Host Hotels and Resorts, Inc. Q3 2009 (Qtr End 09/11/2009) Earnings Call Transcript

Oct.14.09 | About: Host Hotels (HST)

Host Hotels and Resorts, Inc. (NYSE:HST)

Q3 2009 Earnings Call

October 14, 2009 10:00 am ET


Gregory J. Larson – Executive Vice President

W. Edward Walter – President and Chief Executive Officer

Larry K. Harvey – Chief Financial Officer


Joseph Greff – JP Morgan

Mike Selinsky – RBC Capital Markets

Jeffrey Donnelly – Wells Fargo Securities

Chris Woronka – Deutsche Bank Securities

Andrew Whitman – Robert W. Baird

Smedes Rose – Keefe Bruyette & Woods

Steven Kent – Goldman Sachs


Welcome to the Host Hotels and Resorts, Incorporated third quarter earnings conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Executive Vice-President, Mr. Greg Larson. Please go ahead, sir.

Gregory Larson

Thank you. Welcome to the Host Hotels and Resorts third quarter earnings call. Before we begin, I would like to remind everyone that many of the comments made today are considered to be forward-looking statements under federal securities laws. As described in our filings with the SEC these statements are subject to numerous risks and uncertainties that could cause future results to differ from those expressed and we are not obligated to publicly update or revise these forward-looking statements.

Additionally, on today's call we will discuss certain non-GAAP financial information such as FFO, adjusted EBITDA and comparable hotel results. You can find this information together with reconciliations to the most directly comparable GAAP information in today's earnings press release, in our 8-K filed with the SEC and on our website at

This morning, Ed Walter, our President and Chief Executive Officer, will provide a brief overview of our third quarter results and then we will describe the current operating environment as well as the company's outlook for the remainder of 2009. Larry Harvey, our Chief Financial Officer, will then provide greater detail on our third quarter results including regional and market performance. Following their remarks, we will be available to respond to your questions. Now, here's Ed.

W. Edward Walter

Thanks, Greg. Good morning everyone. While the financial results I will discuss shortly reflect the exceptionally challenging operating environment we have been facing, I should note that our performance this quarter exceeded our expectations and we are seeing some favorable trends begin to develop which I will discuss in a few minutes.

Before I get to that, let me first talk about our results for the third quarter. Our comparable hotel rev par for the third quarter decreased 21.3% as a result of a 16.2% decrease in average rate and a decline in occupancy of 4.6 percentage points. Our average rate was $155 per night and our average occupancy was 70%. Food and beverage revenues at comparable hotels decreased 20% for the quarter as banquet business declined as a result of lower food volumes and outlet revenue declined due to lower occupancy and more conservative spending patterns.

Third quarter comparable hotel adjusted operating profit margin decreased 685 basis points and resulted in adjusted EBITDA for the quarter of $139 million. Our FFO per diluted share for the quarter was $0.11. On a year-to-date basis comparable rev par decreased 22.3% and adjusted profit margin declined 560 basis points. Year-to-date adjusted EBITDA was $570 million. Year-to-date FFO per diluted share was $0.33 and that includes a reduction of $0.24 per share related primarily to year-to-date non-cash impairment and interest charges.

While overall demand continues to be weak compared to pre-downturn levels and this weakness is translating into much softer room rates across all segments, we did see several positive trends develop this quarter. Starting with our transient business, for the first time in seven quarters we did not experience a significant decline in transient room nights as the number of room nights sold this quarter matched the prior-year total. Demand in our corporate and special corporate segments fell by just 10% which was the lowest decline in the last five quarters and increases in demand for the lower rate segments fully offset this reduction leading to flat transient occupancy.

The combination of a shift in business to lower rate segments and rate competition across all segments resulted in an average rate decline of 20% which translated to a 20% decline in comparable transient rev par. While the average rate decline is clearly a concern, we were pleased by the improvement in demand on the transient front which we believe was generally driven by improved leisure business in many markets. While it is challenging to analyze the results for the last few weeks because of the shifting impact of the Jewish holidays, so far we have been seeing transient room nights run ahead of last year’s pace in the fourth quarter despite the expected decline in leisure related trends which suggest that corporate demand may be beginning to stabilize.

On the group side, the fallout from the cancellations experienced at the end of last year and the beginning of this year continue to take a toll on group occupancy. Despite better bookings and less than expected attrition on the quarter group room nights still declined by over 15% with the most significant declines concentrated in our higher rated corporate segment. Competitive pricing pressures led to corporate group discounts and short-term group rate concessions and as a result group average room rates fell more than 10% in the quarter leading to a group revenue decrease of approximately 24%.

While our group business does continue to be impacted by the weak economy, there are some indications this aspect of our business is beginning to stabilize. The short-term net group bookings in the quarter for the quarter exceeded the levels obtained in both 2007 and 2008 and on a relative basis the number of overall net room nights booked in the third quarter for 2009 and 2010 improved significantly when compared to our results in the first half of the year. While the booking pace for the fourth quarter continues to trend behind last year’s pace, the booking cycle continues to be very short which offers the potential for additional pick up in the quarter.

