Sunstone Hotel Investors Inc (SHO) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Sunstone Hotel conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded today, Tuesday, August 9th of 2005.

I would now like to turn the conference over to Claire Koeneman with Financial Relations Board. Please go ahead.

Thanks so much and welcome, everyone. By now, you should have all received a copy of the corresponding press release. If you did not, you can access that on Sunstone's website at www.SunstoneHotels.com.

Before we begin the call, I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties, including those contained in the IPO prospectus, 10-Q and 10-K, which could cause actual results to differ materially from those expected. We caution you to consider those matters in evaluating our forward-looking statements.

We also note that this call contains non-GAAP financial information including EBITDA, adjusted EBITDA, FFO and adjusted FFO. We are providing that information in the supplemental information prepared in accordance with Generally Accepted Accounting Principles. Explanations of such non-GAAP items and reconciliations to net income are contained in the earnings release and our 10-K.

With us today from Sunstone are Bob Alter, President and Chief Executive Officer; Jon Kline, Chief Financial Officer; and Gary Stougaard, Chief Investment Officer. Bob will begin and provide us an overview of the operating environment, Jon will provide an overview of 2Q results and the outlook for third quarter and full year 2005, and Gary will comment on the recently completed acquisitions and the current acquisition environment. Following their remarks, the full team will be available to answer questions.

So without further ado, I will turn the line over to Bob Alter.

Good morning, everyone, and welcome to our second-quarter 2005 earnings call for Sunstone Hotel Investors. It has been a very exciting and successful quarter here at Sunstone, as we report our second-quarter results.

Let me first take a couple of moments to recap the transactions that we have completed during the past few months. First, we completed the previously announced acquisition of the six Renaissance hotels, which included the 25% interest in the Washington DC Renaissance Hotel in an off-market transaction with Marriott International. With this acquisition, we were able to add 3,326 rooms and further migrate our portfolio upscale. In July, we completed the acquisition of the remaining 75% ownership interest in the Renaissance Washington DC. That's a convention center hotel on 9th and K Street, adjacent to the brand-new Washington DC convention center.

Secondly, we closed on the Sheraton Cerritos in another off-market transaction that was brought to us by our partners at Interstate Hotels & Resorts. Through our relationship with Interstate, we were able to assume their right to purchase this property at an extremely attractive pricing.

Third, and subsequent to the end of this quarter, we completed the acquisition of the Sutton Place Hotel, which has been renamed the Fairmont Newport Beach, and management has been taken over by Fairmont Hotels & Resorts. We have already commenced on the complete renovation of the hotel, which we expect to complete in early 2006.

Now, looking at the operating environment, we are very pleased with the 11% year-over-year same-store RevPAR increase that we achieved in the second quarter, led by our California hotels, which realized a 15.1% RevPAR increase over the prior-year period. We continue to realize impressive RevPAR gains throughout California, highlighted by the recently renovated Hyatt Regency Newport Beach and our five San Diego hotels, with RevPAR gains of 32.9% and 18.7%, respectively.

Turning to the industry overall, I stand by the comment that we made on our last earnings call. I believe that we are still in the early stages of a broad-based industry recovery that will continue for a number of years. The industry is experiencing strong demand growth and modest supply growth. In the last cycle, which began in 1992, there were nine consecutive years of positive RevPAR growth. 2004 was the first meaningful positive year since 2000, and again we have witnessed in past cycles that the larger full-service type hotels that we own have a longer run, as the barriers to entry are greater and the supply cycle takes longer to accelerate. As we watch the Fed continue to raise rates at a measured pace, GDP growth has been reasonably consistent in the positive 3 to 4% range for the past several quarters. We are seeing limited impact of inflation, and our costs have remained under control.

We are seeing a tremendous amount of acquisition opportunities. We have remained very disciplined, and have lost bids on some very interesting assets, due to to our unwillingness to pay a market clearing price. We have focused our acquisitions on our strategic relationships with brands, as well as off-market situations, and we will continue to be acquisitive but disciplined.

With that, let me turn us over to Jon Kline, our CFO, and he will take you through the numbers.

Thanks, Bob, and good morning. I would like to address three topics -- first, update you on the financing transactions that we executed in the quarter; second, provide you with an overview of the second quarter; and, third, provide guidance for Q3 and the full year '05. Given the nearly $700 of acquisitions that we have completed in the last few months and the related financings, we have also provided pro forma guidance for the full year '05, as if all the acquisitions and financings were completed as of January 1.

