FelCor Lodging Trust Incorporated F3Q08 Earnings Call Transcript

Nov.20.08 | About: FelCor Lodging (FCH)

FelCor Lodging Trust Incorporated (NYSE:FCH)

F3Q08 Earnings Call

November 5, 2008 11:00 am ET

Executives

Stephen A. Schafer - Vice President Strategic Planning & Investor Relations

Andrew J. Welch - Executive Vice President and Chief Financial Officer.

Richard A. Smith - President and Chief Executive Officer

Analysts

Smedes Rose - Keefe, Bruyette & Woods

Patrick Scholes - Friedman, Billings, Ramsey & Co.

William Truelove - UBS

Will Marks - JMP Securities

Nap Overton - Morgan Keegan

Jeff Donnelly - Wachovia Securities

David Loeb - Robert W. Baird & Co

Chris Woronka - Deutsche Bank

Dennis Forst - KeyBanc

Jeremy [Hurz] – Onyx

Rod Petrik - Stifel Nicolaus

William Byrd - Monterey Investments

Abner [Hoshen] – Fortis

Operator

Good day ladies and gentlemen, my name is Eric and I will be your conference operator today. At this time I would like to welcome everyone to the FelCor Lodging Trust Incorporated Third Quarter Earnings Conference Call. (Operator Instructions)

At this time I will turn the call over to your host today, Mr. Schafer.

Stephen Schafer

Good morning everyone. With me today are Rick Smith, President and CEO and Andy Welch, Executive Vice President and Chief Financial Officer. Rick will discuss operations and our current focus and then Andy will discuss the results of the quarter, important balance sheet items and our outlook followed by your questions.

Before I turn the call over to Rick let me remind you that with the exception of historical information the matters discussed on this conference call may include forward-looking statements within the meaning of the Federal Securities Laws. Forward-looking statements are expressions of current expectations and are not guarantees of future performance. Numerous risks and uncertainties and the occurrence of future events may cause actual results to differ materially from those currently expected. These risks and uncertainties are described in FelCor’s filings with the Securities and Exchange Commission.

Although we believe our current expectations to be based upon reasonable assumptions, we cannot assure you that our expectations will be attained, or that actual results will not differ materially.

With that I will turn it over to Rick.

Richard Smith

Good morning everyone and thank you for joining us for our third quarter call.

As everyone is aware, the downward trend in travel that began in May and stayed fairly consistent through August deepened in September and slipped further in October. This morning I want to give you some color on the trends we are seeing, the continued progress we are making, and where our focus is going forward this year and into ’09 to mitigate those trends. Then I will turn the call over to Andy who will give you some further detail on the quarter.

In the quarter, not withstanding the steepening downward trend in September, we were able to meet the guidance we set for the quarter with $0.45 of FFO per share. This was due to some good work on the hotel level cost side and some reduction in property taxes. However, as the economy and market have gotten worse, and the general fear has increased, we have seen a fall out in demand. While visibility is still very limited, it is clear that we will continue to see this until things stabilize, negative sentiment reverses, and consumer confidence begins to improve.

The downward trend from May through August was led by weakened leisure and shoulder period corporate demand decreasing. In September we began to see softening in mid-week corporate travel. While mid-week business remains stronger than other segments, it is that softening that le to overall demand falling further in September and October.

Therefore, occupancy in premium rate segments has continued to decrease while we continue to be successful opening other channels to replace that business. This accounts for the occupancy and ADR splits in our RevPAR growth.

Group pace is mixed with convention and association business performing better than corporate group. Overall both short term and long-term bookings have lessened, which is typical at this point in the cycle. Markets performing the best were San Francisco, Northern New Jersey, Los Angeles, Texas, and Louisiana. As an aside, our hotels in Louisiana have grown RevPAR 23% year-to-date. The markets that are lagging generally have a leisure or financial concentration and they were Phoenix, South Florida, Philadelphia, Chicago, and Charlotte.

Our urban and airport locations performed the best with RevPAR up 6%.

Our airport hotels are in locations that are somewhat isolated from the locations being hampered by capacity cuts, however we do expect to continue to be impacted in a limited number of markets, the primary markets being affected are Minneapolis, Nashville, and Orlando.

The good news is that we continue to gain market share. Our share growth over our comp sets was 3 ½% in the third quarter and actually improved in October up 4.3%. Again, we expect this to continue.

Well we were up 3½ % to our comp sets in the third quarter, we were up 3.7% to the US average. This 20 basis point difference is also true from a year-to-date perspective. This is important as it clearly indicates that the markets we are in are out performing US average. Ti should also be noted that in the 70 hotels which completed renovations in ’07 and ’08 we increased market share by more than 6% and had absolute RevPAR growth of 5.4%.

Given the decline in demand we have met with all the companies that manage our hotels regarding both ’08 and ’09 cost structures. For the remainder of the year all non-essential spending is to be eliminated.

