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Sunstone Hotel Investors (NYSE:SHO)

Q1 2011 Earnings Call

May 06, 2011 12:00 pm ET

Executives

Robert Alter - Executive Chairman

Kenneth Cruse - President

Bryan Giglia - Senior Vice President of Corporate Finance & Acquisitions

John Arabia - Chief Financial Officer and Executive Vice President of Corporate Strategy

Marc Hoffman - Chief Operating Officer and Executive Vice President

Analysts

Shaun Kelley - BofA Merrill Lynch

Dennis Forst - KeyBanc Capital Markets Inc.

David Katz - Jefferies & Company, Inc.

Bryan Maher - Citadel Securities, LLC

Chris Woronka - Deutsche Bank AG

Michael Salinsky - RBC Capital Markets, LLC

Enrique Torres - Green Street Advisors

Eli Hackel - Goldman Sachs Group Inc.

Unknown Analyst -

Ryan Meliker - Morgan Stanley

Operator

Good morning, ladies and gentlemen, and welcome to the Sunstone Hotel Investors First Quarter 2011 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded today, Friday, May 6. And I would now like to turn the conference over to Mr. Bryan Giglia, Senior Vice President of Corporate Finance of Sunstone Hotel Investors. Please go ahead, sir.

Bryan Giglia

Thank you, Britney, and good morning, everyone, and thank you for joining us today. By now, you should have all received a copy of our first quarter earnings release which was released yesterday after market closed. If you do not have yet a copy, you can access it on our website at www.sunstonehotels.com.

Before we begin this call, 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 are providing that information as a supplement to information prepared in accordance with Generally Accepted Accounting Principles.

With us today are Ken Cruse, President; John Arabia, Chief Financial Officer; and Marc Hoffman, Chief Operating Officer. After our prepared remarks, the team will be available to answer your questions.

I'd like to start today's presentation and turn it over to Ken. Ken, please go ahead.

Kenneth Cruse

Okay, thank you, Brian, and thank you all for joining us. I'll cover 5 topics today, including: one, our first quarter performance; two, outlook for the remainder of the year; three, recent acquisitions and perspective on future external growth opportunities; four, balance sheet objectives; and finally, our team, including the addition of Robert Springer as the Head of Acquisitions. After that, Marc will cover operational details and John will review finance details before I wrap up our prepared remarks and open up the call for questions.

I'll begin with our first quarter results. Q1 was a somewhat messy quarter, and while our performance was affected by a number of factors such as renovation, the shift in portfolio seasonality and timing of acquisitions, when you cut through the noise, our fundamentals were very solid.

Pro forma RevPAR for our 33 Hotel portfolio increased 7.6%. Renovation activities displaced approximately $1 million of revenue in the first quarter and also negatively impacted our margins by over 100 basis points. Adjusting out our revenue properties, our 33 Hotel portfolio generated pro forma margins of approximately 24.3%, an improvement of 40 basis points over the prior year. While our renovation efforts typically do result in some short-term revenue displacement, we expect our program will drive significant long-term value creation and enhance growth potential for our portfolio. Marc will go into more detail regarding our operating results in renovation activities in just a moment.

While our full year projections remain in line with Street consensus, our Q1 adjusted FFO per share fell slightly short of Street consensus, which clearly means we should have done a better job apprising the Street of our expected performance, especially as adjusted for the moving parts that affected our quarter. To avoid such disconnects going forward, we have reinstituted guidance.

For the full year 2011, we expect the pro forma comparable RevPAR for our 33 Hotel portfolio to increase between 6% and 8% over 2010. We expect our adjusted corporate-level EBITDA to come in between $204 million and $215 million, and we expect our adjusted FFO per share to come in between $0.78 and $0.88. For reference, we believe the current consensus estimate is approximately $0.86 in FFO per share for the full year, which falls within our guidance range.

To help investors understand the new seasonality of our portfolio, we've also provided pro forma 2010 results with our 33 Hotel portfolio in our earnings release. In a moment, John will provide more detail on our full year and quarterly expectations as affected by seasonality, acquisition time and renovations.

So let's move on to our recently completed acquisitions and dispositions, as well as our external growth prospects. Since our last business update call, we completed all of the previously announced transactions, including the acquisition of 75% interest in the 1,190-key Hilton San Diego, the disposition of the Royal Palm and the insurance of $115 million of 8% Series D perpetual preferred equity. Through these transactions, we successfully recycled capital from a redevelopment project that would've required 2 years of cash outflows into a world-class hotel located adjacent to the San Diego Convention Center, the Gaslamp District and Petco Park. We are pleased with our recent acquisitions and the transformational effect that they have had on our portfolio quality and growth potential. Furthermore, we continue to see a number of attractive acquisitions targets. That said, we will remain highly disciplined in our acquisitions efforts going forward to ensure that external growth is achieved in a way that will be beneficial to our portfolio quality, growth prospects and importantly, our credit statistics.

With respect to our credit statistics, our stated plan is to increase our financial flexibility and improve our credit metrics in a deliberate and measured way by driving improvements in operations, by opportunistically paying down certain debt and by adding additional quality hotel to the portfolio on a credit-beneficial basis. Our objectives are to reduce our debt-to-EBITDA to approximately 6.5x while improving our fixed charge coverage ratio to over 1.65x by mid-2012. John will also provide greater detail on our balance sheet initiatives and liquidity later in the call.

While we believe that various transactions we've completed thus far this year will drive meaningful value, our greatest potential driver of value is our team. We have continued to complement our existing team of lodging industry professionals by selectively adding new talent. And yesterday, we announced that Robert Springer will join the team as Senior Vice President of Acquisitions. Many of you on the call know Robert as he most recently served as Vice President at Goldman Sachs, where he was a key player in the firm's Principal Lodging Investments business. I have the pleasure of working with Robert at Host Hotels prior to joining Sunstone. Robert will lead our external growth and capital recycling initiatives, including sourcing, underwriting and closing targeted single-asset and portfolio acquisitions, as well as selective asset dispositions and capital initiatives. With the addition of Robert, we truly have a world-class team, which includes some of the brightest professionals in our industry, including John Arabia and Marc Hoffman, Lindsay Monge, our Head of Treasury and Administration, Guy Lindsey our Head of Design and Construction, and Bryan Giglia, our Head of Corporate Finance. We as a team are aligned and are focused on creating meaningful stockholder value and transforming Sunstone into the premier lodging REIT through consistent and disciplined execution of our balanced business plan.

