Sunstone Hotel Investors, Inc.
Q4 2008 Earnings Call Transcript

Published: 13 Feb 2009

[Operator:]

Good afternoon, ladies and gentlemen and welcome to Sunstone Hotel Investors Fourth Quarter and Full Year 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 is being recorded, today, Friday, February 13, 2009. I would like to turn the conference over to Mr. Bryan Giglia, Vice President of Corporate Finance of Sunstone Hotel Investors, please go ahead sir.

[Bryan Giglia:]

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. If you do not yet have a copy, you can access it on the Investor Relations tab of our website at www.sunstonehotels.com. Before we begin this conference, I’d 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 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 in reconciliations to net income are contained in the earnings release that we filed yesterday. With us today are Art Buser, Chief Executive Officer and Ken Cruse, Chief Financial Officer. Following their remarks, the team will be available to answer questions. To begin management’s discussions, I would like to turn the call over to Art. Art please go ahead.

[Art Buser:]

Thanks Bryan. I want to start off by thanking the 60 sum people who have called into this conference call, there should be well over 100 that have dialed in on the Internet are listening in today. This is my first call at Sunstone CEO, so let me say a few words, before we dive into the results. I met many of you at our [May, REIT] and what I said there is worth to be stating now. I look forward to [forging] and maintaining an authentic relationship with our investment community. One of the most important characteristics in my mind to have an authentic relationship in this context is frequent, transparent communication. I hope you felt that, these are challenging times, no surprise anybody here, but I’m optimistic that we have the portfolio, the balance sheet, what I would call “super bowl quality team” deliver returns to our stockholders. Our intentions and expectations are that Sunstone will be viewed as a company that exists to outperform. So with that, let’s start the call. During today’s call, we are going to cover five topics. First; let’s talk a little bit about the current economic environment, what we are doing to maximize cash flow. Secondly, our fourth quarter and full year operating results. Third, by preliminary estimate of January’s RevPAR results. Then Ken is going discuss our fourth and fifth topics, to be positioned dividend policies. So, we start with a review of our current operating environment and what we are doing about it. We all know the lodging industry continues to be directly impacted by the global economic crisis that lodging fundamentals continue to decline. We expect 2009 to be one of the most challenging years in recent memory in the industry. Throughout 2008, we worked closely with our managers to right-size the cost model of each hotel, as well as here in our corporate overhead. At the same time, and as a defensive measure, we continue to maintain higher than traditional cash reserves. Now, I can’t tell you today the breadth and the depth of what we are facing nor can I tell you what the market is going to look like on the other side, but what I can tell you is this. First, until there is more visibility, we’re going to continue to release operations update to provide the investment community with current top line performance as well as other information. We hope you find these updates useful as a means to better understand how Sunstone is performing relative to the market. Second, when we work closely with our operators to right size the cost model anticipation of what we saw as meaningful decline in RevPAR 2009. No cost was off limits, carefully reviewed every line and challenged a number of expenses that were previously there to be fixed or untouchable. This review resulted in over $13 million of cost expense reductions approximately $4.5 million because of management and hourly staffing reductions. Third, we carefully reviewed costs at our corporate office and have made several staff reductions and other cost reductions. Cash conservation is one of our goals and is something we preach to our properties and we practice at headquarters. Fourth, our balance sheet is strong with significant liquidity, [inaudible]. We have no near-term debt maturities and we’re holding more than $220 million of cash. We believe our management team is positioned to company the current downturn. We continue to focus on maintaining liquidity and that’s not enough, just not enough to work to write-up the current recession, our intention is to be in a position to capitalize on future opportunities. So, now let me turn to fourth quarter and full-year 2008 results. The fourth quarter adjusted FFO per share was $0.76, adjusted EBITDA was $70 million. These figures include approximately $1.1 million of severance expense related to staff restructurings