As we look into 2010 we are pleased to see that our transient demand is improving albeit at lower rates because we expect that the first sign of better results will ultimately be driven by that segment. Our group booking pace for 2010 is still behind last year’s pace although the decline has moderated from what we had experienced earlier in 2009 and the combination of easier comps and the improving economy suggests that this gap should begin to close.

That said, despite the relative improvement in rev par from the second quarter to the third and our expectation this trend will continue into the fourth quarter we still expect the combination of low occupancy and customers now accustomed to seeking lower prices will mean that rev par will continue to decline during the early months of 2010. As the economy improves, especially on the investment and employment fronts, and demand particularly from our corporate customers begins to recover further, that equation should begin to change. Based on historical trends, occupancy will recover first and then we will see improvements in pricing.

Given that we are currently experiencing record low levels of occupancy, in general we would expect we need to see a meaningful improvement in occupancy before we see pricing strength although ultimately this will be a market by market and even day of the week by day of the week event.

Turning to our balance sheet and capital investment activities, as Larry will discuss in greater detail we were able to continue this quarter to improve the strength and flexibility of our balance sheet as we repaid nearly $570 million in debt and enhanced our investment capabilities by issuing $130 million of common stock through our recently announced continuous equity program.

On the asset sale front, we sold four non-core properties during the quarter three of which we announced on our prior call. In addition to the sale of the Sheraton Stanford, Washington/Dulles Marriott Suites and the Boston Marriott Newton which we mentioned in July we also closed on the sale of the Hanover Marriott in August. The net proceeds of these sales totaled approximately $90 million leading to total asset sales for the year of roughly $200 million. Consistent with our theme over the last several years these hotels were selected for sale because they had less obvious growth prospects compared to the remainder of our portfolio and in some cases required significant capital reinvestment. At this point we do not project any additional dispositions for the remainder of the year.

On the investment front there are a few signs of [involving] markets as publicity around real and potential foreclosures continues to grow. As of yet there is little on the market that we find tempting but we continue to monitor activity and we expect to see deal flow improve in 2010 as the combination of lending debt maturities and depressed operating results create more motivated sellers or inadvertent owners. In fact, looking forward through 2014 there is over $30 billion of hotel CMBS debt that is coming due and although difficult to precisely calculate we think there is over $100 billion of hotel, bank and [license] company debt coming due during that time period.

Given the reductions in cash flow the industry has experienced and the prevalence of higher initial leverage levels on many of these loans, we would expect we would see additional assets begin to enter the market over the course of next year and into 2011. We intend to be opportunistic as market conditions evolve and are optimistic about the future prospects in this arena.

As we have mentioned on previous calls our level of capital spending has declined in 2009 although we have continued to reinvest in our portfolio to assure that our assets are well positioned for the future. One benefit of completing capital projects in this environment is that our construction costs have decreased roughly 8-10% and the business interruption impact is reduced.

For the quarter our capital expenditures totaled $63 million which includes a return on investment and repositioning projects totaling approximately $40 million. This quarter several projects were completed including the 62,000 square foot ballroom with free function space at the Chicago Swissotel and the renovation of nearly 1,500 guest rooms in our Sheraton Boston hotel, San Francisco Marriott at Fisherman’s Wharf and the Westin Tabor Center.

Year-to-date capital expenditures have totaled $255 million including $141 million of return on investment and repositioning projects. We continue to expect our capital spending for the year will total about $340 million.

Now let me spend some time on our outlook for the remainder of the year. Unfortunately our visibility continues to be very limited given the extremely short booking cycle. However, assuming that demand continues to stabilize at current levels and we continue to see pressure on average rate, we would anticipate that our comparable hotel rev par decline would range between 20-22% for the full year which is slightly better than what we had projected in July which reflects our improved operating results this summer.

At these rev par levels we would expect our full-year comparable adjusted margin decline to range between 600-640 basis points leading to a projected adjusted EBITDA range of $760-800 million. This will translate into FFO per share of $0.46 to $0.51 for the full year and that includes $0.25 per share of costs related primarily to non-cash charges for impairment and non-cash interest expense.

As I mentioned earlier, we assume that lodging demand will continue to be weak into the first half of 2010 and our results for the year will depend on the strength and pace of the economic recovery. Due to the current uncertainty surrounding the economic climate, the short booking window and the fact that we are in the initial stages of our property level budgeting process we are not comfortable giving 2010 guidance at this time but will provide more detailed insight into our 2010 expectations during our fourth quarter call in February.

With respect to our common dividend, in September we declared a common dividend of approximately $0.25 per share payable on December 18th, 2009. We will take advantage of the IRS ruling which allows us to pay up to 90% of the dividend in the form of newly issued stock. As a result, we expect that our common dividend will be comprised of a cash distribution of about $0.025 per share with the remainder paid in stock.

