Good day. Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Sunstone Hotel Investors Second Quarter 2021 Earnings Call. [Operator Instructions] I would like to remind everyone that this conference is being recorded today August 4, 2021 at 12:00 PM Eastern Time. I will now turn the presentation over to Mr. Aaron Reyes, Senior Vice President and Treasurer. Please go ahead, sir.

Thank you, operator, 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 EBITDAre, adjusted FFO and property level adjusted EBITDAre. 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; and Chris Ostapovicz, 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. Hello, everyone, and thank you for joining the call today. I'll start with a review of our second quarter operating results, which materially exceeded our expectations and pushed the company back into profitability sooner than expected. I will also provide an update on the current operating environment and forward booking trends, which continue to provide strong signal of continued growth in the third and fourth quarters despite the uncertainty surrounding COVID-19. Last, I'll provide an update on our most recent hotel investment, Montage Healdsburg, and the potential for additional acquisitions of long-term relevant real estate. Bryan will later provide more details on our liquidity, earnings and dividends as well as an update of our recent finance transactions, which have materially increased our near-term investment capacity. To begin, let's talk about our second quarter operating results. Building on the better-than-anticipated results of the first quarter, second quarter materially exceeded our expectations with comparable 17-hotel portfolio revenues of $104 million, and RevPAR of $96. RevPAR at all of our open hotels, including Montage Healdsburg, was $107, made up of an average daily rate of $235 and an occupancy of 45.6%. While the comparison to the second quarter of 2020 is of little value, the open hotel RevPAR of $107 in the second quarter was more than double the open hotel RevPAR of nearly $48 achieved in the first quarter of this year. Furthermore, our occupancy, ADR and RevPAR have each increased meaningfully on a sequential basis every month this year, and our June RevPAR of almost $130 was nearly 5x that of the $27 comparable RevPAR achieved this past January. While we still have a ways to go, the trajectory of the recovery has been far steeper than expected. As a result of the better-than-expected second quarter results, hotel…

Thank you, John, and good morning, everyone. As of the end of the quarter, we had approximately $210 million of total cash and cash equivalents, including $47 million of restricted cash. Adjusting for the issuance of our Series I preferred stock and the expected redemption of our Series F, our pro forma total cash balance at the end of the quarter would have been approximately $235 million. In addition to cash on hand, we also maintained full availability on our $500 million revolving credit facility. During the quarter, we executed another favorable amendment to our unsecured debt agreements, which removed the restrictions limiting the amount of unencumbered hotel acquisitions we could fund from existing liquidity during the covenant relief period. Even after deploying a portion of our excess liquidity in the second quarter, our balance sheet retains significant capacity, and this most recent amendment better positions us to use that capacity to grow the company through additional acquisition of long-term relevant real estate. We appreciate the continued partnership and support from our long-standing lender and noteholder relationships. As John mentioned, since our last earnings call, we also executed upon 2 additional balance sheet enhancing transactions through the issuance of both our 6.125% Series H preferred and our 5.7% Series I preferred. Proceeds from these 2 transactions, both of which were record-setting low coupons at the time of issuance, are being used to redeem higher cost existing preferred equity and will reduce our comparable preferred dividends by $1.5 million per year. Given the attractive pricing and strong demand for our most recent offering, we elected to upsize the Series I transaction to take incremental proceeds. Preferred equity is an increasingly important part of our long-term capital structure and as a result of the acquisition and financing activity in the quarter, we have increased our exposure, and we'll have 3 attractively priced series of preferred stock outstanding. Shifting to the second quarter financial results, the full details of which are provided in our earnings release and in our supplemental. Second quarter results reflect an improving operating environment driven by continued strong leisure demand and an increasing amount of commercial transient and group business. Second quarter adjusted EBITDAre was $15 million, and second quarter adjusted FFO per diluted share was a loss of $0.01. These results far surpassed our previous expectations and marks the return to positive corporate EBITDA, a full quarter sooner than we had previously projected. While total FFO was marginally negative in the second quarter, we expect it to also resume quarterly profitability going forward. Now turning to dividends. We have suspended our common dividend until we return to taxable income. Separately, our Board has approved the quarterly distributions for our Series H and I preferred securities. With that, we can now open the call to questions. Operator, please go ahead.