With regard to our balance sheet, at June 30, '05 we had debt of 967 million and 62 million of cash on hand. As of July 31st, following the completion of the 75% of DC and Fairmont Newport Beach acquisitions, our debt stood at 1,021,000,000.

During the second quarter, we completed four significant financing transactions. First, we amended our $75 million subordinated term loan facility, reducing its borrowing rate from LIBOR plus 400 to LIBOR plus 225. As a result of our operating performance, our first-quarter capital structure initiatives, in terms of fixing the maternal portion of our debt and, importantly, the fee carrot that we were able to dangle with the June equity offering, we were able to renegotiate this facility and obtain these more favorable terms. All but one of the participants in the line rolled, and we were able to replace that one participant hedge fund with two large banks that we feel will be much more helpful to us going forward.

Second, we completed a public offering of 12.2 million common shares, including the full exercise of the green shoe for October's proceeds of almost $300 million. This offering consists of 3 million shares sold by the Company and 9.2 million shares sold by Westbrook affiliates, taking Westbrook's fully-diluted ownership interest down to approximately 9% and reducing the associated overhang.

Third, and concurrent with the close of the six-hotel Renaissance acquisition, we closed on the financing of four individual, non-cross-collateralized fixed-rate loans in the total amount of 250 million. Two of the mortgages, totaling 65 million, have a seven-year term, maturing in 2012, and have an astounding rate of 4.98%. The remaining two mortgages, totaling 185 million, mature in 2016, so it's 11-year money with a weighted average rate of 5.2%.

We also structured an earnout and (ph) 11-year financing. We are mindful of the maturities we have in 2015, and structured the debt to be the 7 and 11-year maturities rather than the more traditional 10. We think we did so at no incremental cost. At the end of the second quarter, our average interest rate was 5.8%, with an average maturity of nearly eight years, and 91% of our debt is fixed.

Fourth, we closed our sale of 4 million shares to the government of Singapore. Also, subsequent to the close of the second quarter, we completed a sale of 4.1 million shares, on an as-converted basis, of convertible preferred stock to Security Capital for gross proceeds of $100 million.

Shifting to our second-quarter performance, to echo Bob's comment, we're pleased with the performance of our underlying business, which continues to benefit from the significant CapEx we've spent. On the second quarter, before I jump in, I would like to make clear that all of the adjusted EBITDA and adjusted FFO figures I will present exclude certain items.

First, there's a $2.1 million reserve, due to a contract interpretation issue. This issue relates to a large customer that has used and continues to use two of our hotels for large groups. As their groups vary in size and have sometimes been too large for our hotels, we have arranged with other nearby hotels to take the overflow. We have done this at a profit, and we are currently discussing with the customer how the profit calculation and expense reimbursement clauses of the contract are properly interpreted. We expect to have a resolution by year end. Second, we excluded a 2.4 million gain on the sale of two of our hotels, the Carlson Doubletree and Mesa Holiday Inn. And, third, we excluded $3.8 million of prepayment penalties and write-off of deferred financing costs associated with the terming out of our debt that we completed in April of 2005.

With that preamble, let me hit the highlights of Q2. Total revenue was 132.2 million, up 11.5 million or 9.5% from the prior-year pro forma period. The topline results were driven by an 11% improvement in RevPAR, which was a 1.5% increase in occupancy and an 8.8% increase in ADR. In other words, 80% of the RevPAR improvement was from rate. Hotel operating margin for the quarter improved 300 basis points from 28.2% to 31.2%. Adjusted EBITDA was 39.7 million, compared to pro forma adjusted EBITDA for the prior year of 31.3, an increase of almost $9 million or (technical difficulty). Adjusted FFO available to common stockholders, 24.8 million, up 5.4 million or 28% from the prior-year comparable period. Adjusted FFO per share was $0.63, up 29% from the prior-year period.

Second-quarter results, I would also like to point out, were negatively impacted by the delayed closing of the Fairmont Newport Beach and by timing issues related to the issuance of the 7.3 million shares and the $250 million of debt that we completed during the quarter and the fact that the acquisitions were completed in a timeframe such that they didn't have any corresponding EBITDA in the period. We estimate that was about $0.02 a share that we would have done better, had those things closed simultaneously. Specifically, the way the Renaissance hotels do their accounting, they employ Marriott's convention of 13 four-week periods, so the last week of the calendar quarter that we owned them will actually be part of Q3's EBITDA. We invested 9.8 million of CapEx during the quarter.