For 2009 budgeting purposes the message is clear: in a declining revenue environment you must operate differently. You have to come up with an operating structure, including reducing labor that allows you to the extent possible to mitigate that decline in revenue. Our conversations have been with the highest level individuals in those organizations and they are on the same page. We will have to see how the budgets come in at the end of this month.

In addition to what we are doing operationally to maintain cash flow and liquidity we are also limiting capital spending to absolutely critical items. We expect capital reserve spending to be significantly below our 6% reserve threshold in 2009.

We are limiting further redevelopment spending during 2009 to the completion of the San Francisco Union Square Marriott. Even with this spending we will still remain below that 6% threshold; however we will continue to pursue the entitlement process for other redevelopment projects for future development once trends improve.

We are analyzing our corporate G&A costs and expect there to be reductions there as well. The dividend decision made in August was clearly the correct decision. Going forward we will continue to be prudent and a decision for the ’09 dividend will be made once we have more insight into ’09 operationally.

We also feel very good with regards to the April ’09 debt maturity, but I will let Andy speak to that further.

The entire management team has been through this before, in some cases under worse circumstances.

With what we are doing to maintain liquidity, coupled with our renovated portfolio being in great shape, we are in the best position we can be in to ride this out.

In this environment market share and flow-through are most critical. We are maintaining rate integrity as well as possible and much better than in the previous down turn. We continue to gain share. We are limiting spending across the company, and are in good shape relative to our ’09 debt maturities. Thus we have the right plan and will continue to execute as we have everything over the last three years.

Finally a word on the decision to sell the I Drive and Cocoa Beach Holiday Inns. Pursuant to our amended contract with IHG from 2006we were expected to redevelop these properties with some combination of new hotel development and condominiums. In this market this is simply not feasible and we will not undertake that $100 million of risk under any circumstances; therefore we have decided to sell these properties and use the proceeds to further strengthen liquidity and determine how to best invest the proceeds once the market stabilizes.

The impairment is, of course, a non-cash hit as related to the allocated value ascribed to them when they were acquired.

With that I will turn the call over to Andy.

Andrew Welch

We are pleased with our third quarter results, especially given the current trend in the industry. Adjusted FFO per share of $0.45 compared to our guidance of $0.43 to $0.47, our adjusted EBITDA was $65 million which met the mid-point of guidance. On a same store basis adjusted FFO increased 11% compared to the same period last year which reflects the positive effects of the renovation program.

The Atlantic hurricanes in August and September impacted our operating results. Specifically, we incurred a total of $1.7 million in clean up and hurricane deductible expenses as shown in our reconciliation of adjusted FFO and adjusted EBITDA. In addition, on a net basis we estimate $600,000 or $0.01 per share in lost business as a result of the hurricanes which is included in our operating results.

For the 70 hotels where we completed renovations during ’07 and ’08 RevPAR increased 5.4% during the quarter and market share increased more than 6%. Hotel EBITDA for these 70 hotels increased 8% compared to the same period last year.

Our portfolio of 85 hotels grew RevPAR by 2.6% and grew market share by approximately 4% in the third quarter.

RevPAR for our comp sets declined 0.9% and declined 1.1% for the US average.

Hotel EBITDA margins grew 45 basis points and were better than expected due to cost containment efforts at the properties and our hands on asset management approach.

Our cost per occupied rooms for the quarter was held to prior year levels.

As RevPAR continues to weaken we are making adjustments in our cost structure to mitigate the decline.

As regarding our balance sheet approximately 45% of our debt is at floating rates, which we view as a natural hedge given the cyclical nature of the lodging industry. Our weighted average cost of debt today is approximately 6% and is over 100 basis points lower than at the beginning of the year.

We continually monitor the interest rate markets and will continue to evaluate whether and when it makes sense to reduce our floating rate exposure to take advantage of low LIBOR rates.

We have no debt maturities for the remainder of this year. Our next debt maturity is April 2009 and is a seasoned low loan to value mortgage facility secured by seven of our higher quality Embassy Suites that are located in major markets.

Despite the current turmoil in the financial market we are confident that we will refinance the loan. We are currently in discussions with several interested lenders that include the incumbent lender, other institutional lenders, and corporate banking relationships and continue to evaluate our options. We anticipate proceeds will be well in excess of the current $118 million loan balance. In addition, as we re-lever this loan from to more efficient loan to value levels we will not only take care of our only near term maturity, but will increase our liquidity position with excess proceeds from the refinancing.

Our next mega debt maturity is not due until the middle of 2010 when we have two mortgage pools totaling approximately $280 million. These two loans have an average interest rate of approximately 8.7% and we have an opportunity even in this environment to reduce our cost of capital when they are refinanced.

As Rick mentioned, our main focus is on mitigating the decline in RevPAR as a result of weakening demand. Liquidity and cash conservation are key, and we will continue to focus on maintaining liquidity and maximizing balance sheet capacity.

