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FelCor Lodging Trust Incorporated (NYSE:FCH)

Q2 2010 Earnings Call Transcript

August 4, 2010 11:00 am ET

Executives

Steve Schafer – VP, Strategic Planning & IR

Rick Smith – President and CEO

Andy Welch – EVP and CFO

Analysts

Patrick Scholes – FBR Capital Markets

Will Marks – JMP Securities

Smedes Rose – KBW

Susan Berlinger – J.P. Morgan

David Loeb – Robert W Baird

Ethan Steinberg – Friess and Associates

Josh Attie – Citigroup

Chris Woronka – Deutsche Bank

Bryan Scinder [ph] – BAM [ph]

Operator

Good morning, my name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to FalCor’s second quarter earnings conference call.

(Operator instructions) Mr. Steve Schafer, you may begin your conference.

Steve Schafer

Thank you and good morning to everyone. With me this morning are Rick Smith, President and CEO; and Andy Welch, Executive Vice President and Chief Financial Officer. They will address the current operating environment, results for the quarter, and our outlook. Following their remarks, we will take 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 in 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 filing 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.

Rick Smith

Thanks Steve, good morning everyone, thank you for joining us for our second quarter call. It was a very busy and productive quarter for us both operationally and regarding the balance sheet.

During the quarter, we exceeded the high end of our internal expectations for EBITDA by $3 million, FFO per share by $0.04, and RevPAR by more than 2%. Further, we are increasing our guidance for the full year significantly from what we set forth in May. Our new full year guidance is in line with First Call estimates, which clearly indicates that the variant in the analysts’ second quarter estimates is the difference between quarters at least partially.

As I do not know what is in the various analysts’ models, I simply cannot speak to that. The only thing that I can speak to is that we are increasing our full year guidance based on much better than expected growth relative to our prior expectations for the second quarter and for the remainder of the year. Now, given the disconnect in the second quarter, while we are not giving full quarterly guidance, I will tell you that the split between the third and fourth quarter is approximately 52%, and 48% respectively for the remaining year EBITDA. Hopefully that will take care of that going forward.

Our operational focus continues to be on maintaining our high market share index and maximizing flow-through. Our market share is on pace with where we expect it to be for the first half of the year and we are very pleased with that. Flow-through to budget once again exceeded our internal expectations. 80% of the incremental revenue was driven by occupancy and yet we were able to flow 62% of that incremental revenue to the bottom line. Going forward, we will look to drive rate through remixing business to take advantage of the increase in corporate and group demand and to limit expense, which we have done to this point.

Demand growth continues to accelerate both in transient and groups. During the quarter, transient room nights increased 4%. More importantly, corporate transient increased 7% compared to prior year. Total group rooms increased 18% in the quarter led by a 24% increase in corporate group. Occupancy levels are beginning to strengthen, and the number of compression days are increasing to the point that allows to push rates in certain markets and on certain days of the week. Tuesday and Wednesday nights were more than 80% occupied during the quarter with occupancy up more than 9% to prior year during those days.

In addition to pushing rates where we can, our asset managers continue to be very focused on remixing business as those opportunities arise. While that is an ongoing process that will take some time to complete, we are pleased with the trending. As a result, ADR increased in June for the first time since September of 2008. Importantly, premium corporate or borrow [ph] rate increased 5% as all of the pricing is set off of the borrow rates, this was positive movement and a good indicator for future pricing traction.

Group pace has also improved significantly. We started the year with group pace down 13% and as of the end of June, we are tracking up 2%. This improvement has been steady and we expect it to continue as we continue to see booking patterns strengthen. So demand continues to improve and we have not seen any signs that this is changing. Lastly, new supply continues to remain low and is lower in our markets than the industry at an average of 0.9%. We also expect this trend to continue.

Now let us turn to the balance sheet. During the second quarter, we had a lot of activity. We finalized the refinancing of all of our new term maturities. We have one maturity in late 2011, which was priced at LIBOR plus 93. It is currently at very good shape and given the pricing, we will not address that one until maturity. We have no further maturity issues.

We raised equity during the quarter. I have always said that we would issue equity if there was a use of proceeds that made sense for our shareholders long term that is exactly what we did. We repaid $177 million of debt at nearly $50 million discount unencumbering two strategic hotels. We have agreed to acquire the Fairmont Copley Plaza for $98.5 million. This is an asset that meets all of our strategic and investment return requirements and will add value for the shareholders long term. This hotel typifies our strategy to acquire upper upscale hotels in major urban markets with high barriers to entry. It will improve the overall quality of the portfolio, increase future RevPAR and EBITDA growth rates, and further diversify our portfolio. It is an irreplaceable asset that is being purchased at a significant discount to replacement cost.