For the six months, our revenue was 248.8 million, up 7.7% from the prior year. RevPAR was up 9.8%, which was driven 71% from rate. Operating margins were up 220 basis points for the six-month period. Adjusted EBITDA was 68.9 million, compared to pro forma prior year of 55 million, an increase of 25%. FFO for the six months was 40.4 million, up 27% from the prior-year comparable period, and adjusted FFO per share was $1.03, up $0.22 or 27% from the prior-year period. We invested 23.5 million in CapEx during the first six months.

With regard to our outlook and guidance, I will run through the third quarter first and then give you full-year '05 guidance and also on a pro forma basis -- again assuming all the hotels, the eight hotels were acquired and the financing is completed on January 1. For Q3, we expect RevPAR to be up 7 to 9%. July RevPAR was up 7.4% from the prior year. Our EBITDA we expect to be 42 to 45 million. FFO to all common stockholders, including OP unitholders, should be 23 to 26 million, which calculates to $0.46 to $0.52 a share. We expect margins to be up 150 to 200 basis points, and we expect to spend 15 to 18 million of CapEx, including work at Sutton Place and the Renaissance acquisition hotels.

For the full year '05, we expect RevPAR to be up 7 to 9%, which is an increase from the 6 to 8% range that we provided on last quarter's call. EBITDA we expect to be between 159.6 million and 163.6 million. FFO to all common stockholders between 93.2 million and 97.2 million, which calculates to 209 to 218 a share. Margins up 150 to 200 basis points. And then CapEx we expect to spend 65 to 70 million, including the work at Sutton Place and Renaissance.

On a pro forma basis -- again, this is assuming that all eight acquisitions occurred on January 1 and all the financings occurred on January 1, so there's effectively 50 million fully-diluted shares outstanding for the full period -- we expect adjusted EBITDA to be approximately 186.6 to 190.6 million. FFO available to common stockholders, including OP unitholders, should be 110.7 million to 114.7 million, and that comes to 2.21 to 2.29 a share.

On the dividend, during the second quarter, we declared and paid a dividend of $0.285 per common stock and OP unitholder and a dividend of $0.578 per share to the Series A. For the third quarter, our Board has declared and will pay the same $0.285 dividend per share of common stock and OP unitholders, and it will be $0.50 from now on every quarter to the Series A preferred stockholders. The level of future dividends will be determined by the Company's quarterly results and expected CapEx requirements. We have said and we will repeat here that we expect to pay out approximately 85% of our cash available for distribution as dividends, and we expect to review our current dividend at our November Board meeting.

A lot of numbers; I apologize for that. But hopefully, it's helpful in terms of building models. And with that, I'd like to turn it over to Gary to talk about our acquisitions.

Thank you, Jon, and good morning, everyone. As Bob mentioned, we have been busy closing on previously announced acquisitions this quarter. In June and July, we closed on eight hotels. On June 23rd, we closed on the acquisition of the portfolio of six Renaissance hotels. Included in the portfolio were Renaissance hotels in Atlanta, Baltimore, Long Beach and White Plains, New York, together with the Renaissance resort at Sea World in Orlando, Florida, and a 25% interest in the Renaissance Washington DC hotel, as Bob mentioned earlier.

On June 27th, we closed on the 203-room Sheraton Cerritos hotel in Cerritos, California.

After the quarter end, on July 11th we acquired, as Bob mentioned, the former Sutton Place Hotel in Newport Beach. The 444-room hotel was renamed the Paramount Newport Beach hotel on August 3rd. Immediately upon closing, we began work on a complete renovation of the property, and expect to have the first 40 fully-renovated guest rooms completed and back in service in early September, with the balance of the guest room, public area and exterior renovation scheduled for completion in stages through the balance of the year and into the first quarter of 2006.

Finally, on July 13th, we closed on the acquisition of the 75% balance of the Washington DC hotel that was not part of the Renaissance portfolio acquisition. We have been pretty busy.

These are all very high-quality assets in markets which we believe are poised for significant growth. We are extremely pleased with these acquisitions, and believe they represent some of the most compelling buys in our industry this year. We continue to see a very competitive acquisition environment, as large amounts of capital have entered the hospitality real estate arena seeking higher yields. As a result, the number of high-quality assets for sale in the market has continued to rise, and sale prices have increased. However, we will continue to be disciplined in our approach to acquisitions, and look for assets that will improve the overall quality of our portfolio and add to the stability and growth prospects of our future cash flow.

With that, I'll give it back to you, Bob.

