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Red Lion Hotels Corporation (NYSE:RLH)

Q4 2007 Earnings Call

February 14, 2008 2:00 pm ET

Executives

William Schmitt – ICR, Inc., Managing Director

Anupam Narayan - Chief Financial Officer & Executive Vice President

John M. Taffin - Executive Vice President, Hotel Operations

Analysts

David Loeb – Robert W. Baird & Co., Inc.

William Marks – JMP Securities

Smedes Rose - Keefe, Bruyette & Woods

Operator

Ladies and gentlemen thank you very much for standing by and good afternoon. Welcome to the Red Lion fourth quarter and year end earnings conference call. Not at this point and during managements’ prepared remarks we do have all of your phone lines in a listen-only mode. However later there will be opportunities for your questions and we certainly encourage your participation at that time. (Operator Instructions) As a reminder today’s call is being recorded. So with that being said we’ll get right to the fourth quarter agenda. Here to introduce the executive team and with our opening remarks is Mr. Bill Schmitt. Please go ahead, sir.

Bill Schmitt

Good afternoon and welcome to Red Lion’s Corporations fourth quarter 2007 earnings conference call. With us today are Red Lion Hotel’s President and Chief Executive Officer, Anupam Narayan and Executive Vice President, Hotel Operations, Mr. Jon Taffin.

Today’s call will follow the following format. Mr. Narayan will begin with a few introductory comments, give an overview of the quarter, highlight some recent accomplishments and discuss the financial results and 2008 outlook. Then Mr. Taffin will provide a discussion on the hotel segment and its outlook and then they will open the call to any questions you may have.

Before I turn the call over to them please remember that in this call management’s remarks may contain forward-looking statements within the meaning of Federal Securities law including statements concerning plans, objectives, goals, strategies, projections of future events or performance and underlying assumptions many of which are based in turn upon further assumptions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Security Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today including, but not limited to, risks and uncertainties related to local conditions such as an oversupply of or reduction in demand for hotels, change in travel time, extreme weather conditions and cancellation of or changes in events scheduled to occur in the company’s markets and the attractiveness of the company’s hotels to consumers and competition from other hotels. Examples of forward-looking statements include statements related to Red Lion’s anticipated or projected revenues, gross margin, operating margin, RevPAR, EBITDA, expenditures and liquidity needs. We would like to encourage all of our listeners to review a more detailed discussion of the results and uncertainties related to these forward-looking statements that is contained in the company’s filings with the Securities & Exchange Commission and in particular on its Form 10K. Any projections as to the company’s future financial performance represent managements’ estimates as of today, February 14, 2008. Red Lion assumes no obligation to update these projections in the future due to changing market conditions or otherwise.

And now with those formalities out of the way, it is my pleasure to turn the call over to Red Lion Hotel Corporation’s President and Chief Executive Officer, Anupam Narayan.

Anupam Narayan

Welcome everyone to Red Lion’s fourth quarter earnings call. Before we dive into the fourth quarter I’d be remiss if I did not take a minute to recognize Art Coffey. As you’re aware from yesterday’s announcement, Art has retired as President and CEO from Red Lion Hotels after spending 27 years with the company and its predecessors in order to spend more time with his family and his own personal interests. We are indebted to him for his leadership and work in turning Red Lion into the success it is today and he leaves the company in excellent shape as we embark on our next stage of growth and on behalf of the entire Red Lion team I’d like to thank Art for everything and wish him and his family all the best. As for me, I’m honored that our Board of Directors has appointed me President and CEO and I look forward to leading a very talented group of Red Lion associates to even greater success in the future.

We’re very pleased with our fourth quarter performance of 8.6 RevPAR growth at owned and leased hotels and a 24% increase in EBITDA from continuing operations excluding 2006 special items. We are particularly pleased to deliver these results in one of our seasonally slow quarters. In addition, our presentation of Walt Disney’s The Lion King in Honolulu provided a great boost to our entertainment segment in both revenues and operating profits in the quarter. Our long-term strategy remains solidly in place as we progress in our key initiatives. As you know in the beginning of the fourth quarter we acquired the Anaheim Maingate Hotel marking our return to the valuable and strategically important Southern California market. The design and procurement stage is well under way and renovations are expected to be substantially completed by early 2009.