I'll now turn the call over to Marc Hoffman to discuss our hotel operations in greater detail. Please go ahead, Marc.

Marc Hoffman

Thank you, Ken, and good morning, everyone, and thank you for joining us today. All hotel information discussed today, unless otherwise noted, is for our 33 Hotel portfolio, which includes all 2011 acquisitions, The Doubletree Guest Suites Time Square, the JW Marriott New Orleans, the Hilton San Diego and excludes the Royal Palm, which was sold in April.

Pro forma RevPAR increased 7.6% in the first quarter, comprised largely of a 5.8% increase in average room rates. Our ADR growth was a result of increases in premium, corporate and leisure room revenue and a reduction of discount segments. In this quarter, 23 of our 33 hotels had positive RevPAR. We see strength in many regions, including the Northeast, Midwest and Southern California regions.

On hotel-specific basis. Our Hilton San Diego, Doubletree Guest Suites Times Square, Renaissance Orlando, Del Mar Hilton, Hyatt Newport Beach, Kahler Grand, Eugene Valley River Inn and Marriott Park City and Residence in Rochester all turned in double-digit RevPAR growth for the first quarter.

Looking forward in our Group business, our current booking pace for 2011 is up 9.2% over 2010 levels. The trend represents a 5% increase in occupancy and a 4% increase in rate as compared to last year.

During the quarter, commercial transient demand replaced a slight decline in group room night production, which helped drive room rates. From a segmentation standpoint, our 32 Hotel portfolio, without the San Diego Hilton, Group revenues were up over 3% driven by a 2.4% increase in group room nights. Our transient room revenue was up 6% to last year with a 6% increase in ADR.

In the first quarter, our revenues from our premium demand sources were very strong with revenues increasing 17%, ADR increasing 9% and premium room nights increasing 8%. In Q1, our corporate negotiated room night demand was also strong, with this segment's room revenue increasing 12%, with ADR increasing 4% and room nights increasing 8%. Our operators continue to push out lower rated segments resulting in an 18% decline in discounted room nights, while at the same time, they increased the ADR of the discounted segment by 11%.

In general, Sunstone continues to pursue its strategy of increasing room rates at the occasional expense of occupancy. However, this strategy has not been implemented in all markets and for all time periods. Our asset managers are working closely with our hotel operators to maximize hotel revenues and profits through nimble rate and occupancy strategy shifts depending upon the market conditions.

Food and beverage sales were down slightly year-over-year as we saw a mix shift from a small decline in banquet sales per group room, affected mostly by a decline in local catering and an increase in F&B sales in restaurants and bars. We expect a similar small decline in Q2, with banquet sales gaining solid strength over 2010 in Q3 and Q4.

During the first quarter, 9 of our 33 hotels were impacted by renovation displacement, which, as Ken noted, resulted in the displacement of roughly $1 million in total revenue during the first quarter, which translates roughly into 50 to 80 basis points of displaced RevPAR growth in Q1 of 2011.

Our focus is to minimize all lost revenue and disruption and complete all renovations as quickly and as efficiently as possible. Our design and construction team, in close coordination with our asset managers and hotels, have done an excellent job of keeping us on track and getting the renovations done on schedule and on budget.

As of this call, we have completed the following projects on time during this year: Room renovations at the Embassy Suites Chicago, Marriott Tysons Corner, Marriott Boston Quincy, Marriott Rochester, Marriott Houston North, Doubletree Minneapolis, Marriott Courtyard LAX, Sheraton Cerritos, the Kahler Inn and Suites and 55 new upgraded executive rooms at the Kahler International. The renovated rooms completed in this just past quarter represent nearly one quarter of our total portfolio’s rooms. We completed lobby renovations and gastro bars at the Detroit Marriott, Newport Beach Hyatt, Rochester Marriott and new lobbies at Philly West Marriott, Doubletree Minneapolis, Kahler Inn and Suites, along with fully renovated meeting spaces at the Philly West Marriott, the Doubletree Minneapolis, the Kahler Grand and the 27 meeting rooms in our Orlando resort. Our remaining 2011 projects include the master plan renovation of the Marriott Long Wharf, the renovation of our Houston Marriott lobby to be completed in mid-June, Houston Hilton rooms and meeting spaces, 64 suites and a new Family Splash Zone at our Orlando Renaissance to be completed in early June, rooms at our Del Mar Marriott and the rooms at the lobby of the LAX courtyard. These renovation projects are expected to displace $250,000 to $300,000 of total revenue in Q2.

Furthermore, displaced revenues for the entire year are expected to reach no more than $1.5 million, inclusive of the $1 million displacement in Q1. We have already seen nice upside from the renovations at Tysons Corner, Philly West Marriott and very positive strength at Marriott Houston.

Let me now turn to our operating margins. Pro forma property-level EBITDA margins for the 33 hotels we currently own declined by roughly 40 bps, 40 basis points, while as Ken noted, margins were up approximately 40 basis points when adjusted for impact of renovations. This headline figure appears weaker than expected, relative to our RevPAR increase of 7.6% but is the result of 2 issues. First, our largest hotel, the Hilton San Diego, negatively impacted our pro forma comparable margins to the final phasing of the hotels union agreement. We took these higher operating costs into consideration when underwriting the hotel, and therefore, anticipated the reduction in hotel margins, which we expect to be approximately 100 basis points in 2011. Second, the renovation disruption just discussed weighed on our first quarter margins as hotels with rooms out of service became less efficient and incurred additional costs and discounts. During 2009 and 2010, our operators took out more than $12 million in costs throughout our portfolio. We continue to work with all our operators to ensure that as RevPAR increases, operating expenses do not creep back in unless significant occupancy increases justify higher cost, and asset managers agree to those increases.