Given our perspective on this business, our operating strategy over the next several months will evolve with the market. At the property level we have stressed realistic revenue forecasting and aggressive expense reductions in an effort to maximize our EBITDA and property cash flow. As various markets begin to show signs of stabilization we will look to adjust pricing strategies to maximize revenue. While the current environment is challenging, the longer term fundamentals of our business are improving.

Supply growth has moderated, especially after 2010 and will likely remain at historically low levels for several years which sets the stage for solid rev par growth once demand recovers since the current distressed operating environment should ultimately result in acquisition opportunities that meet our pricing and quality requirements, we are refining our view of key markets and are working hard to prepare to execute efficiently and intelligently as the markets or acquisitions improve.

Thank you. Now let me turn the call over to Larry Harvey, our Chief Financial Officer, who will discuss our operating and financial performance in more detail.

Larry Harvey

Thank you Ed. Let me start by giving you some details on our comparable hotel rev par results. Looking at the portfolio based on property types, our urban hotels performed the best during the third quarter with a rev par decline of 19.6%. Rev par for our airport hotels decreased 23.1% while rev par at our resort conference and suburban hotels fell 24.6%.

Turning to our regional results, the south-central region performed the best with a rev par decline of 7.8%. As expected the out performance was driven by flat rev par for our San Antonio properties and continued strength at the New Orleans Marriott where rev par only fell 4.2%. The San Antonio market benefited from an increase in city-wide activity and the third quarter 2008 lobby renovation at the San Antonio Marriott Riverwalk. The New Orleans Marriott benefited from strong leader business. We expect the New Orleans Marriott to have another good quarter while the San Antonio market will underperform the overall portfolio in the fourth quarter due to a year-over-year drop in city-wide activity.

The D.C. metro region continued to perform better than the overall portfolio with a rev par decline of 10.5%. Our downtown properties benefited from strong government and government related demand as well as solid leader business. We expect the D.C. metro region to continue to outperform on a relative basis in the fourth quarter.

The Atlanta region outperformed the overall portfolio with a rev par decline of 18.1%. The decline was driven by reduced group and city-wide demand. We expect the Atlanta region to underperform the portfolio in the fourth quarter due to lower group and transient demand and a more significant decline in rate.

As we anticipated, the New England region rebounded in the third quarter with a rev par decline of 16.1%, a significant improvement from the 28.7% decline in the second quarter. Had two of our hotels not been under renovation, the results would have been even better. City-wide room nights in Boston were up over 2008 although rates were lower. We expect the New England region to perform much better than the overall portfolio in the fourth quarter due to growth in city-wide room nights compared to last year.

Overall rev par for our Pacific region fell 23.2% for the quarter. However, results varied by market. The Seattle market outperformed the rest of the region with a rev par decline of 17.4% as our hotels were able to induce demand by offering value promotions. As expected, rev par for the San Francisco market declined 26% as the third quarter of 2008 had very strong transient and city-wide demand.

Rev par for our Hawaiian properties decreased 22.9% due to weak transient demand which led to lower rates and reduced leader demand. For the fourth quarter we expect the Hawaiian market to outperform the majority of the Pacific region due to easier comparisons. We expect the San Francisco market to continue to struggle due to weak group and corporate demand and Seattle will also likely underperform due to lower group demand and weaker transient business.

Rev par for the mid-Atlantic region decreased to 27.2% as our New York properties experienced a rev par decline of 29.2% with significant declines in rates. While group demand declined significantly transient demand was strong but at a lower price point as international leisure demand continued to increase throughout the quarter. We expect New York City to continue to struggle in the fourth quarter although we have seen positive signs from short leads with bookings.

The Philadelphia market continued to perform well on a relative basis with a rev par decrease of 17.2% driven by stronger transient and group business. We expect the Philadelphia market to continue to outperform the portfolio due to continued strength in business transient. As expected, the Florida region underperformed in the third quarter with a rev par decline of 25.1%. Our Tampa properties continue to perform well with rev par down 11.3% and occupancy only down slightly.

Rev par for our Miami/Fort Lauderdale properties was down 16.9% as shortening leisure business was induced by discounting rates. Rev par for the Orlando World Center Marriot declined 38.4% as group cancellations were significant in the quarter. In the fourth quarter we expect the Tampa region to continue to outperform; the Miami/Fort Lauderdale region to struggle due to renovations at the Harbor Beach Marriott and the Orlando market to rebound based on improvements in transient and improved demand.

Rev par for the international region which includes our four Canadian hotels, two hotels in Chile and one hotel in Mexico City declined 23.6% for the quarter. However, using constant U.S. dollars rev par declined only 14%. Year-to-date the D.C. Metro region has been our best region with a rev par decline of 4.6% followed by the South/Central region with a rev par decrease of 15.3%; the mid-Atlantic region with a rev par decline of 27.2% and the international region with a rev par decline of 29.4% have been our worst performers. However, using constant U.S. dollars rev par only declined 14.2% for the international region.