[Operator Instructions] Your first question comes from the line of Rich Hightower from Evercore.

I hate to ask academic questions on these calls, because I'm sure it bores a lot of people, but I want to do that anyway. And it's the same question I asked on a competitor's call earlier. But when you think about ATM issuance relative to NAV, I just want to get a full understanding of how Sunstone thinks about, calculates, what are the different inputs, because there's obviously multiple ways of looking at it. So just help us understand the -- really the cost of equity calculation there as we think -- again, as we think about issuance.

Sure. Actually thoughtful question, Rich. So NAV is something that we look at. It's 1 of the inputs that we do look at. It's -- we spend a lot of time trying to understand, making sure we understand the value of our portfolio. And as a result of that, the value of our equity. When I take a look at consensus NAV of those that I think do a good job of calculating NAV and are thoughtful, knowing that it's more difficult time now than, I would say, before in this type of environment to calculate NAV. But I'd say that those folks did spend a fair amount of time, including you, Rich, consensus NAV is right around $13.25. And I think Green Street is at $13.25, EURO at $13.5. Baird, I think, is it just below $13. I think that, that's in a fair area, so to speak, knowing that over time, that NAV should continue to increase as the recovery increases. How do we look at it? We take a look at a combination of cap rates, discounted cash flow, price per key and then we debate it internally. Knowing that cap rate right now is incredibly difficult. So we have shifted how we look at our own NAV a little bit and how we calculate it over time, probably using a little bit more discounted cash flow now than before. So hopefully, that helps, Rich.

Your next question comes from the line of Anthony Powell from Barclays.

Just a follow-up to that question. So obviously, you accessed the ATM and you issued a bit extra preferred. I guess, did you see an opportunity to do a deal in the quarter that spurred you do those equity offerings or grades actual equity? And what are you seeing out there in terms of long-term relative real estate available for you to buy?

Yes. So let's go back and talk about what we've said in terms of near-term tactics to fund external growth. One, we expect to be acquisitive. We've said that loud and clear. We've already completed $265 million of acquisition through the Montage Healdsburg, which the way we look at it was 100% leveraging. And again, Anthony, we look at preferreds as leverage rather than equity. So then we have also disclosed that we are under contract for an asset on the West Coast of somewhere in the area of just below $200 million. It would be our expectation that, that would be funded as well with debt preferred and a very small portion of the ATM raise. So if you put both of those together and say, we're in the $450 million, $460 million of acquisitions, we're talking about an equity raise of about 8% or 9% of total proceeds, which, again, is using our debt capacity, and we think so wisely. So -- and then following up to Rich's comment, raising $38 million at right around what consensus NAV is. I don't think that hurts us long term. I actually think it's pretty prudent as it will continue to increase the amount of, on a small basis, we're only talking about $38 million here. But on a small basis, it increases our buying capacity, which, as earnings grow, that buying capacity, excuse me, should continue to grow as well as our debt capacity continues to increase.

Got it. Right. And just 1 more on the overall availability of deals, the under contract acquisition is a positive sign, but what else are you seeing out there in terms of just the transaction environment?

We're active. As I said on previous calls and at conferences, we've been active for now well over a year in in-sourcing transactions. Some of the transactions that we've been looking at take a long time. We're active in off-market transactions and in broker transactions, even though I will tell you, it always seems that we do a little bit better in direct communication with potential sellers, but we are active. I'm pleased that we have seen an uptick in the quality of the potential dispositions or -- excuse me, quality of the potential acquisition opportunities for us. It doesn't mean we're going to get them all, as evidence of some of our peers have acquired quality hotels as well. But we expect to be active over the next few years.

Your next question comes from the line of Smedes Rose from Citi.

This is Seth on for Smedes. Just wanted to know what are the gating issues to disclosing the hotel under acquisition?

