LaSalle Hotel Properties' (LHO) CEO Mike Barnello on Q2 2016 Results - Earnings Call Transcript

| About: LaSalle Hotel (LHO)

LaSalle Hotel Properties (NYSE:LHO)

Q2 2016 Earnings Conference Call

July 21, 2016, 11:00 ET

Executives

Max Leinweber - Director, Finance

Mike Barnello - President & CEO

Ken Fuller - EVP, CFO, Secretary & Treasurer

Analysts

Jeff Donnelly - Wells Fargo Securities

Shaun Kelley - Bank of America Merrill Lynch

Smedes Rose - Citigroup

Lukas Hartwich - Green Street Advisors

Wes Golladay - RBC Capital Markets

Thomas Allen - Morgan Stanley

Bill Crow - Raymond James

Rich Hightower - Evercore ISI

Chris Woronka - Deutsche Bank

Anthony Powell - Barclays Capital

Ryan Meliker - Canaccord Genuity

Michael Bellisario - Robert W. Baird

Operator

Welcome to the LHO Second Quarter 2016 Earnings Call. At this time I would like to turn the conference over to Max Leinweber, Director of Finance. Please go ahead.

Max Leinweber

Thank you, Nicole. Good morning, everyone and welcome to the second quarter 2016 earnings call and webcast for LaSalle Hotel Properties. I'm here today with Mike Barnello, our President and CEO and Ken Fuller, our CFO. Mike will discuss our second quarter results and activities and provide an overview of the industry. Ken will provide details on our portfolio performance and an update on our balance sheet. Then we will open the call for Q&A.

Before we start, please take note of the following. Any statements that we make today about future results and performance or plans and objectives are forward-looking statements. Actual results may differ as a result of factors, risks and uncertainties over which the Company may have no control.

Factors that may cause actual results to differ materially are discussed in the Company's 10-K, quarterly reports and in other reports filed with the SEC. The Company disclaims any obligation or undertaking to update or revise any forward-looking statements. Our SEC reports as well as our press releases are available at our website, LaSalleHotels.com. Our most recent 8-K and yesterday's press release include reconciliations of non-GAAP measures to the most comparable GAAP measures.

With that, I'll turn the call over to Mike Barnello. Mike?

Mike Barnello

Thanks, Max and thanks, everyone, for joining our second quarter call. I'd like to start by providing an overview of our performance and activities during the last quarter. During Q2 we had another quarter of stellar operating efficiencies which, with the moderate year-over-year improvement in our portfolio's RevPAR, resulted in increases in hotel EBITDA, adjusted EBITDA and FFO per share. Furthermore, we were active in both the capital markets and the asset transaction market. The transactions we facilitated leave our Company stronger and more flexible including the asset sales which we closed in July. The quarter is reflective of solid execution on all fronts.

I'll speak for a moment about our asset dispositions. First, let's review the Indianapolis Marriott which was an excellent long term investment for us. Over 12 years, this asset provided an average cash-on-cash return of 12% and an unleveraged IRR of 14%. Had we not sold the hotel, we were planning on a $40 million lifecycle renovation which would've been a large additional investment into a noncore market. Including this $40 million of CapEx, this sale represents a 7.9 cap rate on trailing NOI or an 11.3 EBITDA multiple, both of which are very compelling valuation metrics for a noncore market with one of the lowest average RevPARs in our portfolio. In fact, after removing the Indianapolis Marriott from 2015 results, our pro forma RevPAR increases by approximately $4.00.

The second asset sale is the $80 million mezzanine loan on Shutters and Casa which we sold at par. As with the Indianapolis Marriott, this was a noncore investment, yet it provided a solid return over the past year. The sale is a testimony to the quality of the Shutters and Casa assets. Despite current mezzanine pricing several hundred basis points more attractive than the current yield, we were able to sell the loan at par. In addition, as I mentioned earlier, we were active and opportunistic in the capital markets and were able to execute the sale of $150 million of preferred stock at 6.3%, the lowest preferred coupon ever achieved for a lodging REIT.

These transactions leave our balance sheet stronger today, with lower leverage and greater cash available to continue to be opportunistic going forward. Now that we've had a chance to review these great transactions, I want to go back to the fundamentals of LaSalle DNA and recap how our asset managers and operators have continued to push EBITDA and margins. Our consistently best-in-class hotel EBITDA margin rose again to an outstanding 38.6% and expanded by 31 basis points.

The second quarter margin was a new record for LaSalle. One of the biggest contributors to the success was the continued improvement in the food and beverage department due to a variety of initiatives we have implemented over the last 18 months. Another bright spot was energy which decreased approximately 4% per occupied room. This savings resulted from a combination of reduced consumption and a strategic staggering of our utility contracts. We and our teams continue to relentlessly pursue opportunities to operate efficiently while delivering a great product and experience to the guests at our hotels and these efforts are reflected in our standout margins.

Turning to capital, we invested $21 million in our portfolio during the quarter in primarily maintenance-related expenditures. As a result of fewer planned renovations at the end of 2016 and the sale of the Indianapolis Marriott, we're lowering our 2016 anticipated capital expenditures to be between $110 million and $130 million, from $130 million to $170 million previously. Now that we've had an opportunity to recap our activities in the second quarter, we'd like to widen our lens and offer our perspective on current market conditions in the lodging industry.

As many expected, the second quarter was positively impacted by more citywides and the Easter shift. April was the strongest month of the quarter, with 3.7% demand growth contributing to 5% RevPAR growth, largely on the heels of the Easter shift. The next two months were softer, with demand growth of 1.1% in May and 1.9% in June. Total quarter RevPAR growth was 3.5%. The softer overall demand trend against increasing supply keeps us cautious on the industry fundamentals. With that said, we'd like to spend a few minutes updating you on the components of demand as we see it, as well as how those components interact with our performance. First is group.

There has not been a material change in our citywide demand by market since we updated you in April, as most of that business was already booked before the year started. As mentioned before, citywides are up in all of our markets this year, except in Chicago and Seattle. Specifically, citywides across our markets are up in the first three quarters of the year and are essentially flat in the fourth quarter. Regarding LaSalle's group performance, our second quarter group RevPAR was up approximately 4%, driven mostly by occupancy. We noted on our call in April that our overall group pace for 2016 had improved slightly compared to previous quarters, as it was up approximately 4% for the full year.

