Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Sunstone Hotel Investors Second Quarter 2019 Earnings Call. [Operator Instructions]. I would like to remind everyone that this conference is being recorded today, August 2, 2019, at 12:00 p.m. Eastern Time. I will now turn the presentation over to Aaron Reyes, Vice President of Corporate Finance. Please go ahead.

Thank you, Paula, and good morning, everyone. By now, you should have all received a copy of our second quarter earnings release and supplemental, which were made available yesterday. If you do not yet have a copy, you can access them on our website. Before we begin, 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 these factors in evaluating our forward-looking statements. We also note that this call may contain non-GAAP financial information, including adjusted EBITDA, adjusted FFO and hotel-adjusted EBITDA margins. We are providing that information as a supplement to information prepared in accordance with generally accepted accounting principles. With us on the call today are John Arabia, President and Chief Executive Officer; Bryan Giglia, Chief Financial Officer; Robert Springer, Chief Investment Officer; and Marc Hoffman, Chief Operating Officer. After our remarks, we will be available to answer your questions. With that, I would like to turn the call over to John. Please go ahead.

Thank you, Aaron. And good morning, everyone, and thank you for joining us this morning. I'll start the call with a review of our second quarter operating results as well as an update on the current operating environment. I will then provide an update on some of the value-creation projects that continue to provide meaningful revenue and earnings growth for our portfolio, as well as an overview of recently completed projects that are expected to add to our results in the near term. Next, I'll discuss our thoughts on the transaction market and our approach to capital allocation, including our recent share repurchase activity. Afterwards, Bryan will recap our balance sheet strength and provide the specifics on our updated guidance related to third quarter and full year 2019 earnings. To begin, we were pleased with our operating results and earnings for the second quarter, as we were able to offset operating challenges in a few markets with the benefits stemming from our attractive market concentrations, our successful renovation activities completed in previous years and various asset management initiatives that continue to produce outsized revenue growth and operating efficiencies. Second quarter comparable portfolio RevPAR increased a better-than-expected 2.1% over the prior year and comparable portfolio of total revenue increased a strong 3.4%. Our top line growth was driven by a nearly 3.5% increase in transient room nights, which more than offset what we expected to be a soft quarter for group business. Furthermore, our total revenue growth was aided by respectable room rate growth in both group and transient segments, a 5% growth in food and beverage revenues and a 12% increase in other ancillary property-level revenues. Solid total revenue growth resulted in property-level EBITDA increase of 2.6 in the second quarter despite continued cost pressures in wages and benefits, real…

Thank you, John, and good morning, everyone. We ended the second quarter with significant financial liquidity, including more than $740 million of total unrestricted cash and an undrawn $500 million revolving credit facility. We have approximately $1.2 billion of consolidated debt and preferred securities outstanding, and our current in-place debt has a weighted average term to maturity of approximately 4.6 years, and a weighted average interest rate of 4.2%. Our variable rate debt as a percentage of total debt stands at 23%, and 43% of our debt is unsecured. We have 16 unencumbered hotels that collectively generated approximately $235 million of EBITDA over the trailing 12-month period, and nearly 69% of our EBITDA is unencumbered. Now turning to third quarter and full year 2019 guidance. A full reconciliation can be found in our supplemental and in our earnings release. 2019 guidance does not assume any additional share repurchases, nor does it include the impact of any asset sales or acquisitions. Third quarter and full year guidance do include a moderation in transient demand, as well as approximately $800,000 of incremental property insurance expense related to our June 2019 renewal. For the third quarter, we expect total portfolio RevPAR growth to range from down 0.5% to up 1.5%. We expect third quarter adjusted EBITDA to be between $79 million and $82 million, and adjusted FFO per diluted share to be between $0.27 and $0.29. For the full year, we carried forward a portion of our second quarter beat, while maintaining some caution for the remainder of the year. We tightened the range of our total portfolio of RevPAR growth and now expect it to range from up 0.75% to up 2.75%. We also increased the midpoint of our full year 2019 adjusted EBITDA guidance by $2 million to range from $312 million to $324 million, and increased our full year adjusted FFO per diluted share by $0.02 to range from $1.07 to $1.13. Finally, this guidance does not reflect the incremental future earnings potential that would result from the deployment of our meaningful cash balance. Now turning to our dividends. Our Board of Directors have declared a $0.05 per common share dividend for the third quarter. Consistent with our practice in prior years, we expect to continue to pay a regular quarterly cash dividend of $0.05 per share of common stock throughout 2019. And to the extent that the regular quarterly common dividend does not satisfy our annual distribution requirements, we would expect to pay a catch-up dividend in early 2020 that would generally be equal to the remaining taxable income. In addition to the common dividend, our Board has also approved the routine quarterly distributions for both outstanding series of our preferred securities. With that, I'd like to now open the call to questions. Paula, please go ahead.

