Hersha Hospitality Trust (HT) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Hersha Hospitality Trust Second Quarter 2009 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference.

(Operator Instructions)

As a reminder, today's call is being recorded. With that, I would now like the turn the presentation over to your host for today's conference, Mr. Brad Cohen. You may proceed.

Thank you, Doris. I wanted to remind everyone that this conference call contains forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933, and Section 21E of the Securities Exchange Act of 1934, and as amended by the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect Hersha Hospitality's plans and expectations, including the Company's anticipated results of operations, joint ventures, and capital investments.

These forward-looking statements involve known and unknown risk, uncertainties, and other factors that may cause the Company's actual results, performance, achievements or financial position to be materially different from any future results, performance, achievements or financial position expressed or implied by these forward-looking statements. These factors are detailed in the Company's press release, and from time-to-time in the Company's SEC filings.

With that, let me turn the call over to Mr. Jay Shah, Chief Executive Officer.

Jay?

Thank you, Brad. Good morning, everyone. Joining me today on the call are Neil Shah, our President and Chief Operating Officer, and Ashish Parikh, our Chief Financial Officer. Let me begin by discussing four areas which we made progress in the second quarter. First, we saw some stabilization in our markets as the year-over-year decline in RevPAR improved from our experience in the first quarter.

Secondly, we started to benefit from the cost initiatives that we implemented late in 2008. We also strengthened our balance sheet, positioning us well to ride out the remainder of this down cycle. And finally, we forged a relationship with a strategic partner that gave us some financial flexibility in the near term, and a partner for joint venture and other alternative opportunities for the long term.

The persisting economic recession continues to make this a very challenging operating environment and has caused hotel demand to remain negative. However, there are some signs of slight moderation and we remain confident that our strategic positioning with limited service hotels and attractive urban markets, combined with our cost containment efforts, will help to mitigate the stress of the current economic turmoil.

Our operation margins are among the highest in the industry, and we expect that our performance will continue to improve as the year progresses. Furthermore, we have executed on a multi-faceted plan, to generate liquidity and fortify our balance sheet with carefully targeted asset sales, timely refinancings, and the sale of stock to a strategic partner.

Our top-line results still reflect the operating environment and the many challenges that have been negatively impacting the entire lodging sector. These results are a reminder of the ongoing difficult year-over-year comparisons that we'll face through the third quarter of this year. Consolidated hotel RevPAR for the second quarter, including new acquisitions completed in 2008, declined 17.4%, as occupancy declined by 4.8 percentage points and rate fell 12%.

Total consolidated same-store second quarter RevPAR declined 19.2% in the quarter and 19.6% year-to-date. The quarterly RevPAR decline was comprised of a decrease in rate of 13.2% and a 5.4 percentage point reduction in occupancy. Despite these challenges, our dramatically improved margins and the higher cash flow that we delivered in the second quarter of 2009, relative to the first quarter, are reflective of the expectations we conveyed on our last earnings call.

In our most important market in New York City, we had a difficult year-over-year comparisons to the second quarter of 2008 when our New York RevPAR was up 14.4% on a rate increase of 11.5%, an occupancy increase of 2.5%. In the second quarter of this year, our same-store New York RevPAR was down 28.7% on a rate decline of 28.8%, and a 10 basis point occupancy increase to 91.3%. We think that it is a meaningful performance indicator.

Despite the overall negative bias still surrounding the New York urban market year-to-date, we have maintain more than a 91% occupancy in our properties in New York. We've been able to continue to generate demand during this downturn with our value-oriented brands and solid locations, and are benefiting from our selected limited service hotels from an operating perspective. Despite an almost 29% decline in same-store RevPAR, in the second quarter we delivered an EBITDA margin of 40.4%, and if you exclude property taxes, it was 47.9%.

The remainder of the portfolio is benefiting from our diversified market exposure. The Washington DC region is currently one of the strongest in the country and we showed slightly positive year-over-year occupancy. Occupancy at our Boston urban properties and our DC properties were above 80% for the quarter. And in four of our regions, New York City, California and Arizona, Boston and Philadelphia, the rate of year-over-year RevPAR deteriorations slowed from what we experienced in the first quarter.

While occupancy has turned positive in some of our key markets at some of our properties, it has not across the board yet. We were encouraged, as we progressed through the quarter, that the occupancy stabilization trend continued, and in the month of July we had positive occupancy increases at many of the hotels. As this extends, we will continue to test our pricing power over the next several quarters.

Furthermore, our cost containment efforts continue to contribute as we work to align them with current revenues. We have successfully been implementing cost realignment efforts since the beginning of 2008.

The efficiency of our operations, our limited service portfolio, and our relatively stable level of occupancy results and margins, both gross operating margins and EBITDA margins that are well above the industry average. Looking at our consolidated portfolio, gross operating margins were 48.5% in the second quarter, which we believe is near the high end of the peer lodging rates with similar RevPAR.