With that, I'd like to turn the call to John to discuss our balance sheet financial initiatives. John, go ahead.

John Arabia

Thank you, Marc. Good morning, everyone. I would first like to express my enthusiasm to be here at Sunstone. I've known and respected members of this management team and the Board for many years, and I'm very confident that in working together, we can continue to improve the company, reduce risk and maximize our shareholder returns. I'm also very excited to work directly with those of you on this call, our investors and analysts in this new capacity.

This morning, I'll give you an overview of several topics including: one, our liquidity and access to capital; two, our near-term debt maturities and obligations; three, thoughts regarding our financial leverage and capital structure goals; four, details regarding our earnings guidance; and finally, thoughts regarding our disclosure practices.

Let's start with liquidity. Sunstone ended the quarter with just over $214 million of cash, including $153 million of unrestricted cash. Subsequent to the end of the quarter, we raised $111 million of net proceeds from the Series D perpetual preferred offering and received $40 million in gross proceeds from the sale of the Royal Palm, resulting in an unrestricted cash balance of approximately $308 million. We then utilized $181 million of our unrestricted cash to acquire the controlling interest of the Hilton San Diego, which currently leaves us with roughly $125 million of unrestricted cash. We intend to use a portion of our sizable cash balance, say, roughly $90 million to fund the anticipated refinancing shortfall on the $270 million Doubletree Times Square mortgage, which matures in January 2012. We expect to have this refinancing completed sometime near the beginning of the fourth quarter.

As of today, Sunstone has $1.694 billion of consolidated debt, which includes the 100% portion of the $240 million mortgage secured by the Hilton San Diego. Adjusting for the debt attributed to our minority partners, our pro forma debt balance is currently $1.634 billion.

Following the refinancing of the Doubletree Times Square, Sunstone's near-term debt maturities and obligations will be very manageable. In 2012, '13 and '14, our debt maturities totaled roughly $95 million, which includes our only corporate debt to $63 million remaining exchangeable notes. Furthermore, our principal amortization totals another $80 million over those 3 years. Collectively, these obligations over the next 3 years represent less than 6% of the total private market value of our portfolio using various Wall Street analysts’ estimates of our net asset value.

In addition to our larger-than-normal cash position, we have access to our untapped $150 million line of credit, have 11 unencumbered hotels that, collectively, are expected to generate $34 million of EBITDA in 2011. While we currently see no need to access these additional sources of capital, they are available to us if we're to hit another bump in the road.

Let me now turn to our financial leverage. It probably comes as no surprise to many of you that our current leverage level is higher than we would like it to be in the long term. We, as a management team, are completely aligned in our goal to gradually and methodically reduce our leverage, improve our financial flexibility and to reduce our cost of capital. But let me make this perfectly clear.

Leverage reduction will not be immediate nor will it come at the expense of giving away our equity at prices below the intrinsic value of our portfolio. Echoing Ken's earlier comments, we will delever gradually through internal growth, opportunistic debt repayments and highly equitized acquisitions, but again, only if the combined transactions add to the intrinsic value of our shares. Given our current liquidity position, our limited near-term debt maturities and our access to capital, we will be patient on this front.

As Ken also mentioned earlier, we have reinstituted our practice of providing full year earnings guidance. For 2011, pro forma comparable RevPAR for our 33 Hotel portfolio is expected to increase 6% to 8%. Under this assumption, adjusted corporate-level EBITDA would be between $204 million and $215 million, and FFO would be between $0.78 and $0.88 per share. The current consensus estimate of $0.86 per share falls within our guidance despite the fact that our first quarter earnings came in below the consensus estimate due largely to the timing and seasonality of our recent acquisitions.

On a pro forma basis, our 33 Hotel portfolio generated 22% of its full year 2010 EBITDA in the first quarter, while our first quarter of 2011 is expected to capture only 15% of our full year EBITDA. Looking forward, we believe that second quarter adjusted EBITDA will account for approximately 27% to 28% of our full year 2011 adjusted EBITDA.

Finally, let me talk a bit our corporate disclosure. Going forward, we intend to improve transparency by disclosing additional information about our company and our portfolio. We have a lot of good news to share, and our management team is highly focused on providing the investment community the information required to properly evaluate our company and our performance.

With that, I'll turn it over to Ken to talk about our strategic focus and direction. Ken, please go ahead.

Kenneth Cruse

Thank you very much, John, and again, welcome to the Sunstone team.

While Sunstone has made progress on a number of strategic fronts thus far this year, we are by no means satisfied with where we stand. In recent months, investors have shied away from Sunstone for a variety of fair reasons, including lingering concerns about volatility in our Senior Management team, our higher-than-average financial leverage, renovation-related displacements and a lack of clarity with respect to our strategic direction.

Consequently, despite owning a high-quality portfolio of institutional great hotels, which generate superior RevPAR and EBITDA per key, Sunstone trades at a meaningful discount to comparable peer values. We, as a team, have developed and are executing on a business plan aimed at squarely correcting our value deficit through disciplined balance sheet improvement, conservative external growth, operational excellence and clear and consistent communications. We recognize that transforming Sunstone will take time, dedication and considerable effort, and John, Marc and I, along with the talented individuals who comprise the Sunstone team, are all fully committed to the task.

While we have executed on our year-to-date acquisitions of high-quality hotels at very attractive valuations, these acquisitions were encumbered with higher-than-target levels of indebtedness. Accordingly, as John noted, over the next several quarters, reducing our financial leverage will remain a key focus. Under John's financial leadership, we will continue to execute on a measured plan to improve our financial flexibility by enhancing our operational performance, smartly adding high-quality, unlevered hotels to our portfolio and by opportunistically paying down certain debt, such as mortgage on the Doubletree Times Square.