For our European joint venture, rev par calculated in constant Euros decreased 18.3% for the quarter. On a relative basis, the three Italian hotels and the Sheraton Warsaw outperformed the rest of the portfolio while a major renovation contributed to the poor performance of the Crown Plaza Amsterdam. On a year-to-date basis, rev par calculated in constant Euros fell 22.8%.

For the third quarter adjusted operating profit margin for our comparable hotels declined 685 basis points. As we have previously discussed, the treatment of the ground rent for the New York Marriott Marquis negatively impacted our margins for 2009. The effect for the third quarter was to reduce margins by 50 basis points. Year-over-year comparisons were less favorable in the third quarter of 2009 as the implementation of our contingency plans increased in the third quarter of 2008.

Our managers continue to actively cut discretionary spending and have been very proactive in implementing new cost saving measures. Profit flow through in the room department was higher than anticipated due to reductions in controlled expenses and improvement in productivity. Food and beverage flow through was also quite good due to reductions in cost and productivity improvement as well despite the fact the revenue decline was driven by the loss of higher margin banquet and audio/visual revenues.

Overall wages and benefits decreased 11.2% and unallocated costs declined by 13.6% for the quarter as hotels reduced management headcount and significantly lowered other controllable costs. Utility costs decreased 17.3% through a combination of lower usage, lower rates and the impact of energy saving capital improvements.

For the quarter real estate taxes were flat while property insurance costs increased by approximately 18%. Year-to-date our comparable adjusted operating profit margins declined 560 basis points.

Looking at the fourth quarter we think comparable hotel adjusted operating profit margins will decline more than we experienced in the rest of the year primarily due to the significant level of fourth quarter 2008 high profit cancellation revenues, the high level of cost contingency measures implemented in the fourth quarter of last year and decline in average rates in 2009. As a result, we expect comparable hotel adjusted profit margin to decrease in a range of 600-640 basis points for full-year 2009. The treatment of the New York Marriott Marquis ground rent and business interruption proceeds received with respect to our New Orleans Marriott in the first quarter of 2008 will reduce our margins by approximately 55 basis points for 2009.

In the third quarter we repaid the $175 million mortgage loan on the San Diego Marina Marriott, $135 million mortgage from the Westin Kierland and the $210 million term loan outstanding under our credit facility. We also repurchased $49 million of our 2007 exchangeable debentures. We have no further debt maturities in 2009 and only $325 million of exchangeable debentures that holders have the right to put to us in 2010.

We finished the quarter with $1 billion in cash and cash equivalents and $600 million of capacity on our credit facility. We have reduced our debt by approximately $570 million since the end of the second quarter. We believe our balance sheet strategy of primarily utilizing unsecured debt has been beneficial as that market has recovered more quickly than the secured debt market and provides greater access to capital and rates have continued to decline.

In addition, as a result of our secured debt repayment in the third quarter we have $1.2 billion of secured debt on 11 properties leaving us with 101 unencumbered assets which could be available as collateral for other secured loans. We continue to evaluate the secured debt market and have recently started to see reductions in mortgage loan pricing and additional availability.

In August we announced the continuous equity offering program which we believe is a cost efficient way to raise equity capital that we intend to utilize for acquisitions and other investments. We issued $130 million of equity at a net price of $10 per share in the quarter. With our substantial cash balance and access to capital we are very comfortable with our liquidity position.

I want to mention one last thing prior to starting the Q&A session. The full-year guidance that Ed discussed in his guidance includes a $0.01 to $0.015 per share reduction for accounting guidance recently proposed by the EITF that would require companies to account for dividends paid in common stock to be included in the weighted average shares calculation for EPS and FFO purposes as of the beginning of the year. Put simply, instead of including the shares distributed to shareholders on our December 18th dividend date, the shares would be included as if they were distributed to shareholders on January 1, 2009 assuming the proposed requirement is ratified by the FAS-B in November.

This completes our prepared remarks. We are now interested in answering any questions you may have.

Question-and-Answer Session


(Operator Instructions) The first question comes from the line of Joseph Greff – JP Morgan.

Joseph Greff – JP Morgan

I have three questions; two are related to occupancy volume and one on CapEx. You mentioned in your earlier comments that occupancy would need to meaningfully improve to get pricing, I presume that is same store pricing, up and it is market by market, geography by geography. Can you maybe talk about are we 200-300 basis points away from getting pricing or 500-600 basis points and particularly with respect to New York we seem to look at New York as a leading indicator market. Another comment on occupancy you also mentioned was the first half of next year you expect demand to be weak. Do we interpret that comment on the first half of 2010 as occupancy down or occupancy up but still well below normalized thresholds or still kind of below on a 2-year basis?

My final question is how are you thinking about 2010 CapEx? What is the minimum level of maintenance CapEx you can get away with do you think?