Our second quarter EBITDA margins for the entire consolidated portfolio declined by approximately 304 basis points to 39% from the comparable quarter. The decline was driven in large part by property tax increases at many of the properties that had record performance in the first three quarters of 2008. Excluding the property tax increases, the consolidated portfolio held margin deterioration to 166 basis points.

Also contributing the margin decline this quarter were the six newly built hotels we acquired in 2008. We estimate that new assets take approximately 24 months to 36 months to stabilize under normal operating conditions, and potentially longer in an environment such as this.

On a same-store basis, declines in both rate and occupancy produced EBITDA margin declines of 351 basis points. Again, higher property taxes contributed to this decline. Excluding the impact of property taxes, our margin decreased by only 188 basis points. Limiting margin deterioration on a 19% RevPAR decline speaks very clearly to our ability to contain costs and operate efficiently.

As I mentioned before with respect to the property taxes, since the effective -- the tax tends to lag by a year, this increase was assessed prior to the meaningful business deterioration we've been experiencing. We are taking action to pursue abatements, but it is not likely to impact us for several quarters if we are successful.

On the cost front, we remain vigilant about cost savings and maintaining profit margins. Our largest cost area, payroll expenses, were down about 15% in the quarter, and property costs, including property level G&A, repairs and maintenance and marketing were down almost 18% in the quarter.

With almost $55 million of capital invested in our properties over the past five years, and the average age of our overall portfolio at 7.2 years, we are well-positioned and we will require less capital investment over the next several years. Our cost containment plans are expected to save approximately $8.5 million in 2009, and these savings are in addition to the $3 million in savings from the plans we implemented in 2008.

Our business model and portfolio are showing the resiliency and responsiveness as we had suggested in the prior quarter, and we expect this performance to continue. Historically, limited service hotels tend to weather the downturns more effectively and rebound quicker. Limited-service hotels are better able to defend their fundamentals, relative to larger full service hotels, and as guests change habits and move to value-driven overnight accommodations, hotels that are young and well-located tend to benefit.

One of the key attributes of selected limited service hotels is they historically experience less cash flow volatility during downturns, and this allows us to react quickly to the environment to mitigate margin erosion. Additionally, the smaller inventory of rooms at our hotels, relative to the big box hotels in the marketplace, has a distinct advantage that allows us to yield/manage more effectively.

We have a solid portfolio of high quality, newly built assets in both urban and stable suburban markets. These are markets with good travel infrastructure that attract both business and leisure travelers, and are the most likely to experience robust recovery.

From a capital and liquidity perspective, we took steps to further strengthen our balance sheet, which now has little in the way of maturity risk until 2013. Our balance sheet flexibility is an asset in the current liquidity crisis and serves as an additional defensive measure in this uncertain market. Since the end of the quarter, through a combination of asset sales, the refinancing of debt, which leaves us with no maturities in 2009, and the sale of stock to a very well-capitalized strategic offshore partner, our balance sheet is even stronger.

Ashish will discuss our asset sales and refinancing, but before I turn the call over to him, let me briefly discuss our new strategic partner, IRSA. Yesterday, we announced a strategic investment by IRSA, Argentina's leading real estate investment company, which is a publicly traded company in the New York Stock Exchange. They've invested $14.25 million for 5.7 million common shares in Hersha.

Also, in conjunction with the investment, Eduardo Elsztain will be joining our Board. Mr. Elsztain has been Chairman and Chief Executive of IRSA since 1991, and has been engaged in the real estate business for more than 20 years, earning a global reputation for his accomplishments.

We're encouraged by this new investment, which strengthens our financial flexibility and takes entity level risk off the table, also giving us a new strategic partner who sees the long-term value in our business model and our attractive portfolio. This relationship and the capital infusion is quite meaningful in the near term, providing us with the flexibility we will need to weather this economic crisis. Just as importantly, over the longer term, it provides us a potential partner and a source of capital for joint venture opportunities.

Hersha entered into a similar strategic partnership with CNL Hotels and Resorts in the early part of 2003 during the last cycle, which produced outstanding results for the Company and was positive for the stock. We have fortified our balance sheet, making us comfortable with our financial position, and are now well-positioned to continue to execute on our strategy and prepared to be opportunistic at the appropriate time.

Let me now turn the call over to Ashish to go into some additional details on our financials. Ashish?

Thanks, Jay. I'd like to provide a little more detail about our operating results during the second quarter, and then focus on our balance sheet, liquidity, development loan portfolio, and financial outlook for 2009. Our second quarter adjusted FFO was $14.4 million or $0.25 per share in unit, as compared to adjusted FFO of $22.1 million or $0.43 per share in unit in the second quarter of last year.

