million over the full year 2017 franchise divisional profit of $14 million. We continue to expect to execute between 150 and 200 license agreements in 2018, having already executed 132 contracts year to date in addition to the Knights Inn acquisition.We have adjusted our G&A guidance to a range of $19.5 million to $20.5 million to reflect additional resources reallocated out of the hotel division or added to support the growth of the company. Note that we are suspending guidance on RevPAR metrics due to the asset sales. Given the concentration of our franchise contracts that are fixed fee in nature, RevPAR metrics during this time do not accurately reflect the revenue growth in our business model.

Thank you for joining us today. We are now opening up the call for questions. 

Questions and Answers:

Operator

Thank you [Operator instructions] Our first question comes from the line of Eric Wold with B. Riley & Co. Please proceed with your question.

Eric Wold -- B. Riley & Co. -- Analyst

Thank you and good afternoon. I guess, Greg, and I know, it's difficult, given the fluid situation around asset sales and discussions and timing, all that. But maybe, is there a way to kind of give a -- based on your plan of when you plan to list properties, discussions you're having, your view of the market, maybe a best and worst-case scenario for how many properties may be left by the end of '19?

Greg Mount -- President and Chief Executive Officer

Yeah. I think, that we've tried to give a little bit more guidance that relate to the assets before that we talked about that are very active at this point. Again, as we talked about in prior calls, it's just very fluid. And we try to be as proactive and timely as we can with the 8-K like we were this last quarter to get those out early in the quarter so everyone could understand kind of the impact of those asset sales thus far.

But at this point, as you know, Eric, I mean, until the deal is executed and the money has been transferred, it's tough for us to give anything that's really firm.

Eric Wold -- B. Riley & Co. -- Analyst

And I apologize, you gave the four really quickly. What were the four that you expect to be sold in the first half of '19?

Greg Mount -- President and Chief Executive Officer

Yeah, we talked about Anaheim, Salt Lake City, Montana, which is Kalispell, and -- it's got out of my head...

Eric Wold -- B. Riley & Co. -- Analyst

Atlanta.

Greg Mount -- President and Chief Executive Officer

Atlanta. Thank you.

Eric Wold -- B. Riley & Co. -- Analyst

OK, thank you. OK. And then as you look at the 132 franchise agreements signed year to date, it looks like about at least through this third quarter, slightly less than a half were net new agreements versus renewals or conversions. Are the new guys coming in? What's the mix of brands they're choosing? Are they -- where kind of in the scale are they kind of economy up? And what's the mix of brands they're coming over for?

Greg Mount -- President and Chief Executive Officer

Yeah, we're really seeing a good solid increase in our mid-scale and upscale brands as we move forward. And we're also seeing, as we execute the new agreements for assets that have ended their term or are in the process of being sold, we've seen a cost of movement of those from, as we've talked about before, from one year to three to five-year agreement. So the overall net present value and the growth in revenue that we're seeing out of these new agreements, there's really been -- have been very solid and we're very pleased with it and it's going -- it's continuing. And so for us, growing that mid-scale and upscale businesses is key.

And it's a distinct focus for us.

Eric Wold -- B. Riley & Co. -- Analyst

So last question. On that point then, as you look at acquisition opportunities, are you similarly focusing to try to be on more mid-scale and above opportunities, kind of diversify that direction? Or is it kind of really opportunistic, if something like a Knights Inn pops up and the price is right, you won't be selective away from it?

Greg Mount -- President and Chief Executive Officer

Yeah, it's a great question. We are going to be much more focused on mid-scale and upscale opportunities. I won't say never that we will look at economy but we feel that we've got a really good handle on the economy and we need to really grow our mid-scale and upscale platforms. And those are going to be our primary focus.

And we haven't changed from that direction at this point.

Eric Wold -- B. Riley & Co. -- Analyst

And just last follow-on then for me. Does that -- how does that change your thoughts around acquisition multiples going forward versus the five times you're able to get Knights Inn for?

Greg Mount -- President and Chief Executive Officer

Yeah, we talked a little bit about this on the last call, Eric. I think, that we've been very good at finding really good multiples in some of these acquisitions that we've made up to this point. I think, that as we move into the mid-scale and upscale, we've talked about that we're probably going to start to see more of a nine, maybe 10 multiples as we get into those, but still well below what most of the transactions have occurred in the industry in the last 12 months. But we think it's going to probably push up a little bit.

But it's still, for us, given where we're trading, it's still an attractive multiple.

Eric Wold -- B. Riley & Co. -- Analyst

Perfect. Thanks, Greg.

Greg Mount -- President and Chief Executive Officer

Thanks, Eric.

Operator

[Operator instructions] Our next question comes from the line of Alex Fuhrman with Craig-Hallum Capital Group. Please proceed with your question.

Alex Fuhrman -- Craig-Hallum Capital Group LLC -- Analyst

Great. Thank you very much for taking my question and let me just say, all of us at Craig-Hallum here, we're very sad to hear that Doug resigned, and we're all sending positive thoughts and wishing him a quick recovery. But I did want to ask about -- I guess, the one thing that really stands out in your release that I'd love to just get a little bit more color on is the SG&A increase relative to the prior guidance. It sounds like that's, to some extent, that they're kind of maybe moving around from one division to the other.