The gating issues, the disclosure, we're just not ready to disclose it, as we are not yet under hard contract. And once we get to the position where we feel that we have a very high degree of certainty that it will close, then we will announce it. Typically, we actually don't even announce transactions until they're done. But given the preferred equity raise, we were -- we thought it was most prudent to disclose that we were under contract on an asset of that size.

And then just what are you seeing on the group side in terms of composition for 2022 in terms of corporate and social?

So I'll turn it over to Chris for any color, but in general, what we're seeing is we are seeing a lot more activity in group activity starting in the third quarter. As I said on our last call, we had a lot of nontraditional groups that were filling the hotels, and we've seen group business increase pretty meaningfully. Not only have we seen it increase, I think we did something like 50,000 or so rooms in the second quarter, moving up to 80,000 rooms or so. In the second quarter, we anticipate that to continue to increase. But there's going to be a, from what we see right now, there'll be a material shift in a number of city wides in the number of associations, et cetera, that will start coming back. And why is that important? That's important because it represents a pretty meaningful part of our business, but not only in addition to hotel rooms, but out-of-room spend. And so we are very hopeful, and we see evidence of that not only groups come back, but out-of-room spend continues to increase. Chris, any color on types of groups that we expect to see?

Yes. Thanks, John. I mean, when we look at '22 group pace, we're pretty pleased at where it is relative to where we thought it would be at this point. We're definitely seeing strong group lead production. Closure is not as fast as we'd like it to be, but it never seems to be. But being down to '19 for '22 is encouraging. As far as the mix of business, it's across the board. We're seeing very good pickup from associations and corporate continues to be a little more short term, but it's there as well. Speaking to John's comment about the ancillary revenue side of things, we're very encouraged.

And just adding to that, when you take a look at the city wide calendars for '22, several of our markets have very strong city wides relative to 2019 levels. So assuming this recovery continues, we're hopeful for next year.

Yes. Specifically, San Diego is 1 of those markets, John, that, as you know, we're very, very bullish on San Diego, looking at the citywide calendar and what the meeting planners are telling us. More short term, the meeting planners -- 1 of our brand partners just mentioned that 95% of 277 meeting planners that they spoke to, plan to still hold their meeting in between now and the end of -- in '21. So that certainly leads to a very positive trend leading into 2022.

Our next question comes from the line of Lukas Hartwich from Green Street.

So in regard to inflation, there seems to be a divide on whether that's transitory or not. And obviously, we're seeing pressure on the labor front for the hotel industry. I'm just curious, do you think -- where do you think labor cost pressure lands in that debate? Do you kind of anticipate it will be more transitory? Or do you think this is kind of a new area of pressure we're going to be seeing for the foreseeable future?

Well, probably a question a little bit above my pay grade, but what we're seeing down on the ground is there is wage inflation now. It is difficult to hire, source quality employees. Our wage rates are moving up. In certain areas, we are offering small sign on bonuses, et cetera. And we are limiting -- in several of our hotels, we're limiting the number of services that we could provide as a result. However, based on what we've seen in some of those markets where they have cut off the incremental unemployment benefits -- the supplemental unemployment benefits. There seems to be an easing in the hiring process. And that gives us some hope that following Labor Day, following the sunset of some of those benefits, that we should start getting some relief on the labor side.

Your next question comes from the line of Bill Crow from Raymond James.

2 questions here if you don't mind. John, on the labor discussion. As you go up in ADR, I think guest expectations have to go up. And it's 1 thing to have the availability of labor, but it's another 1 to have the quality labor and workforce. And just wondering whether you're running into challenges with people not showing up and higher turnover rates and that sort of thing.