Since April, our full-year group pace has again softened a bit and is now at 3%. Our group on the books for the balance of the year is ahead of pace by 5% which is heavily skewed towards Q3. As a reminder, our business is approximately 26% group and 74% transient. The next piece of demand is corporate. For the S&P 500, revenues and profits are estimated to decline again in the second quarter which will mark the sixth consecutive quarter of revenue declines and fifth consecutive quarter of earnings declines. The current estimate for Q2 earnings declines is negative 5%, but the prognosticators expect earnings will turn positive in the third quarter and continue into the fourth quarter.

We noted on our call in April how inaccurate these estimates have been for the last nine years, so we're pleasantly surprised to see this corporate profit slide end. If corp profits were to turn positive for a few quarters in a row, we expect that may help ease some of the weakness we have been experiencing from corporate demand. Yet again we saw our corporate negotiated room nights decline by approximately 5% in the second quarter. Corporate ADR was up by 2.5%, but it was not enough to avoid a drop in revenue in the corporate segment. For reference, the corporate transient segment averages between 10% and 14% of our overall demand in any given year. However, that only includes the guests who book using the company's negotiated rate code. We do know the pool of corporate guests is actually much larger, especially Sunday through Thursday, but we aren't able to track other guests who are traveling without a corporate negotiated rate.

As with corporate, the data behind our international demand is inexact, given the lack of booking source info from many of the OTAs. That said, our data shows international demand was actually up again by approximately 9% during the second quarter which was an increase of about 9,000 room nights. This is the second consecutive quarter of an increase in international room rates after a steady decrease in the category all throughout 2015. Similar to the first quarter of 2016, the majority of this increase year-over-year is coming from Park Central New York. Looking at our transient segment overall, we're pleased that this segment of demand is growing relative to last year, although we're concerned about how quickly the tide can change.

Our transient RevPAR in the second quarter was up approximately 1%, with an increase in occupancy partially offset by a rate decrease. Visibility continues to be limited on the transient side. In order to give you a sense of how short the transient booking window is and how quickly the pace can change, let's look back at our transient pace from February and April. In February, our overall transient revenue pace for Q2 was up 11%. In April, our Q2 transient revenue pace was 7% ahead and then it faded to finish just under 1% ahead of last year. It's with that backdrop that we provide our transient pace figures for the balance of the year. Transient pace is ahead by 9% which is entirely driven by increased room nights. Unlike the group pace, this transient increase is heavily skewed toward the fourth quarter which we know will continue to move as we get closer to the booking window. When we look at the economic indicators we track, we get mixed signals.

On the positive side, some of the economic indicators we track were generally strong. The two more positive indicators were unemployment and enplanement. Unemployment remained steady just below 5% and enplanements were also steady, with planned capacity increases in 2016 from several carriers. In some cases, the planned capacity increases for the third quarter have contracted during the last month, but they still remain positive for the year. However, recent earnings releases by the major airlines have cautioned about slowing results in the second half of the year and have specifically referenced corporate international business as a worry. On the more positive side, consumer confidence remains at a similarly high level as it was at the end of 2015.

As previously mentioned, corporate profits have continued to disappoint and GDP estimates have also been on the less encouraging side. When we look at the GDP estimates, as with the S&P 500 estimates, they have continued to weaken. Consensus for 2016 GDP growth at the beginning of 2015 was 2.8% which had dropped to 2.5% at the beginning of this year, dropped further to 2% in April and now sits at 1.9%. Additionally, last month the IMF reduced its estimate for the U.S. growth in 2016 from 2.4% to 2.2%. GDP remains a tough indicator to predict. Q2 GDP appears to be better than Q1, as many had suspected and estimates for Q3 and Q4 remain stable. We will continue to watch this trend closely, as GDP growth has an impact on RevPAR growth. Switching gears from the macro economy, I'd like to give you an update on short term rentals or as commonly misrepresented as the sharing economy.

We're encouraged by the regulatory progress state and city legislators have made in several major cities since April. New York City, San Francisco, Chicago and Anaheim have all made movement toward legislation that helps restrict use and enforce laws against short term rentals, including opposing daily finds. We believe this progress will spread to other cities and eventually will reach a stabilization point between the lodging industry and short term rentals. We applaud the AH&LA as well as its many partner organizations in their hard work on this important issue.

Now I'd like to officially welcome Ken to LaSalle. Ken will provide some details about our second quarter performance and an update on our balance sheet. Ken?

Ken Fuller

Thanks, Mike and good morning, everyone. As Mike articulated, our performance during the quarter was solid given the operating environment and led to growth in several measures. In addition to our asset management team's outstanding job, enabling us to continue to increase hotel EBITDA, corporate adjusted EBITDA and adjusted FFO per share, our other activities extended our track record of careful stewardship of the balance sheet and the Company. I'll start by recapping our operational performance. While RevPAR increased 1.7%, our room revenue increased slightly more than that due to keys we added at Gild Hall in a value-enhancing project in which we developed these four rooms well below replacement cost in New York.

Our top-performing markets during the quarter in terms of RevPAR were Los Angeles and Key West, with increases of 17% and 8%, respectively. Within those markets, the best results were at Grafton, Amarano, Le Parc, Le Montrose and The Marker Key West. As with the first quarter, during Q2 LA benefited from strong entertainment demand and renovation ramp-up at the Grafton and also continued impact from the unfortunate natural gas leak that occurred in Porter Ranch which displaced thousands of families. Our strength in Key West was specific to the revenue management strategy at our two hotels, as we significantly outperformed the market. Outside of LA and Key West, our highest RevPAR growth came from Indy, Serrano and Palomar.

Our portfolio-wide RevPAR growth came from occupancy which further highlights the accomplishment of our asset management team and operators in achieving additional margin expansion to a new record of 38.6%. Our top-performing hotels this quarter in terms of EBITDA margin improvement were the Grafton on Sunset and Le Parc, both of which are in West Hollywood; Amarano which is in Burbank; Villa Florence in San Francisco; and The Marker in Key West. As a result of these efforts, our hotel EBITDA and our adjusted EBITDA both improved by $5 million. Our adjusted FFO per share grew 4% to $0.95.