The Back Bay area of Boston has extremely high barriers to entry. The last hotel developed in the area cost over $700,000 per key and there are no hotels currently planned for development. In addition to the improvement generated from the market recovery generally, we have tremendous opportunity to drive results above the market once we complete the redevelopment portion of our capital plans at the hotel and we utilize our asset management strength to drive revenue. The capital will greatly enhance the guest experience particularly for corporate customers with the addition of the state of the art business facility and an improved public space and enhancements to the guest room. We are excited about the acquisition and the clear opportunity that lie ahead with the hotel.

Lastly, I would like to touch on the second phase of asset sales. As I have mentioned in the past, with the turnaround in the secured debt markets and operating performance and vastly improved transaction markets, we will expedite the second phase of asset sales. We anticipate bringing the assets to market in stages for various reasons such as carrying cash flow to peak levels, supply and demand dynamics, and current debt encumbrances. We anticipate bringing the first group of assets to the market in late third or early fourth quarter. The remainder of the hotels will be brought to market at various times in 2011. This process will allow us to significantly delever, restructure the balance sheet, create capacity for future opportunities, and allow us to bring the preferred dividends current more quickly than originally anticipated. The portfolio repositioning plan is fixed and is the right plan to drive long term shareholder value and we look forward to updating you as we move throughout that process.

It was a good quarter. We performed very well relative to our internal numbers and our expectations made a lot of positive movement on the balance sheet and we are very pleased with the quarter. And with that, I will turn over to Andy.

Andy Welch

Thanks Rick and good morning. We are very pleased with the quarter. RevPAR grew 5.6% compared to our internal expectation of flat to plus 3%. ADR was up two-tenth of a percent in June, the first positive comparison in 21 months. Occupancy increased at 69 of our hotels during the quarter including all but one of our major markets.

Overall trends continue to improve steadily and faster than anticipated. During the quarter, RevPAR increased at 56 of our hotels. RevPAR during July increased 5.6% to prior year with ADR up 2% and occupancy up 3.5%. Hotel EBITDA for the quarter increased $3 million or 5% compared to prior year. As I noted during our February earnings call, certain expenses will increase in 2010 that did not occur last year particularly hotel level wages and bonus, excluding those two items which totaled $4 million hotel EBITDA would have been $7 million greater than last year.

Our hotel EBITDA margins were better than expected, declined just 27 basis points even with higher than expected occupancy and the mix between occupancy and rates. Excluding the compensation items just mentioned, hotel EBITDA margins would have increased 132 basis points. Adjusted FFO per share was $0.10 significantly higher than our expectations. The decline to prior year largely reflects higher interest expense of $14 million that is primarily related to our new senior notes.

The balance sheet, we refinanced resolved $1.5 billion of debt over the last 18 months, which is extraordinary given the state of the capital markets during that time. Our weighted average maturity is now March 2014. We have unencumbered seven hotels this year. We now have 11 unencumbered hotels. 12 when we acquired the Fairmont, which gives us additional and added flexibility.

During the quarter, we completed two significant debt transactions. On May 2, we closed a $212 million term loan to refinance our remaining 2010 debt maturities and lowered our interest rate by 63 basis points. Two hotels were released from the collateral pool. On June 23, we repaid $177 million of our debt for $130 million or a 27% discount. Our two hotels that secured these loans are now unencumbered. Last week we repaid two secured loans totaling $5.6 million that had a maturity date in 2011. These two loans were very low levered and repaying these loans create additional capacity. Our embassy suites located in both the Baton [ph] and St Paul are now unencumbered.

We continue to process and it is a slow process transferring two hotels each securing the CMBS loan to their respective service. The two loans totaled $32 million and is secured by our hotels in Deerfield, Illinois and Piscataway, New Jersey. We expect both hotels will be transferred within the next 90 days. When this is complete, we will have revised our debt this year by $247 million. We did raise $167 million of equity in June through our common stock offering the proceeds together with cash and on hand were used to fund the discounted payoff of debt I mentioned and will also be used to fund the acquisition of the Fairmont.

As a side note, based on what we have accomplished with our balance sheet and taken into consideration our revised guidance, our leverage will improve by three turns as compared to our original guidance in February. Again we have reduced our debt by $247 million this year and our leverage is three turns lower compared to our guidance at the beginning of this year.