At the end of the quarter we had $78 million outstanding on our $250 million line of credit. Based on the mid-point of our guidance we expect to generate $274 million in EBITDA for 2008. Our interest coverage ratio is in excess of 2 ½ x and our fixed charge coverage is close to 2 x. There is very little risk in us being in a position not to cover our fixed charges. In addition, we have a much better and stronger portfolio of hotels today versus the last recession, so we do anticipate performing better on a relative basis.

Let me give you a couple of statistics on our changing portfolio.

At the end of 2001 we owned 183 hotels many of which were older, capital starved, located in secondary and tertiary markets with little barriers to entry, and losing market share. Today we own 85 hotels that have received nearly ½ billion in capital over the last three years. These 85 hotels generate RevPAR of approximately $100.00 and EBITDA per room of over $12,000, both of which are approximately twice the level of the sold hotels.

In addition, our concept continues to perform the industry and our portfolio continues to out perform our comp set.

We have eight hotels on the market and have received significant interest in each property. As I said before this is not a fire sale and we will hold out for pricing before selling. Two of the three Kansas hotels are under contract and the third is very close.

As evidenced by the eight hotels being marketed for sale we continue to focus on improving the quality of our portfolio and reducing concentration risks. Five of the eight hotels are Holiday Inns, three of the eight hotels are located in Florida, one in Texas, and one in North Carolina. Following the sale of these hotels we will reduce our concentration in Florida, currently our second largest state by rooms, by 32%. Specifically we will reduce the number of rooms in Orlando by 40%. In addition we will continue to reduce our Texas exposure and we will reduce the number of hotel rooms in Dallas by 25%.

We will evaluate the best use of proceeds at the time of sale and we will use the proceeds in a way to best maximize shareholder value. If the hotels were sold today it does make sense to use the proceeds to reduce debt, improve our liquidity, and create further capacity.

Now I will move onto guidance.

There is no denying the current economic trends and potential for further deterioration in demand which has turned negative to prior year for the industry. Declining consumer spending, restrictions on corporate spending, rising unemployment and negative sentiment towards the economy all negatively affect demand. As a result our new guidance anticipates RevPAR growth of approximately 2% for the full year.

For the fourth quarter we anticipate RevPAR to decline between 3.5% and 5% over prior year. This assumes continued growth in market share for our portfolio which is evident in Octobers results which show market gains of almost 4.5% compared to 3.5% in the third quarter. For the year we expect operating margins to grow approximately 20 basis points over prior year.

Our adjusted EBITDA guidance for the year is now between $273 and $275 million. Adjusted FFO per share is now between $1.93 and $1.96 which assumes $0.19 to $0.20 per share for the fourth quarter. Our guidance does not assume any asset sales during the fourth quarter.

Consistent with our past practice, we will provide 2009 guidance during our February conference call after hotel budgets are finalized.

Thank you and we are now ready to address any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Smedes Rose with Keefe, Bruyette & Woods.

Smedes Rose - Keefe, Bruyette & Woods

On selling the Holiday Inns it sounds like from your comments this isn’t the case, but I thought that if you sold Holiday Inns you would have to pay intercontinental liquidation damages, or use the proceeds in other intercontinental hotels. Is that not the case anymore or?

Richard Smith

That is correct. Like I said in the prepare comments, we were in a position to where when we did the deal back in ’06 that allowed us to sell the hotels that we wanted to sell part of that deal was that these two hotels get redeveloped. The redevelopment risk for these hotels is just way too risky given this market and there was no way we were going to take that risk.

Where that puts us is there is approximately $10 million worth of potential liquidated damages on these hotels that, like I said, potentially would have to be paid down the road; however we do have the option of mitigating that by reinvesting once trends reverse. So, that is something that we will take a look at and make the best decision, but certainly in a worse case scenario paying the $10 million is a far better option for our shareholders than incurring the $100 million of risk in unfeasible projects.

Oh and one other thing, the three Kansas JVs are exploded from that. That is only on the two I Drive in Cocoa.

Smedes Rose - Keefe, Bruyette & Woods

Okay and we were looking at I guess the book value as of year end ’07 on those properties and then putting the impairment charge on top of that, which brings us to around $35 million. Is that around what you would expect to now be able to sell those properties for?

Richard Smith

I don’t want to comment on that for, I think, obvious reasons. I mean we don’t typically, when we sold the 45 we gave a range of expected proceeds, but on one or two hotels we don’t discuss expected proceeds in the marketplace for negotiating purposes.

Operator

Your next question comes from Patrick Scholes with Friedman, Billings, Ramsey & Co.

Patrick Scholes - Friedman, Billings, Ramsey & Co.

I just have a question on the portfolio, where you say you expect in the fourth quarter RevPAR to decline 3.5% to 5% and then you also mention that the portfolio would increase significantly more than your markets in the industry.

I am just curious what your expectations are for those markets and what was the basis point difference between your down 3 to 5 and what you expect the market to do.