Now I'll provide some additional color on our transactions. During the quarter, we issued 6 million Series A preferred shares for $150 million in proceeds. These shares were priced with a 6.3% coupon and we're proud that this marks the lowest-ever coupon issued by a lodging REIT. In addition to record pricing, we were able to use the full proceeds to reduce the amount outstanding on our line of credit. Mike provided an overview of our sale of the Indy Marriott which sold on July 14.

Furthermore, in our earnings release yesterday we included a table which provides the operating statistics for the Indianapolis Marriott including the property's trailing four quarter RevPAR of just $125, well below that of our portfolio average. With that sale and the sale of the mezz loan on Shutters and Casa, we have lowered our leverage level. Pro forma for the sale of the Indy Marriott and the mezz loan, we had total debt outstanding of $1.1 billion. Total debt to trailing 12 month corporate EBITDA, as defined in our senior unsecured credit facility, was 2.9 times which does not include our full cash balance per our covenants. After including $98 million of pro forma cash on hand, our pro forma debt-to-EBITDA would actually be 2.7 times, further demonstrating our focus on the maintenance of a top-tier balance sheet. In addition, we finished the quarter with substantial fixed charge coverage of 5.6 times. Furthermore, our maturities are well staggered.

Our next meaningful maturity is not until 2019 and the majority of our debt matures beyond that, in 2021. We have substantial flexibility, with 44 of our 46 hotels unencumbered by debt. In addition, with nearly $775 million of capacity available on our lines of credit and pro forma cash of nearly $100 million, we have a highly liquid balance sheet, are well positioned to fund our capital needs and to capitalize on opportunities to execute transactions that will benefit our shareholders as they arise.

That completes our prepared remarks and Mike and I would now be happy to answer any questions you may have. Nicole?

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Jeff Donnelly from Wells Fargo.

Jeff Donnelly

Actually I had two questions pertaining to margins. The first question, Mike, I guess in prior downturns management teams have tended to phase in their cost reductions in response to the severity of the weakness they were seeing. And since you seem to have had maybe a more negative view on the outlook than peers, have you enacted those more drastic cost strategies already?

Mike Barnello

No, not really. I think that the thing that we have been trying to articulate to folks for the last couple years is there's a distinction between efficiencies and cost cutting. And we've been really proud of the way our asset management teams and our operators have been very effective in finding more and more efficiencies. So that's what's been going on. If you look at the biggest part of the beat in Q2 in terms of margins, it was F&B. And as you remember, we've been talking about that for the better part of two years, where we've looked at substantially restructuring how F&B works. So we're trying to make sure that the guest gets what they want, happy, but at the same time we become more efficient. And it's a lot of little things, Jeff. As you might imagine, with nearly 50 properties we're not able to do all of those things at a moment's notice.

So it's taken quite a while to actually put a lot of those in place. That's the biggest example, but there are examples elsewhere. So the big story right now is efficiencies. If things get to the point where we're actually experiencing a recessionary environment, like the prior downturns we've seen, then cost-cutting could be put in place. Obviously, we did a lot of those things the last couple of downturns and we're prepared to do that, but those tougher decisions have not been made yet.

Jeff Donnelly

And that dovetails well, I guess, into my next question, because it's one we hear a lot from investors. And that is, do you think the potential for cost savings in that scenario has been reduced by the fact that because of your best practices over the last few years, in effect, you've got less, I'll call it fat on the bone today than compared to prior cycles and so there's a diminished ability to hold margin than you've seen in the past?

Mike Barnello

Well, certainly no one knows and it does depend on the severity of the downturn you're referring to, but I will say this. We had the highest margins in 2008. We didn't know what we were going into, into 2009, until we went through it. And having been here at the time, we did not think [indiscernible]. Wow, there's a lot of fat on the bone; I can't wait for a downturn to go trim it. We thought we were operating pretty well. And so I would say a similar thing now is that necessity was the mother of invention in 2009 and depending on the severity of what happens in a downturn we're very confident that our folks will be able to do the right things to be efficient and get rid of potential waste.

Things do build up at all properties over the course of time. I'd like to tell you that we have a bunch of properties running perfectly and I don't think that's honest. There's always things that could be done a little better. If we get into a period of extended slump, then we'll make those changes. So I think that we'll be able to make changes. Will it be exactly the same magnitude of what happened 2008 and 2009? Don't know. But of course it depends on what happens recession-wise, if it looks like 2009. Remember, that was a drop industry-wide of 17% and that's pretty severe.

Jeff Donnelly

Right. Actually just one last question. You mentioned that you had some strength in the international demand segment. It was fairly weak last year when the dollar was strengthening pretty dramatically. It seems to continue a little bit. I was just curious. Do you feel like some of the strengthening you're seeing this here is really just recovering, if you will, from last year's softness? Or you think its true growth maybe over like a two-year period? I don't know if you have that data.

Mike Barnello

It's a tough question to answer, because that's not the greatest data that we collect. And we don't have a lot of other data from other industries, so we look at our portfolio. Your suspicion is probably right. There was a huge strengthening of the dollar between the second half of 2014, throughout 2015. That then made things much more expensive. We saw a big drop-off.

So between lapping that comparison, between stabilization of the dollar, between other people deciding to get back to work and coming to the U.S. and the fact that we're actually, I think, getting better and better at collecting the data, I think all those things go into it. But I don't have one particular answer to give you. I think the good news from our perspective is as we get better and the OTAs are better at sharing the data, we will have better and better information quarter to quarter, but in our minds, up is up. So we feel pretty good about that.

Operator

And we will take our next question from Shaun Kelley from Bank of America.

Shaun Kelley

Ken, I think in your remarks you mentioned a little bit about the flexibility of everything you have going on, on the balance sheet side. And maybe it was just the way you phrased it -- but it almost sounded like it could be the possibility of dusting off opportunities on the acquisition front. Could you just let us know where you think the asset sale markets stand right now, in terms of bid-ask spreads and opportunity that you guys may be seeing out there? Is there any chance we could actually see something starting to come to fruition?

Mike Barnello

On the acquisition front, we still get packages for what's available. I would think that it's fairly unlikely that we're doing something on the acquisition front. I never say never, but where the trends have gone and what we've been updating you guys for the past five quarters and even this quarter, we're continuing to see things decelerate in terms of demand.