[Operator Instructions]. And first, we'll go to Anthony Powell with Barclays.

A lot of good detail on the out-of-room spend. Could you maybe give us some detail on typically, when is that out-of-room spend contracted with the meeting planners? How has that changed, I guess, over the past few months as corporate confidence has waned a bit? And what are you projecting for that part of the business going forward?

So far, Anthony, we haven't seen any changes in that business. As you know, we've seen material strength in that portion of the business as meeting planners and groups have actually bought up, as the timing of the group gets closer to the day of arrival. So we have not seen any change in that so far. And it's really driven our profitability pretty well.

And on the share repurchase, you mentioned that you've essentially match funded this year's purchase with last year's equity offerings. How can we -- what should we be looking forward at the signals that you're going to be likely buying back stock? Is it a certain EBITDA multiple or cap rate? Or how should we be forecasting that?

Anthony, as a company practice, we don't comment on future investments, including the parameters of future share repurchase. So quite honestly, I wouldn't expect any specific signal from us about when or how the share repurchases will come in. But I would like to highlight that given our significant cash position or significant liquidity or incredibly low leverage level, that we have significant capacity to invest in our own portfolio no matter what happens with the economy. I know that there's been some concern about our balance sheet of late and just how much liquidity we have. Quite honestly, it feels very good right now. And I think it's actually a significant advantage we have going forward.

Moving on, we'll go to Michael Bellisario with Baird.

Just aside from the stock price being down a bit over the last few months, anything else changed in your buyback calculation that got you more comfortable to pull the trigger now?

As I said in our prepared remarks, I thought it was just a worthwhile endeavor to reverse the ATM issue, and so we did at $17.42. We clearly don't need all of the cash. And I thought it was prudent to return some portion of our cash to our investors. We ended up buying back at $4-plus lower than where we issued, and that was about it.

And then just on your transient bookings. I know you said that pace was down a little bit, at least bookings were down for future periods. Any particular markets or segments or price points that you're seeing more or less weakness in?

Yes. As I think some of our peers have mentioned, in July, we just saw relatively broad-base decline in forward bookings for all future periods. It was fairly broad-based, Mike. And as a result of that, we ended up moderating our guidance for the second half of the year, in addition to the property insurance renewal that Bryan had touched on. This is similar. We saw a little bit of this -- there's been sporadic bookings this year, which is -- by the way, it's fairly normal. We saw something similar in April. We saw something similar in kind of parts of November and December of last year. And then both times, in the months following, we actually saw an uptick. So we have layered in a bit of conservatism, which I think is warranted given what we saw in July. But I would also say, one month doesn't necessarily make a trend. So we're going to be very focused on this going forward and see where it goes.

Our next question will come from Chris Woronka with Deutsche Bank.

I want to ask you, John, you talked about kind of a reason -- one of the reasons you don't acquire right now is just kind of a gap and pricing expectations. Do you think that's more a function of how you guys are underwriting the out-years? Or just purely a function of seller expectations on the cap rate?

It's a great question, Chris. As we've always done, we underwrite with downturns in our pro forma, which, I think, if you believe, we are later cycle and none of us know. But if you believe we're later cycle, I think makes us a bit less competitive. Never say never because we could find our right spot. But I think that makes us a bit less competitive in the bidding term. Our private equity, I believe, will generally lever up more than many of us. And so I think they have a competitive advantage right now with the cost of debt. Also, I think there are certain sellers that see what the deck quotes are. And refinancing, as we've been talking about for probably, Robert, maybe four to six quarters, we've -- part of what we're competing with is a refi. Would you agree with that?