at the hotel and corporate level. For the full-year adjusted FFO per share was $2.79, 2.4% below 2007. Adjusted EBITDA was $285.1 million representing an 8.1% decline in 2007. I believe we are going to look back at 2007 as a banner year for sometime. For our 2008 total hotel portfolio, fourth quarter RevPAR decreased by 11.4% and that was driven by 4% decrease in ADR and 570 basis points decline in occupancy. Although, fourth quarter performance was close to the U.S. per upscale average of 11.1% decline, it is disappointing and not outperformed that metric. Full-year RevPAR increased by 2.2%, driven by a 250 basis point decline in occupancy that was offset by a 1.1% increase in ADR. During the past calls, let me briefly note that comparable portfolio RevPAR, which excludes Renaissance in Baltimore, Orlando in terms of our new two non-comparable hotels. With this portfolio, fourth quarter RevPAR decreased 10.6% quietly better than the U.S. per upscale performance. Full-year decrease by 2.3% driven by a 270 basis point decline in occupancy and offset by 1.2% increase in ADR. Beginning the first quarter of 2009, all 43 of our hotels are expected to be included in our portfolio. So, that being the overall comment; let me now talk about the fourth quarter RevPAR by regions compared to last year-end. California, properties were down 12.3%. L.A Orange County area hotels down 11.7%. San Diego, hotels were down 13.1%. San Diego continues to be a challenging market with the new convention hotel line open. We expect this challenging environment to continue. In the Midwest region, our Mayo Clinic portfolio in Rochester continued to outperform Q4 RevPAR for our four hotels there was up 9% given in part by increased demand for our higher-end hotel within a hotel known as the International (Inaudible). The Midwest region itself was down 1.8% for last year and compared by weakness in Chicago and Minneapolis. Moving to the Atlantic region, it was down 13.8% and there primarily the result of weakness in New York and Boston. Southern regions RevPAR declined at 10.6%, reflects the weakness in Atlanta and surrounding markets. Total hotel operating margins for the quarter decreased by 290 basis points, an impressive performance and validation of our cost containment initiatives were successful in mitigating the cost erosion. Q4 margins were negatively impacted by approximately 40 basis points by the impact of severance charges related to staffing reductions restructurings in our property in our corporate office. Including the one-time severance expense, we’re able to the hold margin decline to 250 basis points and 11.4% RevPAR loss, again best results, very pleased about that. Our properties did an outstanding job anticipating top line decline and proactively reduced cost appropriately. Staff reduction restructurings that have been implemented in December, we expect to drive continued cost savings throughout 2009. We believe we have the lowest management fee structure among our lodging REIT peers, our management fee expenses including incentive management fees were $7.8 million for the quarter or approximately 3% of gross revenues, which again compares very favorably to our lodging REIT peers. So, let me move to item three, January operations update and again this is going to be brief and in lieu of separate operations update that we would do for January, we’re just going to give a preliminary update on performance now. RevPAR was down 10.6% driven by a 0.8 decline in average rate and 670 basis point decline in occupancy. On the D.C. area, properties turned in exceptional results in January, as a result of the Inauguration Associated Business. Our D.C. Renaissance more than double this January RevPAR as compared to January a year-ago. We tend to issue an operations update in March, similarly to work done in the past, which will contain final top line results for January and February. Now, before I hand off to Ken, let me end or start it by saying, we believe we are well positioned to weather this unprecedented and uncertain economic environment. We will continue to focus our efforts on cutting costs and ensuring that our properties have the necessary resources to creatively source new business and drive top line revenues. We have a recently renovated high quality portfolio located in many of the top gateway U.S. markets; markets we expect will continue to outperform U.S. upper upscale markets in the long-term. As I mentioned, we believe we have significant liquidity to weather the current economic turmoil. Due to sports metaphor, we said a few times, but again it’s worth restating, we are playing defense, we are waiting to play offense. We’re focusing our efforts on maximizing our portfolio cash flow and at the same time, we are preparing ourselves to be well positioned to take advantage of opportunities, if they might arise. So with that, I’d like to turn the call over to Ken, to take you through capital structure. Ken.