Supply is upticking and pricing hasn't actually come down on the transactions that have happened. So given the potential alternatives to an asset sale, it's hard for us to think that there would be acquisitions on the immediate horizon. Down the road, who knows? But I just don't think that that's probably the best use of our capital at this point.

Shaun Kelley

And, Mike, then to follow up, would you want to see similar stabilization to step in and maybe put a little bit of the buyback to work? Or how are you thinking about that right now?

Mike Barnello

The thing that we've said about buybacks is that we do have an authorization. We've been looking for two forms of stabilization. The first is what goes on with the stock. Obviously putting ourselves in the shareholders' position in terms of potentially buying some stock back. You've seen some of that. There's been somewhat of a band over the better part of the year and there have clearly been ups and downs, but it's tightened. What we haven't seen is the second piece which is stabilization on the fundamentals.

We've noted in the past couple calls that we have seen RevPAR continue to decelerate. And while it did tick up in Q2, it was largely expected and it's pretty much on the heels of Easter. In fact, if Easter was a couple of days different and fell into Q1, effectively you'd see seven straight quarters of decelerating RevPAR. So when you look at the RevPAR and demand on a trailing 12-month basis and you smooth that out, look month-to-month, you see that continue to decelerate.

So when we think about that relative to buybacks and where we're going to end up, we'd just like to see some bottoming of that and perhaps an uptick before we would do something capitalized. And that likely includes anything we do optionality-wise, right? Whether it's buy back stock, whether it's buy an asset, etc.

Shaun Kelley

Last thing for me would be just a quick update on supply in some of your markets. We started to hear I think at NYU and at NAREIT some discussion of maybe construction lending pulling back towards probably broader CRE, but specifically probably on hotels maybe sometime in the -- probably doesn't impact anything between now and 2019. But just anything you're seeing that's changing one way or the other, positive or negative, on the supply in your major CBDs from what you've laid out previously?

Mike Barnello

Shaun, what we're seeing is -- you're pretty well versed on what's going on supply-wise in 2016. In 2017, that supply story continues to not only grow but actually accelerate from the level that it's experiencing in 2016 in most of our markets. As we look further into 2018, 2019, a lot of our markets have big numbers for supply. So we think about it from two perspectives, have we heard of any projects being canceled? And we haven't, doesn't mean that they are potentially in a slow planning situation, but we have not heard of deals actually getting canceled.

We've heard anecdotally that it is tougher to get deals done that have not been announced. But as far as us looking at our supply study and taking deals off of that supply study for any of our markets, we have not seen that. So hopefully it does moderate; but we're very concerned about the pace of supply not just this year, but 2017 and 2018 also look like there's a lot of supply in most of our markets.

Operator

And our next question comes from Smedes Rose from Citi.

Smedes Rose

I just wanted to go back to a question on margin. It looks like in the quarter your occupancy went up and rate went down slightly. I was just wondering. As the pace of RevPAR overall looks like it continues to slow or to be very modest gains, would you consider pushing rate at the expense of occupancy in order to maintain or drive incremental margin? Would that be a strategy to help--?

Mike Barnello

We're trying to get the rate wherever we can. What I would tell you is that there's a lot of places where the compression has not been as strong as we'd like. And a lot of our operators, despite their great efforts, are just not having the pricing power that we would want or expect. So we're trying. We've mentioned before -- a heads and beds strategy, that doesn't mean it's heads and beds only. We don't give away the rate.

So we're trying to do both and we're trying to group up where we can. It's just been a more competitive environment. That combined with the fact that we mentioned earlier, corporate hasn't been as strong and that's a very high rate segment for us. So if that moderates, it's tougher to make it up on the other segments. The other thing we're seeing is that corporate has been more sticklers in terms of their rate categories.

Before they might be a little more open, if their particular rate category was sold out, to buy up at our properties. And we're seeing more and more people enforce that if the first rate, the lowest rate, is not available, they'll go elsewhere versus try to buy up at our property. So that's a trend that on one hand makes sense relative to what you're seeing in corporate America. On the other hand, it's not the greatest for us. But we're trying to do what you said.

Smedes Rose

Sounds like you just described our travel portal. I wanted to also just ask you if you could provide a little more color in New York specifically, just for the Times Square market and how the Park Central is doing relative to its comp set. And just maybe any trends in that submarket, since I know you get that specific data versus us getting the whole MSA from New York.

Mike Barnello

Yes, well, it's interesting. We do get both. We slice and dice New York a number of ways. Park Central is not technically in Times Square as it's defined, but it kind of skirts that edge. We look at that as well as Manhattan overall; we look at Midtown. If you look at our New York, our New York was down just over 6%. Manhattan overall was down about 5%. Times Square did better; they did just down about 2%, so it was a better-performing story. They made it up on occupancy. We didn't have as much occupancy to gain in New York. I think that what we're seeing is it's just -- it's tougher and tougher out there.

There is a lack of pricing confidence that is coming; it's a shift in segments. Those two things are making it tougher and tougher for everybody in New York. Let me give you an example. When you look at the last six years, 2010 through year-to-date 2016, the demand has significantly outstripped supply in Manhattan, with the exception of last year where it was slightly off, by big numbers, quite frankly. And even this year, Smedes, for as much supply as Manhattan's added which is about 5%, the demand year-to-date is up 5.2%. So the business is there. What's happening is two things. It's not coming exactly the same way as before, so if you're not seeing as much high-rated international or that much high-rated corporate, then you're going to be skewed more towards leisure or OTA which is a lower-rate segment and that's going to hurt you.

The second thing is that the more publicized the lows of New York are, then the less confident every operator in the city feels about pricing. And that can become contagious and cause weakness. Now we've seen that before. We've seen that before in DC from, call it like 2011 to 2013, 2014, when people were concerned about the weakness there. The occupancies never waned; the demand growth in DC was still strong; and yet pricing power didn't exist. We're going through a lot of that right now in New York. There is some good news in New York. You've probably seen the Waldorf at some point is looking to close, that's a significant drop of inventory that will help the supply story when it does, if it does.

The second thing you've probably heard about is there's been some encouraging movement on short term rental enforcement in New York City that, if the governor ultimately signs that, then I think you might see a significant number of short term rental supply, shadow supply, come out of inventory which should give a boost to New York City overall. Does that help?

Operator

And our next question comes from Lukas Hartwich from Green Street Advisors.