Yes, absolutely. Refinancing has definitely become a viable competitive to a straight on sale for several deals that we looked at.

Chris, we'll see if some of the pricing expectations by sellers are actually met. So far, we've seen a couple of transactions that I don't know if there's another buyer on that side or what the buyer -- how long -- how far the buyer is willing to go in price. So we'll see. There's a little bit of price discovery, I think, needs to be done out there.

Okay. Very helpful. And then, second question was just kind of, you guys have I think done a fantastic job on some of the bigger repositionings, Boston Wailea with -- and you've gotten a lot of market share gains. I guess, in your experience, how long does that kind of tail last on market share? I know it's hard to know and the market's changed a little bit and supply can come in. But is there any kind of rule where -- general rule where after certain time, you just get a step-down function in the market share?

Eventually. But it really depends on the hotel, the type of hotel and the type of customer. I'll turn it over to Marc in a second. But effectively, if you're looking at a purely transient hotel that people get -- people understand what the renovation is, I think you see that impact more quickly. But at some place like Wailea, where you're going after incentive groups and it takes a couple of years to get in that cycle, so to speak, the burning is going to take a while, and the benefits of that, therefore, will take a while. When you take a look at our second quarter RevPAR growth in Wailea, not only as our market growth but we continue to gain index. And that's one where, as we continue to invest in the property we work with our great operating partners at Marriott to continue to maintain and increase service levels, which they're doing a great job at. We think that the best days of that asset are actually in front of us, not behind us. So it really depends. Marc, anything?

Yes. I think John, that's accurate -- completely accurate. And along with just to piggyback on one thing, it really depends upon the owner's commitment, which ours is huge to elongating what we did. So we are constantly focused -- maniacally focused on keeping the positioning of Wailea, Boston, San Francisco and anything else we renovate, at the level we renovate it moving forward because we believe the customer demand is based upon that. And so we think we get long trails on these.

And next we'll go to Smedes Rose with Citi.

I just wanted to ask you on Wailea. Is it still a story about kind of closing the gap to some of the nearby properties that you had talked about some time ago? Or is it more now about mix change and getting the -- you talked about significantly improving the group there, is that something where there's more upside? Or how do you just think about the growth, I guess, going forward at Wailea, which has been so strong?

Yes. No. As we were just mentioning, we still believe that there is a little bit of room to close a gap and index there. Our group numbers, as went over in the prepared remarks, were -- have been incredibly strong. We look good going forward in that regard. So let's say it's a mixture of both. Now keep in mind, that is a very, very strong comp set, including the four seasons, Wailea, which is arguably one of the best resorts in Hawaii and probably has a rate well over $1,000 a night. I don't think anybody should have any expectations that we will ever reach those levels. But remember, financial success for us wasn't reaching those levels. Financial success for us was closing the gap a bit. And by the way, we've already done that significantly and actually materially outperformed our underwriting expectations.

And then I just want to ask you, is there anything on the cost side that you are seeing that's different? I mean you mentioned insurance costs are higher, but anything on just real -- I guess primarily labor? Then also maybe real state taxes and some of the other costs in the system as you look at over the next several quarters, any changes there?

No real changes there. The only real change is the insurance -- property insurance, which Bryan highlighted, which added probably another $800,000 to back half of the year, which ended up taking down our guidance a little bit as well. That was a really big wildcard considering all the catastrophic claims that have occurred over the past couple of years, and quite honestly our insurance partners losing a lot of money. I can see why they have pushed pricing on capacity the way that they have. But in terms of labor, labor and benefits, which were obviously increasing fairly meaningfully, we had set 4% -- roughly 4% in the quarter. Those are all coming in as anticipated. We've been talking about increased wage and benefits now for probably a better portion of the 1.5 years to 2 years. And so no expectations there, but they are increasing higher than inflation, so to speak.

Your next question will come from Rich Hightower with Evercore ISI.