Richard Smith

I think overall, based on what we are hearing from folks, we are expecting 8 to 10 down for the fourth quarter.

Like I said we did have 4.3% increase in market share portfolio wide. That is not just on the 70 that are in the 15-month window post renovation, 3 months of ramp up and 12 months of getting the return back. It is not just those 70 that the 4.3 is on, the 4.3 was portfolio wide the increase in market share in October.

Operator

Your next question comes from William Truelove with UBS.

William Truelove - UBS

In terms of the hotels up for sale can you give us a trailing 12 months cash flow from those kinds of hotels or some kind of measure like that?

Richard Smith

Due to the lower number of those hotels for sale we really don’t want to give that kind of information to help the buyers’ I this environment.

William Truelove - UBS

Trailing 12 months, I mean it’s trailing, come on they are going to get that data right?

Richard Smith

Yes, we can give you that. Do you have that handy? Actually we will go on to the next question and we’ll come back to that.

Operator

Your next question comes from Will Marks with JMP Securities.

Will Marks - JMP Securities

Can you start with answering the last question, because I think it wasn’t understood?

Richard Smith

It was $15 million.

Will Marks - JMP Securities

I just have one question on maintenance CapEx. In looking at next year you talked about cutting it down from, I guess, 6%. Could you break out what the additional spend needs to be in San Francisco and then approximately what you reserved for maintenance CapEx?

Richard Smith

I can tell you that we are still finalizing budgets across the board and we are still scrubbing all the projects, but as to the expenditure in San Francisco next year, it is approximately $14 to $15 million to finish that up.

As far as the types of items that it is restricted to it is primarily engineering items that need to be addressed. Whether that be mechanical, roofing, exterior, or something of that nature in order to protect and preserve the asset and there are a handful of other things that are already under way, kind of early release for ’09 that we are working on. And some brand related things related primarily to ISG that we are going to be doing next year in relation to their hallmark program and that’s pretty much it.

Will Marks - JMP Securities

On the, just a number to use on the maintenance CapEx, all we have to go with is that the 6% figure should drop, obviously that does not include the $14 to $15 for San Francisco, but it does include some of these other things.

Richard Smith

It is below 6% even with the $14 or $15 at San Francisco, but we will have to get you a final number once the scrubbing is done. There are other potential savings out there that we can pull back on and so we are still working the process. But, we will have to give you that when we give you ’09 guidance.

Will Marks - JMP Securities

Okay that is fair enough, and on the $150 million for this year how much is left to spend?

Richard Smith

It is in about the $30 range.

Will Marks - JMP Securities

That means $30 in the fourth quarter, not from today right?

Richard Smith

Yes, $30 in the fourth quarter.

Operator

Your next question comes from Nap Overton from Morgan Keegan.

Nap Overton - Morgan Keegan

Did I understand you correctly to say that you have got two hotels under contract and a third that is close?

Richard Smith

Yes.

Nap Overton - Morgan Keegan

Okay and could you share anything with us about the level of existing mortgage debt on those properties? Would those sales free up any substantial liquidity for the company?

Richard Smith

There is excess proceed expected on top of the mortgage debt. These are 50% JVs and on smaller tertiary market Holiday Inns in Kansas and Hayden the numbers aren’t that big either on the debt side or the proceed side as far as material difference to liquidity, but yes they will provide some.

Nap Overton - Morgan Keegan

And what about the remaining five hotels that you have earmarked for sale?

Richard Smith

Certainly, we expect proceeds significantly in excess of the debt outstanding on them.

Nap Overton - Morgan Keegan

Then would you just comment a little bit, Andy or Rick, on how it is that you are able to say that you’re confident of being able to refinance the 2009 maturity in light of current credit market conditions?

Richard Smith

Yes, clearly the mid-September freezing of the capital markets is beginning to thaw. I think you are seeing that LIBOR is shifting down; the major government central bank intervention that liquidity is coming back on the market.

Based on the conversations we have had with ten fleshier institutional lenders that have an active interest in financing this portfolio and a number of other relationship, not only banks, but other institutional lenders, there was clearly an interest in refinancing these seven hotels at a material proceeds number well in excess of an $118 million dollar balance.

We are clearly evaluating our options, matures in April, and I am not uncomfortable refinancing those well before April.

Operator

Your next question comes from Jeff Donnelly with Wachovia Securities.

Jeff Donnelly - Wachovia Securities

Rick, it sounds like, in your response to an earlier question, that the relative performance in RevPAR you’re expecting for your portfolio in, I guess, Q4 versus the market is a little wider than I think, I believe it was a 300 to 400 basis point spread you were originally talking about for the RevPAR for the [indiscernible] assets would provide. Do I perceive that right? What is driving that, or is it just for the one-quarter issue?

Richard Smith

I think that if you look at it, like in the third quarter. Let me give you a couple of pieces of information there that will hopefully be helpful here.