Our liquidity position is strong. At the end of the quarter, we had $281 million of cash on hand, following the acquisition we expect to have at least $182 million of cash. We will continue to carry cash in excess of normal working capital needs to fund the retirement of the $87 million of the remaining instead of our 9% fixed rate note next June.

Let me walk you through our mid guidance and comparison to our prior guidance. Our improved expectation reflects several factors. First, actual second quarter results added $2.5 million of EBITDA on the high end and $6.5 million on the low end. Second we have revised our outlook for the remainder of the year as both demand and supply fundamentals continue to improve. And finally, the acquisition of the Fairmont is expected to add approximately $2 million of EBITDA for the remainder of the year.

We now anticipate RevPAR to increase 2.5% to 4.5% for the year compared to our prior guidance of flat to up 3%. As the recovery continues and ADR improves, we expect hotel EBITDA margin improvement to accelerate, and I expect margins to increase year over year. We now anticipate 2010 adjusted EBITDA to be between $177 million and $185 million, representing $11 million to the low end and an $8 million increase to the high end over our prior guidance.

Fundamentals continue to improve. Demand is now growing and supply growth continues to moderate. Supply growth of 2.1% last month is now below historical levels and the pipeline continues to shrink. New construction financing is much more difficult to obtain today than it was prior to the recession. As a result, we expect only moderate supply growth for the next few years. Additionally, fewer hotels are under construction in our market than the overall US. So our markets will have less supply growth than the industry.

To wrap up, fundamentals are improving and we expect that trend to continue. We had substantial cash on hand and no uncovered near term maturities remaining. Supply growth is low in our market and we continue to improve the balance sheet and our portfolio in an accretive manner and expect that to continue.

Thank you and Lisa we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Patrick Scholes from FBR Capital Markets. Your line is now open.

Patrick Scholes – FBR Capital Markets

Hi, good morning. I am wondering if you could give a little bit if possible more color on the hotels that you are potentially planning on selling, as far as what brands you might be favoring selling or which locations, I remember last time when you sold the portfolio of (inaudible) Holiday Inns any particular brand or location this time around?

Rick Smith

By the way, good morning, Patrick, how are you doing?

Patrick Scholes – FBR Capital Markets

Good morning.

Rick Smith

It is not really brand related issue, much of it is a market, sub market real estate issue and let me give you an example and I was just going to say kind of in market X, so you have four or five hotels, two of them very strategically located kind of have some built in protection against new supply and things of that nature, and it covers you for that market the way you need to. So you have got the other two or three hotels that are a little more susceptible to new supply and there is not really any strategic value because you are covered in the other two to hold on to those, it represents an opportunity cost of getting into the market that we need to be represented in that we are not and that is the kind of thinking the concentration of risk issues, the future capital issues, the opportunity cost issues, things of that nature are the things that drove this. So it is going to be a good mix of brands that will be spread across. So all of the brands except Marriott will be part of the assets [ph] on process and we will go from there.

As far as the second part, I think, of where you were going, what this will allow us to do, certainly we are going to stage the timing based on all the factors that I listed. There is some debt encumbrances that we have to be concerned about. There is also some other strategic reasoning for why those assets are going to be timed the way they are. The ability to expedite this is going to do a few things for us and allow us to move forward on the balance sheet restructuring much quicker than anticipated, create capacity much quicker than anticipated, and give the dividend the rarest piece of it for our current much more quickly than anticipated.

The other side of the preferred dividend is when from a pure operational cash flow standpoint you get to a point that, a) you are above the ratio under the indenture and, b) you have enough operational cash flow to justify paying that dividend on a go forward basis. But the asset sales will help with all of that.

Patrick Scholes – FBR Capital Markets

Great, thank you for the color.

Rick Smith

Thanks.

Operator

Your next question comes from Will Marks from JMP Securities. Your line is now open.

Will Marks – JMP Securities

Thank you. Hello Rick, Hello Andy.

Rick Smith

Yes Will, good morning.

Will Marks – JMP Securities

First question I had, you mentioned 21 months without ADR increase till June, what about how we are looking in July and maybe what is the outlook for the rest of the year on that?

Andy Welch

Yes July RevPAR was up 5.6% and of that 2% was REIT. So we are clearly anticipating rate to stay positive for the rest of the year.

Will Marks – JMP Securities

Okay and in terms of just further outlook, I know you are not going to give any guidance into 2011, I assume you think the momentum will continue to move positively.