Just one additional point. Both Jon and Gary used the name Sutton Place. Many of you might have seen that an actual lawsuit was filed against us for the actual -- we assumed an agreement with the previous owner to use the name. The owner of the name Sutton Place disagreed. Ultimately, Fairmont agreed to change the name to Fairmont Newport Beach sooner, on August 3rd, and we have subsequently settled -- for a very small amount of money -- the lawsuit and it will be dismissed in the next few days. But we will no longer use the name Sutton Place but will use Fairmont Newport Beach on that hotel.

Again, thank you for your interest in our company. We are very excited about the very, very strong quarter we had -- 11% RevPAR growth throughout our portfolio -- and we are optimistic about the remaining of the year, as Jon stated in his guidance for the rest of the year.

So with that, I would like to turn it over to questions, and the whole team here will be prepared to answer.

(OPERATOR INSTRUCTIONS). William Greene, Morgan Stanley.

Jon or Bob, can you talk a little bit about RevPAR trends quarter to date here in the third quarter?

Jon, do you want to take him through that?

Yes. As I mentioned -- I know I ran through 1,000 numbers, but July was up 7.4%, which was in line with our expectations. What we have seen is that most of the push, in terms of the strong RevPARs that you have seen, has come from the transient side, but more specifically the business transient side. In the summer months, it's typically slightly more leisure-weighted. So we would expect, as we get back into the fall where it's more business-weighted, we would see continued strengthening.

So is the slowdown from the second-quarter growth rate mostly a comp issue?

No, it's mostly a mix of business versus transient, and how aggressively folks are driving pricing relative to those segments. And again, in the summer it's more leisure-weighted, and the ability to push those folks to pay more is slightly less than it is when it's a business traveler.

And then, this might be hard to answer, given the changes in the portfolio. But, given where we are on the margin front, how far do you think the portfolio is from peak margins?

Well, the margins that we are expecting to run this year are several hundred basis points below what the 51 hotels, the core 51 -- we think of our portfolio right now, at this moment in time, as the core 52 and then the eight that we have added. We are spending a lot of time focusing on the new eight hotels. Of the 52, one of them was constructed last year. The 51 have five years of history -- more than that, but we have looked back at that pool of 51 hotels, and we have looked at the margins over that period. And the margins in '05 we expect to be 200 basis points, approximately, below where they were in 2000.

So it's still down 200 from the peak?

Correct.

And from the peak, remember, in those five years since 2000, we have had a tremendous amount of expense creep with not that much additional RevPAR. In fact, RevPAR is just about equal. But obviously, expenses have creeped up a couple hundred basis points. We expect, in the next couple of years, that we will continue to move rate as the driver over occupancy as the driver, and that will again give us back the margin improvement, as you saw in this quarter.

David Anders, Merrill Lynch.

Could you give us a little bit more color on the relationship with your manager? I see you renegotiated the contract and the compensation level.

We view -- right now, we have a multi-managed portfolio. We have 48 hotels managed by IHR division of Sunstone Hotel Properties, and then we have the nine Marriott's, two Hyatt's and one with Fairmont. The 48 relationship seems to be on track. The entire organization that we had in place prior to going public, when we were a fully-integrated LLC, continues in force to be the manager of the hotels. That team has a little bit of interaction with Interstate as it relates to areas where they can be helpful, but pretty much that division is run separately. We had originally had a fee increase scheduled of 10 basis points, and as a result of some other trade-offs within the portfolio, Interstate agreed to keep the rate at the 1.75, and then first of the year it will go to 2.0.

Jeff Randall, A.G. Edwards.

Bob, back on the management agreements with Interstate, is there any buyback provision that Sunstone has or maybe even a right of first refusal, should Interstate want to sell the Sunstone-oriented portion of its management group?

First of all, there are termination provisions that are on various levels of liquidated damages that basically burn off over a period of time. There is also change-of-control provisions that allow us to terminate the relationship. As you know, as a real estate investment trust, we could not own that management team group internally, because we would be -- we are not allowed to manage our own hotels. Where that entity resides -- or those 48 management contracts resides -- obviously, we felt it was appropriate to do something with a company like Interstate that is public, that has all the Sarbanes-Oxley rules that we as a public company have to face. And so that's why the relationship was done there. And we don't know what the ultimate happens to Interstate, but at this point, I think we are very comfortable with the situation that we have.

Just to be even more (indiscernible), there's some very detailed disclosure in our prospectus about all these terms. If I recall correctly, if there's a change of control at Interstate during the calendar year '05, we can terminate and we pay them two times the annual management fee. And if it happens during '06 we pay one times, and thereafter it's zero. I'd like to just confirm those numbers, but that's what I recall.