[Ken Cruse:]

Thank you very much, Art. Good morning or good afternoon everyone as the case maybe and thank you for joining us today. I’ll spend a moment going over our capital structure and liquidity as well as our dividend policy, before we open up the call to questions. First and foremost and to echo some of Art’s comments, we believe that the liquidity provided by our excess cash and our absence of near-term debt maturities, as well as our portfolios limited capital needs are critical advantages in today’s uncertain environment. We finished 2008 with approximately $220 million of cash on-hand, including restricted cash. This is a $109 million increase as compared to the year-ended 2007. As Art outlined, we’re focused on a variety of measures and retaining and if possible increasing our cash reserves during 2009. As of the end of 2008, our leverage ratio calculated as the ratio of our debt less cash to total assets was approximately 53% and we ended the quarter with fixed charge coverage ratio as defined in our unsecured credit facility of approximately 1.8 times. 100% of our $1.7 billion of debt is subject to fixed interest at an average rate of just 5.5%. The average term to maturity of our debt is more than six years and this is assuming that our 4.6% exchangeable senior notes will be redeemed in January of 2013 rather than at maturity in 2027. Our closest debt maturity is nearly two years away in December of 2010, which is the $81 million mortgage on our Hilton Times Square. Even in today’s challenging financing market, we believe we would be able to refinance this hotel at or above its current debt level. Beyond that, we have a well staggered maturity schedule, extending through 2021. I’ll spend a minute now on credit facility covenants. As we’ve mentioned in the past, the bulk of our debt is in the form of single asset mortgages, which do not contain corporate financial covenants. Our $200 million credit facility, which is un-drawn, is subject to certain financial covenants, including a minimum corporate fixed charge coverage ratio of 1.5 times. As noted, we finished the fourth quarter above this threshold with a fixed charge coverage ratio of better than 1.8 times. However, if we were to continue to see significant declines in our corporate EBITDA, we believe we may not achieve this covenant threshold at some point during the year, which absent on amendment would mean we would lose access to the credit facility. In the event of any such covenant failure, in addition to other alternatives, we may seek to renegotiate the terms of our credit facility, restructure the facility into a secured line or we may simply elect to terminate the credit facility as our business plan does not contemplate its use for the foreseeable future. We own ten unencumbered hotels that we believe we could borrow against to set the need for additional cash arise at a time when the credit facility maybe unavailable. Looking onto dividends, yesterday we declared regular dividends on our Series A preferred stock and our Series C convertible preferred stock. We did not declare dividend on our common stock. While we believe we have sufficient cash reserves, the decision not to pay our first quarter common dividend was made after considering the highly uncertain economic environment and after balancing our liquidity and capital preservation goals, with our goal of distributing 100% of our taxable income to our investors. We believe this decision is what’s best for the company and what’s in the long term interest of our stockholders. I’d like to point out that the level of any future quarterly dividends will be determined by our Board of Directors after considering long term operating projections, expect in capital requirements, rejected taxable income and risks affecting our business. Finally, we recognize that in these challenging times, the conservative approach to capital allocation, appropriate levels of risk tolerance, strong communication and sound judgment are paramount. As Art indicated, our collective focus is on preserving capital and developing a foundation for strong performance through efficiency measures, de-leveraging initiatives and disciplined capital investments. We truly appreciate your continued support to Sunstone and we look forward to continuing to develop your loyalty and trusts in 2009 and beyond. With that, I’ll turn the call back to Art to wrap up.