Rick Smith

Well, certainly. And where that comes from is – I mean, the remixing process is a long process. It takes a while given everything that you have got on the books, all the locum negotiated and corporate negotiated stuff that you have got going forward, it takes a while to do what you need to do to remix. And also, we still – while we have opportunities in certain markets on certain days of the week to push rate because of compression that is certainly not across the board yet. So that will continue as debt moves up as well.

So I think that we anticipate continued improvement certainly even for the quarter higher in rate than what we saw in July and similar in the fourth quarter, but we know that it will be a process both on the remixing side and getting to that compression point where you can push rates across the board going forward. So that will take between now kind of through ‘11.

Will Marks – JMP Securities

Okay and then lastly on the dispositions, a couple of questions, one, when shall we expect them to go into discontinued operations or are they already in it?

Rick Smith

No they are not and that is going to depend on – we have not made final decisions on things at this point. So until we – I mentioned that the first group would likely be out kind of towards the end of the third quarter or early fourth quarter that is because there is some more work to do there. And so we are going to have to finish that work. There is a number of things that – we are going to have to feel that more likely than not that we are going to get those things out the door within the next 12 months before we start moving them into discontinued ops.

Andy Welch

On accounting life where we may separate statistics but they were not doing the discounts till they go into contract like they did on the first side.

Will Marks – JMP Securities

Okay I was not sure from an accounting standpoint, and lastly, did you quantify at all how much capital you think you could raise from these dispositions or do you care to?

Rick Smith

We have not yet. That is part of the additional work that is going on.

Will Marks – JMP Securities

Okay. All right, that is all from me, thank you.

Rick Smith

Thanks Will.

Operator

Your next question comes from Smedes Rose from KBW. Your line is now open.

Smedes Rose – KBW

Hi thanks. I noticed in your release that the investment in unconsolidated entities was up by $20 million and it looks like your pro rata share unconsolidated debt was down $20 million. So did you pay off some unconsolidated debt in the quarter and asset and I guess along that this $80 million of remaining maturities in that bucket, can you just remind us what kind of the maturity schedule is like for that piece?

Andy Welch

Yes the first question to me, that was Tysons Corner that we talked about last call, we did pay that off that was a $40 million mortgage that hotel is unencumbered, that was not consolidated so it is still 50:50 owned. The remaining maturities, we do not disclose in the Q but the majority of that $80 million is 2014 maturity.

Smedes Rose – KBW

2014, okay. And then I just wanted to ask you on your quarter, so in June you put out a release saying that you were pacing ahead of analysts’ expectations, which at the time were around I think $0.09 was the consensus, so you printed $0.10. And I am just curious, at that time did you think that you might come in more ahead than just kind of penny to consensus. I know you said you were beating internal estimates but since we do not know what those are, it is not as meaningful. So did something happen in the balance of the quarter that maybe was a little not what you expected?

Rick Smith

Absolutely not. Let me be really clear on this, okay, I want to clarify the entire timeline and what transpired. Now obviously under FD, we are limited on what we can do with you guys, right? So what happens is before we raise guidance in May, the consensus was 0 FFO per share for the second quarter. We increased our guidance, we beat the first quarter, we increased our guidance, the analysts’ consensus shot up to $0.09 that was too aggressive to begin with. That was higher than the high end of our internal expectations that we set guidance on. So there was clearly some disconnect on the quarter.

Now, after that we had a good April, May and we were going to May REIT, we wanted to be able to talk about that at May REIT, so we put out a release that said the following. We have a:

A) We are significantly ahead of our internal expectation, and B) trending above consensus estimates. What that says to me is that we are saying significant about our internal numbers but just trending above on the others. What I did not expect was consensus to go up on FFO per share by 67% and I figured there would be a slight increase but I never expected it to that magnitude. So once that happens, you guys cannot talk to us beforehand, we cannot talk to you after, so it is a tough thing to deal with.

So I think that the release in June was absolutely accurate, it was exactly what we were thinking. The only thing in retrospect that I think that we could have added is when we said trending above, we could have maybe said trending slightly above, but I thought that was implied by the virtue of the fact that we said we are significantly above our internal and we are trending above analysts. So that is what created the issue.

Look the bottom line here, we had a great quarter. We exceeded even in June every metric that we had that was the basis for our guidance that we gave in May, every single one. Flow through was great, it was not bad it was great. It was 62% on incremental revenue to budget and we were very, very pleased with every single thing that happened. And in addition to that, we made tremendous progress on the balance sheet.

So we do worry about the quarter. It is unfortunate that things transpired the way we did but that is the facts in the chronology of what happened.

Smedes Rose – KBW

Okay, thank you.

Andy Welch

Thanks.