Lukas Hartwich

Mike, I was hoping maybe you could comment. We're about to lap the industry-wide RevPAR slowdown that hit us in August of last year and I'm just curious. What do you think is going to happen industry-wide once we start to lap these really tough comps from or I guess easier comps from last year?

Mike Barnello

It's certainly hard to say. That does happen at any end of a cycle, as you start lapping easier comps and so you think it might be easier to do well. But yet cycles still continue the way that they do. For us it's really a supply-and-demand story. When you look at the first couple weeks of July, we're not too encouraged and specifically we've been looking not just the industry, but really urban and upper-upscale. If you look at the 16 days of July that we have STAR data on, urban looks like it's slightly down, less than 1%. Upper-upscale is flat, 0.1%.

Those are the two segments that we attach ourselves to the most. They fit generally the locations that we have and they're close in terms of RevPARs. So it's not starting out to be great from a third quarter perspective despite the lapping. When we look, Lukas, at what we're seeing, the trends which you mentioned a little bit earlier, is that the demand number, especially if you look at it on a trailing-12 basis, continues to moderate. And the supply number, it's been well documented that continues to accelerate. So those are the two big numbers we look at. And while it might be nice to think there's easier comps, without those numbers working in our favor it's just tough to outperform.

Lukas Hartwich

Can you also maybe touch on the capital allocation priorities today, how you guys are thinking about that?

Mike Barnello

Sure. We don't really have an immediate need to do anything. Ken mentioned in his remarks, we're effectively at a 2.7 time debt-to-EBITDA level. We have a balance sheet that's in really great shape. And what we have now is we're positioned for this part of the cycle. If things continue to soften, we're in good shape; and either way we have optionality to do lots of things. I wouldn't prioritize any of the options.

They have to be taken as a whole at the moment in time we decide to go forward on. And think about this. We obviously can pay off our preferreds; we could potentially buy assets. Other folks have asked about that; that depends on the asset, the price, etc. We could potentially buy back stock. So we have all those things as options. And when we get some clarity on where we're fundamentally from an operating fundamentals, perhaps we'll act on that. But we don't feel the need to do anything at this point.

Lukas Hartwich

Maybe just as a follow-up to that, how about dispositions? How do asset sales fit into that picture?

Mike Barnello

For us, perhaps different than a lot of the peers, we have been vocal that we would sell one asset, several assets, anything, for the right price. That's our job. But we have never talked about selling an asset publicly until something's been announced. So I think that folks can see that we've demonstrated that we would sell assets. We sold assets a couple years ago, noncore assets. We just sold a couple noncore assets this quarter. But our perspective is not to talk about any asset or series of assets until something actually happens. And we look at every asset all the time to figure out whether it's something we should potentially sell and there could be asset sales down the road; but I would tell you that I wouldn't bank on anything until we've made any announcements.

Operator

And our next question comes from Wes Golladay from RBC Capital Markets.

Wes Golladay

Looking at San Francisco this quarter, I thought it would have been a little bit better performance versus the market because of the disruption last year. Is there anything specific that went on this quarter?

Mike Barnello

Yes. We're disappointed with what happened in San Francisco this quarter. You saw the CBD numbers were better than our numbers. The reality is the transitions we made last year from -- in management at The Marker which was The Monaco, the Harbor Court and Triton just haven't been great for us from a top-line perspective. I would combo that with the Park Central which has not been the strongest top line.

So if you looked at San Francisco really without those and we have seven properties. If I take out those four which is a lot, we're basically right in line with the CBD. The thing that you guys don't see is the EBITDAs have actually been performing pretty well. So from a bottom-line perspective they are doing well. From a top-line perspective it's been more of a struggle. It's been something that we're working on with our asset managers and our team basically all the time. So we're hoping that things would turn around there, but that's been a source of disappointment for us as well.

Wes Golladay

Okay. Then looking at what would potentially cause an inflection for the industry, you talk a lot about corporate travel. We see that some of the airlines are saying -- I think it was United yesterday saying flat for the second half of the year. If that were to go around 2%, 2.5%, would that be enough to get the industry to reaccelerate, in your opinion?

Mike Barnello

I'm sorry, if demand would be up 2.5% or the airlines?

Wes Golladay

Corporate travel, yes, would go up 2.5%. Yes, the higher-rated segment having an increase in demand, would that be enough to absorb the new supply?

Mike Barnello

Well, think about it this way. What we track on our corporate is 10% to 14% of our business. We know it's higher than that, but think about it this way. If our corporate was every piece of our transient which it's not, that's 70% of our business. 2% increase in corporate wouldn't cover 2% increase in supply, right, because that would only be 1.4% increase in demand overall on a transient basis, unless you got group to cover it.

I would say that any increase we see in corporate would be good, but I can't give you a number that would actually give you equalization. I think its a couple things, though, Wes. If we see corporate rebound in the second half of the year and folks relax some of the policies because part of it is that, to the extent that corporate America feels tighter, then they can inflict different restrictions on travel policies and that doesn't necessarily tie into them making more money.

Once they feel better and loosen those restrictions and we perhaps we see that going into 2017 -- then we'll feel better about pricing which does set us up for everything else that we want to price in terms of how we price other transient. So that would be good. But I don't know that it's as simple as saying 2% lift gives us that confidence.

Wes Golladay

Okay. Yes, I guess in looking at your other segments, do you feel pretty confident about that? Leisure and your corporate group, are those all coming in as you expect?

Mike Barnello

No, we mentioned in our prepared remarks that transient has been slippery. We mentioned that we saw the pace wane significantly from the beginning of the year from what we mentioned in our call in April and what we ended up at now, is that we have a decent pace but it hasn't held or -- and it hasn't grown and I think you're seeing that across the country. People had grander expectations for the transient customer and they are just not coming in as strong. It's for all the reasons we mentioned earlier in terms of it is part corporate, it is part leisure. And the group has been okay, but it's been still softer than we expected the pickup would be.

Operator

And our next question comes from Thomas Allen from Morgan Stanley.

Thomas Allen

Just a similar granularity around the second quarter and maybe July. Thinking month-to-month versus your internal expectations, how did each month fare?

