Sunstone Hotel Investors Inc (SHO) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Sunstone Hotel Investors Q3 2007 conference call. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder this call is being recorded, today, Tuesday, November 6, 2007. I would now like to turn the conference over to Mr. Bryan Giglia, Vice President. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining us today. By now you should have all received a copy of the corresponding earnings release. If you do not yet have a copy you can access it on our website at www.sunstonehotels.com. Before we begin this conference I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties, including those contained in our prospectus', 10-Qs, 10-K and other filings with the SEC, which can cause actual results to differ materially from those projected. 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, adjusted FFO and hotel operating margins. We are providing that information as a supplement to information prepared in accordance with Generally Accepted Accounting Principles. Explanations of such non-GAAP items and reconciliations to net income are contained in our earnings release that we filed this afternoon.

With us today are Steve Goldman, President and Chief Executive Officer, and Ken Cruse, Chief Financial Officer. Steve will go over the highlights of the quarter and provide his thoughts on current market conditions and a preliminary outlook at 2008 growth. Ken will discuss our balance sheet and provide fourth-quarter and full-year guidance. Following their remarks the team will be available to answer questions.

To begin management's discussion, I would like to turn the call over to Steve. Please go ahead.

Thank you, Brian. Good afternoon, everyone, and welcome to Sunstone Hotel Investors third quarter 2007 earnings conference call. We are pleased to report another strong quarter driven by better-than-anticipated demand and solid profitability throughout our portfolio. Our strong performance this year is largely influenced by the significant capital that has been invested into our portfolio over the past two years. Adjusted EBITDA during the quarter was up 16% to $77 million, and adjusted FFO per share was $0.71, which is a 13.7% increase over third-quarter 2006.

Third-quarter 2007 total hotel portfolio RevPAR increased 11.6%, driven by a 430 basis point increase in occupancy, and a 5.6% increase in ADR. This result is significantly above our guidance of 8.5% to 10% and compares favorably to total U.S. upper upscale RevPAR, which increased 5.9% in Q3, according to Smith Travel Research. Comparable portfolio RevPAR, excluding four non-comparable hotels that experienced material and prolonged business interruption during the current or prior year -- these hotels being the Hyatt Century Plaza, Fairmont Newport Beach, Renaissance Baltimore and Renaissance Orlando --increased 8.2%, also well above the U.S. upscale average.

Before talking about the specific details on our performance this quarter, I'd like to address the recent California wildfires, specifically the San Diego fires. First and foremost our thoughts go out to the families who lost loved ones or their homes as a result of the fires. I'm happy to report that no associate at our corporate office or in any of our hotels lost their homes or experienced significant property damage. Moreover, none of our seven San Diego area hotels were damaged by the fires. We expect disruptions in demand resulting from the fires to be relatively minor and short-lived. Having built a geographically diversified portfolio, the overall impact to our earnings is also expected to be minor. That said, we did lose some business the week of the fire and had several group cancellations. While it is still too soon to calculate the final impact we believe that the EBITDA impact could be between $300,000 and $500,000 during the quarter.

Overall in California, the region experienced 7.8% growth in comparable RevPAR during the quarter. Excluding the Century Plaza and Fairmont, both of which posted significant RevPAR increases Century Plaza 56% and Fairmont 39% -- our Los Angeles and Orange County hotels posted an impressive 11.9% RevPAR increase over 2006. RevPAR from our San Diego hotels increased by 3.8%, slower than we would have liked, primarily due to the impact of new supply on transient business and a weak city-wide calendar. Our Salt Lake area and Houston hotels posted double-digit RevPAR growth for the quarter and our mid-western region also continues to perform well. We are very pleased with the performance of our Rochester, Minnesota portfolio, especially the International Hotel located within the Kahler Grand, which is connected to the Mayo Clinic. The International has established a clear market niche with wealthy, domestic travelers and other international visitors who book multiple rooms for extended periods of time. We believe there is additional value to be derived from the conversion of additional rooms at the Grand, as well as other highest and best-use conversions within the approximately one million square feet of building area we have at this property.