When you look at our portfolio wide for the third quarter the 2.6 of RevPAR if you can just take out two hotels, the Crescent and Union Square which were both under renovation during the quarter, that goes to 3.7. The things that you’ve really got to look at from a market share standpoint on this is looking at the hotels, and we try to give as clear information on this as we can, but you have got to look at the hotels that are in that 15 month window that aren’t being affected by anything else and look at the market share, they were gaining. During the third quarter the market share they gained was in excess of 6%.

If you look at that window every single quarter that we have been reporting this stuff, the hotels that are in that window that should be getting their return at that time have been growing share in excess of 5, 6% every quarter. So that is how we look at it and when you bake everything in together you pick up some other extraneous stuff that impacts that; so you have to keep that kind of bifurcated.

I don’t know if that helps, but in the fourth quarter – we know what we saw in October it was4.3%. That was portfolio wide, that wasn’t the 70. We expect to continue to gain the type of share both on the hotels that fall into that window as well as portfolio wide for the remainder of the quarter.

Jeff Donnelly - Wachovia Securities

I know you haven’t given guidance for 2009 on some of the figures, but I am curious, maybe you can help us out. How much of this relative out performance do you feel you retain as we begin to anniversary upon completion dates or renovation. Is it still as wide as, I guess, the 500 to 600 basis points you have been seeing in share gains, or does it revert very quickly to more of an in line performance?

Richard Smith

No I think next year I think you are looking at 1, 1 ½, 2% and that is the combination of stuff that we finish this year that had this placement this year and Marriott Union Square coming online, but we will have achieved the returns on everything else by virtue of that market share growth by the time we end the rest of this year.

We will have some pick up next year and then we will have some future pick up on the redevelopment that is currently being deferred, from an internal growth perspective.

Jeff Donnelly - Wachovia Securities

I had a question or two about the eight hotels you targeted for sale. How did you guys come to the conclusion to identify those specific assets? Was it something specific in those markets or is it more of a shift in called the required return you might look for on sort of an, I guess, call it a hotel analysis.

Richard Smith

It is kind of all of the above. It was a combination of when the hotels completed and got stabilized, re-stabilized post renovation and that coupled with our hotel analysis which look at future capital down the road, and it looks at where those markets are heading, and where the returns are going to be, and what we think we can do with the proceeds otherwise. Those were the first group of assets.

The eight includes the three Kansas JVs were always expected to be marketed once we got past a certain timing issue. So, we put those on the market. The other five were the first five that popped up post stabilization from the renovation that led us to believe that it was in the shareholders interest to sell them, assuming we could get certain proceeds for them. If we get those proceeds then we will move forward with it and if we can’t we won’t.

Jeff Donnelly - Wachovia Securities

Can I ask what that hotel return is, or at least how it has changed over the last I guess call it 90 days or even the past year?

Richard Smith

Well we look at, it is just a comparison of what we think we can do with the proceeds if we sell and we use the proceeds for something else. We look at various sensitivities on that whether it’s paying down debt, whether it’s using prior positions, whatever the case may be. What we think we can do with those moneys that will help shareholder value relative to what we think the returns are on a go forward basis if we hold it. If we think that we are better off by something – there is no fixed number, it is a comparison between the two.

Jeff Donnelly - Wachovia Securities

Do those hotels come with any assumable debt or would you be prepared to offer seller financing?

Richard Smith

Not right now, we are not going to do seller financing.

Operator

Your next question comes from David Loeb with Robert W. Baird & Co.

David Loeb - Robert W. Baird & Co

Can we just go back to the high driving Cocoa Beach? Maybe I just missed this and I apologize for that, but I am a little confused about the interaction between the impairment charge and the contract with IHG to do the condo portion. I certainly understood the [Smedes] math and it seems like that’s the way this works. You have a book value; you decide what you think they’re worth longer term or when you are going to realize that. I mean if it’s less you would take impairment, but was there some other piece that related to the contract with IHG?

Richard Smith

No, they are not related. The contract with IHG is a different issue.

David Loeb - Robert W. Baird & Co

Does the requirement that those condo projects be built out transfer to the new owner?

Richard Smith

No. We are not going to do any condos. We are not going to do any new development. That was what was expected of us per the amendment we did with IHG in 2006 that really allowed us to sell the 45 hotels and was kind of the lynch pin on the turn around. That was a deal that was exceedingly good for us.

David Loeb - Robert W. Baird & Co

The condos were just something that you were planning to do then?

Richard Smith

Yes. That was something as part of that contract and that amendment that we needed to redevelop those properties, because IHG wanted them, if they were going to stay in the system, to be redeveloped; so that was part of the deal that we were going to redevelop them. At the time that we made that deal those redevelopments were very feasible.

Given the current market conditions it is not anywhere near feasible and it is extraordinarily risky to shareholders for us to try to undertake that, so we made the decision to sell those and move on with life. By the way, the will be sold unencumbered.

David Loeb - Robert W. Baird & Co

That was my next question. So, they are going to be sold without brand at all.