W. Edward Walter

Let me start with speaking a little bit about occupancy. The question you raised about how much of an occupancy increase do we need to see is an interesting one. As carefully as we have tried to look at it, it really does come down to a market-by-market issue. Markets like New York and probably L.A. and D.C. where in New York we are running 90% right now and in L.A. and D.C. we are running close to 80%, I think there is an opportunity in a market like that as we start to see a little bit of improvement in demand it could fairly quickly translate into some pricing strength. We are not at that point quite yet but we are certainly approaching that. On the other hand if you have a market like Atlanta and Denver where we are running in the 60% range right now you are going to need occupancy to rebuild a lot more before you are going to really see any pricing power.

As you know, it really does happen day by day because where we get pricing power ultimately comes about on the days when we have more demand than we have room. So when you get to that scenario that creates the opportunity to really drive pricing by trying to [raise] it. To talk about my comment relative to 2010 I think the way we were thinking about that on the demand side is we would probably start off, I think we expect a little bit lower occupancies in the beginning of the year in 2010 but I think the bigger issue for 2010 is really rate and rate is really the bigger challenge as we transition from where we are finishing this year and into next year we are concerned that rates are just lower than where they have been.

In the context of describing weak demand at least in the beginning of 2010 that is really more of a rate commentary than anything else. To maybe just speak to that just a bit more I think everybody knows that our business is pretty much tied to what is happening in the economy. We are going to be looking fairly carefully at both employment and corporate investment to try to get a sense of how quickly a recovery might happen. A lot of the consensus projections out there right now seem to be expecting that employment will not pick up until the second half of the year and really show investment at this stage in 2010 as being relatively flat to 2009. Those are some of the factors that lead us to conclude it will probably take until the second half of the year before you start to see some sort of a meaningful rebound in rev par.

I think another factor we look at is the run rate when we think over a 2 year time span of where rev par sits in 2009 compared to 2007 and use that as a proxy for trying to get a sense as to what is going to happen with rev par. Our sense is that the fourth quarter even at the better end of our expectations is going to be running behind where we were in Q1 of this year and consequently it is likely we would expect to see the first part of next year would start off negative compared to this year.

On the other hand, as we look further into the year we all know that supply especially in our segment is moderating. It should come in at roughly 50% of 2009 levels. Some of the themes we discussed in our prepared comments about both transient occupancy stabilizing as well as some signs the group is getting better too offers some hope for the recovery especially in the second half of the year.

The other comment I would make in this area is we mentioned before we thought there was some chance there was business that didn’t happen in 2009 that was postponed because of political issues and [inaudible] rebound in 2010. There is no clear indication yet that is happening but we did get some feedback from a couple of our operators that they are finding they are having conversations with corporate customers around having events that were cancelled in 2009 and having those in 2010. So it will be interesting to see if those materialize.

Switching over to the capital question, we are looking at our capital budget right now for 2010. I think our sense is our spending in 2010 will probably be slightly less than what we are doing in 2009. In fact, we still have the ability to refine that as we get a little bit more clear perspective on what 2010 will look like from an operational perspective.

Our liquidity position is very, very solid as Larry mentioned, especially for our core hotels. I think it is important that we continue to have hotels that are in good physical condition. As I mentioned in my own comments, pricing in this area right now is fairly attractive. To the extent we are comfortable that an expenditure is necessary and that is all we would really be doing next year anyway, to the extent we are comfortable it is a smart expenditure, doing it next year really affords us the ability to do it for less and with less disruption which is why I think ultimately you will see our budget be just slightly less than where this year was.


The next question comes from the line of Mike Selinsky – RBC Capital Markets.

Mike Selinsky – RBC Capital Markets

You talked a good deal about acquisitions and when you expect to begin making them. Can you talk a little bit how pricing is in the market right now, kind of what the expectations are out there among those properties that are on the market? Also where you stand right now with regard to your two funds and when you expect to be making acquisitions in those as well?

W. Edward Walter

There is not a lot of detail on where pricing is right now because frankly not a lot of transactions have happened. I think we made some reference in the last call to the fact the one trend we were seeing is as people become more comfortable that we are either at the bottom or approaching the bottom in terms of operating results you are starting to see Cap rates decline and I think that is happening as a natural progression. As people become more comfortable that we are hitting the bottom you begin to build in the growth you expect to see come in the future into any acquisitions.

If we look at where Cap rates have been on the properties we have sold what we are seeing is the cap rates on the ones we have sold have been in the 7.5-8% range on current year numbers but if you really add in the capital that we felt was necessary for the property you are probably starting to look at cap rates further into the 6-6.5% range. I think as you look across the market and look at different pricing segments you will probably find at the higher end where the damage has been greater cap rates have probably dropped lower than that, again depending upon an individual buyer’s expectation of the future. That is probably a fairly good proxy for where cap rates would be for a typical Marriott or typical Westin hotel.

What was the second part of your question?

Mike Selinsky – RBC Capital Markets

With regards to your [Q] fund, when you expect to begin deploying proceeds and what the opportunities look like both in Europe as well as Asia at this point?