Can you give us a sense of what's been driving that? And then as we look out at future years, would you expect future years' SG&A to more approximate the new higher guidance that we saw today? Just curious how we should think about that.

Greg Mount -- President and Chief Executive Officer

Yeah. Hi, Alex. It's good to hear from you. And thank you.

We're all thinking about Doug. Again, as we talked about, really it's not an increase in our G&A. It's really just geography as we kind of allocated, as we've sold these assets. These were expenses that were allocated into the hotel operating P&Ls.

And those assets have been sold and some of that needs to be retained. We still met our goal and guidance of reducing our expenses by $5 million, which we've gone ahead and done. As it looks, going forward, we don't anticipate any significant G&A increases. However, you will see some slight increases as the company grows and we settle into our operating environment.

But at this point, we feel good about the cost that we have removed. And again, these are expenses that are purely geography, we already had the expense there, we're just moving it into G&A.

Alex Fuhrman -- Craig-Hallum Capital Group LLC -- Analyst

OK, that's helpful. Thank you. And then curious about the decisions to bring all of the Baltimore asset in-house. I mean, does that, in any way, change the time line of when you might look to sell that asset? Curious if that perhaps is a model of how we should think about maybe some of your other jointly owned assets? I would just love to get a little bit more color on that decision.

Greg Mount -- President and Chief Executive Officer

Yeah, I think, Baltimore is really into itself. And really the other assets are going to fall closer to what you've seen us execute so far this year. Baltimore, as a market, has just been dreadful and continued to not see the recovery. But I think, everyone in Baltimore hope that it would.

We felt that this asset for us is very strategic. It's been key as we've talked about before in a number of franchise agreements that have been executed, it continues to be, for us, a proving ground and a science lab as we test our new technology and work on kind of the brand standards for that asset. We felt that moving forward and taking on our partners and paying off the current debt is the right move strategically for us and for our shareholders. At the same time, we're going to be coming back and look to put -- place new debt on that asset.

I think, this will be one that will definitely hang around a bit longer. We're excited to have a third-party operator at the caliber of HEI, who has taken over the operations of that asset, which will allow us to continue to focus on our franchising business and allow them to bring their experience and their scale to that asset, which will only benefit and help us move closer toward some form of stabilization. So we can monetize it.

Alex Fuhrman -- Craig-Hallum Capital Group LLC -- Analyst

OK, that makes a lot of sense. And then if I could just lastly ask. I mean, I guess, it's only been a couple of weeks, but just thinking about the new relaunched website. Is there anything you've been able to see in terms click-through rates or time spent on the page that indicate that customers are having a different relationship with the website? Just curious about how you think perhaps redlion.com as a booking agent will play a role going forward.

Greg Mount -- President and Chief Executive Officer

Alex, I think, it's really early in the timetable. We have really great analytics tied to the new website from -- in everything looking at keystrokes to eye-movement to how people are interacting with it. So we'll -- I'll make a note of that, and when we do our next call, we'll give you a quick update on how that's performing. But I think, we need a little bit more time.

It's really fairly new. And so I don't think we have a good data pool yet.

Alex Fuhrman -- Craig-Hallum Capital Group LLC -- Analyst

OK, that makes sense. Thanks, Greg.

Greg Mount -- President and Chief Executive Officer

Thanks, Alex.

Operator

Our next question comes from the line of Richard Whitman with Benchmark Capital. Please proceed with your question.

Richard Whitman -- Benchmark Capital -- Analyst

Yeah, Greg. I may have missed this. Did you comment, at all, on Sea-Tac?

Greg Mount -- President and Chief Executive Officer

We did not. We did not. Sea-Tac still continues to remain an asset that we are working in as we've talked about the negotiations of the new leasehold, and that is continuing to move along as planned. And it's also an asset that we will look to move over to third-party management as we go through that process as well.

Richard Whitman -- Benchmark Capital -- Analyst

OK. One other question. Looking at the numbers. Cash is roughly $23 million at the end of the quarter and debt has come down to $35 million.

Is that correct or is that too low?

Nate Troup -- Senior Vice President and Chief Accounting Officer

Yeah, that's right. This is Nate. Debt is down to $35 million. This also got the $10 million on the revolver.

So in total, you get $44 million, roughly, on that.

Richard Whitman -- Benchmark Capital -- Analyst

OK, and that's down from $92 million last quarter, correct?

Nate Troup -- Senior Vice President and Chief Accounting Officer

Yeah, that -- I believe, that's right.

Richard Whitman -- Benchmark Capital -- Analyst

OK, thank you.

Nate Troup -- Senior Vice President and Chief Accounting Officer

Thanks, Richard.

Operator

[Operator instructions] Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

Greg Mount -- President and Chief Executive Officer

Great. Thank you, operator. I want to thank everyone for joining us today. And we look forward to speaking with you in the future.

Operator

[Operator signoff]

Duration: 32 minutes

Call Participants:

Dan Redmond -- Vice President of Financial Planning and Analysis

Greg Mount -- President and Chief Executive Officer

Nate Troup -- Senior Vice President and Chief Accounting Officer

Eric Wold -- B. Riley & Co. -- Analyst

Alex Fuhrman -- Craig-Hallum Capital Group LLC -- Analyst

Richard Whitman -- Benchmark Capital -- Analyst

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