John, I'm going to ask the buyback question in the -- one of a dozen ways it could be asked. But I think -- you were an analyst once. I think a lot of us on this call like that about you and appreciate that about you, you think like an analyst. So it's a very good thing. So I want to ask, in the context of the, I guess, the 13 and change average basis in the buyback, what is the appropriate comparison? Because you referenced where the company issued ATM equity last year. There's also a comparison against private market NAVs which from time-to-time are disconnected from Street NAVs. And if you look at Street NAVs many of those seem to be going down lately maybe not for Sunstone but certainly for some of your peers at least. And so how do we stack that up in the context of the sort of many comparisons that may or may not be appropriate?

Well, hopefully, the Street NAVs and private market NAVs are the same. But when you take a look at some of the assets we've been chasing, as I mentioned, may be as low as a 3.5% cap rate pricing expectation to most of [indiscernible] property tax resets and the like. You're probably talking high 4s to just over 5%. I think a couple of assets have been acquired, maybe a little bit higher than that once you get into the real fully big number. But when you talk about our investment in our own portfolio, we're talking about probably a cap rate where we acquired at 13.25% in the very high 7s, call it 7.75%, 7.8% somewhere in that, and for $50 million of incremental capacity particularly where we raised it, that just look like a good investment on us. Clearly, it doesn't mean that NAVs can't fluctuate. NAVs will fluctuate over time. I would anticipate that NAVs potentially come down and come down may be even meaningfully if a recession occurs. But if that is the case, not only is our leverage profile incredibly attractive but we have ways, in my opinion, to make mind. And so if we've taken the defense to toss off the table and also have the ability to navigate almost any type of environment, I think we're in a very good position.

Got it. I appreciate the color there, John. And then maybe -- just maybe a little tougher question to answer. But given the concentration in a handful of assets in Sunstone's portfolio but when -- when you're seeing maybe a little bit of slippage in the transient bookings over the back half of the year, what industry groups, what markets, what assets would that most apply to? Are there any themes to pick up from that?

Rich, not that we've seen. We're continuing to look but it was fairly broad based. Now keep in mind folks that month-to-month transient bookings are buyable. In some months -- I'm taking a look now, in some weeks, earlier this year, our transient volumes spiked up 20%, 30%, 40%. In July, most of the weeks were down mid-single digits. So we will see if 1-month data actually makes a trend. We're focused on it. Obviously, we reduced our second half earnings in part because of it, but we have seen this before. And so far we haven't seen it at least in terms of second quarter group production. So a fair number of ebbs and flows right now.

And next we'll go to David Katz with Jefferies.

I wanted to just talk about the underwriting for acquisitions and projects at this point. Has your ROI perspective changed, say, the past 30 to 90 days?

Not in the past 30 to 90 days, I would say over the past -- if you really go back, I would say, over the past five, six years, as overall interest rates have declined, I think pricing -- excuse me, return expectations, not just on hotels, not just on real estate but it seems like on most asset classes return expectations continue to dwindle. I'll leave that up to all the smart people on the phone to figure out exactly why that is. But we've -- over the past several years or over the cycle, we've moderated our underwriting return expectations a bit. So going back to maybe seven, eight years ago. But nothing at all in the past 30, 60, 90 days.

I guess if I can come straight at you and be a bit more direct, have you become progressively more or less conservative as this year has gone on? Or is it the same?

In terms of underwriting or in terms of operational amounts?

Yes. Yes. Underwriting.

Both? Underwriting?

Underwriting.

I don't think our underwriting has changed. I mean in some of the underwriting -- some of the assets we've looked at, we've been probably a bit more cautious on the second half of the year when it comes to certain hotels being able to hit their forecast. But no, I wouldn't say that our underwriting approach, which is done by both Robert and Marc and their teams and look at things incredibly closely, I don't think our underwriting has changed at all.

And next we'll go to Stephen Grambling with Goldman Sachs.

Maybe just a bit of a follow-up to that. But it seems like there's a widening disconnect between some of the assets you're targeting that 3% or 5% cap rate and then the, call it, everything else even as interest rates are coming down. So what do you think changes that dynamic or makes you become an advantaged buyer in the market? And in the meantime, would you consider looking at other types of assets that are maybe being overlooked whether there's more of a supply and balance relative to demand for the assets?