[Arthur Buser:]

Thanks Ken. Again I appreciate everybody’s time today and your continued support in Sunstone and I’ve mentioned that I’m very proud of what this team has accomplished, in particularly what we’ve done in terms of margin and I look forward to speaking everybody who’s on the call today in the coming months. Before we open up to question, we did not talk lots about the super bowl quality team, so I think its important to have more than the quarter back and why we are seeing them show up on the call. So today Marc Hoffman, who’s our Head of Asset Management, is here with us today as well. Operator, please go ahead with questions.

[Operator:]

(Operator Instructions) Your first question comes from Chris Woronka - Deutsche Bank.

[Chris Woronka:]

A couple of quick ones; first could you let us maybe what the impact of Washington, D.C. was on your overall January numbers?

[Arthur Buser:]

Sure, in terms of RevPAR?

[Chris Woronka:]

Yes.

[Arthur Buser:]

Yes, the impact of the inauguration on January RevPAR was about 700 basis points. So, if we said January was down 11, about D.C. would be down to 17.5, almost 18.

[Chris Woronka:]

Then just as you kind of look out, are you seeing anything unusual in terms of the group cancels or booking windows, just trying to get a sense as to things changing pretty rapidly in kind of what you’re seeing and if that has anything to do with the decision not to give much guidance for ’09?

[Arthur Buser:]

Nothing unusual for the current environment compared to three years ago. I guess I’d see it as unusual and so let me get to the heart of your question, which is Chris, maybe why aren’t we providing guidance, is that really the heart of it?

[Chris Woronka:]

Yes, I think I can see the positive and the negative, if not just curious as to whether, there was a further decrease in visibility. I guess the last time you guys officially gave guidance was really back in the fourth quarter guidance in December.

[Arthur Buser:]

Yes, well let me tell you what I do know, because again we don’t like to speculate. Last call we talked about room pays being down about 7.5%. What was interesting was occupied rooms were down 9.5%, but rate was up 2%. Right now, it’s continue to soften, the paces are 14% and there again, occupied rooms are down 15%, but rates up 1%. If you look back at our previous call if you see the trend of deteriorating pace and again what’s interesting to note has been mostly non-occupied rooms.

[Chris Woronka:]

That’s helpful. The final one is just on, Ken can you give us a share count, kind of where you’re going to be for the first quarter because you’ll have that stock dividend in there, right?

[Ken Cruse:]

Yes, sure. After the stock dividend, total share of the principle will include the affect of the conversion of the series D that’s up $58.2 million shares.

[Operator:]

Your next question comes from David Loeb - Robert W. Baird.

[David Loeb:]

Can you give us a little bit of an idea about what do you expect for capital spending? I may have missed that, but I don’t believe you said anything about what do you think the CapEx outlook is?

[Ken Cruse:]

David, important question for you and for me and it’s somewhat related to guidance. We said our capital spending had a lot to do with what our view of the year is and right now because I don’t have a view on the year, we’re hesitant to kind of say what our number is. What I can tell you is, it’s going to be less than what 2008 was. As you know and looking at our past statements, our incomes are $40 million, so clearly it’s got to be over or under or somewhere in between there. I know that’s a bit of a wide gap, but we haven’t set the number until we get more clarity. Until that time but the next question is what you’re doing? To the extent there are finalized safety code issues, kind of things that must to be done, we’re clearly continuing to spend money and we won’t forget we’re in the hotel business. Hotel guests expect that things are in descent condition. So, we’re doing what we have to do, but aside from that we’re really taking a wait-and-see on CapEx. Sorry, I can’t give you number, because I don’t have number yet.

[David Loeb:]

When you’ve got a nice comfortable restricted cash reserve, will most of what you’re spending at least in the near term come out of that reserve is opposed from you freely available cash?

[Arthur Buser:]

I don’t know for sure, but in thinking about it, the majority ought to come from that.

[David Loeb:]

Okay and a couple for Ken, taxable income is almost impossible for us to estimate, clearly you’re not giving us any guidance. I guess the question is, do you see a scenario where your taxable income will be greater than what you would pay, assuming you paid for convertible preferred and straight preferred dividends.