Operator

Your next question comes from Susan Berlinger from JP Morgan. Your line is now open.

Susan Berlinger – JP Morgan

Thank you, good morning.

Rick Smith

Good morning.

Susan Berlinger – JP Morgan

I was wondering if you could – the first question would be if you connect over your kind of top performing markets and then a few of the weaker ones and then just let us know if there is anything going on there that we should expect going forward?

Rick Smith

Okay yes we can talk about that, from a market standpoint, both (inaudible) and San Francisco are performing very well due to higher corporate transient demand across many industry types. Five of the six hotels increased RevPAR by more than 10%. Union Square continues to be a top performer. Minneapolis, Boston, LA were also strong during the quarter and benefitting from various things, higher transient demand. New Orleans has been strong all year continuing to recover and more city wide activity relative to last year and stronger attendance at events like Mardigras plus all the (inaudible) oil spill. Northern New Jersey, which had been our worst performing market at the beginning of the year began to recover later than others but is performing very well as group and transient demand and picked up and it is one of our best performing markets currently.

Atlanta is a mixed bag. The three non-airport hotel benefitting from higher corporate transient demand and more city wides are doing very well. Two airports are lagging a bit. Orlando, San Diego and San Antonio continue to be soft, those are softer markets, and we have been affected by new supply and lower conventions than those markets. Overall, we are beginning to see widespread strengthening in demand for most all of our markets. Our occupancy increased and most of our markets on the second quarter at more than 80% of our hotels.

Susan Berlinger – JP Morgan

Okay. Now my second question would be – I think you said on Copley, you are going to doing a little renovation, is there any additional CapEx we should be factoring into this year or moving into next year?

Rick Smith

Well this year is all planning but all the CapEx spending will be next year but we are pretty excited about it. Whereas we have got a real opportunity to do a lot – I mean some in 11, some in 12, we have a real opportunity to do some things that really kind of reposition this hotel from a corporate traveler standpoint with some of the things we are going to do and we think there is a lot of upside there in addition to just normal market recovery. So we are very excited about the opportunity.

Susan Berlinger – JP Morgan

Great. And Andy I was wondering if you could re-educate me again on the whole preferred situation I guess in terms of if you do notable asset sale, how we should be kind of be thinking about kind of the catch up on the preferred and what other thing we should be thinking about with regards to that?

Andy Welch

Yes, good morning Su. Well there is kind of two metrics, one is the bond indenture, which is the 1.7. We talked about being above that ratio sometime next year. So that will allow us the opportunity to pay and as Rick mentioned from an operating cash flow standpoint that will be the metric to look out to pay the quarterly piece, and the second piece is with the asset sales we use as proceeds to catch up the deferred piece that is occurring. That is clearly a priority for us and we want to get those current as quickly as we can.

Susan Berlinger – JP Morgan

Got it. And then my last question is with all you have been doing on the balance sheet and your continued focus, can you just remind us of kind of a debt target, leverage target that you guys have in mind?

Rick Smith

It kind of depends on where you sit in the cycle. I mean from a pure stabilized basis, we have always thought around 4.5, 5 times. Obviously if you are heading into the downturn or getting towards the top of the cycle, you have got to be cognizant of that and be a little below that. There will be times when you are first starting the upturn where you could be a little above that but from a pure stabilized standpoint I would say 4.5 to 5 times, that has not changed.

Susan Berlinger – JP Morgan

Great. Thanks very much.

Andy Welch

Thanks Su.

Operator

Your next question comes from David Loeb from Robert W Baird. Your line is now open.

David Loeb – Robert W Baird

Good morning. I wonder if you could expand just a little bit on what Susan was asking and I guess as you look at free cash flow which you are going to start to generate before the preferred accrual in our model and based on your guidance, and more so next year as well as assets have proceeds, how do you weigh the various uses of capital before making the preferred current versus acquisitions or more debt retirement?

Andy Welch

From a priority standpoint, how do we weigh paying the dividend versus other uses?

David Loeb – Robert W Baird

Yes and specifically debt reduction and acquisitions.

Andy Welch

From a debt reduction standpoint obviously we have been opportunistic thus far this year and to the extent that opportunities such as that arose, there would be high priority. From a repayment of debt otherwise or reduction of leverage otherwise that is going to stem from the asset sale proceeds. And the plan on the asset sale proceeds is going to significantly delever us. I have talked about looking at the snapshot of the company before and looking at it we do not do anything to add any value, which we have already done in this quarter. But if we do not do anything to add any value and we just have moderate growth and we just sell the assets on moderate cap rate, then you are looking at being at three or four times at the end of the day once you get back to stabilization.