In addition to the operating performance, the adjusted FFO per share comparison was impacted by the issuance of 6.6 million addition common shares, and 2.5 million additional operating partnership units issued in the first half of 2008.

As we've outlined previously, increasing our financial flexibility remains a primary objective, and we are taking steps to enhance our balance sheet and liquidity. During and subsequent to the second quarter, we made some meaningful progress addressing our near term maturities, refinancing existing debt, and selling several non-strategic assets.

Subsequent to the end of the quarter, we sold four non-core properties and used the proceeds to pay down debt. The property sales were part of our strategy to opportunistically recycle capital. We have implemented a plan to explore the sale of certain other non-core brand and assets in locations that we believe have less opportunity for growth in the future.

So far, we have disposed of four properties, including a Mainstay Suites, and a Comfort Inn in Fredrick, Maryland, a Hilton Garden Inn in Gettysburg, Pennsylvania, and a Four Points by Sheraton in Revere, Massachusetts. The Four Points by Sheraton was a joint venture that was going to require significant capital infusion in the near future, and we felt it was a good time to exit this asset.

On a trailing 12-month hotel EBITDA basis, these properties were sold from multiples between 12.3 and 13.8 times. We are pleased that even in this challenging environment, we are able to negotiate deals at favorable multiples, which is further indication that there is a strong market for limited service hotels. The relatively smaller size of many of our assets and stable cash flows make them attractive investment for potential buyers who can access local or regional bank financing to acquire them.

In terms of our outstanding debt, we refinanced two land parcels and two hotels in July. One parcel is located on 8th Avenue in Manhattan, where we reduced the debt from $13.25 million to $12 million, and another parcel is located on Nevins Street in Brooklyn where we've reduced debt from $6.5 million to $6 million. Importantly, not only did we extend the maturity of both of these loans until July 2011, we decreased the interest rate floor on those loans to 6.875%.

We also refinanced a Holiday Inn Express in Hershey, Pennsylvania, and a Fairfield Inn in Laurel, Maryland. We placed a new $6 million mortgage loan on the Holiday Inn Express, and a new $7.35 million mortgage loan on the Fairfield Inn. Both of these mortgages were for terms of five years with fixed-rate financing of 6.5% on each of these assets. Most of these assets were previously pledged as collateral for our revolver, and net loan proceeds of approximately $13 million were utilized to pay down the credit facility to provide additional capacity.

With the completion of these refinancings, we have eliminated all of our remaining 2009 consolidated debt maturities. In 2010, we have approximately $15.3 million maturing, and $18 million in 2011, and we have established plans to address all of these maturities. We have provided some additional disclosure on our recent refinancing activity and pro forma debt maturities in our supplemental schedules.

Regarding our capital expenditures for 2009, we expect our capital investments in the near term to be limited to critical capital maintenance. Due to the young average age of our portfolio, we're able to limit this spending without a measurable impact to the experience of our hotel guests, or the quality of our properties. Through the end of the second quarter, we have spent $3.7 million, and expect to spend between $3 million and $3.5 million for the remainder of 2009. We also currently have approximately $7.6 million in capital expenditure reserves that can be utilized towards these expenditures.

Moving on to our development loan portfolio, we ended the second quarter with approximately $69 million in development loans on 11 hotel projects. This is down from $84 million at the end of the first quarter, as we were successful in executing an equity swap on the outstanding development loan for equity and a newly built Hilton Garden Inn in Tribeca, New York.

We were able to acquire the asset at favorable pricing without significant cash out lays, and simultaneously reduced our development loan exposure from this asset. We also reduced another development loan to $7 million from $10 million as part of this equity swap.

We continue to closely monitor our development loan portfolio and are working with our development partners on an ongoing basis. At this time, approximately 22% of our development loans are on projects that are operational, 47% on projects that are under construction, and 31% are on early stage construction projects.

The Company announced and paid its second quarter common share dividend of $0.05 per share, and our Series A preferred shared of $0.50 per share. Our Board is committed to maintaining a dividend policy that is prudent, but constantly evaluates the Company's capital structure to ensure that it is optimized.

Let me finish with our financial outlook for 2009. Visibility on the demand side of our business remains cloudy and difficult to predict, but we continue to believe that the characteristics of our portfolio should help us as we move through this difficult time.

We are maintaining our previously announced guidance, which assumes that operating conditions remain challenging for the remainder of the year, but also assumes that the overall economy performs better in the second half of the year. We are estimating that RevPAR declines between 14% and 20% in that operating margin deteriorate between 200 basis points and 400 basis points.

This concludes my formal remarks. Now, turn it back to Jay.

Thanks, Ashish. I think at this time I've concluded my remarks as well. We can open the line for questions.

