Sunstone Hotel Investors Inc (SHO) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Sunstone Hotel Investors Inc.'s first quarter earnings call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session with instructions provided. (Operator Instructions) I would like to remind everyone that this conference is being recorded today, Monday, May 10, 2010, at 1 p.m. Eastern Time.

I would now like to turn the conference over to Mr. Bryan Giglia, Senior Vice President Finance. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining us today. By now you should have all received a copy of our earnings release which was distributed this morning. 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 described in our prospectuses, 10-Qs, 10-Ks and other filings with the SEC which could cause actual results to differ materially from those projected. We caution you to consider those factors in evaluating our forward-looking statements. We also note that this call may contain non-GAAP financial information including EBITDA, adjusted EBITDA, FFO, adjusted FFO and hotel EBITDA margins. We're providing that information as a supplement to information prepared in accordance with generally accepted accounting principles. With us today are Art Buser, President and Chief Executive Officer, Ken Cruse, Chief Financial Officer, Marc Hoffman, Chief Operating Officer will also be available to answer questions during the Q&A portion of this call. I would like to now turn the call over to Art. Art, please go ahead.

Thanks Bryan, and good morning and/or good afternoon, everybody. Thanks for joining us today. Since we already provided an update detailing first quarter operating results on our business update call three weeks ago, during today's call I will recap the highlights of the quarter. Following that, I will provide an update on current operating trends and examples of how we're doing with our managers to build on this positive momentum and maximizing cash flow. Last, I will provide an update on internal and external investment opportunities and the results of our RFP process. Finally, Ken will provide additional detail on our finance initiatives, including the acquisition of two pieces of debt. Reviewing current operations for our 29 hotel portfolio, adjusted EBITDA for the first quarter was $27.3 million and adjusted FFO per share were $4.2 million and $0.04 respectively.

Reconciliations for adjusted EBITDA and adjusted FFO to net income can be found in our earnings release filed today. Again, all RevPAR stats discussed on today's call are pro forma for our 29 hotel portfolio unless we note otherwise. For the first quarter, our total portfolio RevPAR was down 6.5% to prior year. Occupancy was up 1.4 points and rate was down 8.4%. Excluding our two DC assets, both of which benefited from the presidential inauguration in 2009, our total portfolio RevPAR was down 4% to the prior year. Occupancy increased by 2.1 points while RevPAR was down -- excuse me, while rate was down 7%. New York City and Boston continuing to be leading indicator markets. Our Hilton Times Square generated 14 sellout nights during the first quarter compared to two sellout nights last year.

Additionally, during the first quarter, our Hilton Times Square realized 35 nights with a higher average daily rate in the same day in 2009. This positive trend improved further in April with 20 sellout nights compared to 15, 2009. I think it is also important to note that there were 15 sellouts during the peak demand period of 2007, so it is a great comp. Like New York, Boston is also showing an impressive recovery over 2009. Our Marriott Boston Long Wharf had 22 sellout nights the first quarter compared to five first quarter 2009, still slightly less than peak of 2007 where there was 28. It realized 14 nights with a higher rate. This trend continued in April with 11 sellout nights compared to two in 2009 and eight in 2007, so April in fact had more than 2007.

Let's talk about the improving business trends and business mix. As highlighted in New York and Boston, our portfolio wide sellout nights in the first quarter showed up meaningful improvement over 2009 and in several cases, our sellout nights are approaching levels seen during peak demand periods 2007. Portfolio wide, in April we had 144 sellout nights in the first quarter as compared to 132 in 2009 and 192 in 2007. April's result provide further evidence that we have entered into the early stages of what we expect to be an extended cyclical lodging recovery. April RevPAR for our portfolio finished up 3.6% to last year and up significantly to our prior internal forecast. 19 of our 29 properties had occupancy increases in April and 11 of our hotels recorded higher rates.