The Middle Atlantic region rebounded nicely in the third quarter with a 7.5% RevPAR increase over 2006. As we stated on the second quarter call, we expected to see some softness in our DC area hotels in the quarter and the region was also negatively impacted by under-performance at Hilton Huntington in Long Island. However, we continue to see double-digit growth at the Hilton Times Square and Doubletree Times Square hotels as well as significant improvement over last quarter at our two Boston-area hotels. Comparable hotel operating margins for the quarter increased by 170 basis points, near the high end of our guidance range. Third quarter margins were slightly pressured by increasing healthcare costs but aided by a reduction in property insurance premiums, which on annual basis, are down 13% from the prior year. Management fee expenses, including incentive management fee, were $8.1 million in the quarter, approximately 3% of gross revenues, which compares very favorably to our lodging (inaudible).

With regard to the performance of our four non-comparable hotels, the Hyatt Regency Century Plaza continues to ramp up as the hotel establishes itself as one of the top hotels in LA's premier business market. Operationally the hotel continues to improve as we work with Hyatt to drive profitability, and in 2008 we are anticipating another very strong year of year-over-year profit improvement at the hotel. As expected, we fully utilized the remaining performance guarantee during the third quarter, booking approximately $750,000 of guaranteed payment. The Fairmont Newport Beach continues to show marked improvements. 2007 booking pace has been strong. The property's pace is up 130% from last year and up 18% In average rate. We are going to focus our efforts with Fairmont management on margin improvement at the property where we believe there is significant upside to current performance. Our two other hotels that recently completed major renovation programs, the Renaissance Baltimore and Renaissance Orlando, are ramping up nicely, posting 10% and 26% RevPAR increases respectively for the quarter.

Our primary focus going forward is to maximize the performance of our recently renovated hotels as well as all of the other hotels in our portfolio. During the third quarter we began to realize the benefits from the renovations completed in the second quarter. This is consistent with the results of many of our other hotels whose renovations were completed late in 2006 and earlier in 2007. With several years of strong demand ahead of us and the majority of extensive property renovation behind us, we expect these assets will outperform in their respective markets and continue to drive meaningful returns on our invested capital.

During the third quarter, we continued our share repurchase program and repurchased approximately 525,000 shares at an average price of $25.38. Year to date we have purchased approximately 3.1 million shares for $86.4 million, and remained authorized by the board to repurchase up to an additional 13.6 million of shares before the end of the year. Any future share purchases will be dependent on a number of factors, including our stock price during open trading windows and other potential uses of our free cash flow. Yesterday the board declared a quarterly dividend of $0.35, which represents a 9.4% increase over the prior dividend. While our CAD payout ratio is still relatively low compared to other REITs, we believe it is prudent to take a measured approach to dividend increases in this environment and to consistent serve cash in order to maintain our flexibility. Going forward, we will continue to evaluate means to return capital to our shareholders, including the possibility of increased dividends and additional share repurchases.

On the acquisitions front we continue to analyze potential deals but at this time believe the pricing of upper upscale assets remains high given the overall economic uncertainty and current credit crunch. We will always be opportunistic and continue to keep our eyes open for new deals, but are more focused right now on opportunities to sell additional hotels that require significant capital investment and do not meet our long-term growth objectives. Accordingly, we expect to be a net seller throughout the remainder of the year.

As for the 2008 outlook, we are in the early stages of our budgeting process. At this time we expect 2008 RevPAR to increase 5% to 7% over 2007, which is in line with industry expectations. Industry fundamentals remain strong as evidenced by a robust group pace, up 10% in total revenue from this time last year and early indications suggest corporate negotiator rates will also show increases over 2007. We will continue to work with our managers to finalize our budgets and expect to provide full 2008 guidance in February during our fourth-quarter call. With respect to supply trends, we expect that certain proposed hotel projects may be delayed or cancelled all together because of the recent shift in the underwriting and pricing of debt. Moreover, we believe that the current demand and supply prospects strengthen the long-term outlook of our earnings and we are optimistic about the future.