Thank you, Mr. Shah. The question and answer session will be conducted electronically.

(Operator Instructions)

And our first question comes from David Loeb with Baird.

Hi, gentlemen. Good morning. I have a couple for you. On the IRSA investment, can you give us just a little bit more color about why you went with one strategic investor as opposed to doing a secondary offering, and how much control or influence you think they want to exercise over this investment, since they will be, I guess, fully diluted, close to 20% holders?

Sure. As this year has progressed, we've explored several different ways to create liquidity. It was not necessarily -- we were not necessarily in a position to have to need it -- we never had a gun pointed to our head, but we feel just with the uncertainty in the marketplace currently and in the general economy, that it was a good idea to have some liquidity on the balance sheet for unforeseen circumstances.

The way we thought about it was we wanted to be very open to a variety of ways of generating liquidity. We've talked about asset sales, which we pursued to some degree, we talked about refinancings, which we've pursued to free up capacity line of credit, we had watched our peers as they went through the recapitalization process by doing public trades of their stock, and that was something that we were just not all that attracted to at the time.

We found that the terms for raising public equity would have required a recapitalization of the balance sheet by 40% to 70%, and we didn't really have a need for that much capital. We were just trying to build ourselves a cushion to take entity level risk off the table.

We've been in contact with several different private equity firms and joint ventures, we had looked at convertible preferred, and so we've been all across the board on what we've explored. IRSA came to us as an in-bound inquiry. We had originally considered doing the investment as a convertible preferred, and in the end we're pretty pleased to do it as a common stock investment.

The -- as we look forward with IRSA's plans with their holding, I don't believe that they have much interest in exerting control. Eduardo Elsztain is going to be on the Board, and I think that is just because they're a publicly traded company and they want to have some representation. From our standpoint, we were very excited to have him on the Board, because he has a great background and years of experience, and a lot of experience dealing with volatile economic times.

They are going to have a 20% interest, slightly less than that, on a fully diluted basis, but they'll be subject to a standstill that will limit what they can do with their voting position, and we feel pretty comfortable that the interest in that regard will be aligned.

David, I apologize, what was your second question?

That was really both parts of that and I haven't asked my second one yet, but I will now. On the development loans, we noticed that the balances on four of those loans went up. It looks like you're accruing the interest and adding that to the principle on three of the Sam Chang entities and one related party. Can you just give us some color, maybe, Neil -- talk a little bit about the situations behind all four of those hotels and your decision to extend further credit by capitalizing that interest?

Sure, David. This is Ashish. Let me start off on that. The four assets for which we've picked the interest, they all are Manhattan-based projects. The two projects that are well under way are the development loans on the 48th and Lex assets -- 48th and Lexington Avenue, as well as the Union Square assets. Both of those assets at this time have topped off, and Neil can talk a little bit more about the plans for those assets. They're well under way, they're fully financed, and we would look for openings on both of those assets next year.

The other two assets are land parcels that have finished the demolition work or are in demolition at this time -- one's on 52nd Street and the other is on Greenwich Street. So, they're all very noteworthy projects. We continue to work with the developers on all of the projects, but the reality is that the most important thing for us is to make sure that the construction gets completed on these, and we don't want to put undue pressure on the developer when liquidity is so precious right now.

And David, just to give you some color on the projects themselves, the two projects that are under construction today and are expected to open some time in the third or fourth quarter of 2010, are the projects at Union Square and the project at 48th and Lexington. The project at Union Square is currently very close to designing an agreement with a major four-star brand, and the -- as we mentioned, the construction continues at good pace.

So, we are very excited about that project when it opens, and think it'll be an interesting opportunity for us long term. The Lexington Avenue project is, again, also under way, is a -- kind of a four-star all suites property.

The two projects that are -- that haven't started vertical construction at this time, are two very strong opportunities long term, so we're hoping that the -- when the construction financing market returns, they would be the -- among the first projects to get new construction financing.

The one is a high placed project in mid-town East on 52nd Street, between 2nd and 3rd Avenue, and the second is on Greenwich Street, the -- is a courtyard by Marriott at the -- just off of the World Trade Center site, both very high quality, strong projects that we believe have a good strong long term future.

And are there any of the development loans other than what you're working through in Brooklyn that you consider in a work-out phase or that you're -- you have concerns about the viability of the projects?

Not at this time, David. We've looked at all of them. We continue to look at them on an ongoing, and especially on a quarterly basis, and we don't believe that any of them deem impairment at this time.

It looks like all the rest of them are cash-paid and current then, right?

That's correct.

Yes. Okay. One more, if you don't mind. In Host's press release, they announced the sale of three full-service hotels. They're -- including two in first [strings], suburban markets, in areas where you compete -- their price per key was not a whole lot more than what you got for your dispositions. Does the strength of the asset sale market in your segment motivate you to look at selling more assets, other than what you've already done and announced?