So there is a plan to delever the company. As far as the preferred dividend, it is a big priority. We want to get there as quickly as we can. We have to be – and Andy talked about this – but there are two components to this. One is paying current and one is giving current or (inaudible) current. On the paying current, you have to be above the threshold in the indenture which we expect to be sometime in 11 assuming we keep on the same growth trajectory that we have been on. And from an operating cash flow standpoint, there has to be funds available for distribution that warrant the payment of a preferred dividend from an operational cash standpoint. So that is the current pay but the bringing current is going to depend on the pace of the asset sales and when they close.

It is a big priority to us. We look at that, at least the accrual similarly like we look at paying down debt there you are kind of one and the same to us and we need to get both doing. We don’t like the overhanging it has on our stock. We want to get to a point where we have the discretion to pay common dividend as quickly as we can as well as getting the preferred current.

David Loeb – Robert W Baird

Okay, if I understood what you are saying, number one, free cash flow generation will likely go towards paying those dividends as they arise and then number two, you will delever just by selling assets including assets that have debt on them but with every dollar of excess proceeds that you get, you are going to look at either catching up on those accruals or acquisitions to give you more cash flow going forward which is a deleveraging transaction, or number three paying off other debt, and I guess what I am asking is when you compare those three options with the marginal dollar of debt reduction, what is the metric that you use to decide which bucket they go to? Does it go to paying down the accruals? Does it go to buying new assets or do they go to a specific debt reduction?

Rick Smith

You fully underwrite the opportunities as they – look you have got three buckets and you describe them correctly and those will be the three things that we will look at. We will pay off debt, we will get the preferred current, we will create acquisition capacity to get into what will be now our other two markets that we will be focused on. So it is going to depend on the underwriting at the time. At the time that what opportunities come to you, when do they come to you, when do you get over the threshold for the preferreds, what opportunities do you have from a debt reduction standpoint based on the proceeds in excess of what you have to pay up on the secured debt anyway. What opportunities are you looking at from an acquisition standpoint, how do they underwrite versus the other two, and it is going to be prioritized based on what is best for the shareholders long term, but all three will get done out of that bucket.

David Loeb – Robert W Baird

That makes sense. And final question for Andy, now that you have more unencumbered assets, are you looking at it considering the line of credit?

Andy Welch

That is not on the write up this year but something we continue to look at.

David Loeb – Robert W Baird

Okay, thank you.

Operator

Your next question comes from Ethan Steinberg from Friess and Associates. Your line is now open.

Ethan Steinberg – Friess and Associates

Hi guys, thanks for taking the call. I want to understand a little better in the revised EBITDA guidance you guys gave, what is implied in the back and the RevPAR guidance, what is implied as far as the breakdown between occupancy and pricing and how are you assuming that affects the margin that drop through in those new EBITDA targets?

Rick Smith

We expect flow-through to continue to be strong. It has been strong all year. We have done a really good job particularly in the incremental revenue to what was originally budgeted. All of the incremental revenue even though it has been 100% occupancy has flown through extraordinarily well but we expect about a 50:50 on the ADR [ph] going forward.

Andy Welch

So for the year you will probably see still right for the year be negative but for the second half be positive.

Ethan Steinberg – Friess and Associates

Okay, so are you saying 2.5% to 4% RevPAR guidance now and 50:50 occupancy versus price in that?

Andy Welch

Right in the second half.

Ethan Steinberg – Friess and Associates

And do you think that swings or accelerates towards pricing as you like each month or each quarter as you get into the back half?

Andy Welch

June was 0.2 positive rate, July was 2.0 positive rate. So we see that (inaudible) plus 3.5, so we expect the 2% to 3.5% to be more 50:50 for the entire second half. Yes we continue to look at that trend.

Ethan Steinberg – Friess and Associates

I am sorry, it is 50:50 for the second half or that would get you to 50:50 for the whole year?

Andy Welch

Second half.

Ethan Steinberg – Friess and Associates

Okay, got you, thanks.

Operator

Your next question comes from Josh Attie from Citigroup. Your line is now open.

Josh Attie – Citigroup

Hi, thank you. Can you talk a little bit more about the guidance for the third and fourth quarter, I think you said 52% of the EBITDA in the third and 48% in the fourth, and when I do the quick math on that it looks like that implies $45 million of EBITDA in the third and like $41 million in the fourth, and from a year-over-year perspective, it does not really seem to make sense, it implies that it is down 1% in the third quarter and then up like 35% in the fourth quarter, I do not think you have really bought or sold any – I guess it depends on when the Copley contributes but am I not looking at that the right way?