Mike Barnello

It's a good question, Thomas. When we think about it -- we didn't give an outlook for Q2 for the year, but obviously we have numbers that our teams put together and that we were hoping for. What I would tell you is that we had grander expectations than a 1.7% number. So from that perspective we were hoping for better turnout really in all segments. But the reason that we haven't given guidance is because that's been a consistent theme for us for some time, where our operators and we had hoped for better performance in terms of demand and pricing and we haven't seen it.

So on one hand, were we hoping for something stronger? Yes. Were we too surprised by what happened? Not really. I think from our perspective we're pretty proud of the way the guys handled the moderation in RevPAR in terms of the performance of the assets. But, yes, we would have liked to have had stronger RevPARs.

Thomas Allen

I guess versus your expectation, was it volatile month-to-month? Or just as you were saying about transient, it just gradually got -- just didn't show up?

Mike Barnello

When we look at -- yes, it's a little different. It's not too far off of what the industry did, Thomas, in terms of April was strong, May was the weakest and June bounced back a little bit. So, yes, we were about 2.5% in April, flattish in May and bounced back to 2.7% in June which was kind of in sync with what you saw for the industry.

Thomas Allen

And then just my follow-up question. Could you give us an update on how the whole hotel brand direct booking push is impacting your hotels? I guess both on the branded side and the independent hotels and how the dynamic between OTAs and hotel brands are impacting independent hotels as well. Thanks.

Mike Barnello

As far as the direct booking, we've met with the folks at the brands recently in the last month and I think they would tell you the same thing which is, it's too early to tell. They've launched those in different parts of this year. You've seen that they've offered discount for direct booking versus going to an intermediary and I think it's just TBD.

Looking at our properties, we don't have a lot of branded properties. And of those branded properties, not every brand is doing that, so we don't have a very good sample size, Thomas. But talking to our guys so far, they're just not being anything meaningful to make heads or tails out of. And I don't know that it would anyway with -- a couple of the brands, we have three hotels we're testing and one we have won. As far as how the independents are doing, our independents, that's a tricky question, because it depends on the operator as well as the market. Different hotel operators have had different levels of success.

The thing that we look at is not just the RevPAR which I know is a focus for a lot of you guys and it's definitely a focus for us. But we also look at the bottom line and how these guys are going to bring profit to the shareholders. And that's the most important thing for us. We can't forget about revenues, but we have to watch the bottom line at the same time. So I don't know if there's something different you want me to answer on the independents if I didn't nail that.

Thomas Allen

I guess my question was just in terms of are they benefiting from moving up in the search order or is it too hard to tell?

Mike Barnello

Yes, we have not seen anything on that, if that's what you're asking.

Operator

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

Bill Crow

A couple of topics, Mike. First of all, you talked about the rationale for selling the mezzanine note. If we're in or heading into a downturn, like you mentioned last quarter, it seems like nearly 8% income and the spread on the cost of financing is pretty healthy and maybe even provides you an opportunity to acquire the assets if things get bad enough. And if we're in an upturn, I think the strength of the note only improves. So relative to maybe selling other assets, talk about why you sold the mezz note.

Mike Barnello

This is an investment that's noncore for us. The things that you mentioned, they are accurate. For us it just came down to if we're looking at potentially strengthening the balance sheet, looking at alternative uses down the road and something that actually is more core for investors, it made sense for us to potentially sell this asset. And you're right, during periods of downturn there is some level of stability, assuming that things are performing and there's payment and that's true. Could there be a path to ownership? There could.

And we always thought this was a super-small chance of ownership, just because the sponsors are so intertwined with this asset that we don't really think that there would be a situation for us to take over. It's not zero, but it's not high. That was part of it. But I think it's just about strengthening the balance sheet and giving ourselves alternative options which could be the same thing. If you think about optionality, Bill, just for the moment, $80 million at 8%, we could pay down the preferreds at 7.5%; so it's similar.

Potentially you could buy back stock. The stock is trading in about the same range and certainly has fluctuated a little bit. And then, hopefully, there will be opportunities, whether it's soon or down the road for acquisitions that would yield higher than that. So we do think there'll be more interesting opportunities than what we have now that would mean more to the investors.

Bill Crow

Mike, I think there were some margin questions earlier. I guess the question I have on that is, do you think relative to 2008/2009 you are better off or worse off in your ability to cut expenses, to maintain industry-leading margins? Only because you've now entered San Francisco. You've entered New York. You have what I'm guessing is much more union exposure and maybe more work rule issues. Is that a fair way to think about it, that it will be more challenging to maintain those margins?

Mike Barnello

It's hard to say. I don't know that our percentage of union hotels has changed that much over the years. We've gotten, obviously, a lot bigger. So I don't remember what it is off the top of my head in 2008. But I think it depends on the circumstances, Bill. To the extent that there is a moderate downturn, then some things change. If there is more severe, then we have to make changes. So I don't want to speculate on what those changes will be, but I will say that, again, if we were back in 2008, nobody -- ourselves included -- would have thought that we would have been able to become as efficient and cut the things that we cut going into 2009.

So we surprised ourselves then. The one thing we do know is that, relative to our peers, we'll be in the best shape. We just have the most alignment with our operators in terms of the types of contracts that we have. A lot of our operators we worked with in the past; we know their flexibility; we know their attitudes are great towards those things. So we feel like relative to the others, if we can't do it, we just have a hard time believing somebody else will do a better job at that.

Bill Crow

No, agreed. Agreed on that. You guys were terrific last go-round. Finally for me, Mike, is it possible to just quantify what the overall portfolio of RevPAR pickup is in the second half because of the Park Central issues a year ago?

Mike Barnello

When we look out into the second half, I think that the thing that we gave out last year was probably the most handy. Since we didn't give an outlook, you can't really add anything or take anything away from that. But between the two quarters we lost about $9.2 million of EBITDA. And what's the -- do you know what the RevPAR is? I think it was about a point; no, it was probably 2 points because it was over a point for the year, Bill.

Ken Fuller

Q3 was three points.

Mike Barnello

And then Q1 was about a point, right? So I think the blended impact was probably 2 points for the second half of the year. I think you saw that -- if you look at our year, we did I think 1.4% including the impact. It was about 2.6% taking out the impact, Bill.

Operator

And our next question comes from Rich Hightower from Evercore ISI.