With that, I'd like to turn the call of the Ken to take you through additional details on our capital structure and credit ratios, as well as fourth-quarter and full-year guidance.

Thanks, Steve, and good afternoon, everyone. In addition to Steve's comments on turning in strong operating results for the quarter, I'd like to also point out that we continue to improve our capital structure and credit ratios. We ended the quarter with $1.7 billion of debt, 100% of which is fixed at an average rate of 5.5%, and the average term to maturity on our debt is eight years. This is assuming we redeem our 4.6% exchangeable notes on the first call date in 2013. In August we repaid $13.1 million of a mortgage loan secured by our Crowne Plaza in Grand Rapids. This loan had an interest rate of 8.51% and was scheduled to mature in September of 2007. While we continue to keep a close watch on any potential business effects related to the ongoing turbulence in the credit markets, from a capital needs prospective we believe we are well insulated. We have no significant debt maturities until 2010 and no immediate need for external financing. We estimate that the value of our unencumbered hotel portfolios is approximately $900 million, providing significant access to mortgage capital should the need arise. And finally, with $91.4 million of cash and cash equivalents, we ended the quarter with a strong liquidity profile.

As for our credit ratios, currently our debt to total enterprise value is approximately 50%, slightly above our long-term target of 45%. We ended the quarter with net debt to EBITDA of approximately 5.9 times, which is slightly better than our 2007 target of six times. We also ended the quarter with a fixed charge coverage ratio of approximately 2.0 times, which is at our 2007 target level. As our hotels continue to ramp in the fourth quarter and into 2008, we would expect to see additional improvement in both of these credit ratios. Based on our current projections for 2008, our new dividend will equate to a fully-loaded CAD payout ratio of approximately 75% which, as Steve mentioned, is still well below the industry average of 85%. To reiterate Steve's comments, going forward we will continue to evaluate our dividend and share repurchase policies for the goal of maximizing the return to our shareholders while maintaining a payout ratio that will tolerate the levels of operational volatility that's inherent to our industry.

I have a couple of accounting matters to discuss. First, as we mentioned on our previously quarterly call, the FASB is considering certain to the way exchangeable notes are accounted for. The contemplated changes may result in us reporting higher interest expense for 2008 due to the inclusion of implied non-cash interest on the bond component of exchangeable notes. We expect to have more information regarding this potential accounting change on our fourth quarter call. Second, I want to point out that during the fourth quarter we revived our diluted share count calculation to apply the treasury stock method when accounting for unvested restricted stock awards, as provided for in FAS 123(R). Historically Sunstone has taken an overly-punitive approach to calculating dilutive shares by including the entire number of shares underlying unvested restricted stock awards in our diluted share count. By correctly applying FAS 123(R) our diluted share counts for the 2006 periods represented in the Q filed today have been reduced by 308,000 shares for the three-month and 287,548 shares for the nine-month periods represented. As these changes are di minimis they had no effect on the fully-diluted EPS for the periods reported.

On to guidance. I want to point out that the guidance we are providing at this time is based on expected performance of our existing portfolio, including all completed acquisitions, dispositions, debt repayments, and share repurchases. Our guidance does not assume any additional share repurchases for 2007, nor does our guidance contemplate any displacement or any potential business interruption in terms of reimbursement as a result of the recent San Diego fires, as we are still assessing the potential impacts. Our fourth-quarter and full-year guidance does include one-time add-backs to adjusted EBITDA and adjusted FFO of $400,000, and $4.7 million respectively, for costs associated with our CEO succession and executive officer severance occurred earlier this year. Full-year adjusted EBITDA and adjust FFO also include add-backs of $800,000 for costs associated with the write-off of deferred financing fees and prepayment costs associated with the repayment of the Hyatt Regency Century Plaza mortgage debt earlier this year.

