Sunstone Hotel Investors, Inc.

good morning ladies and gentlemen and thank you for standing by welcome to the sunstone hotel investors second quarter 2022 earnings call at this time all participants are in a listen-only mode later we will conduct a question and answer session and instructions will be given at that time i would like to remind everyone that this conference is being recorded today august 3rd 2022 at 12 o'clock pm eastern time i will now turn the presentation over to mr aaron reyes chief financial officer Please go ahead, sir.

Thank you, operator, and good morning, everyone. 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, 10Qs, 10Ks, 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 EBIT.RE, adjusted FFO, and property level adjusted EBIT.RE. We are providing that information as a supplement to information prepared in accordance with generally accepted accounting principles. On today's call, references to our comparable portfolio will mean our 13 hotel portfolio, which includes the confidant Miami Beach, but excludes Montage Hillsburg and Four Seasons Resort Napa Valley. Additional details on our second quarter performance have been provided in our earnings release and supplemental, which are available on our website. With us on the call today are Brian Gillia, Chief Executive Officer, Robert Springer, President and Chief Investment Officer, and Chris Ostapovich, Chief Operating Officer. Brian will start us off with some commentary on our second quarter operations and recent trends. Afterward, Robert will discuss the transaction activity we completed in the second quarter. And last, I'll provide a summary of our current liquidity position, recent refinancing activity, and a recap of our second quarter earnings results. After our remarks, the team will be available to answer your questions. With that, I'd like to turn the call over to Brian. Please go ahead.