Rich Hightower

Just one quick question here. On the revised CapEx budget, I know part of that is due to the Indianapolis sale. But can you give us a little more color on what happened to the other, the remaining part of that delta? Was it just projects that are going to be pushed into 2017? Or was it projects that were canceled outright? Or just a little more color on that would be helpful.

Mike Barnello

You're right. Indy was a big piece of it. And as far as the other projects, we slate a number of projects every year in the beginning of the year that we get approved with our Board and we communicate the ranges to you guys. It doesn't mean we actually do every one. So there were a number of properties that we thought didn't need -- it was not a dire situation which is true about all of our portfolio, that doesn't need CapEx. So we just thought it would be better off to push some of the potential renovations in 2017.

There is nothing that's going away. The only thing I would say that is tabled for now is that there still is a number of projects to add rooms, whether it's San Francisco, potentially San Diego, other places. I don't think right now we need to spend capital dollars adding rooms, really in any market.

So those things, I wouldn't say -- they haven't gone away forever, but we didn't just push those back into 2017. Whereas normal lifecycle renovations we thought, we don't need it; we have a decent pace in some of those markets; let's wait until 2017 to do those. We still are going forward with a number of renovations in the end of the year. Embassy Suites Philadelphia, L'Auberge Del Mar and Chamberlain are the ones that are slated for the fourth quarter.

Rich Hightower

And then on the $40 million CapEx that you avoided in the Indy sale, how much of that was allocated to 2016 versus 2017 versus any other time period?

Mike Barnello

It was probably $10 million to $15 million in 2016 and the rest would've fallen into 2017.

Operator

And our next question comes from Chris Woronka from Deutsche Bank.

Chris Woronka

Mike, I was hoping you could go back to one of the data points you mentioned early on about the pacing of transient, where you were at the beginning of the year, for 2Q, where you ended up. What do you attribute that to? Do you think this is -- do you guys track the percentage of reservations that get rebooked? Is that it? Is it cancellations? Is it just something else?

Mike Barnello

We do track the cancellations and the cancellations have been, I'd say, steady. There was a point where some of the hotels in New York were getting a super-high amount of cancellations; that has moderated a little bit. Remember it's just a pace. It's just a year-over-year comparison, Chris. In our transient, even though we give it to you the way we have it, think about this. There's not a ton of transient business booked four months out.

So effectively, that's -- when we gave you the number at the beginning of the year for Q2, you're talking about people who had to book really in Q4 for Q2. There's not a ton of transient that does that. So the percentages are accurate, okay? But the transient when you get further out, they are very small numbers. You think about it yourself. I don't know how often you book a transient hotel room, four or five, six months out. Probably not a lot, right? A lot of the corporate or even leisure book, whether it's a month our or two months out. But certainly a lot of it is within a week or two.

So part of it is that. And part of it I think is just the factors that are working against us. You're seeing demand overall slowing down a little bit. You're seeing supply increase. You've seen short term rentals in a number of places. So I think all those factors are coming together to cause that moderation.

Chris Woronka

And then just on your reported ADR, I think mix is playing a role in part of that. Is there any way to quantify it in terms of you're getting a little bit less premium corporate, a little bit more group, a little bit more leisure? Is there any way to break it down or is it tough?

Mike Barnello

Well, we do break it down. What we mentioned in the call is really the way to think about it. Our rates are up for our corporate negotiated, but our room rents are down 5%. So net-net in that category we're down about 3%. And that's the highest-rated category, Chris, as you know. So we're up in group; we're up 4%. That's ultimately a mid-level category. And the OTAs are decent, but that's the lowest-rated category that we have. So it is definitely a mix shift.

Operator

And our next question comes from Anthony Powell from Barclays.

Anthony Powell

Could you talk about the overall cost environment throughout your portfolio? Are you seeing increases in labor costs, property taxes, energy and OTA commissions? And what overall RevPAR growth do you need to offset ongoing cost increases?

Mike Barnello

In terms of -- the taxes have been fairly steady. We've mentioned that to you if we've seen something high or low in a particular quarter; so nothing really odd there. When you think about the -- you mentioned OTA commissions. Those -- the more impactful number is if we change the percentage of business we take from the OTA, because that's a big commission. As far as the commissions themselves, percentages haven't hurt us. They are not going up. In fact, with some of the branding combinations, you're seeing some downtick in the commission itself. When you look at labor, that's the big one, Anthony. You think about our portfolio and probably many others, about 60% of our costs are labor-related, wages, benefits. When we think about what goes on from the beginning of the year, we find ourselves generally in a 2% to 3% environment from a wages perspective.

We do have other things to deal with that have gotten a lot of notoriety. You've seen minimum-wage increases throughout the country. They've tended to go West to East in terms of the cities that have enacted those; some cities are continuing to think about that. That has an impact. Those are already factored in and we think that that by itself was probably a couple million dollars this year in terms of minimum-wage increases. We've seen and we will see a slight increase next year because of the Department of Labor's categorization of who gets overtime. If you are familiar, overtime was calculated for somebody making less than $23,000; that number has gone to about $47,000 because we have fairly well-paid management the impact to us on that is -- of that on us is about $300,000 to $400,000 next year.

So it's not huge. But these are all factors that add up. So between those minimum-wage movements, between those slight changes, those are the pressures that we're up against. So when you think about how we think about costs, a lot of it is not made -- a lot of the things we're becoming more efficient on really doesn't happen there. It happens in other ways of operating our business.

Anthony Powell

Going back to San Francisco, you mentioned the Park Central there. Could you update us on the arrangement with Starwood that you have? And are you considering any alternative strategies with the revenues today, like with like a soft brand or anything like that?

Mike Barnello

Sure. As a reminder, we had signed a temporary agreement when -- or temporary -- we signed a one-year agreement in February of 2015. We announced to you guys in October during our call that we had extended that arrangement. It's a five-year arrangement, but we can get out anytime we want. So it is five years, that's true; but if we decide that it's no longer working or if we find something that we'd rather do, then we can get out of it. I would tell you that we don't have any plans to do that, but we have that optionality.

And we wouldn't really talk about it until we actually did it. But I think from your perspective, you should just think that -- know that LaSalle is aware of what's gone on there and is constantly measuring not just the top line, but how it affects the bottom line and what the best thing to do for the asset is. So the things we did talk about with San Francisco were true. It is that we've seen some hotels that are suffering on the top and that's unfortunate and we're trying to right that ship with our asset managers and our operators. However, the name of the game is EBITDA and that's been holding out much better, so we're pleased by that.