Go on to fourth-quarter guidance. For the fourth quarter we expect total RevPAR to increase between 10% and 11% over the fourth quarter of 2006. This represents an acceleration over the trend we've seen thus far this year and is largely the result of continued ramp-up at our non-comparable hotels. If we back out our non-comparable hotels we expect comparable RevPAR to be up 7% to 8% over Q4 2006. We expect total hotel portfolio operating margins in the fourth quarter to improve by approximately 300 to 350 basis points, significantly enhanced, again, by operational improvements at some of our repositioned hotels; chief among them the Fairmont Newport Beach, the Hyatt Regency Century Plaza and the Renaissance in Orlando. Comparable hotel portfolio operating margins are expected to increase approximately 100 to 150 basis points over the fourth quarter in 2006.

Also during the fourth quarter we expect to invest between $27 million $32 million in capital improvements. I should point out that this represents cash payments, meaning a significant portion of the capital outlay is for work completed earlier in the year. This does not represent a delay in any of the projects or an increase to previously disclosed scope. For the full year we expect total RevPAR to increase between 8.5% to 9.5% over the full year 2006 and we expect comparable RevPAR to be up 6.5% to 7.5% over 2006. We expect total hotel portfolio operating margins to improve by approximately 215 to 230 basis points over 2006, and comparable hotel portfolio operating margins are expected to increase by approximately 90 to 125 basis points over the prior year. For the full year we are increasing the bottom end of our adjusted EBITDA range by $2 million to $309 million and the bottom end of our adjusted FFO range by $1.9 million to $178 million.

And finally we are increasing the midpoint of our adjusted FFO per share range by $0.035. If you will recall last quarter's range was $2.76 per share to $2.84 per share. Our new range has been increased to $2.81 per share to $2.86 per share. Some of this is attributable to the share repurchase program that Steve mentioned as well as the FAS 123(R) changes that I had mentioned. For the year we expect to make between $130 million and $135 million in capital investments in our [increasing] portfolio. This includes the recently scoped and budgeted Marriott Boston Long Wharf guest room renovation project, which is scheduled to begin shortly and is expected to be completed in April of 2008.

So to wrap up my comments I'd like to say that we're very proud of our performance this quarter and thus far in 2007. We believe we have positioned the Company well to produce solid results in 2008 and beyond. I'll now turn the call back to Steve.

Thanks, Ken. We remain focused on execution and improving our effectiveness at maximizing the value of our assets. We own a geographically diverse portfolio of principally institutional quality upscale hotels. We have implemented new levels of discipline and accountability and we share a cohesive vision for creating long-term value. We will continue to focus on our core competencies while as we drive internal growth while continuing to evaluate acquisition opportunities that will enhance our earnings, thereby allowing us to build long-term shareholder value. Two weeks ago we celebrated the third anniversary of Sunstone going public and I'd like to take a moment to recognize Bob Alter. As you know, Bob has transitioned out of the Company to Chairman of the board and we would like to graciously thank him for everything he has done to get this Company to where it is today. Bob has been a great friend and colleague to me over the past eight months and I very much look forward to continuing to foster the hard work, enthusiasm, and culture for growth and success that Bob has established at Sunstone.

With that, I would like to open the call up to questions. Operator, please go ahead.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Michelle Ko from UBS. Please go ahead.

Hi, good quarter. Just a few questions. Was wondering for the fourth quarter, the expectations seem slightly lower than we anticipated. I was wondering if you were just being more cautious because of the economic environment or has your estimate for the renovations for the Boston Long Wharf increased from the last quarter? Secondly, I was wondering if you could give us an update on your plans for asset sales, given that you said that pricing for upper upscale remains high? Also, I was wondering if you've seen an increase in group cancellations?

Okay. Why don't I take these questions, Michelle, in the order that you asked them to us. I think Q3 was obviously much better than we or the rest of the industry had anticipated I think pretty much across the board with all of our peers. Group business is projected to be strong in Q4, but we have seen some groups not pick up to anticipated levels. Transient demand has surprised our expectations year to date, but because of the short booking windows and limited visibility, I think, frankly, we want to be conservative with our projections and be very careful not to project year-to-date trends into the fourth quarter.