Thank you, Aaron, and good morning, everyone. Overall, we are pleased with our performance in the second quarter as the growth that began in mid-February continued into the spring and early summer months. With accelerated corporate and group demand and continuing strong leisure travel, our portfolio generated its highest monthly occupancy since the onset of the pandemic. On the pricing side, our operators have remained disciplined in the revenue management approach and have maintained strong rates with nearly every hotel at or above 2019 levels in the second quarter. Our comparable portfolio achieved a second quarter average daily rate of $295, a 14% increase as compared with 2019. This is the highest quarterly ADR ever achieved for these hotels, driven in part by meaningful growth at our resort assets and by growing demand at our urban and group-oriented hotels. Our two wine country assets generated a combined second quarter ADR of nearly $1,350. We continue to be pleased with how these market-leading hotels are ramping up and the recognition they have received from numerous travel sites and publications. Including these two hotels, Our total portfolio generated a second quarter rev par of $237, made up of a $320 ADR at 74% occupancy. Non-room revenue continued to be a bright spot during the second quarter. We once again saw significant sequential growth in food and beverage revenue, which increased 74% from the first quarter for our comparable portfolio and is within 3% of 2019 levels. While our second quarter outlet spend continued to grow, the primary driver of the higher out-of-room spend in the quarter was increased banquet contribution from the group activity at our hotels. Banquet and AV sales per group room was $212 for the comparable portfolio in Q2 and surpassed the prior high water mark for this metric from Q4 2019. We also saw meaningful increase in destination and facility fee revenue as these programs have now been rolled out to most hotels. Including the out-of-room spend, our total portfolio generated an additional $134 of revenue per available room in the quarter for total rev par of approximately $372. Turning to costs, while the property teams have been successful in reducing certain operating expenses and achieving permanent cost savings, our operators have not been immune from the labor and other cost pressures that have been impacting our industry. We are seeing some moderation in wage growth, and we continue to support our managers in their efforts to benchmark best practices and drive efficiencies where possible. In addition to labor, other items such as food costs have also been rising, and we are in close coordination with our operators to ensure they are adjusting menu offerings and prices accordingly. Despite these cost pressures, our comparable hotels generated a combined EBITDA margin of 35% during the quarter, which is in a similar range to that achieved for the same quarter in 2019. If we exclude the two hotels in our portfolio with significant renovation activity in the quarter, our pro forma comparable hotel EBITDA margin was a very strong 36.8 percent. While we are very pleased with our operator's ability to deliver this level of profitability, Our focus is increasingly shifting to maximize portfolio EBITDA as the hotels return to normalized occupancy levels. Now shifting to segmentation. Our comparable portfolio generated 214,000 total group room nights in the quarter, and the group segment comprised roughly 42% of our total demand. This group room night volume represents a 66% increase from the prior quarter with average rates that were 7% higher than the same quarter in 2019. Group production for all current and future periods in Q2 was 197,000 room nights, which is consistent with the volume we put on the books in Q2 2021, but at a 40% higher rate. In terms of transient business, which accounted for roughly 51% of our total room nights in the quarter, comparable rate came in at $338 and was 24% higher than the pre-pandemic levels that we saw in the same quarter of 2019. Based on our second quarter performance and what we are seeing in July, we remain encouraged about the outlook for the remainder of 2022. Our recent trends reflect increasing lead volumes and strength in short-term booking activity with a higher contribution from corporate group events. Our group pickup in Q2 for the third and fourth quarters was nearly 170% of what was booked for the same time period in 2019. Group room nights for the third and fourth quarter 2022 are pacing at approximately 82% of pre-pandemic levels at an average rate that is 5% higher than 2019. This would imply that our overall group revenue pace for this time period is down only 15% from the same time in 2019. We have seen strong group booking activity in Boston and San Diego where active citywide calendars should allow us to take advantage of compression in those markets. The group outlook at our Hilton Bayfront has improved as the year progressed, and the second half of the year is down only 5% as compared to 2019, and the hotel's full-year EBITDA should finish higher than 2019. Boston has also shown solid growth on the transient side with increased demand from both leisure and corporate travelers. While San Francisco has been slower to recover, we are encouraged by positive recent trends in the market as well. Our second quarter occupancy at the Hyatt Regency San Francisco more than doubled year over year with rates higher by nearly 40%. Our newly renovated rooms are generating great guest feedback as they continue to come online. the city remains a supply-constrained, desirable long-term lodging market, and we expect it will continue on its positive trajectory as it catches up to the other major gateway markets. While the strength of the recovery has not been uniform across all markets and segments, we are increasingly seeing signs that travel patterns are normalizing. While leisure has led all segments, we expect increasing amounts of corporate and group travel to become a larger portion of demand as we head into the fall and that traditional seasonal patterns will increasingly reemerge. This is consistent with what we experienced in the second quarter with group and business transient strength in certain markets, as well as a higher degree of seasonality in the quarter as our recent wine country acquisitions moved into their peak seasons. our wine country resorts continue to ramp up nicely. And for the current year, we expect that they will generate approximately 80% of their combined full year earnings in Q2 and Q3 with a balance coming in Q4. As travel demand normalizes, we would anticipate the cadence of our quarterly profitability to also more closely resemble historical patterns with some adjustments needed for the current composition of our portfolio. Later, Aaron will provide some additional information on the historical distribution of our quarterly EBITDA to help put this into context. Based on what we see today, we expect that our comparable portfolios, percent growth, and average daily rate for full year 2022 as compared to 2019 could be in the high single digits. with full-year occupancy about 15 to 16 points lower than 2019, which is weighed down by the Omicron impact earlier in the year. Moving to our transaction activity, following the sale of three non-core hotels in the first quarter, we redeployed those proceeds plus additional capital in the second quarter into the purchase of the Confidant Miami Beach and the remaining 25% interest in the Hilton San Diego Bayfront. We are excited about these transactions and believe they will provide a combination of near-term cash flow from the Hilton San Diego Bayfront and long-term growth potential from the conversion of the confidant into the Andaz Miami Beach. We continue to employ a balanced approach to capital allocation and returning capital to our shareholders. In addition to deploying capital into hotel acquisitions, which we believe will create long-term earnings growth, we also deployed an additional $34 million into the accretive repurchase of our own shares during the quarter, which brings our total year-to-date repurchase activity to nearly $80 million at an average price of $10.92 per share, a meaningful discount to published estimates of NAV. Additionally, our board of directors approved a five cent per share common dividend for the third quarter. The reinstatement of our quarterly dividend is a product of our hotel earnings continuing to recover and the strength provided by our prudently levered balance sheet. While future dividends are always subject to expectations of earnings and liquidity, we believe we are well positioned to resume the same quarterly based dividend we had in place prior to the pandemic. To sum things up, as we move into the third quarter of 2022, we are encouraged by the recent trends we are seeing across our portfolio. We expect that our well-located urban and group-oriented assets will see continued growth in the coming quarters as demand for business travel and corporate events continues to catch up with the already robust leisure demand at our resort properties. Additionally, Sunstone continues to actively allocate capital, investing in our portfolio, recycling sales proceeds into new growth opportunities, and returning capital to our shareholders through share repurchase and dividends. We believe this is a winning formula that will provide long-term value to our owners. And with that, I'll turn it over to Robert to give some additional thoughts on our recent hotel transactions. Thanks, Brian. We are very pleased to have closed on two hotel transactions during the quarter, which further enhanced the quality and value of our portfolio. Starting with our value-add acquisition of the Confidant Miami Beach, this off-market transaction represents a compelling opportunity to acquire well-located, fee-simple, oceanfront real estate at an attractive purchase price and to utilize our in-house expertise and prior experience to renovate and reposition it as a premier beachfront resort under Hyatt's luxury lifestyle Andaz brand. The 339-room hotel sits on 1.5 acres and has a generous backyard. There is significant potential to enhance the property and transform its earnings potential. Post-repositioning, we expect the hotel to generate a very attractive 8% to 9% yield on our total investment and we will own a fully renovated oceanfront luxury resort at an all-in basis of $900,000 per key in a market where per-key valuations for similar assets are well in excess of $1 million. This is a type of investment we know well and have had great success with in the past. On the opposite coast, we also completed the acquisition of the remaining 25% interest in the Hilton San Diego Bayfront. This is a great group hotel in a premier convention market, and consolidating our ownership of this asset makes a lot of sense for us. The hotel continues to perform well, and with the addition of a redesigned restaurant and marketplace combined with a new 6,000 square foot waterfront meeting venue, we expect this hotel to continue to grow earnings as corporate meetings return. Our other two major renovation projects remain on schedule. The full rooms renovation at the 821 room Hyatt Regency San Francisco is slated to finish up in the fourth quarter. We have already begun selling new rooms and they look great. Work is also progressing on the conversion of the Renaissance Washington DC to the Westin brand. The meeting space has been completed and we are now in the process on the rooms renovation and lobby upgrade which are on schedule to wrap up during the second quarter of next year. While we will experience some displacement during the third and fourth quarters of 2022, these projects should provide meaningful growth next year, especially during the first quarter of 2023 when these large group hotels will be comping off of the Omicron impact from earlier this year. We are finalizing our next round of internal investments that will help to drive continued growth in the portfolio, and we will have more to share with you in the coming quarters. With that, I'll turn it over to Aaron.

Please go ahead. Thanks, Robert. As of the end of the second quarter, we had approximately $153 million of total cash and cash equivalents, including $46 million of restricted cash. Subsequent to the end of the quarter, we completed an amendment to our bank credit agreement, which expands our term loan borrowing capacity, extends our maturity, and restores full capacity on our $500 million revolving credit facility. We are very pleased to have completed the amendment, and we appreciate the support and partnership from our existing and new banking relationships. We continue to have one of the strongest balance sheets in the sector and retain additional capacity that we can use to grow per share earnings and NAV in the coming quarters. Shifting to our financial results, the full details of which are provided in our earnings release and our supplemental. The quarterly results, which surpassed our initial expectations, who reflect continued strength in leisure travel and strong sequential growth in corporate and group demand. Adjusted EBITDA RE for the second quarter was $74 million, and adjusted FFO was 30 cents per diluted share. As Brian mentioned earlier, we are seeing indications that travel patterns are normalizing, which should result in the return of a more traditional seasonality into our quarterly earnings cadence. In 2018 and 2019, we generated approximately 30% of a full year corporate EBITDA in the second quarter. Given the Omicron impacted start to the year and the anticipated contribution from our recent acquisitions, we currently expect that our second quarter will comprise approximately 33% to 37% of our full year EBITDA. While there is generally less variation in the distribution of our quarterly earnings in the second half of the year as compared to the first, Historically, our third quarter contributes more to our full year earnings than the fourth quarter. In 2019, our current 13 hotel comparable portfolio, which includes the Confidant Miami Beach, but excludes our two wine country resorts, generated rev par of $212, made up of a $252 ADR and an occupancy of 84%. As Brian mentioned earlier, given what we see for the remainder of the year, we expect that that percent increase in the full-year comparable portfolio ADR in 2022 could be in the high single digits as compared to 2019, while occupancy is likely to be 15 to 16 points lower than 2019, which is skewed by the Omicron impact earlier in the year. Given the impressive rates garnered by Montage-Hillsburg and Four Seasons Napa, these two assets are expected to add approximately $25 to the total portfolio's ADR for 2022. As hotel demand continues to rebound, we expect to experience approximately $8 million of revenue displacement and $5 million of EBITDA displacement in the third and fourth quarters at our hotel in Washington, D.C., due to the in-progress renovation work. Now, turning to dividends. Our board has reinstated our base quarterly common dividend of $0.05 per share for the third quarter. This payout amount is consistent with the quarterly base dividend we distributed prior to the pandemic. Separately, The Board has also declared the routine distributions for Series H and Series I preferred securities. And with that, we can now open the call to questions. So that we are able to speak with as many participants as possible, we ask that you please limit yourself to one question. Operator, please go ahead.

At this time, if you would like to ask a question, press star 1 on your telephone keypad. Again, we ask that you please limit your questions to 1 and re-enter the queue for any additional questions that you may have. Our first question will come from the line of Anthony Powell with Barclays. Please go ahead.

Hi. Good morning. So you reported some very strong, I guess, in the quarter and for the quarter group data and also for the year. I guess I wanted to ask what you're seeing for 2023, just so we make sure that we're not seeing any kind of pent up demand concentrate in this year as people get back on the road for conventions and group.

Good morning, Anthony.

During the second quarter, in the quarter, for the quarter, and in the year, for the year, group bookings were very strong. In the quarter, in Q2, we picked up 14,000 group room nights compared to 2019 when we only picked up 6,000. The lead volumes were also much stronger in Q2 than what we were seeing in 2019. in 2021 and about the same level of what we were seeing in 2019. Most of those bookings point to something that we've seen throughout this year is that bookings tend to be, even for larger group business, tend to be shorter term. And so the majority of those bookings were either for Q2 or Q3, Q4. Because of that, we haven't talked a lot about 23 pace yet. I think that that's something that we'll focus more on as we get into next quarter because of the shorter term window compared to what we would have traditionally seen. We do see good production. And based on what we realized in Q2, our expectation is then that window will start to move into Q3 into Q4 and into Q1 as we book this quarter. On the rate side, we do continue to see strength for the rest of the year, as Erin said, and would expect rates to continue to move up as we book groups into 2023. But because of the window is shorter now, either groups have been a little conditioned to... to be a little bit last minute. We talked about last quarter, you know, larger corporate events that we're booking in the quarter for the quarter. And that's just sort of the environment that we've seen. But based on what we've seen in Q2, there is quite a bit of pent-up strength and pent-up demand strength. And then when you look into next year, you have to... recognize also that Q1 will be an interesting comp because of the Omicron hit that we had in this year.

Your next question will come from the line of Duane Finningworth with Evercore ISI. Please go ahead.

Hey, thanks for the time. Can you comment on potential asset sales from here? How are you looking to shape the portfolio going forward? You know, as markets like San Francisco continue to recover, How do you think about your assets there longer term? And beyond just geography, what are the attributes of assets you may be looking to sell?

Okay. Thank you. So capital recycling is always going to be part of our capital allocation strategy. Since 2020, we've sold roughly $440 million of non-long-term assets. hotels and redeployed those proceeds into about $830 million of higher quality, higher growth, mainly resorts and then the JVP at San Diego. Right now, when you look at our portfolio, we have a very high quality, a much more balanced portfolio than what we had previously. Looking at our mix of of transient group and resort hotels, we're now on a run rate basis, roughly 44% group, 25% business transient, and 31% leisure, much healthier mix than what we were going into the pandemic. As we look forward, future asset sales, there's no need to... sell off the bottom, to improve the quality of the portfolio. The portfolio is in a fantastic position. All future sales will be opportunistic, will be opportunities where we can harvest gains, realize private market values, and then redeploy those in a tax-efficient way into new assets where we see additional growth. Now that we brought some balance back to the portfolio, that growth can come from urban assets, that growth can come from resort assets. And because the future sales will be opportunistic, they could come from either of those assets too. The key is to look and do what we've done in the past is find... find assets that we can achieve a value that's higher than our internal hold value, and either take advantage of market dynamics or other higher, better use as we did in La Jolla, take advantage of those, and then go at a market clearing price take those proceeds and redeploy them where we think we can have more growth. So it could either be an asset that is more end of the life of our investment thesis or assets where there's just a special situation where we can deploy them. That's what we'll use to grow the portfolio in the future. To your specific question in San Francisco, San Francisco is a We believe it's still a fantastic long-term market. It continues to be supply constrained. When you look at the velocity and where we're having transient bookings, group bookings, it still has a long way to go to 2019. I don't think that's going to be a shock to anyone, but we've seen very good acceleration. similar to what we saw in a Boston market several quarters ago. The interesting thing about this recovery is the different markets rebounding at much different timing and a different pace. So our view on San Francisco over the coming quarters and years is that it's been slower to recover, but the acceleration is good, and we expect it to provide meaningful growth both from a top line and a bottom line for the rest of this year and into next year.

Your next question will come from the line of Chris Darling with Green Street. Please go ahead.

Thanks. Good morning. Brian, I'm hoping to get your views on how the transaction market has evolved over the past three or four months. Obviously, fundamentals are continuing to accelerate, but we've also seen some choppiness in the debt markets, and I think there's some more macro fears out there. So just curious to get your views on how valuations evolved.

Sure. Why don't I all start, and then Robert can add in on that also. So the transaction market, exactly to your point, there are two competing factors where you have the operations and the cash flow increasing, but then you have through either interest rate increases or debt market availability, you have that offsetting factor. For hotel owners, especially private hotel owners, the CMBS market is the primary funding mechanism for hotel transactions. And over the years, going back, you know, over a decade, if you look at the CMBS market and as it's matured over time, there's been points in time where it, for lack of a better term, seizes up, slows down significantly, and then will come back. I think we're in one of those points right now where there is a fair amount of uncertainty out there and that market is less efficient than it typically would be. that is absolutely going to slow down the pace of transactions. You know, I still, you know, I think we'll see transactions get done. I think that that will be at a much slower pace than what we saw at the beginning of this year. And then as it typically has always done, it will then start to come back again and transactions will continue to flow at that point. We're at a point now where there are several factors of interest rates and other economic concerns and other things that will impact pricing. Cash flow of the hotels and the performance of the hotels can absolutely be an offsetting factor to that. But until the market and the debt market really gets its legs back, I think it's going to be probably a little bit cloudy on what, if any, impact that will have in the current environment. Robert? Yeah, well said. I don't think there's much to add. I agree. I do think we will see a slowdown in transactions. I do think, as Brian pointed out, the challenges in the debt markets will definitely slow down transactions, especially larger transactions. as they're just harder to finance.

Obviously, movements in the equity markets will also have an impact as REITs are making decisions on capital allocation. So we do expect that things will slow down here in the near term, but we still think the lodging recovery is very much intact. And as Brian said, we feel that it's more of a – it's more –

a shorter-term impact than more of a longer-term statement on, you know, values or impact from there.

Our next question will come from the line of Patrick Scholz with Truist Securities. Please go ahead.

Hi. Good morning.

Morning, Patrick. Morning. Morning. With Europe opening back up again, have you seen any pressure on demand for some of the resorts, what I would call hot resorts, that did exceptionally well over the last year or two, namely in Florida or Western resorts? Any pressure on demand from that higher-end customer choosing to look to go to Europe instead of staying domestically?

Yeah, Patrick, I mean, when we look across the portfolio, and granted that we have a handful of resorts, that during the summer, late summer into July, in some places there's been some, you know, little bit of pressure on occupancy um where we've seen that dip a little bit um you know key west market's been one where i think if you look at the star data the market's down on occupancy a little bit um and um you know but on the rate side we continue to see strength from the rates when you look at uh you know go to the other side of the portfolio and you go to maui That's a hotel that also has a good amount of group business in it. It was able to fill with a lot more leisure, but when we look at the Q2, Q3, Q4 for that hotel, the demand, it's hard to see any impact there. Rates are still up. Group business is up. Incentive business is up. And so in that market, we continue to see good strength. And as we look out to the rest of the year and as summer comes to an end over the next couple of weeks, as schools start, it seems, earlier and earlier every year, when we look into Q3 and Q4, end of Q3 and into Q4, we see really good demand both up at the Napa hotels. And remember, those hotels are building, are still ramping up. And so we're still a ways away from stabilization at both of those hotels. But we are where we were hoping to be when we underwrote them. Those hotels, as they open, and Montage, remember, opened before the Four Seasons, We're starting to see good group business get layered on, which then will allow us, especially during the high season, during the crush, will allow us to compress rates. Four Seasons is a little behind because they open later than Montage and building that group base, but they're doing it. We expect that to continue as we get later into the year. It takes a little bit longer to book that business than Transient, as you would imagine. Key West is looking strong for Q4. And like I said, Hawaii, we're very optimistic for the rest of the year.

Our next question will come from the line of David Katz with Jefferies. Please go ahead.

Hi. Thanks for taking my question. Hi. So just given the commentary about what sounds like a slowdown in the availability or some of the challenging underwriting conditions for properties, how would you have us square that with, you know, the other update in terms of expanding your availability of capital? Was that just available now and so you took it? Or, you know, is that something that could, you know, wind up in the return period you know, channel, or how would we think about all that?

So with the credit facility, one, again, as Aaron said, we, in a time period where, you know, capital gets a little tighter, we want to thank our bank partners for not only, you know, going through the process and extending our existing debt, but actually allowing us to expand and expand the term loan debt. We did have after the acquisition of Confidant and the San Diego JV interest, we did have about 230 million or so drawn on our credit facility at that point. So by adding to the term loans and taking them from 108 million to 350 million, it allowed us to then pay off the or not pay well term out the line draw replenish our line where now we have that additional capacity where it might not be today because of where the market is but if we do find something today and there is dislocation we now have a fully undrawn line where we can go ahead and deploy without having to add on additional debt capacity or recycle other assets to acquire. David, you've pointed this out in the past, is we absolutely have more debt capacity, but sometimes getting access to that in certain times, especially now where there's market dislocation, might be a little bit more difficult. That's why it's so important to have access, the full access to the line. It allows us to be nimble when others are constrained. And so that's why we thought it was very important to not only find a more permanent or longer-term placement for that line draw, but more importantly, to replenish the line to be able to go and deploy that into future opportunities.

Our next question will come from the line of Chris Veronica with Deutsche Bank. Please go ahead.

Hey, good morning, guys. morning chris morning chris morning the question is it's kind of on on margin potential i know there's a lot of different ways to look at it and i think you guys in q2 had just a couple hotels that because they're further behind on recovery drove down your you know your overall potential but um going forward as we add a little bit more occupancy back um and rates I don't want to call it top, but if one were to call it top on rate growth, do you think you can still get margin expansion or are we in a situation where inflation is kind of catching up and now you're adding more variable expense at a time when rates are potentially getting close to a peak?

If you look at margin, and your point is absolutely correct, that San Francisco would be the largest, weighing down on our margins on a quarter-over-quarter basis. And based on what we've seen in Q2 and expectations for continued acceleration in Q3 and Q4 and into next year, San Francisco, a very large 800-plus room hotel, will help that margin story. as it normalizes back to where it should be. Our view and what we said on margins all along is we expect to achieve 100 to 200 basis points of improvement compared to 19. Even, as you said, if rates sort of plateau or stall or where they are, That rate has obviously helped margins quite a bit. Cost cuts throughout the portfolio have. I think when we look at the different cost components, we see labor in the same range of where we thought it would be, kind of 4% to 5%, maybe a little closer to 5% this year. Other costs, we've been able to... you know, offset on the food and beverage side, either through, you know, pricing, menu, other ways of being able to make sure that we are, you know, fighting those costs also. And then I think in the long run, it will also be determined by a couple of those larger fixed costs that sometimes you have less control over, the real estate taxes, which real estate taxes have actually been pretty decent this year. I think we're up 4% or 5% in that area. Insurance has been something that's been a big increase over the last several years. But the way we look at the way the hotels are running, the cost savings we put in place, and some additional efficiencies on the food and beverage and other side, once we normalize back to normal volumes, while there are, as you said, a lot of moving parts, we feel good that we still have a path to better margins once we normalize.

Our next question will come from the line of Bill Crow with Raymond James. Please go ahead.

Hey, good morning. A couple of quick ones here. Any material cancellation or attrition fees collected in the second quarter?

Yeah, and did you have another one? Yeah, sure.

san francisco and the group outlook specifically in the first quarter of next year i mean that's typically a really important uh quarter for the year overall and i'm just wondering how that's how that's starting to shape up okay um so the first one on cancellations cancellations if you go back to the first quarter and you remember you know the omicron impact we saw cancellations i think it was like six million for the portfolio when normally would have been

one one and a half two around there um in the quarter uh we had about 1.8 million of cancellations compared to call it one one one two uh in second quarter of 2019. so there were a few our expectations for the rest of the year is that that's going to normalize back to a million to a million and a half on a quarterly basis. So a couple one-offs, but nothing material. On San Francisco, I'll turn that over to Chris in a second. But just to start, we've definitely seen, and you can see in our supplementals, that San Francisco has absolutely been a market that has lagged up to this point. We've seen fantastic growth as we get into, you know, as we got into the second quarter, the year-over-year growth, still far from 19, but it's been very strong. We've seen good business transient pick up there also from financials and legal. So the current trajectory and the story on on San Francisco is definitely improving. I know next year, looking into the first quarter, the rates are up.

Chris, do you have? Sure. Thanks, Brian and Bill. San Francisco, certainly in Q2, as Brian mentioned, has performed much better than what we thought going in, especially on the rate side. When you consider certainly the citywide production, there has not been what we've seen in the past. As we look at Q1 specifically, pretty confident that we're going to have a much better Q1 in 23 than 22, obviously, with the impact of homework. I remember J.P. Morgan at the last kind of the health care citywide fell apart there and was canceled. We don't obviously expect that cancellation activity. And the other thing we have going for us is our We had a room renovation going on most of 2022, and right now all we are selling right now are renovated rooms, very well received, and we continue to see better rate traction than what we even expected from the second quarter by going to the third and fourth quarter. So we're fairly confident that we'll perform well in Q1, relatively speaking.

Our next question comes from the line of Smedes Rose with Citi. Please go ahead.

Hi, thanks. I just wanted to ask you a little bit about the capital return program you put back in the five-cent dividend. Does that reflect just sort of confidence in the business going forward, or is that something that reflects, you know, taxable income that needs to be distributed? And would you expect a need to do some sort of true-up at year-end? And then maybe just help us think about how you're thinking about share repurchase here since you still continue to trade at a pretty steep discount to at least consensus NAV.

Okay. Good morning, Smith. It's nice to hear you back on the calls. As far as the dividend,

Dividend, in the way we've always looked at dividend, is dividend as a function of taxable income. And taxable income comes from, you know, the performance of the assets, gains or losses on sale, and any NOLs that you have. You know, where we are on the dividend right now is, you know, as we have seen the hotels ramp up, and the group hotels come back, where we stand today on a trailing basis, we're providing or producing enough taxable income to support that dividend. And then so from that standpoint, our Dividend policy that we had in the past would be to pay the base dividend for quarters one through three and then quarter four have a true up dividend. Where we stand today, we believe that the five cent dividend, even based on the trailing cash flow of the trailing rents of the hotels, is sufficient to support that. Going forward, as we see things improve, as we see other opportunities to deploy capital, any true-up dividends in the future will be based on those needs and other areas where we can deploy capital. When it comes to our return of capital in the way we think of returning capital to our shareholders. We want to make sure that we remain focused on balance. And so just like we've tried to balance the portfolio by bringing in more resorts and lessening our dependence on urban and group, now being a much more healthy 44% group, 31% leisure, 25% business transient, We use some of our balance sheet to do that in bringing, you know, by doing that, we started to bring our leverage back into balance. We still obviously have capacity in our balance sheet, but we use some of that. And then when we look at return of capital, we want to be balanced between share repurchase and dividends also. So we have multiple levers to return capital. And hopefully as we use those we will you know we can we can then you know balance it between growing the company and making sure that our cash flow the way we've sequenced it with you know acquiring the confidant which has good in place cash flow now but then we'll go under renovation layering in San Diego which you know we acquired just over a the interest over at 13 times multiple, as things continue on 22, as things have improved, we're probably, we're sub-13 now, so that's good current cash flow. And then we'll look to, you know, balance share repurchase and dividends to return capital to our shareholders.

Our final question will come from the line of Michael Bellisario with Baird. Please go ahead.

Thanks. Good morning, guys. Thanks for squeezing me in. I have two questions. First one's very quick. I'll ask them both together. One, you guys have an updated pro forma net leverage calculation you could share adjusted for the recent transactions. And then bigger picture in terms of fundamentals, I know you said you're not seeing any signs of slowing, but if you were to see some softness or were to see cracks emerge, what markets or what segments, customer segments, that is, do you think you'd see that pop up first? Thanks.

Okay, why don't I, I'll take a crack at the leverage and then Aaron can correct me where I'm wrong. So leverage is a little tricky right now. I think probably the best way to look at it is doing some normalization of Confidant. It will obviously have contributed less cash flow in the short term once it's renovated, but let's just say whatever was in place today, we'll use that. And then some ramp up, which we said that the two wine country assets still have continued ramp left in them. I think we said our stabilized year would be somewhere in kind of the 25 range. So if you take all that and you look at a net debt plus preferred to EBITDA, our portfolio is probably somewhere between three and three and a half times leverage. A little of that is pro forma-ing in the confidant, but I think that that's a fair way to look at it because it represents the current earnings power of the portfolio. Aaron, do you have?

Yeah, Mike, just to add to that, I think Brian's certainly in the neighborhood as he thinks about the pro forma adjustments. If you actually were to just look at the face of the financial statements and then some of the information we've provided in our supplemental, you know, you'd see that, you know, on a net debt to EBITDA only, you know, it's sub four on a current basis. But certainly as you adjust for some of the stabilization of the new assets that you get to something with that three handle, that's pretty very manageable on attractive leverage level.

Yeah, and then to your question of... where the cracks, what's going to crack first, if there will be cracks. When we look at our portfolio, it all starts with the real estate, and we try to focus our capital on places that have multiple demand drivers, and take Wailea, for example, of, okay, well, maybe some of the families that you know, we're going to Waialae and now have Europe as an option or somewhere else. Well, okay, some of those, you know, maybe we move back to some more normalized there, but then also, you know, U.S. just opened up, you know, recently a couple, a month or two ago to international travelers. And while Hawaii doesn't have an Asian inbound traveler that, or Maui doesn't, that's more Oahu, Eight or nine or eight or nine percent of our historic Room nights come from Canada. And so we've seen those Canadian travelers come back quick. So, you know Other markets we haven't seen a lot of international inbound. So when US Travelers go elsewhere. There's also other travelers that can come in You know when we When I look at the portfolio or just the lodging market in general, the areas of concern would probably be, and I don't think that we have much exposure to this, but it would be those secondary or tertiary resort markets that have been able to really push rate and really drive rate because of this confined compression that we've had over the last year and a half. You know, so those markets will probably feel it more or start to feel it first. And, you know, you're going to Florida, you want to go to Miami, you want to go to Key West, you want to go to some of the other, you know, primary markets. If those markets are full, then it compresses out to the secondary and tertiary markets. That's where I would guess that, you know, If we start seeing some of the cracks, it should be more there than others.

I will now turn the call back over to Brian Julia for any closing remarks.

I wanted to thank everyone for the interest in the company and we hope that everyone has Good summer break and get those kids back to school and look forward to seeing you all at conferences soon. Thank you.

Ladies and gentlemen, that does conclude today's meeting. Thank you all for joining. You may now disconnect.