Andy Welch

Yes, I do not want to start down the road of getting into more full guidance on the fourth quarter but there is a number of factors in there for us and there is a – it is approximately 52:48 on the split that based on all of those factors but there is a – without really jumping in I am basically giving full third and fourth quarter guidance which we are not going to do. I cannot really start to get into that level of detail Josh.

Josh Attie – Citigroup

Just help me understand why it would be down year over year in the third quarter on RevPAR that is trending up 5 to 6?

Rick Smith

Josh, I do not know what – maybe we talk offline, it is not, it is up year over year, in the fourth quarter it is up significantly year over year.

Josh Attie – Citigroup

Okay and then I guess a separate question, when you think about your RevPAR growth is trending up 5.6 in July and the industry is trending up a lot higher than some of your peers, what do you attribute that performance gap to, and do you think it is just the second and third quarter issue and do you perform more in line with the peers in the fourth quarter, what is driving that?

Rick Smith

Yes, first of all it is not a performance issue. Secondly, we are maintaining market share where we expect to. We have this every summer Josh, I mean June, July and August when school is out we have a high base of embassies that run at much higher occupancies than what others typically run and we have a dip every summer. Even if you go back and you look at the years, you look at us versus the industry and the years we gained immeasurable market share, we still dipped in the summer. So it was absolutely expected. The numbers that were achieved in June and we are thus far achieving in July are at that level above expectations certainly for June, I am not going to comment on July but it is not a performance issue, it is a typical thing for us and we on ‘08 and ‘09 combined we had very stellar results relative to our peers but in the summer months we dipped every one of those years.

Now the other aspect of this thing is that certainly we have more difficult comps than some of our peers who have bigger group houses, because groups like I said group was at 18% in the quarter, 24% from a corporate group standpoint, and so when there is more pick up in group and you are competing against people with peer group houses, you are going to have a little bit of a dip there as well.

Josh Attie – Citigroup

Well I guess just from a sequentially then do you think that your RevPAR growth is going to be higher in the fourth quarter than it is in the third quarter?

Rick Smith; No, from a comp to year-over-year basis it is fairly much the same.

Josh Attie – Citigroup

Okay, thank you.

Rick Smith

Thanks.

Operator

Your next question comes from Chris Woronka from Deutsche Bank. Your line is now open.

Chris Woronka – Deutsche Bank

Good morning guys.

Rick Smith

Hi Chris.

Chris Woronka – Deutsche Bank

I am not asking for guidance on 2011 but can you talk a little bit about how you see the mix shifting next year in terms of more transient – I mean is it conceivable that occupancy is almost flat but rates are up pretty significantly, is that the most likely outcome on rate occ for next year is that among the most likely?

Andy Welch

I think there is opportunity for a slight increase for occupancy next year because you have a lot of things happening on an unbudgeted basis this year. So I think there is still going to be some room, people will be adding to their budgets next year, so I think you still can see a slight occupancy increase, but I do think it stabilizes and I think from both perspectives from a standpoint of being able to actually push rates a little more because you are going into this year’s RFP season having better input than you had last year so you are going to be able to negotiate the rates a little better. And from a standpoint of just having compression, you are going to be able to push trendier rates a little better and also from a standpoint of remixing the business and continually pushing that envelope to mix out, the lower rate of base business and let that fill with corporate transient as well as corporate group to build your base a little higher. All of those factors are going to lead to higher rate next year but I do think that there is some opportunity for slight occupancy increases.

Chris Woronka – Deutsche Bank

Okay great. Have you seen the booking windows increase at all on the transient side in recent weeks or months?

Andy Welch

A little bit. I mean, it is starting to increase a little bit. It is not – we are not anywhere near where we used to be as far as booking windows for groups but it has picked up a little bit, yes.

Chris Woronka – Deutsche Bank

Okay and then I apologize if you may have covered it early but on the asset sale front, it is the current market encourages you to try test of the upside for some of these non-core assets more than it might have say six months ago?

Andy Welch

Absolutely, I mean there is a number of factors here. One is when the secured debt market really started to turn around in March that was kind of the first (inaudible) right, because the transactional volume was down for a number of reasons but that was one of them. The second thing was that operational results started to come back and that really picked up strongly in March as well concurrent with kind of the secured debt markets opening up, that led to transaction volume picking back up and that put us in a position to where we were able to expedite that pretty dramatically.