W. Edward Walter

I think in Europe, the Europe market at this point feels a lot like the U.S. and I would say there is even fewer properties in Europe on the market but we are in a wait and see mode there. It wouldn’t surprise me at all if we didn’t deploy capital in Europe next year. In Asia, I think you all know the Asian economies have recovered more quickly than in Western Europe or in the U.S. While we don’t have anything to announce in Asia at this time we are working fairly hard on a number of transactions.

Our focus in Asia, as we have mentioned in the past, is not just on full service but it is also on select service opportunities and our sense of those types of opportunities is they continue to be attractive. Everything, however, it takes a little bit longer to get done than it has in the past so I wouldn’t expect in either case we would be announcing anything this year but at this stage I feel fairly confident we would be announcing at least some investment in Asia next year.


The next question comes from the line of Jeffrey Donnelly – Wells Fargo Securities.

Jeffrey Donnelly – Wells Fargo Securities

If I could go on your earlier response, I am just trying to reconcile your comments on cap rate. Maybe how we should be thinking about distressed asset pricing if and when you do see it. Several of the assets that recently have been back and other private companies handed back are on pace to deliver EBITDA for 2009 that was 60-70% below their peak. Do you think when we see someone such as Host make acquisitions that you will be using sort of those mid, single digit cap rates on those types of trough numbers or is it possible we could actually see assets that are even cash flow negative or much, much lower cap rates? Effectively even some earnings dilutive of any long-term might even be accretive?

W. Edward Walter

I don’t know there would be too many assets I would see us buying where you would look at it where we would be buying negative cash flow. I wouldn’t concretely rule that out because you have to look at the specific circumstances surrounding an acquisition to see if that was merited. If there was a situation with mismanagement or the opportunity to change brands, something like that, that might create a situation where we would make that type of an acquisition. The way we are going to look at acquiring hotels this cycle is going to be pretty similar to the way we have looked at it in the past. That is we will underwrite a 10-year IRR on the asset to try to build in what we think a reasonable growth prospect over the life of that hold period. We are going to look to buy assets that will be at a premium to what we believe our cost of capital is that that time.

Now if we were looking today we would probably be expecting depending upon the market, the quality of the property and things like that for properties that would deliver a return somewhere between 11-13% on an unleveraged IRR basis. If you think about the way that analysis and the way that valuation process works you could end up with, you would love to see properties that were bought in that 7 to 8 to 9 cap range but there may be other opportunities where you end up at a lower cap rate and that was simply because our evaluation of the recovery for those particular assets would be stronger than the assets that might be bought in the 7-9 range.

Jeffrey Donnelly – Wells Fargo Securities

How are lenders right now? I know there is not a tremendous amount of activity but how are lenders looking at mortgage financing on these types of assets? Using an arbitrary example if an asset has $10 million of EBITDA and it sells at three it really couldn’t support that much leverage at the trough versus maybe it would over a typical period of time. So I guess how are you thinking about deploying it and I guess how are lenders offering for that?

W. Edward Walter

I think for us we have typically not bought properties with property specific debt as part of the financing package. We typically have done our acquisitions on an all cash basis and then figured out the leverage either using corporate debt or in some cases secured debt sort of after the fact. I think you raise a good point which is one of the challenges that people that rely on secured debt for acquisitions are going to run into is that secured debt is still pricier than where it was during the last cycle even though those levels are getting a little bit better right now. I think what Larry has generally indicated in the past is it is hard to find leverage that is much above 50% loan to value. Even that value in that context is fairly conservatively underwritten.

So my guess is in the equation you are playing out you would probably see, especially if you get a little bit more price discovery in the market, you should start to see lenders get comfortable with slightly lower cap rates for valuation purposes but those loan to value ratios are still going to be relatively low.

Jeffrey Donnelly – Wells Fargo Securities

Marriott indicated on their call they expected to see owners would see points of operating expense growth going forward. How are you thinking about expense growth in 2010 and beyond now that we are beginning to anniversary the expense cuts? Is there much left to implement particularly as you think demand is going to be rising?

W. Edward Walter

As we progress through each quarter this year we have seen in our results the margin comparisons get more difficult and as a result you have seen the margin deterioration each quarter become a little bit more significant. I think you are right to identify that as you look to both Q4 and into next year that scenario is going to get more challenging because there have been I think tremendous efforts that redesign the way we deliver services and how much that costs at our properties which is why we have been fairly happy with the margin results that we have had given the revenue decline we have experienced.

That challenge, while I think there is still going to be opportunity to do better and take some costs out of the system and obviously there are some costs in a negative revenue environment that will go down such as fee based costs, there is a chance next year that utilities and taxes could be a little bit lower. Again, in the utility case that depends on a lot of external forces. Not everything about expenses next year is necessarily about an increase. Some things could be better.