David, this is Neil. We do continue to explore other asset sales in markets that we deem non-strategic or non-core. Getting any transaction done in today's environment is a very long process -- six to 12 months I think is what we've been working on in these last few transactions on.

So, absolutely, we continue to explore it. There's just -- we can't kind of count on closures that we can talk about at this time, but we do continue to explore it pretty actively.

Great. That's very helpful. I have more but I'll come back later. Thanks.

And our next question comes from Smedes Rose with KBW.

Hi. Good morning. You mentioned in your prepared remarks that July occupancies, I think you said they were up year-over-year in some markets. Could you talk about rate as well of what you're seeing so far in July?

Sure. Smedes, this is Ashish. I think that for July, we're seeing that the overall trend are that the occupancy declines continue to, I guess, be less worse, as well as the rate declines -- where we were trending sort of in the first quarter closer to the low to mid-20s through January and February, and then some abatement in March.

And then we were in the second quarter sort of in that 17% to 20% range. I think that in July, RevPAR in general seems to be more in the negative 15% to 17% range with sort of a two to one occupancy in the 4% to 5% decline range, and rates kind of in the 10% to 12% range declines.

Okay. And then I just -- you mentioned the property taxes went up. Is that mostly in New York, I guess, that property taxes are going up, or are you seeing that just throughout all your -- the markets that you're operating in?

If we take a look at our same-store portfolio from last year, New York did account for approximately 50% of the property tax increase, and I think that it's -- primarily, it was very difficult to obtain abatements in 2008 because our properties in New York were up, through the first nine months somewhere in the range of 14% to 15% in RevPAR and profitability. We will go back and try to obtain abatements for a large portion of our assets in this year with the overall decline in operating performance.

Smedes, this will give you a little more color on New York City urban property taxes. In the first quarter of '09, we saw real estate taxes increase generally on the consolidated same-store in New York portfolio by about 31.8%. And then in the quarter two of '09, this last quarter, we saw a 45.3% increase in property taxes.

So, it's been -- New York has clearly been the major driver of it, but we're seeing property taxes -- we've seen them move up in other markets as well, and it's just because we had a pretty robust quarters one, two and three last year, and so we're sort of having to re-educate.

Okay.

The appeals process lags kind of performance pretty significantly, and in New York, since it was performing so well until so late makes the appeals process a little bit later.

Okay. Great. Thank you.

(Operator Instructions)

And we'll go next to Will Marks with JMP Securities.

Thanks, and good morning, everyone. I did get on the call very late, and so you probably addressed supply. If you haven't, can you talk about your various markets and what you're seeing in supply growth? If you did, then I'll call you back.

This is Neil. We didn't address supply to date, or until now, so I can do so now.

Great.

Yes, no problem. Generally, I think nationally in most markets around the country, on the average markets around the country, we're seeing 2009 register growth around 3% in supply, and in 2010, most expectations are around, close to just a little bit less than that in the mid-twos. Most of our markets generally fall within that range. The only exception, and where we are probably most focused and concerned is in New York City, which is getting more supply than those national averages.

But again, in the Boston's metro market, the Philadelphia metro market, the DC metro market, in our sub-markets in those locations, we are not feeling any particular concern for new supply.

In New York City, we've, in 2008, we've registered about a 3.4% increase in supply. In -- year-to-date in 2009, we've seen 2,100 hotel rooms open, or about 3.2% new supply year-to-date in New York City. Depending on when these -- when hotels open that are actually currently under construction in between 2009 and 2010, there is clearly the possibility that as much as 10% new supply will come on line in between the years 2009 and 2010.

So, that is kind of where our concern and focus is and kind of affects our operations view of the world. Beyond 2011, 2012 in New York City, we don't expect very much supply at all.

I'd say about the New York City supply, that 40% to 50% of that new supply is in mid-town West. That's a sub-market that HT doesn't have a presence in today. It's most adjacent market, Times Square, is also a market that we don't have a presence in today. That's not -- that doesn't provide perfect cover, because compression will be impacted, but it's not as -- I guess not as much of a concern as it could be.

I think where we see the most impact from this new supply is in when the new hotels open up, low introductory rates make it doubly hard to push rate on our existing portfolio when there's a flood of new hotel rooms with entry kind of rates in the marketplace.

Does that answer your question?

Yes, that's perfect, and taking it a step further, is that -- you gave us the stats on New York in terms of rate and occupancy, and would you say you did see it in the quarter, although it seems like occupancies were fairly firm, but you dropped the rate, did I have that right?

Yes. I think the -- because of the new supply in the market, charging lower rates, lower introductory rates, everyone in the marketplace has to react to that. And so, absolutely, that drives some of the lack of pricing power in Manhattan.