Richard Smith

Correct.

David Loeb - Robert W. Baird & Co

IHG lives with that because you are going to pay them liquidated damages if you buy something else?

Richard Smith

Yes, we may pay liquidated damages.

David Loeb - Robert W. Baird & Co

So they have never been redeveloped and clearly that is going to have some impact on their value, hence the impairment?

Richard Smith

Well that doesn’t really have any impact on the – when these things were acquired the value was attributable to the hotels that they were and that is still the case today. I mean the allocation that went to those hotels when they were acquired relative to the market value in today’s market. That is what gets you to the impairment.

David Loeb - Robert W. Baird & Co

But the new owner, regardless of what brand they chose, will likely need to put some CapEx into those.

Richard Smith

I would imagine.

David Loeb - Robert W. Baird & Co

Yes, that is obviously the new owners’ problem. Andy I have a couple of questions for you.

In the kind of June to December of 2011 time frame when all your senior notes and your line of credit come due, essentially that is all of your unsecured debt. Are you thinking now about, I guess what is your long-term thought about whether you leave all that unsecured or whether you go and look to your remaining unencumbered assets, which were obviously many, and shift to a secured borrowing strategy.

Andrew Welch

The answer is technically the line could extend to 2012, but practically yes, they are all coming due in 2011. We are sensitizing various capital structures. Both the advantages and disadvantages of being 100% secure versus a more balanced structure.

Historically we have had a structure that has been more balanced for secured and unsecured. I think you have seen over the last couple of cycles that we have been better off, all secured or unsecured and we will certainly take that into account if we look to an overall capitalization of the company.

Richard Smith

One thing that I feel good about is, we are looking at very specific options with that, even though it is three years out and we will definitely have a plan in place far in advance of that being an issue.

David Loeb - Robert W. Baird & Co

Hopefully by then the markets will be a bit more cooperative anyway.

Finally, can you just talk a little bit about where your tightest covenant restrictions are and what happens in a more extreme downside scenario to those covenants?

Andrew Welch

Yes this was asked last quarter and let me expand on it. Our line of credit is the only debt facility we have that has a financial covenant. The two senior note adventures have an incurrence test, the ability to incur additional debt. The line of credits carved that out. Out of that all refinance is carved out. Those really aren’t relevant.

The line of credit covenants, the unencumbered we still have over $35 million of cushion, even with our new guidance. That covenant obviously is dependent on both EBITDA and debt as we talked about conserving cash, paying down debt, all but cutting capital expenditures, reducing unencumbered debt, it all impacts those cushions and I would say finally, we have an eight bank group of very strong relationships, five of those have been in our line more than ten years; an extremely supportive bank group. If the time would come we would need additional support from the bank group I do not see that being an issue.

Operator

Your next question comes from Chris Woronka with Deutsche Bank.

Chris Woronka - Deutsche Bank

Can you comment a little bit maybe on how you are starting to remix the business and maybe some of the rate implications from that as we go fourth quarter in ’09 and directionally how do we think about that in terms of margins more for ’09? I mean do you think you can, let’s say hypothetically your rate was down a couple of points. Can you offset that with the cost cuts, or just how you are looking at the mix of business right now and the flow through implications?

Richard Smith

Let me take that in two parts.

The first part, from a remixing standpoint now, as I mentioned earlier, in September and October we started to see, and this was a change, mid-week corporate begin to soften and so kind of premixing that into government corporate negotiated using travel industry promotion, third parties and so forth to kind of fill the gap on the softening, transient corporate market has been what we have done to remix. Like I said that did have something to do with rates there. We were able to flow pretty reasonably, given that, in the third quarter.

The outlook for the rest of the year and for ’09 is really kind of stop all non-essential spending to offset the declining revenue and/or the remix of business in that way for the remainder of this year. For ’09 it’s really, when you get to a point to where you are looking at declines in revenues such that people are talking about the market place, and we have yet to see where we think this is coming in. But when you start to look at declines in the market place such as that, it is a different way of operating. You are basically taking a blank sheet of paper and saying okay we get a hotel that has $20 million of revenue, we’re losing $2 million of revenue.

What is the plan to mitigate that, to keep GOP margins constant, which is way south of a 50% negative flow through. You have some negative flow through, but it’s not typical type of cuts that you would look at. You take out a blank sheet of paper; you look at managers, managers’ start doing work instead of just managing. You look at outlets. You look at the times that the outlets are open. You look at menus. You look at ways to be more efficient with regard to labor as it relates to serving your guest and things of that nature, so it really is a different operating model. We will need to get the budgets done before I can give you a lot of detail, but it is important to know that it is not just like the next level of contingency plans. It is a completely different operating model that you are going under when you have this kind of reduction.

We have had all the discussions with the brands and both the people that are directly responsible for working with us to make those decisions, but also all the way up the ladder to the very top of the company and they all basically say you get 100% support from us. We understand it is a different dynamic. We understand we have to do things differently and we are going to do that. Those changes are being worked through right now as we work on the budgets.