[Arthur Buser:]

Again, the answer to that is, yes. We could see a scenario where we would have distributable taxable income. Taxable income, if you look back to ’08, I think we’re going to keep with the theme of looking back instead of speculating on ’09. If you look back to ’08, we had about $84 million of operational taxable income and then we had another $29 million or some of gain that were distributable. Depending on what we do this year in terms of capital markets and assets sale transactions, you could see a distributable gain arising from that. Operationally, we are not going to comment on what we expect to come out for taxable income, but I think if you use 2008 as a baseline, you can view that $84 million as your flex point.

[David Loeb:]

Okay and one final technical question. We noticed in the 10-K, that there was not a table that actually listed the individual mortgages in which assets they were tied to. Is there some reason why that was out or is that something you could provide to us?

[Ken Cruse:]

We got the schedule at the very end of our release?

[David Loeb:]

Yes, it’s just doesn’t identify which hotel go with which mortgages?

[Ken Cruse:]

We haven’t provided that level of detail on the past, but that’s certainly something David that we can consider providing.

[Operator:]

Your next question comes from Dennis Forst - Keybanc Capital Markets.

[Dennis Forst:]

I wanted to ask question about the corporate overhead. Art you said that there have been cuts there? I don’t think there is going to be much in the way of severance this year. Can you give us a general idea of what corporate overhead is going to like this year?

[Arthur Buser:]

In terms of just the dollar amount or in terms of the base?

[Dennis Forst:]

Yes, dollar amount. It looks like it’s been last three quarters running around $4 million a quarter and I would suspect that it could even be a little less than that this year?

[Arthur Buser:]

So, we should be down in terms of cash, down 3.5%. So, total should be $17 million.

[Dennis Forst:]

Okay, $17 million or so, full-year?

[Arthur Buser:]

And I’ll add the technical ish after that.

[Dennis Forst:]

Okay, and then I wanted to understand the total portfolio occupancy in ADR for ’08, what we’re comparing against. We now have 43 hotels, what is it around 14,500 rooms. Can you walk us through the prior year occupancy and the ADR’s by quarter?

[Arthur Buser:]

By occupancy and ADRs by quarter for either the comparable or non-comparable?

[Dennis Forst:]

No, just the total 43 properties.

[Arthur Buser:]

Okay, what if I give you RevPar?

[Dennis Forst:]

Okay, I can look with that.

[Arthur Buser:]

For 2007 or you want to go 2008?

[Dennis Forst:]

Just 2008, I can compare it with our model of ’09.

[Arthur Buser:]

Yes, it was 114 and up, still less than 3% year-over-year. Q2 we’re 130, like 132, that was a little under 4% up year-over-year. Then Q3 was 126, if you start to see the slide we’re almost down 2% year-over-year and then Q4 was 107%; again that was 11.4%

[Dennis Forst:]

Yes, and then the full year number are in K, I’ll spell it out. Okay, and last question for Ken; there is a covenant that you have on the Series C preferred that might prevent you from paying it, can walk us through with that covenant is?

[Ken Cruse:]

Sure, I’ll give you a moment on the Series C. We didn’t spend time on the call today because we view that as a less restrictive and les eminent covenant concern as compared to our credit facility. Series C has a couple of financial covenants as a leverage ratio and that’s calculated debt-to-EBITDA, a maximum of the eight times. It also has a fixed charge coverage ratio at 1.15. The way it’s awarded in the Series C s, it’s much restricted than the credit facility. We would need to breach a covenant and fail a covenant for four consecutive quarters, before we have what’s called a financial ratio violation. If a financial ratio violation were to occur, we would end up having a couple of different restrictions. We’ll pay a little bit more in interest on the Series C, so basis point increase in the interest rate. The Series C holder will have the right to elect one board member of the company and we would also have certain other restrictions such as a restriction on paying dividends on the common stock and it helped us as we cleared the financial ratio violation.