We had come into this year thinking, I do not know how realistic it is to get there and start that process until 2012, maybe even mid 2012 and now we are going to be starting it later this year, the first group of assets will probably be ready to be approved and put on the market late third, early fourth quarter.

Chris Woronka – Deutsche Bank

Okay, very good thanks.

Andy Welch

Thanks Chris. And operator, we will take one more question.

Operator

Your next question comes from Bryan Scinder [ph] from BAM [ph]. Your line is now open.

Bryan Scinder – BAM

Hi guys, congratulations on a good quarter by the way.

Rick Smith

Thank you very much.

Bryan Scinder – BAM

A couple of quick clarifications, on the bond indenture and the hurdle that you need to achieve in order to be able to pay a little bit of dividends, it is 1.7 times, how exactly is that measured? Could you take me through that math quickly and then I have got one follow up.

Andy Welch

The simple math is consolidated EBITDA to consolidated interest. There is a couple of (inaudible) that actually improved that ratio by a tenth or so and it is complicated to go over now but if you could do that simple ratio and add about a tenth, that is where we are.

Bryan Scinder – BAM

Okay so meaning that there is some add-back to EBITDA that may be slightly different from a gap computation?

Andy Welch

Correct.

Bryan Scinder – BAM

Okay, so it is basically interest coverage defined as consolidated EBITDA with some additional room for add back and divided by interest expense?

Andy Welch

Correct.

Bryan Scinder – BAM

Okay that is very helpful, and then on the asset sale side, there was lots of discussion at net REIT and we have had lots of discussions with other companies in the lodging space that are out trying to make acquisitions that is much more competitive on the acquisition side than they would have ever expected meaning that if they are presented with an opportunity, do you think there could be one of three or four or five people looking at it and it turns out that there is 15 people potentially bidding on it and in fact I think to a certain extent some of your commentary during those presentation sort of ratified that deal. If that is the case and there are actual buyers and there are clear benefits to disposing some of the properties that are considered non-core for you, why not try to expedite the timeline in order to make that happen sooner? I am just curious what your views are on the timing and why.

Rick Smith

Based on all of that and everything else that I said earlier, we basically moved the timeline up almost two years. So we are doing that. As far as why they are not on the market today, there are a number of factors there. Some of it has to do with EBITDA, some of it has to do with debt encumbrances, and the timing it typically takes to sell assets, and when things sink up so to speak not to shoot ourselves on the foot from a – you get a double whammy because you sold it before it may be optimal and you have done it before you have hit a trigger point on a repayment of debt and things of that nature. So there is a number of factors in there that will all be part of why and when assets are going to be going to market. It has been an effort to expedite as much as we can but at the same time not to do something that is disservice to the shareholders because we are trying to just at all cost run after market as quickly as we can.

So it is kind of a – it is a fine line you have got to walk between what makes sense and what does not make sense as to when you bring things to market. We want to get the first group to market as quickly as we can and we will do that and then there is reasons whey that the second group will go, when the second group does then the third group will go when the third group does, all various items.

Bryan Scinder – BAM

What I see is it is happening more likely in three phases or staging of certain properties because of the various factors that you just mentioned.

Rick Smith

Right, it is all between kind of the end of the third quarter of this year and the end of the ‘11 as far as when they are going out to market. So it is not like it is going to last three or four years. It is over a 15-month period that we are getting them out on a market as it makes sense.

Bryan Scinder – BAM

Okay now as I recall the original basket of non-core properties I think defined as a rough number of around 30, is that still a good working number.

Rick Smith

It is still a good working number. There is going to be some finalization of some things but that is a good working number.

Bryan Scinder – BAM

And then there were a few properties that have opened up by virtue of some of the more recent actions that you have taken buying back debt at a discount doing some other things you have freed up some properties, how many are in that basket of unencumbered properties and would any of those be expected to be sale candidates as part of this process or do you view those differently.

Rick Smith

There is, first of all, we have unencumbered seven properties this year and when you add in the Fairmont it makes it eight and it gets you to 12 total a lot of those are core properties but there are a handful in there that are potential sells.

Bryan Scinder – BAM

Okay, so some of those may be sold and again would be sort of part of this other process that may occur and some of the other unencumbered are considered core properties. So could be available to either be relevereged at some point or just simply held as unencumbered properties.

Rick Smith

Certainly.

Bryan Scinder – BAM

Okay. Thank you very much for the clarifications guys.

Rick Smith

Thank you. And operator, thank you very much for your time today everyone, and we will talk to you next quarter.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: FelCor Lodging Trust Incorporated Q2 2010 Earnings Call Transcript
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