Overall, our outlook on the remainder of the year is very positive as our operators continue to handily beat their forecasts submitted just 30 days prior. Really speaks to the rate of acceleration we're seeing. That said, we do expect to see some pockets of weakness as the recovery takes hold. For example, and as we previously noted, we expect our two Houston hotels to lag the broader US lodging recovery for the balance of 2010 due to the reduction in certain government contract business and new supply in the submarket. And we expect softness in Chicago through 2010 due to a continued weak city-wide calendar. Our group booking pace continues to show significant improvement each month. Current group pace is down just 10% to the same time last year. That's made up about half and half of occupancy and rate. That's a significant improvement to last year's pace of down 12% and an even more meaningful improvement to our pace at the turn of the year, which was down 18%. Actual group room nights booked on the our hotels through April was 12% higher than April 2009. I think this is very important to note. At our largest group houses DC Renaissance, Orlando and Baltimore, the average rates on roomed booked in 2011 and 2012 are up 9% and 13% respectively, certainly boding well for, again, ongoing improvements looking forward. Again, for 2011 and 2012, group rates up 9% and 13% respectively.

Going forward, our primary asset management focus is to drive rate and produce margin growth. We are encouraging our operators to set confident and aggressive rate strategies by one, reducing inventory available through discount channels, two, increasing benchmark rates and, three, projecting high compression nights farther out in order to more aggressively yield management inventories. These rate tactics are most effective in hotels with high occupancies. Clearly, as our portfolio average occupancy was approximately 70% at the end of 2009 and our occupancy improved during the first quarter, our portfolio is well-positioned to execute aggressive rate strategies. We understand that by aggressively driving rate, our RevPAR index may actually decrease in the short-term, but we believe that by taking a rate leadership role, our hotels will stand to maintain the highest rates, and we'll be better able to sustain rates in the future.

Let's talk about expenses. On the cost side, we continue to see benefits of the redefined cost structure implemented throughout the industry over the past few years. And again, hats off to Mark and his team for all the things they've done there. In spite of a 1.4 point increase in occupancy during the first quarter over Q1 last year and the general expectation that year-over-year expenses might begin to increase in 2010, as a result of the aggressive cost cuts we implemented in 29, so it was going to make it a really hard comp, our absolute expenses decreased by $3.5 million, or over 3% in the first quarter, again, herculean effort. Occupancy was up and even comping against some pretty tight expenses that -- expenses were down by that amount. Good job, Mark. Going forward,we expect the significant changes made to the hotel cost model, including right sizing the food and beverage outlets, streamlining management positions, the optimization of several operating processes such as housekeeping, beverage control, and the upgrading of energy control systems that will provide significant flow through and results in margin just as we have seen and they should pass -- and they should surpass prior peak margin as a cycle improves.

Let's shift to my favorite subject, that's acquisitions. As we finish the first quarter with approximately $374 million of cash and cash equivalents, we hold significant dry powder, but then again, who doesn't. Accordingly, we continue to evaluate both external and internal opportunities to invest our growth capital. Through both marketed channels and through our own industry relationships, we're seeing an increase in the quantity and quality of acquisition targets. Our primary focus continues to favor high quality, upper upscale or premium limited service assets in strong locations within top gateway markets that is we expect to outperform the US average.

We also look at value add acquisitions where there is a turn around story and where we have the ability to create value through renovation, rebranding, and through the implementation of our asset management systems. We're also evaluating targeted debt instruments which Ken will speak to later on the call consistent with our debt investment and the repurchase of the three Mass Mutual assets earlier this year, we continue to seek opportunistic, creative, nontraditional investments where meaningful value may be created. As a complement to our external growth strategy, we have identified several meaningful investment opportunities in our existing portfolio where we believe we can achieve outsize returns. 2010 projects include a complete renovation of the Embassy Suites Chicago, guest room renovation at the Renaissance DC, rooms and meeting space upgrade at Kahler Grand in Rochester, rooms at the Marriott Tysons Corner. These projects are expected to begin between the second and fourth quarter this year that will carry over to 2011. With the acceleration of this program, we'll now expect to invest between $60 million and $80 million into our portfolio during 2010. By proactively investing in our assets and increasing their ability to drive rates and penetrate their comp sets, we expect to deliver a superior product during the early stages of what we think could be a prolonged cyclical recovery.