While we're pleased with the continued improvements in demand for lodging and the improved efficiencies we've implemented throughout our portfolio, continuing to enhance our operational performance remains a priority. Under Marc's leadership, we have reworked our approach to asset management and are adding key professionals to lead our property-level efforts to maximize the long-term value of our portfolio. We, as a team, are working with our operators on a variety of initiatives aimed at challenging unwarranted brand initiatives and ensuring brand standards are expanded only in ways that will truly add value to our hotels.

Finally, as John noted, without clear company communications, stockholders cannot make sound investment decisions. We can and will do a better job of providing you with the tools you need to evaluate Sunstone. For example, as I noted earlier, had we provided guidance earlier this year, as many of you asked, the factors affecting our full year and especially Q1 performance would've been better understood by the Street, and consequently, some the recent disconnects between our internal forecasts and Street consensus would've been avoided. As mentioned earlier, we are focused on earning the trust and support of the investment community, and we believe that by providing additional transparency, reinstituting guidance and meaningfully ramping up our Investor Relations efforts, we are taking meaningful steps in the right direction. In working to build your support and trust, we will seek to schedule in-person meetings with many of you in the very near future.

Before I turn the call over to questions, I'd like to discuss the innate quality and potential of Sunstone's current portfolio. Our portfolio's characteristics have improved materially over the last several years. When I joined Sunstone over 6 years ago, our Hotel portfolio primarily constitute of small, mid-sized hotels in secondary and tertiary markets with an average RevPAR of $69 and an average size of just 240 keys. We now own a 33 Hotel portfolio that consists of institutional quality, well-located, upper upscale assets with an average size of 408 keys and which generated an average RevPAR of approximately $115 during 2010.

The majority of our earnings are generated by large, high-quality urban hotels, including the 1,190-room Hilton San Diego, with 870-room Renaissance Washington DC, the 412-room Marriott Boston-Long Wharf and the 920 rooms we have in the heart of Times Square in the form of the Hilton Times Square and the Doubletree Times Square, which, as Marc mentioned, we are rebranding as the Hilton Suites Times Square.

Our pro forma adjusted corporate EBITDA for the trough year of 2010 was north of $200 million. As a point of reference, 2007 peak RevPAR and hotel EBITDA for our current 33 Hotel portfolio were $134 and $315 million, respectively. Based on our current stock price, our portfolio trades well below market comps at just over 200,000 per key. As industry fundamentals continue to strengthen, noting that Sunstone's margins in 2010 were more than 200 basis points higher than the margins achieved on a same-store basis during the 2003 trough, our portfolio has the potential to meaningfully exceed prior-peak performance levels over the next several years.

Going forward, our objectives are clear and our strategy is simple: We, as a team, are highly confident in our ability to unlock and drive significant value above current levels through the disciplined execution of our balanced business plan.

With that, let's open up this call to questions. Operator, please go ahead.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Ryan Meliker with Morgan Stanley.

Ryan Meliker - Morgan Stanley

A couple of quick questions here really surrounding the Hilton Bayfront. I guess, first is, can you give us color on how your demand mix is shifting other for 2011 or maybe where you're expecting to go now that you bought this big group branded hotel? and then also maybe some color on Group pace across your portfolio and revenue and rates?

Kenneth Cruse

Ryan, this is Ken. I apologize, you're very garbled. And your request – it’s sounds like you're asking for a shift in Hilton Bayfront?

Ryan Meliker - Morgan Stanley

Yes, I was just wondering if the demand mix across your portfolio has shifted? If demand mix has shifted across your portfolio after the acquisition of that larger group branded hotel? And then where group pace is looking for 2011 in terms of rate and revenue.

Kenneth Cruse

Sure. We won't give specifics on the San Diego hotel, but I can tell you that our segmentation has certainly shifted over time. In 2009, for example, Group rooms comprised about 29% of our demand. They are now at about 33% of our demand. So it certainly shifted over into a more of a group orientation. Transient is comprised primarily now of Business Transient whereas over the last couple of years, that Business Transient segment, which was the highest-rated segment, had been a lower percentage. So you're seeing a shift within that Transient segment as well into the higher-rated areas.

Ryan Meliker - Morgan Stanley

Is the 33% Group that you're seeing now kind of where you guys want to be? Or are you hoping to see that change over time?

Kenneth Cruse

I think with the existing portfolio, you're going to see Group continue to expand as a percentage of our total demand base. We could certainly see it reaching the 35%, 36% level. Ultimately though, our portfolio is primarily business transient-oriented. So while adding Group hotels is certainly a facet of our strategic plan. Also driving business within that transient segment from the lower rated Leisure, Government and Contract segments into business is also a key focus item.

Ryan Meliker - Morgan Stanley

And then any color on your portfolio revenue pace in the Group segment?

Kenneth Cruse

Portfolio revenue base in terms of pace?

Ryan Meliker - Morgan Stanley

Yes, the pace, whether it be volume or rate or combination.

Kenneth Cruse

Sure. Pace trends are looking very good. We're up about 9% at this point, and that's split pretty well between -- it's about 5% in the Rooms and about 4% in Rate at this point.

Ryan Meliker - Morgan Stanley

Great, that's helpful. And then just one last real quick question. You mentioned that the 2007 peak EBITDA and RevPAR of your current portfolio was about $134 and $315 million. If I recall correctly, 2007 was when the Hilton Bayfront opened. So is it safe to assume that a more stabilized Hilton Bayfront revealed at a much higher peak level?

Kenneth Cruse

That's actually a really good question. Now we've tried to factor for what would have been a pro forma number for that hotel had it been opened in '07. And I'm glad you asked the question because the $134 and the $315 million does factor for a kind of our estimate of the run-rate potential for that hotel.

Operator

And our next question comes from the line of Ian Wiseman [ph] with ISI Group.

Unknown Analyst -

May be you could talk a little bit more specifically about deal pipelines. Obviously, you hired Robert to come in and head acquisitions. What are you seeing in the marketplace today and are REITs clearly at the same advantage as they were in the past?