Anthony Powell

One quick one for me. Seems like you outperformed the market in Chicago and Boston in the quarter. What do you attribute that to?

Mike Barnello

Two things. In Boston, we had a tougher quarter last quarter at the Liberty; and they were able to rebound, so we're pleased by the reaction there. That was a good bit of it. We also have great locations, great properties and great teams. So I don't want to just make it sound like it was just the Liberty, but all four of the hotels in Boston actually did very well. I would say the same thing in Chicago. We're seeing both Westin Michigan Avenue, the Hotel Chicago, they took what was a negative quarter for Chicago and they beat it handily. So we're up much more than the CBD. So I feel good about that. That's just hats off to the teams.

Operator

And our next question comes from Ryan Meliker from Canaccord Genuity.

Ryan Meliker

Most of my questions have been answered, but I did have two things I just wanted to touch on. We talked a lot about margins and your guys' ability to create additional efficiencies. Food and beverage margins were up almost 300 basis points this quarter. Should we think about the efficiencies that you've generated thus far as recurring and an ability to see a new run rate, higher-margin level at the F&B line? Or were there anomalies this quarter that brought that up so high?

Mike Barnello

Well, I would say a couple things. You've seen improvement in that category for the better part of two years. We made a lot of headway throughout 2015, Ryan. So a lot of these things we can do once in terms of adjusting menu pricing, portion control, etc., hours of operation. The things we've done now, it may just be some of the hotels we've gotten to. But I want to also add that part of it was our food and beverage revenues were up significantly in Q2. We saw a big contribution from the big-box hotels. Part of that was citywide related; part of it was in-house group.

You saw a big performance from Westin Copley, San Diego Paradise Point, Lansdowne; so they had some good food and beverage stories and, as a result, they were able to capitalize on that. So part of it was a revenue story and these guys are good at operating. And part of it was efficiencies we put in place. I don't think you could -- because this has been stretched out for a while I don't think it's fair to say we can operate our food and beverage at 300 basis points better every quarter, that's too extreme. I would love to tell you that that could happen. That's not something we can count on.

Ryan Meliker

No, that makes sense and that's helpful color. The second question I was hoping you could give us an update on was San Francisco market. It looks like you guys underperformed a little bit this quarter. I'm wondering what was going on there. And then what's your outlook for 2017 with the Moscone Center renovation? Whether you're expecting material disruption and if there is anything you guys are doing to try to counteract that.

Mike Barnello

Sure. We did mentioned earlier that three of the hotels -- the Harbor Court, Triton, Marker and to a lesser extent Park Central -- the transitions there haven't worked out as well as we hoped on the top line, Ryan. But on the bottom line, they've done fine. When you think about 2017, 2017 is going to be a struggle in San Francisco. Citywides are down 37%, that's a big impact. You're seeing supply uptick which is -- it's not a big supply number overall, about 1.7%. The problem is that's a city that's not really used to much supply. It hasn't had it for a while, so that's a bigger number than they are accustomed to.

So supply uptick; citywides are down. Some of the big boxes are doing better at filling in with in-house group. I know SF Travel is trying to do its best to actually fill in some of those groups effectively in-house groups. And to the extent they can do better, the city will do better, but that's a big hole to start with, to get out of. So I think San Francisco will be a struggle for the better part of two years, starting from now and through probably the mid-2018. 2017 will be -- the toughest part will be Q2 when they are doing most of the expansion work. The good news there -- I think everybody needs to keep this in mind -- is that, unlike some things happening in cities which is just negative and we're worried about it, this is a short term negative.

There is going to be a significant amount of new meeting space added to Moscone. So the city will become much stronger, have a lot more room for demand generation. And we're not adding that many hotels to the city that will absorb it, so the city should remain strong really once that is done and for a long time after that. So a little bit of a hiccup in San Francisco for a while, but we remain very confident that that performance there will be very strong.

Ryan Meliker

Just to make sure I heard you correctly, sounds like citywides are down 37% for San Francisco on your numbers and you're expecting the negative impact to start showing up maybe in the third quarter?

Mike Barnello

Yes, well, the citywides are down 37%, that's for 2017. As far as the negatives, when you look at San Francisco overall, for this year --

Ken Fuller

Citywides are up 13% in Q3 and then they are down about 20%.

Mike Barnello

That's 2016 that Ken is giving you. But they are really -- they are getting into the heart of the expansion really Q2 of next year, Ryan. What you're seeing is, if you look at the quarters, Q1 is actually okay. Despite the fact that Wearable was there last year the citywides look decent. Q2 is when things really go south. So Q2, Q3 and Q4 of next year is really not very strong.

Operator

We will take our next question from Michael Bellisario from Baird.

Michael Bellisario

Last quarter you mentioned some leisure demand slippage in San Diego and RevPAR was negative again this quarter. Did you see that same slippage again this quarter? And then any other markets where you might be seeing some weakening in the leisure demand side of things?

Mike Barnello

The San Diego market is the toughest one for us to give out -- to give you guys a comparison to. It doesn't really line up with MSA; it doesn't line up with CBD. And the reason is that we have five hotels there. Two are downtown; that would be CBD. We have two in Mission Bay; that wouldn't really line up. That would be more in the MSA and then we have one in Del Mar. So they're in three different submarkets. Nonetheless, you're right.

As far as what we're seeing in terms of softening, I'd say it's a combination of things, Mike. It's a little bit of all that. But remember, on the leisure side, the only way we can assume it's leisure is if they don't have a corporate account with us. But that might not be a good assumption, especially in the people who are coming midweek. So the Bay has seen -- the two properties in the Bay have had a tougher time. Part of that's been group-related; but I wouldn't necessarily say it's been solely leisure. But it's different for each of those three areas.

Operator

[Operator Instructions]. It appears we have no further questions at this time. I would now like to turn the conference back over to our speakers for any closing remarks.

Mike Barnello

Thanks, Nicole. Thanks, everyone, for listening to her second quarter earnings call. And everyone please enjoy the rest of your summer.

Operator

Once again, ladies and gentlemen, that does conclude today's conference. We appreciate your participation. Have a good day.

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