It's a great question. This is particularly for assets like Wailea, Oceans Edge, Healdsburg, et cetera. There's always a challenge in operations, but at those types of hotels, we think that we brought back staff accordingly. And just to make sure that we are servicing the guest and meeting their expectations. And as I just said to Lukas, there are a couple of areas in our hotels, we're actually limiting the number of folks that we can accommodate. For example, in Healdsburg right now, we have so much demand for restaurant and spa that we are turning away outside guests for those services, because we just don't yet have the full strength or the full capacity, so to speak, of associates. And we want to make the experience, particularly at those price points, we need to make the experience right, because that's what's going to build a loyalty back to those hotels.

Yes. All right. And John, you mentioned wiles. So let me just pivot there real quick and ask if we're starting to hear more pushback from politicians and residents on over tourism already. We just started again, and they're pushing back. I'm just wondering what your thoughts are and whether that poses a risk to Hawaiian Hotels?

I don't think so long term, Bill. Tourism represents such a major component of the economy there that I just don't see that being an issue long term.

Your next question comes from the line of Michael Bellisario from Baird.

John, just want to -- just want to go back to capital allocation. Is your view on M&A changed at all given the fundamental improvement that's occurred in the divergent stock prices that we've seen recently? Or do you think that the path to growth will be mostly through single asset transactions?

I'm sorry. Can you ask that question again?

Just has your view on M&A changed at all recently, given the fundamental improvement that's occurred? Or do you think Sunstone's path to portfolio growth is really going to be driven mainly by single asset transactions?

I'd say it's far more likely to be single asset transactions. Yes. I -- everything I see right now, I would say it's probably more likely to be single asset transactions. If -- the more likely scenario is if the hotel REITs, which are now trading at discounts to NAV, if they stay at discounts to NAV for some time, there's so much capital out there that I actually think that the next transaction could be a privatization rather than M&A, should share prices stay where they are and should operating fundamentals continue to expand.

Got it. And does that relative pricing to NAV change your view about how you think about dispositions and pruning part of the portfolio going forward?

Not really, we're going down that path regardless. And I am probably off by my numbers a little bit, but we've sold in my time here, '22, '23, 24 hotels. I think we've sold 10 or so in the past 3-plus years give or take. We've been very vocal that there are still a handful of hotels in our portfolio that are not long for our portfolio. And so we'll continue to do that.

Your next question comes from the line of Floris van Dijkum from Compass Point.

Just maybe if you can give some perspective on your Oceans Edge acquisition and return. I mean, obviously, things are incredibly strong right now in Key West and on that property. If you can -- for us to get more comfortable with some of the other higher priced acquisitions you've done, what is the return expectations for Oceans Edge based on your $1 million a key acquisition, I think, in '17 today? And can we expect something similar for some of the other higher end acquisitions that you've either done or are contemplating on doing?

So Oceans Edge -- Oceans Edge, the hurricane set us back a little bit shortly after we acquired it. And -- but this year, we're probably looking at -- little bit more delayed than we had anticipated. We're probably looking around a 6% yield on investment. So an asset like that, we're in the money now. Although I will tell you, the first couple of years largely because of hurricane and displacement in the market, it was a little bit bumpier than we thought. As evidenced by the significant rate increase, the repositioning of the asset, the asset management work that we've done, we believe that we are on path there. And as I said in my prepared remarks, consumers are really supporting the hotel, given that we've moved rates so much. But at the same time, we're now a top 10 resort in the Key West market. When it comes to Montage Healdsburg, we've said loud and clear that we expect a stabilized yield on that asset to be in the 6% to 7% range. That was underwriting a rate of 4, 5 years out of $1,250. Last month, we did a rate of $1,250. Now that 1 month does not make a year, because of seasonality, et cetera. But I feel very comfortable given what we've come to know that we will do just fine with that asset and create value. So there's been a lot of focus on price per key. But when you take a look at the economics of that hotel, the economics of that hotel will generate as much EBITDA as several 500- to 600-room hotels. So it needs to be taken into perspective.

This concludes the Q&A session. I would like to turn the call over to Mr. John Arabia for closing remarks.

Thanks, everybody, for your time. We are around today if there's any follow-up calls. And please, please, please, if you have not been vaccinated yet, get your butt into the doctor and get vaccinated. Appreciate it. Have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.