Kenneth Cruse

The deal pipeline continues to be very robust. As you know, from the 3 transactions that Sunstone's closed on thus far this year, we're highly focused on "off-market transactions," and I say quote because obviously, in an efficient market, there's really no "off-market deals." But we're really focused on leveraging our relationships and getting out there and acquiring hotels where we can add value to the current ownership in an un-marketed format. And so those continue to be the types of transactions that we look for. Again, the deals that we've done thus far this year the total in value, roughly $900 million, and they were acquired in EBITDA multiple instead of 14x on a trailing basis. Those are the types of deals we'll look to continue to do and we do think that those opportunities do exist.

Unknown Analyst -

Can you remind us again where your unlevered IRI targets are?

Kenneth Cruse

Sure, we think our weighted average cost of capital is in the high-single digit, and we look to, on an unlevered basis, achieve returns that are 100 to 400 basis points and hurdle above that.

Unknown Analyst -

And finally, you talked about potential for reinstating the dividend this year. Can you may be talk about timing and level?

Kenneth Cruse

Sure. John mentioned that we're likely to generate positive taxable income to our common shares during the course of this year. We had our board meeting this week, and during that meeting, we decided that we would make a decision on the timing of our dividend in our August meeting. So you can expect great deal of additional color on that in our next call.

Operator

Our next question comes from the line of Eli Hackel with Goldman Sachs.

Eli Hackel - Goldman Sachs Group Inc.

Just one question on leverage levels. Can you guys give a little bit more detail in terms of leverage levels that you're comfortable? Maybe talk not just now, over the next year, but leverage levels that you're really comfortable with long term, i.e., maybe going through another downturn part of a long view that is from now and how you adjust your strategy over the next -- not much 2 years, but I'll say 3 to 4 years or whenever the next recession comes?

Kenneth Cruse

Really good question because I think discussing our credit strategy really does require a long-term focus in terms of timing. Let me shift the call over to John here to walk through some of the specifics, but the general objective here is to continue to improve our coverage and reduce our leverage over the next 3 to 4 years to get to a point where if we're at the peak of a typical cycle, we will have a great deal of financial flexibility going into the trough. So why don't I just turn it over to John to give you more specifics on how we will obtain those objectives and what we believe those objectives, the attainment of those objectives, will bring to the company.

John Arabia

Eli, John Arabia here. When determining the leverage levels that we would really like to drive to long term, the way we are thinking about it is we want to be able to have access to multiple forms of capital at the trough when that next trough comes. We don't know exactly when it will come, we're hopeful that we have a long run in operating fundamentals over this next cycle. But I think history has proven that those cycles eventually play out and we've just gone through 2 very significant downward cycles where we, as a management team, would like to position our capital structure is that we cannot only survive, but operate our day-to-day business, including funding capital expenditures, but also at that point in time, remain able to go on offense. And so longer-term, the way that we are looking at it internally is we would like to get to a leverage level where if we witness earnings decline like we have witnessed over the past 2 cycles, let's call it 40%, 45%, which again were considered anomalies, that we would be able to, again, go on offense. That's a fairly low debt-to-EBITDA number, and it's going to take pretty active balance sheet management, albeit very disciplined. I just want to reiterate a point that the goal here is not that reduction, but the goal is improving shareholder value and so we will do this on a step-by-step gradual basis. Does that answer your question?

Eli Hackel - Goldman Sachs Group Inc.

Yes. And maybe just to follow-up to it. So does that mean that it'll be more in the -- if you guys are doing acquisitions to this very high equity values or you think you'll just do one-off equity raises just to straight out reduced leverage?

Kenneth Cruse

This is Ken. Let me just jump in because I think your question was a fairly specific one. We will not be raising equity simply to pay down debt. John and I both outlined in our comments that there are really 3 means to reducing our leverage overtime and John said it's exactly right. That this is going to be a measured and disciplined approach. So the 3 goals are: number one, focusing on operational excellence and improvement; number two, funding acquisitions much more highly with equity, but not raising equity to pay down debt; and then number three, opportunistically using our excess cash balances to repay a portion of our debt as we're able to. For example, our plan calls for a partial pay down of the debt on the Doubletree Times Square later on this year as we embark on that refinancing.

Eli Hackel - Goldman Sachs Group Inc.

Great. That’s very helpful.

Operator

Our next question comes from the line of Joseph Greff with KeyBanc.

Dennis Forst - KeyBanc Capital Markets Inc.

I just missed 1 of your 3 points that you were just saying. Can you talk about operational improvements, pay down debt, and what was the third?

Kenneth Cruse

Well, the third one would be that we'll look to acquire hotels that are additives to our portfolio quality and growth profile in a way that also benefits our credit metrics. And so what that means, in simple terms, is that we'll look to acquire hotels using more equity than debt.

Dennis Forst - KeyBanc Capital Markets Inc.

Okay. If you can explain that using more equity than debt. It sounded almost out of cash.

Kenneth Cruse

.

Correct. So we would look to fund our acquisitions, basically match fund equity raises with the additive acquisitions.

Dennis Forst - KeyBanc Capital Markets Inc.

Okay. So you would raise equity to make acquisitions not to pay down debt?

Dennis Forst - KeyBanc Capital Markets Inc.

That's correct.

Operator

Our next question comes from the line of Chris Woronka with Deutsche Bank.

Chris Woronka - Deutsche Bank AG

I want to ask you on the Doubletree Times Square. Can you may be give us again some kind of direction in terms of the ADR or maybe the RevPAR lift that you expect from that conversion to the Hilton Suites?

Kenneth Cruse

Sure. I'll turn this over to Marc for that. He's done a lot of work on the project. We're not going to be able to give too much in terms of specifics, but we're pretty excited about the impact of this project. So let me shift it over to Marc.

Marc Hoffman

Sure. In general, obviously, the Doubletree currently runs significantly high occupancies in the mid-90s is the #1 in that entire set. But even with that high gauge who you know who runs that hotel and also now runs our Hilton Times Square hotel really has superior intel in the market, they provided us with, and we strongly believe that there is upside, particularly by changing the brand to Hilton. What you will do, there are significant amount of Hilton other customers that we believe that will be willing to pay premium, slight premium. We think there is a premium in ADR in the range of $8 to $15 in that range in terms of the switch once we get that done, and we will be doing the work approximately post-January in 2012. Also, of the international clientele really does see Hilton as a much more of a buy-in. We have a very large international potential market in that entire area.

Chris Woronka - Deutsche Bank AG

Sure. And then I guess, John, the signage revenue from that, does that just go into the Other hotel revenue line?

John Arabia

Yes.

Chris Woronka - Deutsche Bank AG

Okay, great. Also, I want to ask you about that earn-out feature on the Royal Palm Miami. Can you share with us where the hotel is with respect to those hurdles and how long does that earn-out extend?

Kenneth Cruse

Sure. Chris, this is Ken. The earn-out is a perpetual earn-out. So obviously, we're not in the money and are not at this point. But the Royal Palm, being a repositioning and renovation project, is going to realize its value on the backend of that renovation. So you're likely to realize that on sale.

Chris Woronka - Deutsche Bank AG

Okay, great. And finally, on the San Diego Bayfront, can you -- and I don't know if you guys even have the information, but relative to where you think this might have been underwritten when it was built in terms of the RevPAR number, do you have any sense as to where we are in terms of the ramp up?

Kenneth Cruse

Sure. Certainly, against performance, the hotel is outperforming. I think that's probably a unique claim as far as the hotels that were built during that time period. It was built very well in a market that really needed that product. So it's outperforming underwriting, and we're pretty excited about the pace going forward. It is the #1 asset in the San Diego market.

Operator

Our next question comes from the line of Enrique Torres of Green Street Advisors.

Enrique Torres - Green Street Advisors

Could you just comment on have you seen any operating impact from Sales Force One hat has been a net positive or negative and what you project the impact to be going forward?

Kenneth Cruse

Enrique, I'll take this one and then I'll shift it over to Marc. That's a very good question. As I noted in my comments and Marc echoed, we, as a team, are very focused on analyzing and challenging brand initiatives. But I think Sales Force One is a fairly new initiative. With any new initiative that's as sweeping and as ambitious as this one, you're going to see some turbulence and some growing pains. Marc is going to give a little more detail here, but the short answer is the jury is still out.

Robert Alter

Enrique, Marriott is still the #1 driver of Group rooms in North America. Their ability to drive Group rooms is still #1. I would tell you that we will continue to work with them. I was recently in Washington last week going hotel by hotel with the highest level of sales people and the highest level of people in Marriott. And we are confident, particularly with their flexibility and openness to our feedback that we will continue to see improvements.

Enrique Torres - Green Street Advisors

Okay, all right, it's a good color there. And as follow-up question on the disposition, as you mentioned or capital recycling initiative, can you provide a little color on, it's not what as specifically, perhaps what type of asset within your portfolio you would be looking to target there?

Kenneth Cruse

Sure, Enrique, this is Ken. We had some capital recycling earlier this year with the Royal Palm, where it was a nonconforming project. There are other legacy assets in this our portfolio that don't fit the mold of the assets that I described on the call, those high-quality institutional assets in primary markets. Our top 10 hotels generate 66% of our EBITDA. So we really want to focus on owning a portfolio that is comprised of those large institutional quality assets. So if you look at the map on our website, I'm not going to name names, but you can see certain assets that probably would qualify as mid-term sale candidates, and so stay tuned on that. In the interest of not disrupting operations or distracting the team from the focus of running the hotel to the max potential, stay tuned and we'll let you know if there are any dispositions in our future.

Enrique Torres - Green Street Advisors

That’s helpful.

Operator

Our next question comes from the line of Shaun Kelley from Bank of America.

Shaun Kelley - BofA Merrill Lynch

I just wanted to talk real quickly if we could go back, I mean, Ken, now with the acquisition of the additional interest in the Doubletree Times Square, in New York and D.C., both had a little bit kind of weather issues in the first quarter. I don't think you broke it out in the REITs, I apologize if I missed it at the very beginning of the call, but any sense on how much that impacted you in the first quarter and what you're seeing, particularly in New York and D.C. since they are some big hotels for you now?

Kenneth Cruse

Let me shift it over to Marc. We did break out regions in our press release, but Marc can you give us some specific information about those.

Marc Hoffman

Sure. I know some of the other REITs that talked about the Northeast. I mean, overall we did have some impact in occupancy. I don't think we've calculated it down to specific percentages, but we did take some RevPAR decline in those same weeks similar to a diamond rock, those types of things. We didn't feel it was meaningful enough that we really needed to call it out.

Shaun Kelley - BofA Merrill Lynch

Okay, that's helpful. And then I guess, secondarily, I just wanted to ask about the kind of the acquisition strategy going forward. Kind of thinking about the Royal Palm, and obviously, that was a bigger repositioning story. You guys made a kind of decision to move away from that. So could you just kind of walk us through what you think is going to be different about the way that the Royal Palm kind of process went through versus what you're going to be looking for next as we think about the difference in that deal and the difference in the kind of the go-forward deals and where Robert maybe comes in on that front?

Kenneth Cruse

Sure. Good question. It's pretty simple and somewhat boring, but our focus right now is to acquire institutional quality assets with in-place EBITDA that are well located in primary markets that have more than 350 keys that generate in-place trailing RevPAR that's additive to the pro forma of our portfolio, which was about 115 last year branded. And while we certainly can and do look to add value through our design and construction function and our asset management function, we're looking for projects where we can add value on the margin without doing deep, deep dive repositionings at this point. And ultimately, once we grow the company and build up the portfolio over the next several years, we'll certainly take on more of those deep dive accretive value-add initiatives, but the first order of business is to focus on middle of the fairway institutional quality assets that are branded.

Shaun Kelley - BofA Merrill Lynch

And maybe just the last question would be as you kind of think about pricing in some of the markets, we've obviously continue to see some pretty big headline price-per-key numbers coming out of New York, D.C., San Francisco. So do you think the strategy, kind of what you talked about there, kind of in terms of RevPAR premium to the existing portfolio, can you do that in -- I mean, would you look for markets outside of maybe the big 3 or 4 at this point and kind of how do you think about kind of weighing that versus just pound for pound? You might something that checks a couple of those boxes, but you're going to pay a really low cap rate to get in.

Kenneth Cruse

Sure. We're certainly not married to the top 3 markets. We acquired New Orleans, for example, earlier this year which is a terrific asset, very well located, but all of our parameters and that takes us to top 30 market, if you really want to break it down. So we're not of -- so that looking at some of the top markets, and I think that's one of our strengths rather than going through the market of generals and competing with all the other players on some these high-profile deals, we're going out and spending time in those top 15 to top 30 markets looking for the right assets that fit are profile. And those deals can be done as we've demonstrated in the 3 deals that we closed thus far this year at far better valuations than the marketed deals.

Shaun Kelley - BofA Merrill Lynch

And just one last one I thought, of. But Houston was a drag with some group business that you think have been changing out there or some contracts that you guys had lost. But with oil kind of coming back quickly as it has, borrowing yesterdays drop, obviously, did that provide a tailwind there? Are you seeing any improvements in Houston above and beyond kind of what you would've expected because of the disruption from the contract loss?

Kenneth Cruse

Yes, good question. Obviously, the contract loss was we had KBR in the hotel for several years, and the hotel did superior during that timeframe. We now have completely refocused the hotel, both from rebuilding to sales teams to spending considerable capital to position the hotels. RevPAR at our Houston hotels was down approximately 7.8% to last year in Q1. Although down on a year-over-year basis, we meaningfully beat our budgeted expectations in Q1 by 12%. As the hotels experienced an increase in transient group bookings, we've continued to see strength. If this trend continues forward, which we think it will, we could see year-over-year RevPAR increases earlier than previously expected. The Houston Marriott will see positive RevPAR in Q2, while the Houston Hilton will see positive RevPAR growth in Q3. And for full year forecast, we expect both hotels now to have RevPAR growth, albeit slight growth for 2011, which is significantly better than we were before.

Operator

Our next question comes from the line of David Katz with Jefferies & Co.

David Katz - Jefferies & Company, Inc.

So I missed, I apologize I've been sort of on and off a bit, but during some of the commentary, we were curious about the margins that were sort of clean, stripped away for same-store and as well for construction. And I believe the commentary reflected 2 reasons, one of which was a union cost that occurred. And would you mind revisiting what that second reason was? I'm not sure I was clear on it, please.

Kenneth Cruse

Sure. The margins were a part of the complicated set of factors. First of all, the data point that we offered up that was adjusting for the renovations were our margins would've been up about 40 basis points. One of the big factors in our margins this year, because our pro forma numbers include the prior year of the Hilton Bayfront current year. The Hilton Bayfront has its full union wage scale in place this year. That was obviously underwritten by us when we acquired the hotel. But our results had a lot of noise in the year-over-year comparison in the margins. Beyond that, you've also got a shift over in wages and benefits across our portfolio, which were up slightly, actually in the low teens. And in fact, slightly higher than that in the number of our hotels. So wage pressure certainly was accounted for throughout our portfolio. A portion of that and a portion of the cost pressure at the property level was also related to bonus accruals and so on. As the hotels continue to ramp up in performance, we incent our operators through financial bonus metrics. And so it was a positive indicator of the performance of our portfolio you are seeing, now bonus metrics creep into the scheme. Marc, do you think you have anything else to add on that?

Marc Hoffman

Just a few other items. Our Q1 2011 Hotel EBITDA margins for the 33 hotels were 23%, down 20 basis points to last year. Excluding the hotels under renovation, our margins would've been up 40 basis points. Ken talked about the other items that were involved with that. And in addition, the 2 Houston hotels again continue to negatively impact us from the first quarter. We expect that, that negative impact from Houston to diminish during the second part of the year, as I talked about a moment ago, as RevPAR continues to improve there.

David Katz - Jefferies & Company, Inc.

If I can just follow that up for a moment, did you say -- are we clear that some of these issues will carry through into the second quarter and through the rest of the year? Because I think 1 of the things that has come across from not only from you all but from others in your category is that we're looking at a ramping and backend loaded year, which, I guess, introduces an element of risk to estimates. And we just want to make sure that we're properly reflecting any impacts in 2Q, 3Q that we should.

Marc Hoffman

We don't see it as being a fully transferable into the second, third, and fourth quarters of this year. Another thing that hit margins in the first quarter was that 100% margin business in the form of attrition payments were significantly lower in the first quarter. We think that will moderate out during the course of the year. And we think that the more important point, with respect to our portfolio, is the efficiency level that it's currently running at. So while the year-over-year comparisons may be more moderate than we would've liked in the first quarter, the absolute performance in terms of margins is pretty impressive, as I noted in my comments, were 200 basis points higher than where our same-store portfolio is running at the trough of the last cycle.

David Katz - Jefferies & Company, Inc.

Got it. And one last 1 on that issue. Many companies have talked about New York and it's sort of impact on their portfolios to varying degrees. Why is it or should we consider New York isolated to 1Q or is that an issue that we expect to pervade the rest of the year?

Kenneth Cruse

Well, let me take a bit of that 1 and then I'm going to give it over to Marc. On a pure economic standpoint in terms of supply and demand, we haven't seen some supply additions in New York, and they continue to increase above the historical average. But that's really a broader New York issue, and you’ve got to think of New York as a very pluralistic market. Our presence in the Times Square core market, the 920 keys that we have on the corner of Mean and Main. So when you look at the supply impact from a broader New York market, those certainly are noteworthy. But we look at our hotels as being highly protective in their current locations. Marc, do you want to add anything to that?

Kenneth Cruse

Sure. Our 2 hotels are a combined Q1 RevPAR growth of 9.8%, which was significantly higher than the Manhattan track, as you well know, and even significantly higher than the mid-Manhattan track. The Hilton ran 85% occupancy, the Doubletree ran 92.3% for the quarter. Our preliminary numbers for the month of April show the hotels running a combined RevPAR in north of 12%. We will continue to watch supply. We're closely with Highgate but believe that we own the 2 best-located hotels in the markets and feel that the impact of those 2 hotels will be less because everything emanates from Times Square out, and we still feel pretty solid about particularly with our results being so much more than the tracked.

Operator

Our next question comes from the line of Bryan Maher with Citadel Securities.

Bryan Maher - Citadel Securities, LLC

I guess my question is a little bit bigger picture and kind of falls a little bit from David's questioning, but it really relates to RevPAR. Pretty much the party line for all the companies at the report is this 6% to 8% for the year. But on the back of that, many of the companies kind of came up short in the first quarter. So based upon the kind of tepid economic recovery, high unemployment, commodity prices and kind of a slowing of occupancy growth, can you kind of handicap how you feel about that 6% to 8% RevPAR growth forecast?

Kenneth Cruse

Sure, Bryan. Let me jump on this 1, and once again, I'll shift over to Marc to give you the actual facts. But our current projections would indicate that RevPAR, given our pace trends, given our forward bookings, et cetera, is likely to perform kind of 7% to 8% in the second quarter, significantly higher just based on comps more than anything in the third quarter in the higher-single digits. And then back down to kind of that 7% to 8% in the fourth quarter is how we're currently projecting things out. And again, that's substantiated by our property level buildups. Marc, do you want to add any?

Marc Hoffman

Yes. I mean look, I think that your comment is a fair comment about what happened to the economy and where we go. I mean, I think at this point, that's why we've given the range of 6% to 8%. The good news is that the pace that we have on the books is 9% ahead and the 2 beads that we need to book in our hotels for the remainder of the year, while is a reasonable number, it continues to fall as it should be as we move to the out months. Again, I think the range is a appropriate. Q1 is a softer quarter in general around the country, which is why you heard what you heard from most of the comp said of the REITs.

Operator

Our next question comes from the line of Michael Salinsky with RBC Capital Markets.

Michael Salinsky - RBC Capital Markets, LLC

First question since you gave guidance, just curious if you'd walk through kind of the sources and uses, specifically CapEx spend that you guys have kind of budgeted in that guidance for 2011, as well as what you're kind of assuming in terms of the debt pay down and what you anticipate for end of the year cash balance.

Kenneth Cruse

Sure, Mike, this is Ken. I'll jump in on that 1. Our CapEx forecast for this year is for the full year roughly $100 million to $120 million. We did about mid-thirties in the first quarter on CapEx and completed a number of projects as Marc mentioned. As far as debt reduction during the course of the year, it's going to come in 2 forms: amortization of roughly $20 million, and then we do expect to pay down a portion of the Doubletree Time Square loan at the end of the year, at the fourth quarter. We think that, that pay down is going to be roughly $90 million. We certainly don't know the specifics at this point, and we would expect to end the year with cash. We do want to have a little bit more efficient cash position to end this year. And so we would expect to end the year with cash in $40 million to $60 million range.

Michael Salinsky - RBC Capital Markets, LLC

Okay, that's helpful. I don't know if you mentioned this in your prepared comments, but did you give the RevPAR for April for the portfolio?

Kenneth Cruse

We did not. Hold on, Mike, and we'll pull that together for the group.

John Arabia

And Mike, just to follow-up to Ken's comments, remember, we are moving into the period of the year where we're going to be generating more and more cash from operations as opposed to the first quarter, which is fairly like that regard.

Michael Salinsky - RBC Capital Markets, LLC

That's helpful. Just to follow-up to Enrique's question while we're waiting here, he asked about asset recycling. Just curious if you guys are actively marketing any properties right now.

Kenneth Cruse

We are not actively marketing any properties right now. We're certainly entertaining inbound calls in a number of properties once in a while, but we do not have any active marketing efforts. And then to answer your question about RevPAR for April, for our portfolio, it was up 5.5% across-the-board.

Operator

And our next question is a follow-up question from the line of Dennis Forst with KeyBanc.

Dennis Forst - KeyBanc Capital Markets Inc.

My timing was perfect because I was going to ask about the April RevPAR. First of all, Easter falling in April have an impact on that 5.5% number?

Kenneth Cruse

Yes, that's correct. It's makes it a little bit lighter in our business hotels. That is correct.

Kenneth Cruse

And that April number includes all the properties that you currently owned, the 33 versus those same 33 a year ago?

Marc Hoffman

Yes, that's 33 versus 33.

Dennis Forst - KeyBanc Capital Markets Inc.

Okay. And then lastly, I'm wondering about your thoughts about limited service hotels. There's been a lot of talk by investors about limited service hotels. You've got a Residence Inn, you've got a Courtyard, but certainly, wasn't in your dialogue, Ken, about looking forward going forward.

Marc Hoffman

Good question, Dennis. Because we certainly don't want to -- we don't want to box ourselves to any specific brand names. We like urban upscale and upper upscale hotels in top markets. We would certainly consider an urban Courtyard, for example, or urban Hilton Garden Inn, for example, to fit within our target profile in the right markets and the right locations. So you could certainly see a limited occurrence of us investing in those types of assets. But primarily, we're looking at the upper upscale side.

Dennis Forst - KeyBanc Capital Markets Inc.

And limited would only be in the top 5, top 10 markets where you could get a very high rate?

Marc Hoffman

Correct.

Dennis Forst - KeyBanc Capital Markets Inc.

Got you. Okay.

Operator

And there are no further questions in the queue. I'd like to turn the conference back to Mr. Cruse for any closing remarks at this time.

Kenneth Cruse

Great. Well, thank you, everyone for participating on the call. We look forward to speaking with you later in the year in our inter-quarter update. And we also look forward to meeting with many of you over the next several weeks at maybe NYU or at several road shows that we talked about going together. So thank you.

Operator

Thank you. Ladies and gentlemen, that concludes the Sunstone Hotel Investors First Quarter 2011 Earnings Conference Call. We thank you for your participation. You may now disconnect.

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