The flow through in a typical down year like this started out to be is, where you shoot for 50%, it is a completely different operating model going forward in that kind of environment.

From a brand standard stand point there has been massive kind of relaxing from an operating cost perspective on things that were going to be required and things of that nature. That also factors into it.

Across the board we are working with our partners very closely and looking at all types of spending, not only to maintain liquidity, but to maintain GOP margins to the greatest extent possible.

Operator

Your next question comes from Dennis Forst with KeyBanc.

Dennis Forst - KeyBanc

On the hurricane damage are there any insurance claims available or does everything fall underneath the deductibles?

Andrew Welch

Everything falls underneath the deductible.

Dennis Forst - KeyBanc

Then on the two Kansas hotels that are under contract when should you complete the sale of those two properties?

Andrew Welch

They are not hard yet, so I don’t want to speculate, but we would hope sooner than later. [Interposing] being hard, but they are not hard yet.

Dennis Forst - KeyBanc

Will they be discontinued operations in the fourth quarter?

Andrew Welch

If they go hard they would be – but they are unconsolidated so they won’t show up as [inaudible].

Dennis Forst - KeyBanc

Okay, so they are unconsolidated right now.

Andrew Welch

Yes.

Dennis Forst - KeyBanc

You said when you refinance the ’09 maturities you will have significant excess proceeds. What would you do with those proceeds?

Andrew Welch

We would pay down debt.

Dennis Forst - KeyBanc

You would pay down the line, your bank debt?

Andrew Welch

Correct.

Dennis Forst - KeyBanc

Okay any plans or thoughts about either buying stock, buying preferreds, any equity like that or do you not want to touch that trounce?

Andrew Welch

Well we are not precluded from buying back bonds, so when I said buy back, pay down debt that may include bonds or a line of credit or other secured debt that’s appropriate to pay down. As we’ve talked about before there is a long answer and a short answer to buying back stock. The short answer is we’ve precluded it today from buying back stock, so that is not an option.

Dennis Forst - KeyBanc

Does that include preferred stock?

Andrew Welch

Yes.

Dennis Forst - KeyBanc

Was there any significant number of rooms out of service in the quarter?

Andrew Welch

No there were not, other than San Francisco Union Square.

Dennis Forst - KeyBanc

My last question had to do with a comment that, I think, Andy made when you were talking about the 2010 maturities. You talked about the two loans 8.7%, $280 million and said when you refinance those you would lower your cost of debt?

Andrew Welch

Yes, those are 870 and my view of the world is that today’s rate and next years rate is going to be below 8.7% or that would be our expectations.

Dennis Forst - KeyBanc

So you would be able to do a secured mortgage loan for less than 8.7% some time between now and when those mature?

Andrew Welch

Correct.

Operator

Your next question comes from Jeremy [Hurz] with Onyx.

Jeremy [Hurz] – Onyx

I just have a follow up on the RevPAR question that was asked before, how you guys were seeing the industry for 2009. What quarter in 2009 do you go more in line with the industry?

Richard Smith

I think through out 2009 I think you can expect that, you know I was talking 1 ½ to 2% improvement based on getting back the – and that was for the full year. I didn’t give any timing on when things stabilize. Part of that is the 14 hotels that we completed in the first quarter of this year that would stabilize more toward midyear, but on the Marriott Union Square it will be available all year. It is kind of a split, I mean after we open it which is the end of the first quarter.

Jeremy [Hurz] – Onyx

So would you expect then to out perform much more in the first couple of quarters and then that will slow down a little bit in Q3 and Q4?

Richard Smith

No, because there is every bit as much pick up from the Marriott Union Square coming online as there is from the 14 public area completions that we finished in the first quarter of this year.

Jeremy [Hurz] – Onyx

Got it, and then in this quarter how much did you out perform the industry by this quarter? I might have missed that.

Richard Smith

It was 3½%, 3.7% over the US average.

Operator

Your next question comes from Rod Petrik with Stifel Nicolaus.

Rod Petrik - Stifel Nicolaus

How do you determine the value of the hotels secured by the $118 million due in April? You mentioned its 35% loan to value, but what metrics were you using?

Andrew Welch

Our current cash flows and market value of those hotels which if it’s a range of EBITDA mostly it’s on a trailing 12-month basis.

Richard Smith

It is a typical cap rate scenario on cash flows that lenders are using.

Rod Petrik - Stifel Nicolaus

What would they be?

Andrew Welch

I don’t want negotiate against myself with a discussion about lenders.

Rod Petrik - Stifel Nicolaus

Do you have a trailing 12-month EBITDA on those seven?

Andrew Welch

Yes, but given my discussions with lenders I don’t want to get into that Rob.

Richard Smith

They see that. We can give the trailing 12 months; we’re just not going to give the Cap rate’s that we’re under running it at.