Yes. I agree with -- please -- most of our commentary on pricing is really related to long term relative real estate assets. We do not traffic at least on the buy side in terms of the more commodity assets which I agree with you Stephen, as we're -- that's a different level of cap rates and we've seen cap rates in -- from the 6.5% all the way up to the 9s, quite honestly. We still have a few hotels like that but quite honestly, most of our portfolio I put into the LTRR category in terms of pricing. So would we shift strategy and move away from LTRR in the more commodity assets because of higher cap rates, no.

Maybe I asked another way. Is there a way to -- is the definition for LTRR assets evolving or as may be the labor force is evolving, are you finding that there's a different level of demand for places that may be you hadn't looked before?

No. I don't think so. No.

Okay. Fair enough. Maybe one another follow-up. Just on the [indiscernible] relaunch in the quarter with Marriott, did you see any notable impact or difference between those assets versus the rest of the asset as that relaunch was taking place? I know there's some choppiness that happened at the end of last year and beginning of this year.

This is Marc Hoffman. We've been very pleased overall with the complete relaunch. We don't own any Starwood -- original Starwood hotels. And our Marriott hotels have done well and in particular, the way Marriott rolled out the program in the redemption hotels.

And moving on we'll go to Dany Asad with Bank of America.

So just to add another question on the transaction environment and your underwriting, so at the margin what is the type of buyer that's ultimately pricing you out for your specific type of assets?

Private equity -- both the large private equity and maybe some of the smaller hotel center private equity. They have been more active in terms of actually acquiring and getting deals done, at least what we've seen here over the past couple of quarters. And as Robert had mentioned, a refinancing seems to be also in the mix.

Okay. And just as a follow-up, so Summit on Wednesday announced that they are entering a JV partnership with GIC. And in theory that's one way to juice your IRs. And so is that something that: a, could be interesting to you? Or how do generally think about JVs as a way to add to your long term more than real estate portfolio?

That's an interesting question. I think it's something that we generally have an aversion to JVs. But if the right situation came up with the exact right partner and a right structure, could we consider it? Sure, we would consider it.

And next we'll go to Anthony Powell with Barclays.

Just one follow-up from me. A lot of the buyers usually have been private equity, using lot of leverage. Obviously, for you, CapEx has been a big story about your ability to grow RevPAR. Do you think these new buyers will be able to do the type of renovations you've been doing recently? And could that give you an advantage over the next two years as you continue to reinvest in your portfolio?

I don't know if I fully understand the question, Anthony.

Just in terms of maybe -- in terms of RevPAR growth outperformance of newer hotels that are renovated and do you think your ability to reinvest in your portfolio will give you an advantage over, let's say, other buyers who maybe more cash trapped in a downturn or less robust environment?

Well, clearly, the latter part of your question is true. If I'm interpreting the question right, there's a couple of markets we see. For example, like Wailea, we expect our friends next door to Grand Wailea to go under a pretty heavy knife here in the next year or two depending on their plans. And we believe that can only lift that market. There'll be some disruption that they have, which will be a benefit of. But longer term, the more that we -- the more that people invest in that market, I think the higher the rates go and we all benefit. And it just continues to become a world-class destination. In terms of our abilities to allocate capital, okay, I think as I mentioned on our prepared remarks, we have a track record of creating value by buying LTRR-type assets, complicated assets, ones that have been undercapitalized and need a new life, so to speak. And our most successful investments have been a fairly meaningful repositioningns, and I think it's something our team does incredibly well. It doesn't mean that we can't have a good investment, buying something that is more stabilized but we have a lot of different abilities to drive that value. And if in a downturn we can find something or at any time if we can find something that we believe that can add to and it's great LTRR, that's right down in the middle way for us, even with some disruption short term, that's something that we can easily do.

And we will conclude our question-and-answer session at this time. I'd like to turn to back to Mr. John Arabia for any additional or closing comments.

Thank you everybody for joining us today. I hope you have a wonderful rest of your summer, and thank you very much. Take care.

And that does conclude today's conference. We'd like to thank everyone for their participation. You may now disconnect.