With regard to the asset sale question, we're looking at a few assets that we don't think have long-term growth potential consistent with the rest of the portfolio and that will require greater than 5% to 7% capital improvement over the next few years. We're in the early stage of discussion on some assets. We think that pricing on these levels of assets have still held okay and we think that there's still a window for sale, and we think particularly since they're fairly good quality assets, they just need a little bit more tender loving care than we're prepared to give right now. So that's really the trend that we see in asset sales. With regard to group bookings, we really haven't seen much of a fall-out in group bookings. There's been isolated incidences of cancellations, but overall the trends are still fairly sound and we like the fundamentals going forward.

Okay, great. Just one more additional question. You talked a little bit about San Diego and given that there's new supply and the convention calendar, it underperformed for the third quarter, what are you expecting for next year?

I would say of all the markets that we're in, probably San Diego and Baltimore are the two of most concern to us. In the near term, you have some big hotels -- hotel projects coming in line, particularly in San Diego and Baltimore. We've also experienced some competition at the higher-end transient level, the opening of -- the recent opening of the Ivy and the very short coming opening of the Hard Rock Hotel. So overall,we're looking at San Diego now and Baltimore into 2008 cautiously optimistic.

Okay, great. Thanks very much.

Thank you. Our next question comes from the line of [Kevin Komoto] from Bear, Stearns. Please go ahead.

Hey, guys, I was hoping you guys could make a comment on what sort of renovation activity you have planned for 2008 and how that would impact EBITDA? If you can't quantify then just kind of directionally and maybe site some projects.

Great. Sure, Kevin. Just to reiterate, in 2007 we expect to spend somewhere between $130 million, $135 million, maybe $140 million on our capital program for the year. I just want to say up front, we have not given guidance for 2008, but probably the best way to look at it is you should expect our spend to be back to normalized levels, somewhere in the 5-ish % of total revenues, plus identified ROI projects. Today the only project that we identified for 2008 in the ROI category will be the continuation of the Boston Long Wharf renovation.

Okay, appreciate it.

Sure.

Thank you. And our next question comes from the line of Celeste Brown from Morgan Stanley. Please go ahead.

Hi, guys, good afternoon.

How you doing?

Good. It was actually nice to see a really clean quarter. That was good in all accounts from a company.

Thank you.

It's the end of earnings. Can you talk a little bit more about the strength that Century Plaza and the Fairmont Newport Beach -- based on your guidance, obviously you're surprised at the upside -- where is that coming from, which one in particular? And then secondarily, with those properties doing so well, could you see -- shouldn't it be driving RevPAR above industry averages next quarter -- sorry, for next year or are you just being conservative given the economic uncertainty?

Yes, let me take that in two parts. With regard to hotel specific, we're very pleased with both of these hotels, particularly the Century Plaza. The EBITDA at the Century Plaza in 2007 is probably going to be approximately three times what it was in 2006 and that's not including guarantee payments. And what's particularly encouraging about the Century Plaza is that we believe that there's continued growth in rate and the group bookings look very good. At the Fairmont, we're also seeing a very good group booking pace, and I think with regard to the Fairmont, we're optimistic because frankly, the revenue side -- the performance of the revenue side has eclipsed the performance on the expense side of the hotel and as the hotel has grown in revenues and is expanding its business. We don't think it's done quite as good job as controlling its expenses so we think that there's upside there as well. With regard to projections for the other hotels and overall, yes, I think the answer is we are being cautious and conservative and I think as we put our budgets together through the remainder of this year for 2008, we really are going to take a cautious and prudent view of 2008. And I don't think we want to get out ahead of ourselves, given somewhat of a lack of visibility and more specifically, I think a little bit of uncertainty as to where the economy is going to go in 2008.