[Operator:]

(Operator Instruction) Your next question comes from Michael Salinsky - RBC Capital Markets. Michael Salinsky - RBC Capital Markets I know you guys are not giving guidance and you guys have done a very good job on the expense front over the past four quarters here. Just given the expenses reductions we seen, thus far in 2008, how much is really left to eliminate in 2009 and just looking at that I know I guess that you guys are providing guidance, but can you kind of give us a sense of what kind of flow through. If RevPAR is down, 10%, what kind of impact do you expect to see on the margin front, just given what you guys have rolled out thus far this year?

[Arthur Buser:]

That was Michael a direct question. If we saw a 10% further RevPAR decline, what might we see in the EDITDA? Michael Salinsky - RBC Capital Markets No, what might you see on the margin front? I mean what’s the flow through essentially on the margin front?

[Arthur Buser:]

Again, tough to calculate; it’s somewhat store-by-store. I think in the past we talked about that for every 1% decline in RevPAR that the result declined in EBITDA. It could be kind of two to three time, that doesn’t tell you what the margin is, but at least tells you what the gross EBITDA is. So that indicates to you that what we expected, there’s been a decline in RevPAR, and we all know there is diminishing returns on the first dollar loss in revenue and these are kind of expenses that as it continues to go it’s more, more difficult. I think as you’ve heard on the call, Marc and his team did a great job of continuing to find expenses and make cut. So, I would expect that kind of that, and a two to three times reduction in EBITDA would likely still hold, again depending on is it 100% ADR or kind of which will tell the default. So, I know I didn’t answer your question directly in terms of how much it would change EBTIDA margin, but if we see that’s where the EBITDA would change and I think, staffing reduction should be over about $4.5 million in cost savings for 2009 based on what we’ve done thus far. Mark, you do have anything to add to that.

[Ken Cruse:]

Thank you, Art. Mike, when we build the cost models for 2009, we were very cognizant and we were very proactive working with our partners; we’ve taken approximately $13 million in peer cost model changes for operating these hotel. It’s not a cost reduction from the normal, if the hotel goes from 80% to 70%, that’s normal cost. It’s really remodeling the way the hotel has run and so we took out of pure $13 million additional cost, which should helps us to meet weather the storm of what the RevPAR’s are as they decline.

[Mike Salinsky:]

Okay. Responding on the expense line, what are you guys looking for, for utilities, insurance and real estate taxes in 2009?

[Ken Cruse:]

We haven’t given that level of detail again. Part of the reason why we’re not giving you clear guidance on the top-line is we’ve redone the budget a couple of times and clearly as occupancy changes, some of those expenses that do vary along with occupancy are going to change as well. So unfortunate I can’t give you a lot of guidance on that.

[Mike Salinsky:]

Okay. Secondly, your fourth quarter results and the guidance you provided originally, does that include the guarantee in there?

[Ken Cruse:]

Yes, it does.

[Mike Salinsky:]

Did that come in more or less expected, or was it inline?

[Ken Cruse:]

Outline.

[Mike Salinsky:]

Finally, several of your peers and some of the other sectors have been authored by buying their converts back as it related to de-lever. Is that been something contemplated and will that provide you with enough liquidity to maintain the covenants on your line, if you were to do so?

[Ken Cruse:]

We’re not a buyer of those right now. Again our stated goal has really been to maintain and build our cash reserves; never say never but it’s something that we’re not a buyer of now.

[Operator:]

Thank you and I show no additional questions at this time. Please continue.

[Arthur Buser:]

Again thanks again for all of you listening in. I look forward to our next call; it’s going to be scheduled for sometime in March. Thanks again, good bye from Sunstone.

[Operator:]

Ladies and gentlemen, this concludes the Sunstone Hotel Investors fourth quarter 2008 conference call. You may now disconnect. Thank you for using AT&T conferencing. Copyright policy