Overall 2007 was a very successful year for Red Lion as we achieved our goals in RevPAR and margins and more importantly we are well positioned for the long term. Our balance sheet is strong with cash of $17 million and undrawn credit facility of $50 million and strong credit ratios. Our product standards have been tightened to ensure the quality of the Red Lion brand and with these new standards we’re working to expand our presence and further increase Red Lion brand recognition. We firmly believe our strong core business and strong balance sheet will enable us to execute on our long-term strategy whether we face a prosperous or challenging economy going forward.

Now I’d like to cover the financial results in more detail and provide you some information on key transactions and initiatives. But before I speak to our financial results I’d like to remind you that these financial results reflect our continuing operations because we feel that that’s more meaningful to investors. The operating results of discontinued operations are listed as a separate line item which in the fourth quarter comprised of certain expenses related to our Lincoln office building sold in the third quarter. Further, I will also discuss certain financial items before various special items in 2006. Please refer to the exhibit in our press release issued yesterday afternoon for a reconciliation of these items to the nearest GAAP measure.

Turning to our quarterly results total revenue in the third quarter increased 11.6% to $44.1 million. Hotel revenues which account for 84% of total revenue increased 3.7% in the third quarter to $36.9 million. Fourth quarter 2007 hotel results included no revenue from the Red Lion Hotel Sacramento compared to three months in the prior year period. In addition fourth quarter 2007 contained two and a half months revenue from the recently purchased Red Lion Anaheim which is not in prior year period results. So on a comparable property basis, hotel revenues increased 6%. Total revenue increase was driven by the 8.6% growth in RevPAR I mentioned earlier at owned and leased hotels and was achieved with a combination of a 4.5% increase in average daily rates and a 200 basis point increase in occupancy.

Franchise and management revenue declined primarily to the receipt of a franchise termination fee in the prior period and fewer franchised hotels this year. This was partially offset by fees from the new long-term franchise agreement for the Red Lion Hotel Sacramento. Entertainment revenues increased $3.4 million in the fourth quarter of 2007 due to strong sales from our presentation of Walt Disney’s The Lion King in Honolulu. Operating expenses in aggregate for the fourth quarter of 2007 increased $4.4 million to $44 million. Operations in our hotel division continue to improve as hotel expenses rose by 1.3% on a 3.7% increase in revenue resulting in hotel operating margins improving 205 basis points and driving a 19% increase in direct hotel operating profit.

Direct costs for the franchise and management segment increased slightly in the quarter and entertainment expenses increased by $2.8 million primarily due to the expenses related to the successful presentation of Walt Disney’s The Lion King in Honolulu. Depreciation and amortization increased to $4.3 million mainly due to a capital expenditure associated with renovations completed in 2006 and 2007 as well as additional depreciation expenses associated with the Anaheim acquisition. With the positive flow through from hotel operations EBITDA from continued operations before 2006 special items increased 24% to $4.7 million. Overall, for continuing operations before special items net loss was $1.1 million or a loss of $0.06 per fully diluted share an improvement from a loss of $1.4 million or a loss of $0.07 per fully diluted share in the same period last year. As of December 31, 2007 our cash position was strong. Capital spending during the quarter was approximately $11.4 million mainly for renovation at various properties and the $8 million acquisition of the Red Lion Anaheim. We believe that our current cash position, cash from operations and the $50 million undrawn credit facility provide us with sufficient resources to meet our existing needs as well as fund our long-term growth strategy.

In the fourth quarter we repurchased 924,200 shares at an aggregate cost of $9.1 million and in January of this year we bought back 93,000 shares which completed our $10 million share repurchase program. Going forward we will evaluate further repurchases in the context of all our investment options.

In addition to our fourth quarter results we are introducing our 2008 guidance. We expect 2008 RevPAR growth for company owned and leased hotels in the range of 3 to 6%. We expect 2008 direct hotel operating margins to improve between 50 and 100 basis points from 2007 and expect 2008 EBITDA from continuing operations to be in the range of $34 to $36 million which is a 3 to 9% increase from 2007.

With that I will turn the call over to John Taffin.

John M. Taffin

Good morning everyone. As we’ve previously discussed the company has worked very hard during the past few years to improve our brand and to significantly enhance our hotels through renovations. The enhanced brand improved systems and service and our revitalized properties have driven our strong fourth quarter and annual results.

The increased RevPAR at owned and leased hotels of 8.6% in the quarter and 12.3% for the year reflects the success of our strategy to realign our business mix and to target higher-rate market segments. We deployed this strategy upon the completion of our renovations and have seen strong increase in our transient segment as evidenced by our occupancy increases in 2007. The repositioned hotels have also been successful in building a good base of future group business. Our group rooms pace for 2008 is 13% more than the pace for 2007 at the same time last year. This gives us a satisfying feeling knowing our improvements have also been recognized by our group guests and have driven additional group bookings. The company’s central reservations system contribution continues to grow. In 2007 the brand delivered over 47% of rooms revenue to our system hotels up from 43% in 2006.

RedLion.com has continued to perform beyond our expectations too and is our single largest electronic distribution channel. For the year our GDS related business or that which is booked through traditional travel agencies also performed very well and this is a good indicator of commercial transient market segment traffic. Revenues through this channel through our owned and leased hotels grew by 13%. Our company has reported very strong RevPAR gains during the past two years for our owned and leased hotels. Same store growth in 2006 was 7.2% and 12.3% in 2007. We believe that in many markets we’ve outpaced the growth of our competitors and we continue to make market share penetration a high priority. I think this will even be more important in 2008 as we move into a cycle in our industry where analysts are still expecting higher than inflationary average rate gains and slower growth to slight declines in occupancy.

The Red Lion system includes a high concentration of properties in the Northwest. In this region we are seeing some positive economic indicators that could be favorable for us. First as the Canadian dollar as become stronger against the US dollar we’ve seen an increase in Canadian travelers to our Northwest cities. Though this is current a very small market segment for us the trend would suggest that a weaker dollar is attracting more foreign visitors to our hotels. It’s also interesting to note that bookings to our hotels generated through [AMADEUS] which is primarily a GDS for non-US travelers grew by more than 29% in the fourth quarter. This has further supported the theory of an increase in foreign travel to our hotels. Much of the economy in the Northwest is agriculturally based and as many of you probably follow the demand for grains and other organic-based materials has risen dramatically. This increased demand has created higher prices, more production and higher profits for this sector of the economy and this could help insulate our region in the face of a more stagnant overall economy.

We’ve also proven to be a good steward of our margin. We have steadily improved margins during high demand cycles and protected margins when demand has not grown. We’ve delivered a 205 basis point increase in the fourth quarter and 250 basis points for 2007. This follows a 190 basis point increase in 2006. We intend to continue to focus on profit flow through regardless of shifts in business cycles.

We previously reported that the company has made major investments in its owned and leased hotels and significantly enhanced the hotels through renovation. We’ve also required our franchisees to make the same upscale property enhancements that are now brand standards. I believe that the majority of our franchisees have embraced this requirement and have been working diligently to renovate their hotels. We have reported that there are three franchised hotels totaling approximately 300 rooms that will be exiting the Red Lion system during the first half of 2008 and we expect that there may be two to four more franchised hotels that will not meet these new brand standards and will be terminated from the system in 2008. The result however will be a much improved Red Lion system and we believe that all remaining Red Lion hotels and the Red Lion brand will be much better perceived. Additionally, one of the hotels whose franchise agreement expired at the end of the year has entered into a new long-term agreement with us.

We’ve also mentioned that we intend to grow the Red Lion brand portfolio of hotels in key Western markets. Our strong balance sheet, credit facility and solid core business will help with our expansion plans in major hub cities. With a difficult financing environment in the capital markets and increasing cap rates for hotels we believe our strong financial position makes us uniquely positioned to competitively bid on quality assets in a more rational marketplace.

I am very proud of our accomplishments in the fourth quarter and for the past year. I am also confident in our long-term strategy and I believe that the momentum that the teams at our hotels have built in 2007 will help carry us through 2008 no matter the economic environment.

With that I’ll turn the call back over to Anupam for some closing remarks.

Anupam Narayan

As you heard we are pleased with our 2007 results and we expect 2008 to reap the benefits from our investments in the business. At the same time we will monitor economic conditions and be prepared to respond to any changes. It should be an exciting year as we look to execute on our long-term growth plan and continue to deliver good financial results.

With that we will now open up the call for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen as you’ve just heard we are inviting any questions or comments that you may have. We have a full panel assembled for you today so please take this opportunity to queue up. (Operator Instructions) Representing Baird our first question we go to the line of David Loeb. Please go ahead, sir.

David Loeb – Robert W. Baird & Co., Inc.

Now, a couple questions, John, I guess, can you give an update on the schedule around the Anaheim conversion?

John M. Taffin

Oh sure. Yeah. We have the rooms design plan completed and we are currently reviewing it with contractors so we can be underway as quickly as we can. We’ve got quite a bit of business coming in because of Spring Break through March so we intend to take a portion of the rooms down in April and start accelerating the room renovations. Simultaneous to that we’ll be finishing up our design plan for the public space and we expect to have everything done early in 2009. We have received approval from the City for exterior plans. We’ve got jurisdictional approval for the curb cuts and changes that we’re going to make to the plaza area so things are moving along very nicely.

David Loeb – Robert W. Baird & Co., Inc.

When do you think it’s Red Lion enough that it carries the Red Lion brand?

John M. Taffin

I think that’s going to be I’d say late second quarter, early third quarter.

David Loeb – Robert W. Baird & Co., Inc.

Can you just give a little more color on the franchisee adoption of the new brand standards? You mentioned that you think most of them are proceeding and things are coming along.

John M. Taffin

I have regular dialog with the GMs and the owners there and we are in the process now of going out and inspecting so we can compare our PIPs to the actual construction that’s going on. I believe that the owners have embraced the program because of the testimonial that we have provided over the last couple of year with the growth that we’ve seen. So I think that there’s a lot of confidence out there that gets them the return. Now, as we’ve reported there are a couple who are going to be something differently with their properties and so we expect them to leave this year and if there are any delicate ones I’m actually meeting with them personally this month. There are a couple of those.

David Loeb – Robert W. Baird & Co., Inc.

On the flip side of that, given this confidence that the owners are feeling, what’s the outlook for additional franchisees or it really to early to be thinking about that still?

John M. Taffin

We still have that as a priority and I’m helping to provide support on the franchise side. But one of the things that is interesting to us is, because of the way that the capital markets are progressing and the way that cap rates have come down, more properties are actually coming on line and so we think that by trying to accelerate our acquisition strategy, that actually is a better approach for adding value to the company and I think it’s just simply the equation. If you looked at a matured asset that we purchased it would provide EBITDA of maybe, what six to eight franchisees would. So we are certainly putting our capital and our talent towards the acquisition strategy to try to get that moving.

David Loeb – Robert W. Baird & Co., Inc.

Final question for Anupam. On those six to eight franchise equivalents, what’s the acquisition market like these days and if you found something you liked how would you be likely to finance it?

Anupam Narayan

That’s somewhat two different questions, David. The acquisition market, as John just said, I think it is actually opening up quite a bit, cap rates have gone up which is great and I think we’re not seeing the same competition, what I recall from the spectrum of money that we saw in earlier years. So the marketplace has changed. Financing, we’ve got a fair amount of capacity on our balance sheet, a very low leverage, you’ve got our unused credit line which can have an accordion feature that can be expanded from $50 $100 million and we have cash now on our balance sheet and we will finance acquisitions. So we think we have enough capacity as the acquisitions come on, depending on the size, we will look at all options.

Operator

Next we go to the line of Will Marks with JMP Securities. Please go ahead.

William Marks – JMP Securities

I first wanted to ask you about your replacement as CFO. Anything you can tell us there?

Anupam Narayan

I guess it’s too early but the fact is we will be looking for a replacement for me. We will be looking for an appointment of a CFO and I hope to have that sometime soon.

William Marks – JMP Securities

Second, on share repurchase. You’ve completed your program. Would I be presumptuous to say that you’ll at least consider another program given your stock price?

Anupam Narayan

Just like anything else we will continue to evaluate all investment opportunities which include a share repurchase for the best return to the shareholders. So we will consider that as part of it. No immediate plans right now, but that’s one of the investment options that’s open to the company.

William Marks – JMP Securities

Question for John. Haven’t really heard anything about individual markets and what we’ve seen from the Smith Travel data is a pretty weak Seattle year to date and my understanding is that [inaudible] had mentioned business hasn’t been great. Can you comment on maybe your top few markets and what you have seen so far and expect to see this year?

John M. Taffin

Let me address Seattle first. I actually had a conversation with the director of the CBB there and thought the January group sales were down he believes that 2008 is going to be a pretty successful group year for that city. Also the transient volumes in that city continue to grow and then based on the foreign exchange, we think that that bodes well for a port city like Seattle. In fact, recently there have been more foreign direct flights that have been added in the Sea-Tac area including London, Paris, Frankfurt. So we think that is going to help on that side. Other markets that we’re in we haven’t seen significant supply growth. So we believe that by building a base of business as we have done with our group and we’re evaluating any permanent accounts. I think that positions us very well. I’m not going to give you specific statistics market-by-market but we think that we have a lot of momentum going into 2008. We’re going to be very careful about watching it in the event we need to make any contingency plans, but I don’t see any huge holes out there.

William Marks – JMP Securities

Is supply an issue in Seattle?

John M. Taffin

The supply has been growing in Seattle over the last three years and occupancy is still very high there. I think the supply is starting to mature but demand I believe has kept up with supply.

William Marks – JMP Securities

On Anaheim, should we expect a flat year this year? A slight loss? In terms of EBITDA?

Anupam Narayan

I think as we’ve said for Anaheim we don’t expect it to cover its lease payment in 2008 primarily because of the renovation and the disruption. So I would expect it to be below its lease payment and on an EBITDA basis be a negative contributor to 2008.

William Marks – JMP Securities

How much is the lease payment there?

Anupam Narayan

It’s a $1.8 million lease payment.

William Marks – JMP Securities

And then my last question on the franchise system just to quantify it, you said 300 rooms in the first half. Would be that two hotels or maybe you mentioned that?

John M. Taffin

There are three.

William Marks – JMP Securities

Three hotels and then possibly two to four more?

John M. Taffin

Possibly.

William Marks – JMP Securities

So that’s down from the 21 that you show today, right?

John M. Taffin

Yes.

Operator

(Operator Instructions) Next representing KBW a question from Smedes Rose.

Smedes Rose - Keefe, Bruyette & Woods

I think most of our questions are answered but I just want to – maybe you could speak a little bit about where you’ve seen cap rates go over the last six to nine months. One conference call company noted that they though they’d seen them come up about 100 basis points. Have you seen a similar level and where do you think they need to go from here for you guys to be more aggressive on the acquisition front? And I guess part two of that, it sounds like in terms of your overall strategy here, you’re basically looking at either full ownership or partial ownership of properties essentially for conversion to the Red Lion brand? And maybe the franchise effort is not on the back burner but maybe a little bit less of a near-term issue for you. Is that a fair way to characterize it?

Anupam Narayan

Let’s deal with cap rates first and I think you were at the [inaudible] Conference too, I believe. And you have heard the conversations there that 50 to 100 basis points is probably a very fair assessment of the change in cap rates. Now having that said that, obviously the movement in cap rates just depends on the outfit and where the outfit is located and the quality of the outfit. So in some cases it could be a lot more. But truly what’s more important and is driving some of the I guess greater opportunities for companies like us with strong balance sheets and the ability to execute on a transaction is simply the fact that some of the speculative buyers are no longer in the market or have at least cut back dramatically. It sort of starts creating a more level playing field and quite frankly a little bit more competitive pricing. In terms of the franchising side we are focused on acquisitions. We think there are some great opportunities out there. We also think that having put in a few hotels, whether they be 100% owned or whether we continue to do some joint ventures with some partners, if you put them in some key markets that will actually facilitate franchise interest in the future. So right now the market is sort of focused on and we are focused on acquisitions because we think it will drive future growth in our various markets.

Operator

With that Mr. Narayan and our host panel, I’ll turn the call back to you for any closing remarks. There are no further questions.

Anupam Narayan

Thank you for all your questions. It has been a very busy last few days here at Red Lion and we look forward to executing on our expansion plans and continuing to deliver strong financial results while increasing shareholder value. On a personal note I’d also like to say that I’m personally energized from and thankful for the well wishes and support that I’ve received after the announcement of my appointment and I look forward to speaking with you again on our next earnings call.

Operator

Ladies and gentlemen your host is making today’s call available for digitized replay for six whole weeks starting at 3 pm PST February the 14th all the way through 11:59 pm March the 31st. To access AT&T executive replay service please dial toll-free 800-475-6701 and at the voice prompt enter today’s conference ID 908979. That does conclude our earnings call for this fourth quarter. Thank you very much for your participation as well as for using AT&T’s Executive Teleconference Service. You may now disconnect.

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