As we have thought a little bit about next year and we haven’t even started on a property level budget so these comments are incredibly directional because they are not really based on anything specific yet one way we have thought about it is if you go back to the last downturn and you look at the third year of the last downturn that being 2003 our rev par in 2003 was down 4-4.5 points and our margins were down around 300. If you think about what that may mean in a context of 2010 obviously if the rev par number is better than the margin number would have been better. I think there is some sense of guidance one could take from that as an estimate.

Jeffrey Donnelly – Wells Fargo Securities

Do you think that period of time was as applicable because post 9/11 it seems like many operators and owners were very slow to cut costs because 9/11 wasn’t a planned event and its impact, people didn’t understand how long its impact would be felt for. It felt like expenses got cut late in that cycle, not early.

W. Edward Walter

I would agree with you in part although by the time we got to 2003 if you remember the events of 9/11 sort of dwarf everybody’s recollection of what was happening in 2001 but we were already headed to a negative rev par year in 2001 before 9/11. That just exacerbated it. Then at least in the full service sector 2002 was negative and then obviously as we worked our way through the second half of 2002 we had that build up for the Iraq war that was present in everyone’s mind. As we look at what happened in our portfolio back then I think the margin results in 2001 were actually pretty good given the level of decline that we experienced in 2001.

In 2002 we dropped around 5% in rev par and only 200 basis points in margin but as you got to 2003 I think they had pretty much exhausted their options and that is why you saw gross margin performance when actually a slightly better rev par decline. I think it is not perfect and there are a lot of factors that changed from market to market or year to year but I don’t think it is at least a place to start in terms of evaluating what might happen next year.


The next question comes from the line of Chris Woronka – Deutsche Bank Securities.

Chris Woronka – Deutsche Bank Securities

I was hoping you could talk a little bit about we have heard some of the operators as they have gone back and tried to get group contracts finalized. Instead of additional rate cuts I think there has been a lot of talk of them throwing in some incremental items, ABC, parking, breakfast, things like that. How should we think about that impacting? Is that a meaningful impact on margins next year? I would have to think it is optimal to cutting rates, but how do we think about that? Is that even a blip on the radar or is it too insignificant?

W. Edward Walter

I wouldn’t call it a blip on the radar because I think you are right in that has been happening to some degree with a variety of our different customers. Obviously it trends a little bit differently in different markets. I think it is hard to separate that effect out from the other issues. That may be one of the reasons you may see food and beverage revenues decline a bit more than what one might expect but I think you can kind of see that being captured in the overall margin results that are being delivered right now.


The next question comes from the line of Andrew Whitman – Robert W. Baird.

Andrew Whitman – Robert W. Baird

I wanted to focus back in on the acquisition market and take a little bit different approach. I think we would agree as you look at the numbers of CMBS maturities, other bank debt and insurance debt maturities that the opportunities for distressed acquisitions is out there. I guess I wanted to get some color. Practically are you gaining any confidence with what lenders or special servicers are actually doing in the market place that suggests they are going to take action and not just delay and pray as the industry terminology goes today?

W. Edward Walter

That is a great question. I would say right now the answer to that is relatively muddled. You are right, a lot of special servicers or lenders right now in part because they don’t have either confidence on the ability to exit if they take a property back or are concerned about the loss or the mark they might take if they act now, are in many cases sort of kicking the can down the road and wait and see what happens.

Now in order for that to happen though the general theme we hear is that generally requires that the borrower is prepared to continue to cover debt service. In a sense if they are in a scenario where there is no real pain associated with taking action on the property then they are prepared to wait a little while.

On the other hand obviously there have been a number of highly publicized instances of this. There are other scenarios where the owner is taking a look at funding a negative cash flow situation in order to cover debt services. In those sorts of situations if they are not prepared to fund I think we have begun to see lenders take stronger steps. It still takes awhile even in those situations for an asset to work its way through the process and I think that is why you haven’t seen too many properties come to market.

Our sense is as we get a little bit further into next year and into 2011 as the shortfall to refinancing becomes a little bit more apparent and at some point as it starts to become more expensive for a borrower to subsidize a property where they don’t see a good outcome, you will probably start to see activity begin to accelerate. I think will every property that is struggling right now on the market? Certainly not. A lot of these deals are going to get worked out in some other fashion. There still is a lot of property that is over-leveraged that are ultimately going to work their way to the market. I think we will have an opportunity as a result of that to make some good acquisitions.

The other thing I would add by the way is that while it is sort of exciting to talk about distressed acquisitions and everything else the reality is there will be other properties that will come to market outside of just that environment. We may see more activity initially flow from that but as the environment becomes a little bit better you are still going to see some acquisitions and dispositions that are happening in some ways for the same reasons ours were. We were not a distressed seller. We did not need the capital but what we were making is a judgment that in the long run those assets did not belong in our portfolio and we saw a better use for that capital.

I think you will also see that happening with other people who are transitioning their business in some fashion and may see a better place to invest capital in which case they are a seller even if they are not under distress. So that is another area where acquisitions may come from.