Andrew Welch

It’s in the $40 million range.

Operator

Your next question comes from William Truelove with UBS.

William Truelove - UBS

When you did the new dividend policy, which I totally agree with was the right decision back in August, when you ran that I know that you mentioned that you had done some sensitivity analysis as to what that kind of policy would be able to maintain at a different various RevPAR situation. I know that you may not want to comment about the ’09 potential what could happen, because of the budget stuff coming up, but when you ran your sensitivity analysis back in August to set that dividend policy what was the range of, especially with the downslide obviously, when that policy was set, could you remind us of that?

Richard Smith

I did not give a range. I said we ran from down side sensitivities and that we had estimated, based on the best information we had, but I wanted to steer clear of giving guidance in a position of where there is very little visibility, so I did not give that and I am not going to give it today either.

I can tell you that we approach this stuff the same way. Once we get the budgets in and take into account everything else as it relates to liquidity, we will take a renewed look at the dividend. We will discuss it with the board and then we will have more color on it later.

William Truelove - UBS

A lot of the four star hotels which I knew you used to run in a past life, they would have multiple restaurants and that as always the big example that was talked about in terms of shutting down. From your portfolio, your hotels really don’t have multiple restaurants that you are going to be able to shut down. I mean there is still one. So, besides just putting the managers to work and what not, is there any kind of like major kind of obvious big chunk of savings that is there from an operational point of view that can be used at your type of hotels?

Richard Smith

Yes. You can run the unit and the outlets differently. You can run them from a time perspective. You can run them differently from a menu perspective which gets you to a labor perspective that is very different, cooks, hosts, bus boys, etc… So from a labor perspective you can save quite a bit of money while you are still servicing your guests. You are shrinking down the hours of operation, you are shrinking down the available options to guests, etc… from a menu perspective, and that’s how you combat that. If you have got one outlet you can’t close the outlet, but you can operate it differently.

Operator

Your next question comes from William Byrd with Monterey Investments.

William Byrd - Monterey Investments

I am interested in if you are hearing from any lenders or any operators who are coming to you and offering you a chance to be a part of their hotels or trying to sell you any at this time?

Richard Smith

We are not hearing much. I mean we are getting a little bit as far as wanting to know if we are interested in investing in their hotels and things of that nature, because there may be some distress situations starting to occur. There has been nothing of interest to us, nothing that we are pursuing, and nothing from lenders.

Operator

Your next question comes from Abner [Hoshen] with Fortis.

Abner [Hoshen] – Fortis

I have a follow up question on flow through. What do you guys think your typical NOI flow through is? Then what do you think your NOI flow through will be with your cost cutting measures in place?

Richard Smith

Well it is hard to determine what it is going to be on the ’09 budget. Like I said, it really is a completely different way of looking at it. It is not taking and doing the budgets based on the cost you had last year and looking at reasonable increases. It is changing your models, changing labor staffing guidelines, and things of that nature; so I can’t really comment on what we expect it to be next year, although what I did say before I will reiterate.

Our goal and what we have communicated to the operator, which are on the same page with us and understand where we want to get to and are trying to get there, is a place where we keep GOP margins flat. That would indicate a very low negative flow through to declining revenue.

Our goal for the remainder of this year, because things are already in place, is certainly 50% negative flow through. As we go through November and December that is a tough goal to hit in an environment like this, but that is our goal.

Abner [Hoshen] – Fortis

One other follow up was just when you guys were talking about 6% CapEx, does that include the [FF Inny] reserves that you are going to be required to put up?

Richard Smith

Yes.

Operator

Your last question comes from Chris Woronka with Deutsche Bank.

Chris Woronka - Deutsche Bank

In terms of the expense reductions what kind of opportunity is there at corporate? You are running at maybe $25 million this year; is there any way you can ballpark it?

Richard Smith

Well we can’t ballpark it for you yet, because we are going through that process right now. I can tell you that we are looking at every single line item. Next year when you meet with us at Alice you will be meeting with me instead of me, Steve, and Andy for example. Things of that nature we are cutting back across the board.

One note I want to make here. We are pretty much the leanest reed out there by pretty much all measures, number of rooms, number of hotels, percentage of revenue, etc… etc… and so we are pretty thin to begin with.

We made some changes when we started this thing three years ago, from a G&A standpoint, and really worked to get as lean as we possibly could and the use of outside consultants, contract labor, things of that nature. We have done a good job on that front already, but we are taking a complete look across the board including everything, every possible option. We will make the best decision for the company going forward: keeping long-term in mind but also being as efficient as possible next year. But, I can’t give you a number right now.

Chris Woronka - Deutsche Bank

I appreciate the color. I did not mean any implications there; I am just trying to get a sense. But I mean, it should be down year-over-year is that fair?

Richard Smith

Yes, we certainly expect that to be the case, and no offense taken Chris.

Richard Smith

Thank you everyone and we will talk to you next quarter.

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