I think there are two things that are driving lack of pricing power in Manhattan. One is new supply, and second is just the lack of corporate transient demand. Unfortunately, the -- kind of the growth channels for Manhattan room nights right now are advanced bookings, Internet channels, and FIT business, and those three happen to be pretty low-rated markets for hotels. So, we are -- we're continuing to work through that.

I'd say that -- I'd kind of put this in perspective, though, a bit by mentioning that of kind of any market in the United States, perhaps globally, I think new York City is a market that can and has absorbed supply in the past, and has found new source of demand as well. I think across the last 20 years, there's only been six kind of negative RevPAR years through that period.

If you look at like the last development cycle in Manhattan that peaked in 2000, there was about the same amount of new supply as what we're forecasting for this cycle. And so, we saw, after the new supply that came on in the last cycle, that we were still able to register very strong RevPAR growth in this cycle.

I can answer anything else as well, if you have --.

No. That's great. I really appreciate it. Thank you.

Not at all.

(Operator Instructions)

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

Hi. Good morning.

Good morning, David.

So, I think most of the operating questions have been discussed, and I am still a bit curious about the equity deal and what this means going forward. Should you decide to do more equity going forward, under what conditions would you look to do that, and would you necessarily go back to this particular shareholder as a source, or should we consider the notion that you'd go into the public markets, and under what -- what would those conditions have to look like?

As we think about our capital needs going forward, we feel reasonably comfortable right now that we don't necessarily have any capital needs for a good while. So, in the immediate term, we're going to focus on asset management, driving performance, and controlling our expenses, and trying to drive rate as best as we can, and we feel that we have a balance sheet now and liquidity situation that gives us that kind of flexibility and cushion to focus on just those things.

As the cycle starts to turn and we start seeing acquisition opportunities that are very attractive, I think if we were to go out looking for equity at that point, we would be limited from issuing any more equity to IRSA as it is without having to do a public offering. So, any additional comments/doc that we issue would be through the public markets, and we'll pursue that when the time is right and it makes sense.

I think, just another way -- David Loeb asked how we should think about the future of this relationship, and I think here in the near term we talked about it. I think it gives us some cushion and it gives us the ability to ride through the storm with alternatives.

I think in the medium and long term, there's very different areas of emphasis for the relationship. As I mentioned earlier, I think in the longer term, when the acquisitions market returns, I think IRSA can play a very attractive role as a joint venture partner, allowing us to leverage the equity that we do have where we would stay in the venture in an asset management capacity as the hotel expert.

As I mentioned earlier, we had done a transaction, not exactly similar, but somewhat similar to this where we took a direct investment into the entity from CNL Hotels and Resorts and then also entered into a joint venture with them for the acquisition of one of our early New York City assets -- an asset that's been extremely successful for our portfolio. We eventually bought CNL out of the transaction.

I think in the medium term, and I think a way to think about the transaction is I think there's some focus on this five-year option. I think it what's very important to note is we were very sensitive to having a five-year option out there, and so we were able to negotiate a provision for a two-year call.

The two-year call, the way it works is in two years from July 31st in 2011, when the stock trades at $5.00 after July 31, 2011 for 20 days, we'll have a right to call the option. And that would mean that either IRSA would have to exercise the option at that time and purchase an additional 5.7 million shares at $3.00, or if they elect not to do that, we can do a cashless exercise.

So, just as a hypothetical, let's say the stock is at $5.00 for 20 days and we've pulled that trigger. So, at that point you'd have an additional $2.00 per share over the option price. So, we would, at that point -- so, for discussion sake it's $11.4 million of benefit that they would realize. We would then issue shares at $5.00 to compensate them for that $11.4 million of benefit. So, we'd be issuing them somewhere less than -- certainly less than half of the 5.7 that we've issued now. And then that option would then be -- would be cancelled.

I think what's most likely to happen is as we go forward and get into the recovery and raise equity to take advantage of the acquisition opportunities and the new cycle, the new up cycle, and we enter it, it's most likely that IRSA will either participate in the public markets to maintain either their percentage/ownership, or to add to their ownership, not necessarily maintaining their 10% interest or 20% interest, as the case will likely be at the time. So, they would just participate in a public offering.

You know, again, the most likely scenario is that they'll recognize some gain, hold the position that they currently have, and then continue to look to do joint ventures with us going forward where they would have a greater IRR potential at that time.

Just to add to that, I think that it's -- as far as the joint venture and the future assets we do with them, it was very attractive to us to have them make an investment into HT to kind of align interest, as well as show a commitment to the venture and to the Company and to the things that we're going to do together.

You often see people go through painstaking negotiations to create a venture and then have very little to show for it a few years later. Here we get the initial benefit of a cash cushion, and they get the benefit of aligned interest as we look at future opportunities together.