So before turning it over to Ken, let me finish up on our management agreement RFP. Almost six months ago, we initiated this process to evaluate the options regarding our non-branded operators for our hotels, and the sole purpose of the RFP was to ensure we have the most highly qualified management companies operating our hotels in order to consistently deliver best in class results. We concluded the evaluation and selection process in April.

I am happy to say Interstate Hotels and Resorts will continue to manage 13 of our 15 non-brand managed hotels. In addition, we selected Davidson Hotel Company to manage our Embassy Suites Chicago and Sage Hospitality Resources to manage our Hilton Del Mar. We do expect to incur some customary transition costs associated with those changes. We're excited about our new relationship with Davidson and Sage, as well as our renewal of the existing relationship with Interstate. We believe Interstate is really positioning itself to be the preeminent global independent operator of hotels. Our two new managers will provide a fresh set of eyes to evaluate our property strengths and weaknesses, as well as access to new best practices and processes we can add to our existing policies and cross-pollinate across our portfolio. I truly believe that having relationships with the top management companies in the industry will result in the highest performing portfolio in both up and down markets. And so with that, I would like to turn the call over to Ken to provide an update on our finance initiatives. Ken, please go ahead.

Thanks a lot, Art, and thank you to everyone for joining us today. As we updated you on recent finance transactions during our April intraquarter updat,e my comments today will be fairly brief. We ended the quarter with approximately $374 million in cash and cash equivalents, including restricted cash, and pro forma for the repayment of the mortgage on the Times Square Hilton, 11 of our hotels will be unencumbered of debt. With just over $1 billion of well staggered, flexible debt and only $100 million of debt maturities through May of 2015 we feel our capital structure is appropriately balanced at this time. With that in mind and in light of the continued economic stabilization and improving fundamentals in the lodging industry, one of our key 2010 finance goals is to reduce our excess cash balance to a more appropriate level through disciplined investments.

As previously disclosed, subsequent to the end of the quarter we invested $83 million to release three assets from the $246 million cross-collateralized mortgage pool. These assets were the Courtyard Los Angeles Airport, the Kahler Inn & Suites in Rochester, Minnesota and the Marriott, also in Rochester, Minnesota. We're in the process of conveying the remaining eight assets in this loan pool to the lender in satisfaction of the remaining debt balance, and we expect to complete this process during the second quarter. We continue to work with the lenders representative on the prepayment of the $81 million Hilton Times Square mortgage, which matures at the end of this year, and we intend to complete this prepayment, which will eliminate nearly $5 million of annual interest expense during the second or third quarter of this year.

Also on the finance front, we recently purchased a package of two hotel loans with a combined principal value of $32.5 million plus approximately $800,000 of accrued interest for a total purchase price of $3.7 million or roughly $0.11 on the total dollar amount of the principle plus accrued interest. The first loan in the package is a $30 million, 8.5% mezzanine loan maturing in January of 2017, which is secured by the equity interests in the Double Tree Guest Suites Times Square. You may recall Sunstone holds a preferred equity investment in this partnership, which was marked down to zero in the fourth quarter. The Double Tree Times Square mezzanine loan ranked junior to $270 million of mortgage debt, which matures in 2012. You may recall also that Sunstone formerly owned this $30 million mezzanine loan. While a small investment dollar-wise, we believe that given our history with and knowledge of the Double Tree Times Square, as well as the strength of the recovery in New York City, this mezzanine investment makes solid economic and strategic sense for Sunstone. The second loan in the package was a $2.5 million, 8.075% subordinate note maturing in November of this year, which is secured by a 101 room boutique hotel known as 12 Atlantic Station in Atlanta, Georgia. As we have previously noted, while we do not expect alternative investments such as hotel debt will represent a significant percentage of our total acquisitions, we intend to continue to capitalize on creative opportunities to drive stockholder value as we uncover them.

Going forward, it is our goal to maintain an appropriately leveraged capital structure to help enhance total returns to our stockholders through strong growth in FFO per share and by expediting the future reintroduction of cash common dividends when appropriate. With that, I would like to thank you for your time today, and I will turn the call back over to Art to wrap up.

Thanks, Ken. We end these calls by telling you that we continue to run our business with a single focus we exist to outperform. You might ask, what exactly Sunstone is going to focus on to outperform? With a third of the year behind us, we remain focused on four things, growth, rate, expense creep and our people. And to speak to those, first about growth. It is not news that we're chasing acquisitions and that a lot of others are, too. I am optimistic that we will transact the right deals for the Company.

To answer the question we're always asked, are you getting close on any deals? Let me simply say we cannot get any closer than we have without closing on one. We have pointed to CapEx as an area to get returns that could be superior to some acquisitions, and it appears that now is the right time, both in terms of minimizing costs and minimizing displacement. Fundamentals suggest that we're at a point of the cycle that the Company should grow and will do so with well-timed and matched capital, be it common, preferred, or debt. And overequitizing, while arguably is not a word, it is something we don't aspire to.

Let's talk about rate. I am optimistic about the prospects of our managers to increase the rate. Well, I should be. Sunstone and many of our peers ran close to 70% occupancy last year, and with higher occupancy trends this year, rate compression ought to be happening right now. While 2010 rate is pretty well baked, particularly for group and corporate negotiating segments, the opportunity this year, probably mostly in mix and granted, corporate negotiated volume is up a lot for some hotels, as much as 20%. But at the same time, most often, that amount of the volume is at a flat or lower rate, getting more of that business and shutting other channels should lead to rate improvement. We'll continue to encourage our managers to be aggressive in that regard.

We all know that until the worst hotel in a comp set increases its rate, the best ones really have a ceiling, but none of that happens until someone leads with moving price, so we have told our operators we would love to see rate index go up, even if op index goes down more. In this cycle, with the increased realtime access to data like day and week star and TravelCLICK, and we expect the competition to watch and see the success of higher rates and to follow at some point. Operators need to stop living in the past. We're in a market where demand is increasing. Discounting helped no one, and we need to get back to appropriate pricing. I think everyone shares my impatience with this issue, and I look forward to less talk, particularly by me and more action. While we may see lower RevPAR in indices in the short run, getting the managers to move now on rate is keyed out performance. So focusing on 2011 we're again asking our managers to ensure that double digit rate growth is a real possibility if t they manage mix and rate correctly. Now knowing managers have much to gain by getting back to income levels that support their incentive fees, I would expect that they should have similar strong motivation to do so.

Preventing expense creep. Again, one of the more frequent questions we're asked, again, aside from, when are you going to close on a transaction, is how sure are you that expense creep can be held in check? And the answer is, we're increasingly sure. In the latest flow throughs of revenue over budget are a great indicator of that. While cost cuts are mostly behind us, reengineering of food and beverage to make it consistent with our guest expectations should be an opportunity to do so. At the same time, while most hotels have had revenues in excess of budgets, we are closely watching the flow of this added revenue. I can proudly say that for the first quarter for our portfolio, the flow through was approximately 75% for the revenue that came in above budget, and it is an impressive number avoiding expense creep. And that's on occupancy led revenue increases. It is really amazing results. The hotels that really performed at the highest level, we're going to seek to employ their best practices across our portfolio.

Focus on people. To outperform, everyone has to be held accountable towards an ever-rising standard of performance. Now is an exceptional time to invest in the best talent, particularly for our hotels and the organization. We expect the quality of our results to match that to the quality of the people delivering the results. So with those as our focus items for outperformance, combined with the right capital structure, it is worth rementioning free cash balance is well in excess of the next five years of debt maturities, our debt being fixed 5.5% averaging nearly seven years and life and having exposure to outperforming markets like New York, Boston, DC, Rochester, Minnesota, combined with increasing operating results, I am optimistic about the prospects of Sunstone and its stockholders. And with that, I'd like to open up the call to questions.So operator, please go ahead.

Thank you. (Operator Instructions) Your first question today comes from Chris Woronka of Deutsche Bank. Please go ahead.

Hey, good morning, guys.

Hey, Chris, good afternoon.

Thanks for the color on the strategy and everything, Art. Very helpful. Two things, I wonder if you can talk about the rate strategy, and do you feel as if you're differentiated there, and what is the operator reaction so far in terms of being able to push rate now as opposed to, I think we've -- some of the other weaker players might still be having some ground to make up on occupancy. What's your reaction been from the operators?

Sure. Mostly great. Again, because many management contracts have incentive fees, they have a financial incentive to be aggressive. And like I mentioned, because there is more clarity in how and any market competitors are pricing, I think hotels can simply watch. If the hotel next door is charging more and having success, at the active management level, Mark Hoffman is on the phone within a day or week saying, why aren't we doing the same or why aren't we leading in that regard? So I think the information flow helps there. So it has been mostly good. In terms of the first part of your question, do we differentiate ourselves? Listen, we're a REIT. We don't manage the hotels. So we're simply asking and directing. So it is difficult to say that we have the special sauce that's going to allow people -- we're being possibly more aggressive and we're telling our managers, take risks and as we mentioned, if we see falls in op index but increases in rate, that is the right thing to do. So nothing secret about that, probably more of a point of view in style than anything in particular.

Okay, great. And then on the loan purchases, I think the two you have done are pretty straightforward, but are you finding a lot less competition for these kind of things relative to stand alone hotel assets?

No. What we have really observed is that as there was increased competition for single assets, people were having a tough time getting deals done, but a lot of money was shifting into debt as well. Again, it depends on the size, the larger the loan, probably the less competition, but we see equal competition in that space.

Okay, thanks.

Thanks, Chris.

Your next question comes from Kevin Milota of JP Morgan. Please go ahead.

Good afternoon, guys. Was hoping you could give some -- maybe provide some trajectories in terms of your pro forma expenses going forward where you see some of the inflationary pressure and also just upward pressure as occupancy continues to claw its way back?

I can tell you thus far, we have been surprised. At the beginning of the year I would have seen that where our first quarter numbers would have ended up, I would have guessed that had our margins would have been far worse because when occupancy increase and rate declines, you certainly wouldn't have seen that. And to see -- to have a take 3% of our costs out when occupancy went up, that wasn't anticipated. So, difficult to project because we haven't given guidance how it is going to look going forward. But certainly, if we can continue to deliver that, I think the outside risks are taxes, utilities, and of course in the long run, healthcare. That probably reaches beyond 2010, and you look two or three years out when the healthcare bill expands, that is something we look at.

Okay. Thanks a a lot, guys.

Thank you.

Your next question comes from Patrick Scholes of FBR Capital Markets. Please go ahead.

Hi, good morning. I am wondering if you can give a little bit more color on the -- in your conversation -- or excuse me, in your prepared remarks you talked about the rates for next year for certain segments being up high single digits. A little bit of color, if you could provide on what types of customers at this point are booking those rates? Are we talking groups, corporate customers, and you also mentioned about mix shift. Can you give a little more color on who is being mixed out and who is being mixed in at those higher prices? Thank you.

Patrick, Marc Hoffman, good morning, good afternoon.

Thank you.

Good question. I will run through the segments. The good news is that on the group side where we have continued to have better production, we are booking next year's rates and out year rates at better rates than this year. I think Art talked about that being roughly at about 9% for our three big hotels, and we're seeing that consistently.

As it relates to the mix management piece, what we're seeing aggressively being mixed out is what you would want to see mixed out. Price Line is going away, Hot Wire is going away, lower end of the spectrum of discounts are going away. And as it relates to corporate negotiated, we're in the process. The managers are in that mix right now today, and certainly, the messages we have gotten back from them and that we've given to them is to be one very simple four letter word, and that's bold, and we think boldness is the right approach. I think what we'll end up seeing is that through 2009 and 2010, and '08, '09 and 2010 what we saw is that the hotels ended up giving value adds, they gave internets, those types of things. They will continue to give the value adds, but they'll then build rate above the value adds. And our hope is that we will see in the high digit increases in corporate negotiated. Particularly what will happen there is you will start to see the lower rated corporate negotiated companies who are providing lower numbers of rooms being swept out or even higher number of rooms, and you will mix to a higher corporate negotiated.

Great. Thank you for the color.

Your next question comes from Andrew Wittmann of Robert W. Baird. Please go ahead.

Hi, guys. Good morning.

Good afternoon.

I wanted to dig in a little bit on the two debt purchases here. In the past, Art, you mentioned you might do debt repurchases with a partner. Is there anybody that brought you this deal that helped advise at all in either of these deals?

No, it particular because of the Double Tree Times Square, we were the previous owner. This is probably the one marked exception where we had great knowledge about the asset and the instrument.

And same thing goes for Atlanta?

We were not the previous owner of it, but given that it was a $250,000 investment, the risk reward fell asymmetric.

Okay. Just a minute on Times Square, there an option here to take out your partner? I got to assume the ventures is -- obviously you wrote down the equity. Is there an option to take them out and get this thing totally onto your balance sheet before the maturity in 2017, I guess?

Hi, this is Ken. I will jump in and take that one. I wouldn't say there is an explicit option. What we invested in those, the first loss debt position in the capital stack, there is $270 million of senior debt in front of us and as I noted in my comments, we feel that this is a pretty good strategic investment for Sunstone. But it does not come with an explicit option to buyout or take out any of the partnership equity.

Got you. So -- but this transaction, being the mezzanine position doesn't get you consolidated today, this will still remain an unconsolidated venture going forward?

Correct, still remains unconsolidated.

Got you, okay. So then in Atlanta, just hoping for a little bit more color here, and maybe you mentioned this and I missed the note, but can you give us what your last dollar is on a per key basis? Or maybe a little bit of color on what the capital structure looked like when the original deal was transacted, whenever that was?

Sure. We can give you a little bit of additional detail on that one. And again, this was thrown in as part of a package with the Double Tree Times Square deal, which we thought had much greater strategic significance for the Company. The Atlanta deal has $17 million of senior debt in front of it, and our $2.5 million B note position is (inaudible) with a second size of the same B note, so there is $5 million of B financing, total capital stack of $22 million.

Okay. When was it last sold? Do you know when this was lined up?

It was in new build, and this was lined up in, I believe in '06.

Okay, and then I guess just one final outlook, and I think we asked this on the update call. Now that you're beating your internal forecast, to me that's some indication of visibility is improving, what's your outlook for providing guidance?

When we get numbers we can rely on, I will look forward to sharing them. Because as I mentioned, we're still getting -- it's the opposite of last year. Last year we were getting numbers that 30 days later proved to be in the wrong, in the wrong direction. Now we're getting numbers 30 days later that prove to be wrong in the right direction. And just to give you some comment on that, when you look at -- we're mostly a transient hotel company, 70% of our business. And I had heard of a stat that it's more countrywide, but the group of hotels said their transient pace was 4% above last year a week out, just a week out, but after the actual was realized, they were up 11%. So hotels are realizing more business even a week out, a lot more. So while it is great that we're having misses to the ups, we're still not getting number that is we can rely on and pass along to you and ask to you rely on them. The good news is when we're wrong in this direction and market team does a great job of managing costs, we just need to find a way to deposit the cash quicker, so it is a good business challenge to have.

Okay, good. Thank you.

Andrew, thanks a lot.

Gentlemen, there are no further questions at this time. Please continue.

We appreciate everybody's time today, particularly on a Monday morning or afternoon and as well as your continued interest in Sunstone. We look forward to speaking with you on our second quarter intraquarter update later this summer. Thank you.

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation, and you may now disconnect your lines.