With the uncert -- if next year ends up being a bit slower than all economists are expecting, is the best use of capital then just continued reinvestment in the Company or is it -- if you have a strong balance sheet, maybe it's time to take a look at acquisitions again?

I'll answer that. I think there's two things that need to come out of that question. First, I think we want to be very prudent with our capital. I think we want to look very critically at every renovation we do and every capital project that we start to make sure that it is beyond the normal FF&E that needs to be put into an asset to maintain competitiveness and just general state, that the additional dollars are going to generate returns. We consistently view those dollars as among the highest returned capital that we can invest. So overall, I'd like to be very prudent with our capital and really miserly in terms of the way we spend it, looking to maximize the value of every dollar.

To that end I think it's to be able to keep our balance sheet and our powder dry, because my personal view is I don't know when but I do think there are going to be opportunities. We want to put ourselves in a position where our assets are in pristine quality and we're watching every dollar that we put into it so that we can keep those remaining dollars to be nimble and flexible when acquisitions do come up. We had a board meeting and we spoke a bunch yesterday about acquisitions and philosophy and I think the interesting conclusion that came back from the board was, look, we know there's going to be opportunity. We don't know if it's in the first quarter, we don't know if it's in the second quarter, we don't know if it's in the third quarter, but we like the strategy of stay the course, be prudent with the capital, be very cautious as we approach and be available as opportunities come up so we can be nimble and jump all over them.

Okay. That's great. Thank you.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from the line of Dennis Forst from KeyBanc. Please go ahead.

Good afternoon. I had two questions. One was on the share repurchase. I think, Steve, you mentioned that you have up to 13.6 million more shares to repurchase this year. Does that mean that there's a sunset clause on those share repurchases?

I wouldn't call it a sunset clause. When we got authorization, the authorization was for $100 million of share repurchase through 2007. We'll reevaluate whether we go back for additional approval depending on what we do this quarter and depending on our general outlook in terms of how our share price is trading and our alternative uses of cash.

You said $100 million of share repurchase.

We had $100 million total -- and I may have misspoke. We spent approximately $86-and some change million which leaves us approximately $13 million.

Oh, okay.

I don't know if I misspoke. I've got a couple people who signaled to me to clarify.

Yes.

Si to answer your question, we had $100 million authorization, we've spent approximately $86 million and some some change.

On 3.1 million shares.

And we have -- correct. We have approximately $13 million left through the end of the year and we will reevaluate into the next quarter.

kay, that clarifies that a lot. Then the second quarter was the difference between the comparable portfolio, the total hotel portfolio, there are four properties, when do they transition into the total hotel -- or into the comparable portfolio?

Ken, why don't you take that.

Sure. Hi, Dennis, how are you?

Good, Ken.

The comparable definition, which we revised -- this is the first quarter we're really applying the new definition of comparable -- calls for us to pull out of our comparable portfolio any hotels that experience sustained and material business interruption during the current year, or the preceding calendar year being compared. So as a result, this year we've got the four hotels out. Next year we'll only have two hotels pulled out. That'll be the Orlando Renaissance and the Baltimore Renaissance as the Century Plaza and the Fairmont both completed the material disruption phase of their renovation in the fourth quarter of 2006.

Okay, but does that mean Orlando and Baltimore are out for the full year or just until they anniversary the disruption?

Full year.

Full year, so they will -- those two will be out all of '08?

Correct.

And then would Boston Long Wharf also be out in '08?

We do not believe so. If it pas -- we actually have a subjective test that we'll run to determine if there's material and prolonged disruption but we do not believe that that hotel renovation is going to trigger the asset -- the non-comp test.

Okay, great. Thanks a lot. Good quarter.

Thanks, Dennis.

Thank you. (OPERATOR INSTRUCTIONS) We have no further questions at this time. Please continue with any closing remarks.

Great, thank you. Well, we very much appreciate your time today as well as your continued support of Sunstone. I'm very proud of what the new management team has accomplished over the past three quarters and we look forward to talking to you again in the coming months. Thank you very much.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.