Got it. Thank you. That's very helpful.

Sure.

And our next question comes from Bill Crow with Raymond James.

Hi, guys. So, how did you value the option? Take us through the math that you used to value the option.

Bill, this is Ashish. From an options standpoint, first and foremost, we looked at the common share issuance to them as one -- as part of getting this joint venture going, not so much a need or a trepidation on our part.

I'm sorry -- is there a formal joint venture agreement in place, or is this just something that may or may not happen?

Yes, it's something that may or may not happen.

Okay.

That's how we looked at this investment though is from that standpoint -- from a standpoint of the option valuation, we -- I mean we looked -- we ran our traditional set of actuals, models and things like that. We would have to book this when the shares were above $3.00 -- we'd use the treasury stock method to do that, and we'd record the differential between sort of the stock price and $3.00 and add that to our diluted share count.

How did you come up with $3.00?

For the option? It was a 20% premium to the $2.50.

And that was calculated how?

$2.50?

Or, that was something that was just determined was the right number.

Yes, $2.50 was really just slightly higher than the 20-day volume weighted average for the shares.

You're sitting there at ten times the debt to EBITDA and almost $800 million in debt, how does $14 million of proceeds get you to the other side when you're paying out $11 million of dividends a year, including an additional $1 million in dividends that you now have to pay on that 5.7 million shares, when you're not sure what sort of liquidity it created?

Yes, I'm not -- I don't think that if we wanted to get to the other side, if we really felt that there was that type of a risk, I think we would have had to go out and do the large 50% to 100% diluted raise.

Yes. I guess my point is you didn't gain anything in this transaction from a liquidity perspective. $14 million doesn't move the needle at all.

Yes, I don't think it does. I think it gives us a little bit of cushion, but I think it's more that we have a capital partner going forward --.

Talk about the math between selling $14 million of assets and selling what, in effect would be 20% of the Company for an average of $2.75.

Just before the math, Bill, just keep in mind that transacting on assets in today's market is very challenging. We continue to pursue that.

Well, you guys did a great job last quarter, too.

Thank you, and we're going to keep doing that as it makes sense, but we can't count on that for our planning and for kind of calculating our cash cushion. So, although it's -- regardless of the math, but we should go through that, but regardless of the math it's hard to compare though, it's apples to apples, this transaction and the asset sales.

Yes. Sort of the way we looked at it, we had cobbled together in this past quarter and starting in the quarter prior, but when you look at the combination of the sales, the refi, and this capital infusion, we've generated about $36.5 million worth of liquidity.

And again, it's, as you mentioned, it certainly doesn't move the needle for our purposes, however, it's not an insignificant sum and it gives us a very attractive cushion as we move through the year, Bill. And the thought is we never want to be in a position where we're putting any undue risk on the Company, and where we can remove risk from the Company, we want to do it, and this makes sense to us.

You know, the question of whether we reduced dividends instead, I think the dividends are very much a Board issue, and the dividend policy is something that the Board is very firm on, and we as a Company, have been very assertive with the dividend since we became public in also a very difficult time.

But you could have used shares to pay the dividend for essentially $11 million dividend commitments. You could have used the stock and not given up the option value down the line. Is that fair?

Yes. I guess the option value -- I guess that's a fair statement. But, you know the option value, we look at that as currently we're trading at approximately $2.50 to $2.80, in that range in the last couple of days. Our 20-day average was about $2.40-something. The option is priced at a premium to that and when those shares come in, we'll obviously be getting another small slug of capital.

But I think what's going to happen over time is, and as we move into the recovery and start raising equity again, some of the dilution that you see here is probably going to not be as impactful as we start raising equity at higher and higher prices.

One of the things we didn't want to do was raise a whole lot of equity at this number, and so we felt that this was a very right sized capital infusion to give us just the amount of cushion we felt comfortable with that made sense to us going forward. When the price is more right from our standpoint and the market suggests that there is a reason to have even more liquidity on the balance sheet, we'll be raising it at higher numbers, and I think the impact of this transaction will be felt less.

From an earnings dilution standpoint, from an FFO dilution standpoint this is about -- for a full year, it's about 8% from our calculations, it's 3.5%, 3.6% for the remainder of the year and 8% for the full year, and so that's something that we feel that we'll be able to manage into next year, and we felt that it was worth it, the earnings dilution, to have this kind of security.

And again, it was not in response to anything specific, it was just wanting to stay away from -- keeping this Company away from any potential trouble or risks that are associated with the uncertainty we're seeing.

Okay. And let me ask just one operating question, which is on the revenue management front and your decision to actually increase occupancy or maintain occupancy at the expense of a pretty dramatic drop in ADR. It seems to me that there's some fine line there where you want to give up some occupancy, which allows you to cut some of the variable costs and maintain, or at least show lower reductions in ADR. Can you talk about how you're managing revenues from that perspective?