Andrew Whitman – Robert W. Baird

To keep going on that one a little bit, could you just talk a little bit about the nature of the buyers of those assets? Are we still seeing all equity buyers with plans to refinance later? Is that foreign money? Domestic money? High net worth? Just give us a little bit of a feel about some of the buyers on your assets.

W. Edward Walter

In our transactions it has generally been domestic buyers and my sense is that they had the cash available to complete the acquisition and then they were planning on levering up at some point after that. I think some of the other transactions I am aware of involved some foreign money and some of that comes from Asia. I don’t know that you have seen a huge influx of foreign money that has actually closed on transactions. I think they are obviously in a little bit better of a position than some of the U.S. buyers from a capital perspective which is probably why they are looking here.


The next question comes from the line of Smedes Rose – Keefe Bruyette & Woods.

Smedes Rose – Keefe Bruyette & Woods

You mentioned that in the quarter for the quarter group bookings in New York picked up. I wasn’t sure if it was for the third quarter or fourth quarter and I just wonder if you could talk a little bit more about the makeup of those group bookings. Is it your traditional sort of customers that are just having shorter lead times or is it coming from new areas? What is behind that?

W. Edward Walter

I don’t think…I know I said in our comments we saw an increase in the quarter for the quarter bookings. We didn’t necessarily attribute that to New York. My comment on New York was more about the fact that the occupancies in New York are fairly strong.

I would say in terms of where the customers have come from, the bulk of the business was probably more in the discount category than anywhere else. There certainly were some bookings that happened on the corporate side but by and large those bookings were dwarfed by the overall decline we experienced in corporate business. That has been the weakest segment in the corporate group side. Where we saw a relative uptick appears to be more in the discount area which probably isn’t surprising given the environment.

Smedes Rose – Keefe Bruyette & Woods

It looks like the guidance for the corporate expense line item went up by about $10 million for the year. Was there anything specifically behind that?

Larry Harvey

The bulk of it is basically our stock compensation getting back to more normalized levels.

Smedes Rose – Keefe Bruyette & Woods

On the disposition front are there still more non-core assets that you would like to sell in the near-term or are you kind of done for now?

W. Edward Walter

There certainly are over the next 2-3 years a number of additional non-core assets that we would look to sell. Our sense is that we probably would not be that active over the next 12 months. We never rule out there might be something that happens on an opportunistic basis where there is a buyer that finds some additional sources of cash and we can facilitate a deal because of that. By and large at least as we think about 2010 right now I would expect that our disposition pace would probably be a bit lower than what we saw this year.


The next question comes from the line of Steven Kent – Goldman Sachs.

Steven Kent – Goldman Sachs

Just to go back to the question I think two ago about essentially inadvertent owners I don’t think I have heard you talk about since Chris and Terry were running the company. That was different. That was the RTC and others. I just want to understand the logistics of how quickly you can buy something. The other thing I always struggle with your company is you are inherently net buyers. If you look out over two years are you going to be bigger or the same size or smaller? Because I guess there is also an opportunity for you to start to sell some of the assets.

W. Edward Walter

Answering the second question first, I think you are right. Ultimately over time we have been a net buyer. I would say looking out over the next few years I would expect that will happen again. I think that we are in a good position from a capital perspective and from a management infrastructure position to be able to take on more assets and create value through those acquisitions. While I would project as we think about the next several years we would probably see an additional sales velocity to what we did over the last 7-9 years I still think over time we will have grown in terms of size and we will be a net buyer.

On the inadvertent owner side, I am thinking a little bit more how that process works. It is interesting that I would guess this time around it is going to be a lot more complex than what we faced in the 90’s. That is because in a number of transactions there are so many different layers of debt that you have to work through with the different players of debt in order to actually get to an ultimate resolution.

An example of that might be the infamous St. Regis at Monarch Beach where I think at this point as I understand it there has been one level of a foreclosure where Citi Bank has stepped in and taken control of the asset and now they are trying to decide what they are going to do. Below them there is both a senior piece of debt and a junior piece of debt and Citi was the mezzanine piece of debt. So it is depending upon where value on that asset ultimately falls out. You could have to work your way through a couple of different foreclosures and proceedings before you actually get to an entity who could be a seller.

I do think at the end of the day whether it is through that course of steps, whether it is a special servicer ultimately selling an asset or it is a traditional commercial bank lender who ends up with the title to the property we are going to find different than what we found say after the 2001 to 2003 downturn, we are going to find more financial entities or institutions that are owning hotels that don’t want to and they will end up having to be a seller of those.


Ladies and gentlemen at this time that is all the time we do have for your questions today. I would now like to turn the conference over to W. Edward Walter for closing remarks.

W. Edward Walter

Thank you everybody for joining us on this call today. We appreciate the opportunity to discuss our third quarter results and outlook with you and look forward to talking with you following the close of 2009 with more detailed insight into 2010. Have a good remainder of the week and do us all a favor; travel a little bit this winter. We could use it. Thanks everybody.


That concludes today’s conference call. We thank you for your participation.

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