No, that's fine. Jon, you mentioned an earnout in one of the financing transactions, and I just wondered if you could maybe give a little more color on that.

Basically, on the Orlando hotel, there is a lot of upside. That hotel had a rough year last year because of the hurricanes. And as a result, the advance in terms of the dollars funded on that particular loan were lower than we want to put in place on a long-term basis. So we came up with a formula with our lender where we will get a supplemental advance at any point over the next year, at our option, based on the cash flows performing as we expect them to. It's $15 million, so it's not a giant amount, but it does give us the right advance rate on the asset.

And then, just lastly, just a housekeeping number. If I could get the management fees paid during the quarter, as a breakout from corporate G&A?

I have that figure. Are you interested in just the Interstate or everything?

Everything.

The management fees paid during the quarter were $3.4 million.

And would you happen to have the number for the first quarter? I thought that number had been around 2.8 million, and that --

2.7 in the first quarter.

2.7?

2.7 in the first quarter, 3.4 in the second quarter.

Joe Greff, Bear Stearns.

Just a clarification on your 3Q and full-year '05 outlook. The hotel operating margin gains that you're forecasting, is that on a same-store basis -- i.e., is that before the recent acquisitions?

Yes, that is on a same-store basis. What we tried to do is we went to great lengths to try and make it easy for you guys to analyze this -- give you the 52 hotels as one business unit, effectively, and then give you the incremental from the acquisitions. If you look at the pro formas that we included in the Q, you'll see that the '04 pro formas that we gave you income statements for both the quarter and the six months are just on the core 52 hotels. And then we also gave you a three-month and a six-month '05 pro forma that includes all the 60 hotels. The margins are lower, Joe, as you know, on the Renaissance hotels, which is part of the interesting part of the acquisition.

Part of the opportunity.

Yes. We've commented before that we think there's potentially very, very significant margin improvement opportunity in that portfolio. We'll give you more color as we have actual operating history with them.

Jeff Randall, A.G. Edwards.

Jon, just on that last point, I didn't think that the margin upside -- you had said, though, in the last conference call that that wasn't included in the margin guidance. That's still the case, correct?

Correct. We are hopeful and fully expect to realize that, but very candidly, Marriott is managing those hotels, the six Renaissance hotels. And it's a process to be impactful from an asset management standpoint.

Just to give everyone some color on that, as you know, we hired Ken Cruse as Senior VP and Asset Management. Ken has been extremely active over the last 90 days, working with both Renaissance and Fairmont on having impact. We've actually conducted third-party operational studies to all the hotels. We've had one of the leading folks in revenue management go in and do complete market share and RevPAR studies on the six hotels. We additionally have spent a significant amount of time with Mr. Hank Biddle (ph), who is the new EVP of Renaissance, and we are very optimistic about the changes going on within Renaissance, in terms of how we think they will impact the margins and the improvement of those hotels. Additionally, Gary Stougaard has spent a tremendous amount of time with Guy Lindsey, our Senior VP of Construction, on all of the capital requirements that we and Marriott are working through to improve those hotels.

For us, it's all about implementation and creating additional upside through asset management. And we believe that the wheels are in motion to make that happened. We are very optimistic about the future of those hotels.

As just a quick follow-up, did you guys quantify the margin opportunity there? I thought there were some numbers thrown out on the conference call.

I don't know that what we have done --

On the last call, we said 3 to 500 basis points.

So it was 3 to 500?

Yes.

And that's comparing it to the core 51?

That's comparing it to the three hotels that we currently own that are managed by Marriott. It's a different analysis when Marriott manages versus when the Sunstone Hotel Properties people, manage from a margin standpoint. There's a different balancing of objectives, if you will. (Multiple speakers) cash flow is the entire focus when our Interstate folks are focused.

(OPERATOR INSTRUCTIONS). There are no further questions at this time. Please continue.

Well, just to close, again, I think the entire management team, you can tell, is excited by our results. I think our results, both on an operating basis as well as on the acquisition side and the growth of the portfolio in the future, all lead to a very bright future for Sunstone. And we are very optimistic about our remaining of the year. As indicated in our guidance, as well as in, I think, the quality of the assets that we have added to the portfolio leave us really strongly bullish for the future.

And on that note, I would like to close the call and look forward to everybody's participation in the future call next quarter. Thank you.

Ladies and gentlemen, this concludes the Sunstone Hotel conference call. If you would like to listen to a replay of today's conference, please dial 1-800-405-2236 and enter a pass code of 11034884. (OPERATOR INSTRUCTIONS). Thank you for participating. You may now disconnect.