Yes. In New York -- this is what we were talking about earlier, just to put it a different way, we're just finding the demand in New York to be extremely elastic, and at some point, there is a fine line between the trade-off between ADR and occupancy, but in this kind of environment, we're just not getting the ADR no matter, no how.

So, reducing the rate -- reducing the occupancy or driving rate at this point would probably just leave us with a -- with less revenues overall on the top line, but a decent ADR. And I think our RevPAR would overall suffer, and this is something that we've been monitoring on a very, very close basis. But just with the level of discounting we're seeing with the luxury and full-service hotels in the marketplace, there's no question that it puts pressure on our pricing.

And that level of discounting, particularly when so much of the demand is coming through -- right now such a significant portion of the demand is coming through Internet channels and online travel agents and through tour operators who are all familiar with what's going on with the discounting, it's just -- it's been very difficult for us to do it, to be able to drive rate at all.

And the view is is at this rate are we going to -- it's a real trade-off. If we were to -- I don't know that we would give up any more rate than we have already to gain another several percentage points in occupancy, but that is a -- that's sort of a balancing act that we go through on a very regular/weekly basis to make sure our operators are kind of aligned with where we want them to be.

Just to add to that, Bill, we spend a lot of time on this internally. And just to share a little bit of data as we're seeing this year progress, in Manhattan -- in this -- in May and June in Manhattan, ADR was down as a market overall, according to PKF, by 30.4% in May and 32.6% in June.

Our New York City portfolio was down 27.8% in May and 30.6% in June. So, the ADR drops feel very difficult and tough, but we are able to keep it inside of the drops in ADR of the overall market in Manhattan, and that's leading to better RevPARs than -- less RevPAR down in the overall market.

So, it's a tight balancing act. I think in April, we were on the wrong side of that balancing act, and in fact, our ADR slipped -- our RevPAR slipped 100 basis points more than the Manhattan marketplace. But by May and June, we're outpacing the market in RevPAR by 300 basis points or so, and that's a function of our occupancy and rate gain here.

It's -- it feels a lot like 2002, 2003. In the last cycle, as our hotels opened up, we were frustrated by the inability to move rate because the Hilton 20 blocks up was charging very similar rates as we were. But we were able to increase occupancy and kind of eke out some growth with tight margin controls and some new assets and things, but it was always -- it was a tough battle in 2002, 2003 as well.

And then once 2004 hit, there was -- once there was kind of pressure and demand in the market, there was double-digit growth, then you could really start to right size your operating leverage or your occupancy.

Okay. Thank you.

And our final question will be a follow-up from David Loeb with Baird.

Bill just asked one of mine, which was the occupancy rate trade-off and then elasticity. But I had one more briefly, if you could just talk about the cost control and what's coming in the future, how much more room you have for cost reductions, particularly in the face of declining rate. You've done very well at cost control with -- even though most of your RevPAR is coming from rate, but that's got to get harder going forward. Can you just talk about what's left?

Yes. You know, generally speaking, most of these costs -- the cost savings come from, as I had mentioned earlier, payroll benefits, rooms, other expenses, A&G, and sales and marketing. To be quite frank, I don't know that we've got a lot more room to reduce expenses from where we are. I think we might see some marginal improvement and cost containment from here on out. But I think the numbers that we were able to achieve this year are generally going to be where we're going to be in the third quarter.

I think the real challenge is going to be keeping those numbers as close to what we have seen in the second and third quarter, going into the fourth quarter. And there we're going to have the dynamic of hopefully an improving marketplace marginally, but it is going to be seasonally our second to lightest quarter of the year.

And so, generally the demand dynamic in the fourth quarter goes away. But then again, in New York we'll see generally a very strong fourth quarter. So there's lots of different dynamics that are all going to be brought to bear on what our margins look like.

So, we're staying very focused on that, David. I don't have a real clear answer for you on how much more we'll see in the -- how much more cost-cutting we're going to see in the third quarter. I have all of the operating companies that we work with very focused on eking out some more and we'll continue to execute on that, but I don't know how that's going to go.

I think if there's improvement from what we've seen this quarter, it'll probably be marginal. And the real challenge, and already everyone's focused on it, is how to hold these margins as best we can for the fourth quarter.

Right. Yes, clearly it's very hard and that's why I was asking, because clearly, the comps get tougher, too.

Yes.

That's great. Thank you for your candor on all of these subjects.

Sure.

And there are no further questions. I'll turn the call back over to you, Mr. Shah for any additional or closing remarks.

I have no further remarks. I want to thank everyone for being with us this morning and for your continued support. If any questions occur to anyone after the call, we're all available in the office today -- feel free to give us a ring. Thank you.

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation.