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Strategic Hotels & Resorts, Inc. (NYSE:BEE)

Q4 2007 Earnings Call

February 28, 2008 10:00 am ET

Executives

Ryan Bowie – Vice President & Treasurer

Laurence S. Geller – President, Chief Executive Officer & Director

James E. Mead – Chief Financial Officer & Executive Vice President

Richard J. Moreau – Executive Vice President Asset Management

Analysts

William Crow – Raymond James

William Truelove – UBS

Jeffrey Donnelly – Wachovia Capital Markets, LLC

William Marks – JMP Securities

Chris Woronka – Deutsche Bank Securities

Michael Salinsky – RBC Capital Markets

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 Strategic Hotel & Resorts earnings conference call. My name is Eric I’ll be your coordinator for today. At this time all participants are in a listen only mode. We’ll facilitate the question and answer session towards the end of the conference. (Operator Instructions) As a reminder the conference is being recorded for replay purposes. I would now like to turn your presentation over to your host for today’s call Mr. Ryan Bowie, Vice President & Treasurer. Please proceed.

Ryan Bowie

Good morning everyone. Welcome to Strategic Hotel & Resorts fourth quarter and year end 2007 conference call. Our earnings press release and supplemental financials were distributed yesterday and are also available on the company’s website at www.StrategicHotels.com within the investor relations section. We’re also hosting a live webcast of today’s call which can be accessed from the same section of the site and a replay of this call will be available for one month on the company’s website.

Before we get underway I’d like to state that this conference call will contain forward-looking statements under Federal Securities laws. These statements are based on current expectations, estimates and projections about the market in the industry in which the company operates in addition to management’s beliefs and assumptions. Forward-looking statements are not guarantees of performance and actual operating results may be affected by a wide variety of factors. For a list of these factors please refer to the forward-looking statement notice included with our SEC filings. In the press release and supplemental financials the company has reconciled all non-GAAP financial measures to those directly comparable GAAP measures in accordance with Reg. G requirements.

I would like to introduce the members of the management team with me today, Laurence Geller, President and Chief Executive Officer and Jim Mead, Executive Vice President and Chief Financial Officer will lead today’s discussion. Also available during the Q&A session will be Richard Moreau, Executive Vice President and Head of Asset Management.

With that I’d like to turn the call over to Laurence.

Laurence S. Geller

Good morning and I’d like to thank everybody for joining us today to discuss our fourth quarter and our 2007 results. By the beginning of 2007 as we continued to build a sustainable business and corporate franchise we have methodically transformed our company’s portfolio of assets to form the basis of the unique collection of high end properties comprising of over 9,000 rooms that we have today, each replete with multiple opportunities for internal growth. As we discussed on our call with you a year ago, our primary focus is on the systematic and disciplined execution of our well researched operational marketing and capital master plans, in addition to resolving the issues surrounding our property in New Orleans, executing against the Del Coronado’s leading edge residential strategy, recycling capital based on our decade long lifecycle strategy, firming up our balance sheet and setting in place and extensive and compelling pipeline for high ROI returning investment opportunities.

Our execution focus has delivered financial and operating results for 2007 that we are pleased with and that have made those objectives that we set ourselves at the inception of 2007. These include consistently being at the high end of our guidance range and hitting or exceeding our Wall Street targets, having property level metrics that significantly outperformed our peers be it RevPAR growth, GOP and EBITDA per room expansion or property level EBITDA margin expansion. Notwithstanding that our non rooms business which is much lower margin but very profitable in absolute dollars earned provides us with just under 50% of our revenues as compared with our peers with their average in the mid 30% range. We’re very pleased with our total RevPAR growth through the year of 9.9% and although our peers do not report against this all important metric we’re confident we’ve substantially outperformed others and will continue to do so.

Our 2006 capital expenditure projects generated an annual yield of 20% in 2007 and we delivered $122 million of similar projects in 2007 as we consistently and methodically continued to execute against our master plans for each of our properties. It is these deeply researched and well conceived plans which give us the seeds for systematic long term and consistent internal growth while allowing us to modulate capital expenditures in line with the exigencies of the marketplace and the economic environment.

Coming into the year the Hyatt Regency New Orleans remained out of service because of the devastation caused by Hurricane Katrina in August of 2005. This complex and extremely difficult situation required a great deal of management’s attention and complicated our financial metrics. During 2007 we concluded the settlement of our insurance claim and the sale of the hotel realizing a combined $175 million. This was an exceptional outcome for a property with little apparent upside. As you can see from the results we delivered the execution of our operational strategies was spot on during the past year. We began the year concluding the implementation of our food, beverage and labor systems into all of our 2006 acquisitions. And, during 2007 we implemented our other systems that we had previously discussed with you such as for example our microsite Internet systems, our beverage control systems and our increasingly sophisticated yield and revenue management processes. These systems provide us with permanent margin enhancements as we continue to develop, refine and expand upon our operating initiatives at all levels throughout our properties.

During the year we also partnered with Sunstone in a purchasing platform called BuyEfficient which will enable us to quickly further penetrate our reach into all aspects of our properties purchasing activities with the resultant effect of driving down our costs and further enhancing and protecting our margins as we continue to expand and extend our value added asset management activities to maximize profits and values. Additionally, we expect to benefit financially from the businesses growth as it further develops and expands its application to other companies and industries.

During the third quarter and well ahead of our operators and peers we began to implement our multiphase hotel contingency plans in anticipation of an uncertain business environment in 2008. This early, efficient and continued execution has placed us in the strongest possible position to react to market events if or when they happen. Our lifecycle approach to each of our properties, was, has been and remains a founding principal of this company and has been an important guide to our property buy, hold and sell decisions since our 1997 founding. Based on its continued disciplined application we executed on our plans to recycle capital through a strategic partnership involving the joint venture sale of the Hyatt Regency La Jolla and the InterContinental Chicago to the government of Singapore with whom we’ve had a decade long and multifaceted relationship. This not only yielded an outstanding return on our investments but importantly gives us a long term and lucrative source of revenue from asset management and other fees.

We executed our residential strategy at the Hotel Del Coronado with the sale of 34 of the 35 hotel condominiums for an industry leading average sales price of $2,150 per square foot. This project generated over $110 million in gross revenues thus far with and over 40% pre [inaudible] and tax profit. While extraordinarily profitable in its own right, this strategic development not only left us with 78 additional keys in the hotel rental pool for much of the year but gives us the high end hotel within a hotel that our master plans for this iconic resort with its multiple non rooms income generators call for. We continue to evolve and refine the master plans for the South Beach land parcel which as previous entitlements for 144 rooms plus substantial other income generating facilities.

Last year we firmed up our balance sheet by increasing our fixed interest rates, extending our fixed maturities and expanding our line of credit to $500 million at a time of low spreads and interest rates. By completing a majority of our property level master plans and intending to finalize the balance during this coming year we set up a future investments pipeline that extends to 2010 and in some cases beyond for lucrative and high returning investment opportunities. Some of these include the purchase of the Hotel Le Parc in Paris which his being operated in tandem and close conjunction with our extremely successful Marriott Champs-Elysees property. We saw an opportunity here to not only buy terrific real estate complementary to our existing Paris asset at significantly below our view of its value but to entirely reposition this hotel creating immediate near term value enhancement and a longer term platform for high return investments. We closed the hotel for the month of January and completed our initial capital plans. The hotel has now reopened and will be reborn as a Renaissance at the end of March and should immediately benefit from the pent up unsatisfied demand at our Champs-Elysees property. We expect to complete our master plan for the Parc during 2008 and commence the substantial upgrade and repositioning of this property immediately thereafter.

Last year we also completed the plans for the all suite La Solana Hotel and Residencies adjacent to our very successful Four Seasons Resort in Punta Mita which will significantly benefit from our unsatisfied demand and the tremendous reputation we’ve deliberately developed as we executed upon Punta Mita’s original very profitable high return master plan. We are currently developing model suites and whole ownership residencies and will soon decided on the appropriate timing and phasing of this unique mixed use resort which promises to quickly become and icon in its own right. We also purchased the remaining 60 acre ocean front site in Punta Mita for a mixed use residential and hotel resort. Having control of three properties at this highly sought after and internationally acclaimed 15,000 acre secure peninsula in Mexico gives us myriad profitable financial opportunities. It protect each of our assets from competitive erosion and allows us to position our properties and indeed the entire Punta Mita resort at the very top of the rapidly burgeoning and expanding luxury Mexican resort market.

We commenced development of the 225 all suite and 20,000 square feet of ballroom space at our building expansion in Chicago. This will be known as the Fairmont Towers at the Fairmont Chicago and will provide our company with a substantial and unique multifaceted asset in a major market. We also signed a favorable option to purchase on completion a high rise space in a residential community known as City of Santa Fe outside of Mexico City for a Four Seasons Hotel to compliment and works to logistically win our existing highly profitable market leading Mexico City property.

Let me comment at this point that we look at each of these opportunities not only as profitable in their own right but far more importantly from a strategic perspective as significant lifecycle extensions of our master planning activities for our existing properties. We’re pleased with the beginning of the tangible results from our strategy which, as you’re aware, is principally based on the redevelopment and repositioning oriented value creation business model at each of our hotels and which already represents the highest end portfolio in the lodging RET public markets. This will only further improve as we continue our methodical and systematic execution of our master plans.

While we understand that it’s difficult to focus on the long term in times of uncertainty the tendencies to look immediately ahead at the short term ramifications of current events, our collective corporate challenge is to learn from the lessons of the past and look beyond the near term to the future and demographically researched consumer strategies that create incremental and sustaining values we journey through the inevitable cycles in our industry. It’s these strategies that underpin our differentiated business model which is far more than just selling rooms by the night. Our expertise is to identify all the myriad and evolving areas to make money from and around each of our affordably selective assets. We have to then lock in the opportunity and create as much value as possible from our unique collection of high end hotel and resort real estate and to execute or find the best partners be they operating, marketing, development, financial to help us execute efficiently and effectively.

I wanted to share with you some of the thinking behind our forecast of this year’s activities. In order to provide background to James upcoming discussion of our last year’s exceptional results and this year’s forecast. Let me start by saying we do not claim to be economists and can only follow those forecast of economic growth that the professionals make. While we take a reasonably balanced view of consumer and business confidence as they directly affect our own properties. We have excellent visibility on supply and have a clear and detailed view of what businesses on our properties book at this moment and what’s in their pipelines. We have equally good knowledge about key elements of our costs, labor, insurance, cost of goods and materials. Obviously, energy prices are difficult to forecast with accuracy however we can build in contingencies that give us some comfort for forecasting. When we blended all of these factors into our forecasting models and intensely discussed them with the brands that operate our properties we came to the conclusion that RevPAR ranges that we’re projecting of between 2 to 5% were both logical and prudent. Once we determined the RevPAR range and extrapolated total RevPAR we than forecasted the impact on margins and profitability. While wishing to maintain a prudent approach to our guidance and based on all that we know at this moment we concluded that a range of margin growth from 0 to 50 basis points was again, both logical and prudent.

If the economic environment improves or worsen or if unexpected events occurred then obviously they’ll be a likely impact on revenues with the resultant effect on margin growth. In this uncertain economy that’s only to be expected and we continuously reforecast based on the latest blend of information we have at our disposal at any moment in time and then trigger different operating plans accordingly. We can’t change the economy or make the market, equally we can never lose focus for one minute on our long term value creating goals and corporate imperatives. Therefore, our challenge has been and will remain to adopt plans and strategies that cause us to systemically outperform our competitors and maximize the results from whatever economic environment or market condition in which we operate at any moment in time. Simply stated, for this company mediocrity is not acceptable. This simple maxim is both our goal, our intent and what has driven us to our more than satisfactory 2007 results and will drive us through this uncertain and difficult period and we never waiver from our objective of building sustainable value growth for all of our shareholders.

I’ll now turn the call over to Jim to discuss our fourth quarter and 2007 results in more detail and then I’ll return to give you my thoughts on how we look at the overall impact on us from this cyclically economic environment.

James E. Mead

Good morning. I’ll give a brief review of the drivers of our performance during the quarter and the year and outline our thoughts on guidance for you but, let me start by referring you to the financial supplement on our website. Just click on fourth quarter info and it will be there along with a capital project icon where you can see imagery of many of the capital project completions we’ve had.

Our year-over-year comparable FFO per share growth was 17% and 43% for the fourth quarter. We are absolutely delighted with these results. Our numbers from the fourth quarter and 2007 year do not reflect any systematic weakness in the markets. In North America we had outstanding performances at most of our properties which contributed to the fourth quarter 7.5% and full year 9.9% total RevPAR growth. In a few hotels that did show some weakness can be explained mostly by discreet circumstances. For example, we saw some large meeting cancellations throughout the year at the Fairmont Scottsdale. Although one large financial institution canceled the majority were pharmaceutical companies that did not get FDA approvals for drugs or collateral materials in time for the schedule meetings. Last year we had myriad issues at the Ritz-Carlton Laguna Nigel and in conjunction with senior management both at Marriot International and at Ritz-Carlton our implementing new and more sophisticated revenue management processes and direct sales programs in addition to installing a new enthusiastic management team. We believe that this will go a long way to remediating the issues and in conjunction with our intense asset management processes enable solid and sustainable improvements in operating results.

Lastly, the Hotel Del Coronado’s financial results slipped this year as a result of the $90 million construction program which included a 311 room renovation, beach club, restaurants, spas and fitness center, ENO wine room, multiple retailing additions and new hotel condominium units. This phase of the hotel’s transformation is complete. The improvements are stunning and we have seen the expected acceleration in group booking activity with definite group pace up about 26% in revenues than this time last year. We continued our strong margin expansion into the fourth quarter with gross operating profit margins increasing 270 basis points. For the year, the same store North American portfolios gross operating profit margin increased 220 basis points. Margins improved despite a 4.6% increase in energy costs and a 6% increase in hourly wages. Our operating and labor management systems were very effective in reducing the impact of labor cost increases. For example, even as occupied rooms increased 2% and food and beverage revenues increased 8% the number of hours worked declined slightly in comparison with the prior year. In combination with the beneficial change in the mix of business at our hotels we had exceptional flow throughs with food and beverage at 60% and rooms at 83%.

Margins at the EBTIDA level increased 140 basis points for the year. The difference between GOP improvements and EBITDA improvements can be accounted for with contractual step ups in base management fees in three hotels, higher insurance cost and increase real estate taxes which were partially offset by our continuing programmatic success and tax reductions in three properties totaling approximately $2 million. So, the bottom line was a healthy 16% GOP and EBITDA per room growth last year.

Europe remains a consistent performer with total RevPAR and RevPAR growth during the year of 12.6% and 13.6% respectively in our owned and leased properties. Foreign exchange movements improved the results so in constant dollars total RevPAR and RevPAR grew about 5% throughout Europe with stronger performance in Paris with the Marriot Champ-Elysees RevPAR growth of 8.7% and in London with the Marriott Grosvenor Square RevPAR growth of 10.6%. EBITDA grew 12% across the portfolio in constant dollars reflecting the implementation of our cost management programs at the InterContinental Prague and Marriott Grosvenor Square. Including the effects of foreign exchange our US dollar EBTIDA grew almost 40%.

Turning to residential, in the fourth quarter we closed sales on six of the remaining seven units at the Hotel Del Coronado North Beach Village leaving one unit remaining unsold. In total for the year we’ve sold 34 units with total sales of $110 million and cash flow after tax for the venture of about $32 million. These residential sales contributed $1.1 million or $0.01 FFO per share during the quarter and $8.6 million or $0.11 per share for the year. And, in the beginning of the year we recognized the remaining sale of the first phase of our fractional program at our joint venture in the Four Seasons Punta Mita Residence Club. Profits from these last sales were largely offset by marketing and other expenses related to sales on subsequent phases but the sale proceeds from the initial 103 of 108 fractional closings were approximately $190,000 per 112 fraction. We are now marketing the 180 fractions in phase two and 120 fractions in phase 3 will follow.

The Hyatt Regency New Orleans sale closed in December for $32 million. That gave us total proceeds of $175 million when combined with the $143 million insurance settlement. So, netting out cost of demolition and rehab after Katrina the sale and settlement provided $125 million in cash. Ownership of the hotel had a negligible impact FFO for 2007 as the hotel expenses were offset by the income from a negotiated settlement with Hyatt for substantially lesser amount than we had accrued. As a result, we did not incur the $4.7 million in carrying costs that had previously been estimated and the $125 million realized from the settlement and disposition exceeded the $96 million we had previously estimated.

Our hotel master plan execution continues to ramp up and we delivered 17 projects in 2007 representing an investment of $122 million of which $55 million was related to the hotel condominium construction at the Hotel Del Coronado and the returns on the non-residential investments are expected to be consistent with the 20% range we’ve been achieving on 2006 projects.

We don’t have time to review all of our projects so let me discuss a few of the completions this year. We invested $15.6 million to expand our room count at the Four Seasons Punta Mita by 28 keys in addition to expansion of the spa and fitness center. The first phases of the Hotel Del Coronado transformation is essentially complete with condominium hotel rooms completed and a $26.8 million investment in a major 311 guest room renovation, restaurant renovation and an addition of our ENO wine tasting room. By the way, our successful ENO concept is now in four hotels in our portfolios and we already have three more planned or in construction. We opened a Michael Mina restaurant at the Fairmont Scottsdale that’s been doing an average $17,000 in sales per day since it’s opening on Super Bowl weekend as well as a Randy Gerber Stone Rose Bar that’s been equally successful with average sales of $12,000 per day since its opening. A $5.6 million new spa and fitness center at our Fairmont Chicago has just opened as the first phase of the hotel renovation. Our Starbucks on Michigan Avenue cost approximately $1 million. This is just a small project but it will contribute almost $600,000 in EBITDA which translates into about $0.05 per share.

Let’s turn to the balance sheet. We made a number of strategic moves prior to the fourth quarter to reposition our balance sheet. In March of last year we took advantage of the favorable credit markets and completed a restructuring of our debit that was started a couple of years ago. We now have an attractively priced $500 million line of credit and the remainder of our debit is non-cross collateralized variable rate mortgages. In April we perfectly timed the issuance of a $180 million, five year, 3.5% exchangeable notes offering. Throughout the year we used interest rate swaps to fix all of our US mortgage debt and have of our European debt and as rates fell we extended our LIBOR cap at the Hotel Del Coronado to give us the greatest overall interest rate protection. So, despite the current credit market turmoil, we have a great deal of liquidity in our line and we are 81% fixed at an average rate of 5.4% and we have no debt maturities until 2011.

As for guidance, we are not alone in that our outlook is far more uncertain this year than in prior years so let me start by outlining some of the major considerations. First, our results will be driven by economic growth and for planning purposes we assume our results will lag between three and six months or so after an economic slowdown starts and to continue for at least the same period lag after a recovery begins. Consistent with overall economic assumptions we naturally much anticipate some weakness within our portfolio. Our group pace within the portfolio is still strong at 105% plus over last year with increases in both room nights and revenues for 2008 and we’ve had no major cancelations this year. But, our transient indicators give initial signals of diminishing amounts of compression and demand. While we expect to hold our group pace for the year based on history we anticipate that attendance will be down as we assume that company’s may rather pay the attrition fees then send additional people as they endeavor to cut back on travel and entertainment expenses. The inevitable results of these assumptions would be fewer 100% occupied nights at our properties and a loss in the ability to price against compression.

Counter balancing that overall general downtrend view are a couple additional factors. Supply in our competitive markets will remain relatively stable for the next few years. Our master plan investments should continue to provide an underpinning [inaudible]. For example, we continue to expect solid contributions from our growing list of completed projects such as our new Mina Restaurant and Gerber Bar in Scottsdale and the simple example of our Starbucks on Michigan Avenue here in Chicago. As Laurence said we were early in implementing our execution of our property level contingency plans at our properties in August of last year. We previously spoke about the three phases of our contingency plans we have at each property which are reactive to specific triggers and drops in property performance. From a portfolio standpoint our contingency plans were designed to hold a 50% retention, that is a 50% margin against a decline in revenues below our property budgets. This means that our margins should not contract if for example portfolio revenue were to fall. Our internal target is to maintain existing margins through a fall in RevPAR growth into the 1% range. Our assumption for guidance is that we have no change in margins at the low end of our range or 2% RevPAR growth. The implementation of these plans should not have a material longer term ramification to the portfolio although we naturally have other plans to deal with more severe events our current planning assumptions do not include these. We have multiple well thought out plans in place and are nimble, flexible and sensitive to trends and changes which could then alter our later year operational and financial planning and activities.

So for guidance we are assuming like others a 2 to 5% RevPAR and total RevPAR growth during 2008. We expect our operating margins to be flat to 50 basis points positive given where we are in the implementation of our contingency plans. We are assuming no capital market activity or acquisitions in 2008, no profit from residential sales at our Four Seasons Punta Mita Residence Club is assumed, we are forecasting the delivery of $125 million in RLI projects throughout the year. Importantly we expect that these RLI projects will displace about 30,000 room nights and other revenues resulting in a reduction of $6 million in EBITDA or $0.08 per share. Finally we are forecasting a reduction in G&A from 2007 as a result of a corporate focus on controlling expenses. We are working toward total G&A expenses of $28 million for 2008.

All of these assumptions lead to guidance in the range of $1.60 to $1.75 comparable FFO per share for full year 2008. This is between a 3.9% and 13.6% increase year-over-year from comparable 2000 FFO per share excluding residential sales. First quarter guidance assumes total RevPAR growth between 0.5% and 1.5% and RevPAR growth between 1.5% and 2.5% which are both negatively impacted by group calendar this year shipped in Easter and the major renovation of the Fairmont Chicago. By the way if we look at RevPAR for the first four months to take out the impact at Easter as it stands now it would increase by about 2.5%. Additionally the renovation of the Fairmont cost us about 1%. So first quarter FFO is expected to be in the range of $0.30 to $0.34 per share which has been reduced by $0.03 due to disruption from capital activities.

Now I’d like to turn the call back to Laurence.

Laurence S. Geller

Before we take questions I should like to give you a macro sense of how we see the impact of uncertain economic environments as they pertain to our company. We’ve consistently stressed that lodging is linked to GDP and although there is historically a demand segment by segment lag time before we feel the impact of rising and falling economic cycles we as an industry can’t be immune from economic events nor do we suppose that the resulting time lag impact this time will be different as Jim mentioned. We have equally consistently stressed that the high end lodging segment in which we have deliberately chosen to operate will fare better overall than other segments for mostly obviously reasons. These include our often unique and always non-commoditized locations which we’ve selectively chosen over the time. The scale of our properties also allows to aggressively and simultaneously work with multiple demand segments and our meeting rooms capacity enables us to increase or decrease the amount of group business accommodated in line with our views of localized market conditions while we end up being very innovate and creative in how we promote and solicit varying different types of group demand. This flexible operational and physical meeting strategy not only gives us the ability to avoid reliance on the more short term corporate or individual transient business but to bring in business which creates higher total RevPAR through our ancillary facilities which house multiple businesses which in turn generate almost half of our total revenues.

Additionally the high end leisure market is relatively price insensitive and allows us the ability to generate high total RevPARs through creative programs, incremental amenities and service enhancements. The same scale of our properties offers our seasoned and experienced team all proven lodging industry professionals the scope to implement our operating systems and contingency plans and to better flex and modulate our variable costs in line with the same ability to do so without capital costs. We’ve often discussed the reality that great real estate such as our properties holds value far better than the commoditized product during an economic slowdown. It’s that value which has always underpinned our portfolio and gives our investors comfort during the short term vicissitudes of downward trending economic cycles. But in any equation it’s not only demand that’s critical but also supply. I don’t need to go into macro statistics about the lack of future supply nor the obvious impact that the lack of liquidity combined with rapidly rising construction prices has on projects that may have been in planning or merely a twinkle in an ambitious developer’s mind. Suffice it to say there’s little supply coming in to the high end segment in general which [augers] well for overall demand increases and the result in supply compression that it bring with it the inevitable rate increases.

However today I’d like to share with you the specifics of directly competitive supply coming into the composite of those North American markets in which our company operates. In 2008 we forecast a 0.4% increase only in competitive supply across our portfolio. In 2009 we forecast an 0.5% increase in supply and in 2010 we forecast an 0.2% increase in supply. Obviously these unusually low levels have the competitive supplier well below the macro supply levels for our market segments that are currently being discussed in our industry and are needless to say extraordinarily healthy statistics for this company as it pertains to the velocity of a recovery from any downturns in business. Future lodging demand driving pricing ability and importantly to our longer term real estate valuation which has always been the bedrock of our fundamental business model it’s with this knowledge in mind that we continue to execute against our master plans secure in our belief that we are as we’ve consistently done for over a decade of our history creating substantial real estate value enhancement increasage which give us no shortage of liquidity options at any moment in time. This has always been the underpinning of our strategy and drove our decision to undertake our transformational activities in 2005 and 2006. So despite the ups and downs of these uncertain times we remain firmly convinced that our chosen path reaps substantial benefits for our shareholders.

We’ll now open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bill Crow with Raymond James. Please proceed.

William Crow – Raymond James

Let’s pick up from where you left off with the transformational activities, what has the current environment out there, the debt market environment, done to your intent or desire to sell two or three of your assets, where do you stand on that program?

Laurence S. Geller

Bill, we hadn’t previously announced our immediate intent to market our Phoenix hotel, the Hyatt Regency. As you know we told you we went out to bids and bids came back. We had one bid that was a very high bid in line with our expectations. We believe that bid will fail and we have no intention of selling this hotel below what our anticipation of a price should be. Let me stop there for a moment and what we’ve seen. Concurrent with that conclusion we watched pace increase for the year for 2008 and 2009. We took it on the chin pretty much when the convention center was being built as they worked 24 hour shifts to catch up on their delays. The convention center is there now. There’s new supply coming in, in two years time but our pacing and our average rate is well ahead of the new supply. So we’re not particularly concerned about that. The net of it all is we’ll manage this property for the time being, we’ll look after it appropriately, this will remain an asset that we will dispose of at the appropriate time but we will not and I stress we have no need to sell this hotel below what we think is the right value. That’s just not what we do. We’re real estate people. The second hotel we have discussed is the Marriott in Lincolnshire. There are certain things that need to be done before we can package this hotel for a sale and we intend to accomplish those during this year and try and time any disposition with an uptick in the market. So at this moment in time, Bill, I would not forecast any immediate sales for assets.

William Crow – Raymond James

And given that backdrop and I know you’ve included no accretion or dilution from acquisitions in your guidance but how do you view the environment out there for acquisitions? Have cap rates moved enough to make deals compelling even if you have to stretch your balance sheet a little bit or are is this year characterized as just kind of hunkering down and trying to get through the economic downturn?

Laurence S. Geller

Well first of all you’ve asked me seven questions or six questions, Bill, and so let me give you the first one. We have heard of cap rate appreciation in the more commoditized hotels. We have not seen or experienced cap rate appreciation in our segment. There just simply aren’t trades. I think the lack of liquidity is holding back on trades and people are saying this supply is so benign unless we have to sell we won’t sell to go against that liquidity. So I can’t tell you I’m seeing pricing up or down or anything compelling or non-compelling. Second we’re not forecasting doing anything in terms of acquisitions this year. Thirdly and therefore part of my answer, thirdly we have plenty of very high ROI and IRR projects that we have already bought in terms of buying the assets and have on our plate to execute this year, next year and 2010. Parenthetically we have the ability to modulate many of these in these and the spend of capital expenditure in line with market exigencies. So whereas the fourth point I would make we have no plans to make acquisitions this year. We’re opportunistic enough that if we see a benefit from an opportunity we give it serious thought although it would have to complete for capital with our internal growth opportunities. Long answer to your question, Bill, I hope it gave you some thoughts.

William Crow – Raymond James

You did. Let me throw one other question then I’ll yield the floor and that is as you think about 08 RevPAR growth and total RevPAR growth how do you break that out between your US or if you want to classify North American assets versus the UK and European assets?

James E. Mead

How do we break it out in terms of –

William Crow – Raymond James

You’re talking terms of 2 to 5% revenue growth.

James E. Mead

I think that Europe is going to certainly as historically we’ve seen certainly lag and be less volatile than US market events. Given the sort of context we would expect to see Europe relatively the same through the rest of the year I think and perhaps begin to slow down towards the end of the year if at all.

Laurence S. Geller

And, Bill, one of the issues is we didn’t discuss it because you’d only have so little time that we’re going through a major capital expenditure exercise at the Marriott in Grosvenor Square last year which as Jim pointed out had double digit RevPAR growth last year. So we’ll have some displacement for that which will modulate this but I’m not going to pretend that this is a science this year. RevPAR extrapolation is a science, it’s intuitive, instinctive and you have to look at trends as well as economic forecasts. Paris and London are certainly strong markets and we have yet to see any weaknesses in those markets especially core assets in centers such as our properties but it’s not immune, any thought of Europe or Asia not being impacted by what happens in the US is clearly nonsensical and so we are not immune. So no science about it, rather somewhat intuitive about the European [inaudible].

James E. Mead

Having said that, we had a fantastic week this week.

Operator

Your next question comes from the line of William Truelove with UBS. Please proceed.

William Truelove – UBS

Just following up on his questions, you mentioned about the Phoenix asset not getting the business you wanted but then cap rates haven’t seen changed so does that mean that there’s just a growing bid ask spread and how does this bid ask spread translate relative to the past downturns, Laurence, I mean is it greater because of the credit market or is this normal just because of the economic environment and then my follow up question to that would be not only doing the life cycle analysis for all of your assets but also doing a similar kind of analysis for your stock. Many of your competitors have issued share repurchase programs. How do you think about that in this type of environment?

Laurence S. Geller

The bid ask spread is somewhat different this cycle. There is always a bid ask spread but here because of relatively low cost financing for most of the assets that we look at there is very few financing or refinancing imperatives on assets today. Secondly the one major differentiation in our segment of the market compared to previous cycles has been supply. So anybody owning a hotel today will be able to look at a relatively benign supply situation going forward and therefore say look at construction cost comparables and make decisions on a bid ask. So I would say the ask is firmer than it was previously. The second part of your question goes to share repurchase or not. It simply is return on invested capital for us an allocation of resources. We have internal plans for capital expenditure, we have plans to ultimately dispose of assets, we look at the various returns on each of those and we weigh the current yield and the capital appreciation of these projects against each other opportunity. So it isn’t a hard and fast principal, it’s more a modulated return to it. We can’t forget we’re in a business and it’s not a supermarket to buy and sell and trade with. We have long term plans which thankfully none of these plans have short shelf lives so we can modulate capital expenditures in these goals. So we’ll just play this month by month and quarter by quarter and work with our Board on the right strategies if there are substantially changing circumstances. It’s just return on capital.

Operator

Your next question comes from the line of Jeff Donnelly with Wachovia. Please proceed.

Jeffrey Donnelly – Wachovia Capital Markets, LLC

Laurence, I have a question about just market share and pricing sensitivity and what you’re observing in the market, when you look across all the hotels in each of your I guess competitive sets are you seeing the higher price rate leaders maybe losing share to some of the lower price upscale other luxury assets I guess trading down within certain price points? I guess an example maybe is in Santa Monica, are people not staying in Shutters on the Beach but rather the Fairmont or your Loews.

Laurence S. Geller

Jeff, we haven’t seen any of that, not at all. I think what may happen based on history alone is that some demand compression around the edges will dissipate but not enough to impact our pricing strategies at the hotels. So whereas you may not have as much pent up demand it hasn’t impacted our pricing strategy in a trading down perspective, it’s merely demand driven pent up compression demand. Therefore people aren’t saying we’re not going to go to the Loews Santa Monica we’ll go to the Holiday Inn Express four miles away because of pricing. That’s not happening. It’s really a blend that’s a transient decision but this really is a blend of the meetings, leisure and corporate business that forces changes in compression which will affect our overall pricing. But we are not, let me make this very clear, we have seen no evidence of trading down at this moment in the cycle.

Jeffrey Donnelly – Wachovia Capital Markets, LLC

I’m curious, I guess I’m just a little surprised that you guys were looking for maybe flattish margins on RevPAR as low as 2%. Does that mean or set the stage potentially in 2009 to the extent that your business recovers a little bit and we could see sort of a wave of expenses come back that were deferred this year under your contingency plan?

Laurence S. Geller

Jeff, I am so pleased you asked that question because it’s a question we probably should have addressed. What we are doing is becoming more efficient rather than cutting out costs and services. We put pressure on labor productivity standards, food purchasing systems, beverage controls, we put increased pressure on revenue management and you can see from our purchase of 50% buy efficient we’re trying to save pennies and dimes from purchasing every goods. So frankly I think the opposite question might be the better one and that is can we expect to see exceptional margin increases when room rates drive past the 2 to 5% range. So, no we’re not at the stage of cutting out services. The only time I really recollect that was immediately in the aftermath of the September 11th events when we literally in some of the hotels, particularly in New York, we had to slash services as well. We see no need or demand for that at this stage, nothing in our planning model calls for that at this moment. Now anything can happen but I think the opposite question that is should margins really expand afterwards is better.

Jeffrey Donnelly – Wachovia Capital Markets, LLC

One last question, can you give us a little more color on the Four Seasons project you mentioned in Santa Fe, specifically what sort of I guess local market is that and are you anticipating – I’m assuming it would be more of an urban hotel and how do the units work, etcetera?

Laurence S. Geller

Santa Fe would be the equivalent if you will of Canary Wharf in London just by way of example. Because of the traffic and the various issues in Mexico businesses have gone out to this particular area particularly the American businesses and services and this has become a very high end commercial retail and residential market highly sought after as a totally separate destination to the downtown reformed area where we dominate that marketplace. So it’s a mixed use, it’s a very high end, high rise, the project we have in the central wall of that is a development by Mexico’s leading developer called City of Santa Fe and in the center of City of Santa Fe the developer has agreed with us to make the mixed use development a Four Seasons Hotel and Residences and we will be buying the Four Seasons Hotel from this. So we do not bifurcate our markets, we will run these as we are the two hotels in Paris in the synergistic and complementary format.

Jeffrey Donnelly – Wachovia Capital Markets, LLC

And is there anything near term in terms of I guess expenditures on your part or in longer term what do you expect this is going to cost for construction for your participation?

Laurence S. Geller

I’m not at liberty to divulge the cost because of confidentiality at this stage. However let me say this, we will be buying the hotel with no land value, no air rights costs and at a substantial discount, substantial discount to construction costs for the synergistic benefit of bringing a Four Seasons Hotel to the residences. So one way or another I think it’s safe to assume that we benefited from residential sales in this and will have a hotel at a price substantially below construction costs when we’re done. It should be a very profitable situation. We’ll buy this on completion but completion is several years away as really merely ground works have started at this time.

Operator

Your next question comes from the line of William Marks with JMP Securities. Please proceed.

William Marks – JMP Securities

I had a question on, St. Francis is now at least in the fourth quarter far and away your biggest contributor to EBITDA and first of all it had a huge jump in the fourth quarter, can you explain that?

Laurence S. Geller

Look, we started slow at the St. Francis, we had a hiccup as you know when we first bought it on pricing. That was fine. We got over that, we learned from those lessons, we put in a plan last year of substantially improving part of the bedrooms, the balance of which will be improved this year. We’ve worked very hard on mix of business and group pacing and this year we’ll see, this particular year we’ll see because of the market compression in San Francisco, it’s a very good year for San Francisco from a convention meetings perspective, we’ll do very well there. The fourth quarter was a good quarter for the company, this hotel did well as did others in the hotel but I think Will if I could point you, we got this hotel clicking, we’re doing the A capital programs now not only in the rooms but the public areas, this hotel should shine for us in 2008 by comparison to the competition.

James E. Mead

By the way, we were looking at each other because the top line was pretty good all year long and the fourth quarter was good but we also had big insurance savings in the fourth quarter. So, I think that probably picked up the bottom line.

Laurence S. Geller

Having said that, Will this hotel is on track and we’re very excited about what we’re seeing for 2008, very excited.

William Marks – JMP Securities

What about when you had an analyst day over a year ago you had talked about a more major renovation. Is that still in the planning?

Laurence S. Geller

Yeah, let me divide it into two, our current plans entail the opening of the Clock Bar in the lobby just opposite Michael Mina which will happen in the next couple of months. Building a new restaurant and bakery which will open up on to the street, building an ENOs, redoing the lobby in the portico share and restarting our re-retailing program in the lobby, at the same time we’ll finish the bedroom. Now, that’s more than enough for the time being to get done and get this hotel motivated. Likewise, we have come up with two excellent complementary plans for ballroom expansions and meeting space expansions which we will go through the plan and development of but we will defer execution of until we see the success of the first phase of this project. So, look to this year and early next to complete the first phase of the plans, we’ll take a breather, see how the success is and then consider the ballroom expansions. A more modulated approach based on the realities of how that performance is.

William Marks – JMP Securities

Okay. Great. One other question about another property, on Fairmont in Chicago across the way, I think they were talking about a Raffles building, is that still on track?

Laurence S. Geller

We determined through consumer research that we would not do a Raffles Hotel there and as I mentioned earlier on what we are building is a 225 all suite expansion to the Fairmont Hotel which will have an incredible ballroom, it will be a unique ballroom in that it has got a glazed window terraces for outside meetings and will overlook the park. But, that will be operated in conjunction with the Fairmont Hotel and will be probably known as I mentioned as the Fairmont Towers. The best analogy would be the Waldrof Hotel and Towers and this hotel will be connected by two levels of pedestrian walkways below ground and will have great visual connections. So, it really is we’ve come to the conclusion that the ability to dominate in the high end meeting segment existed and we’ve positioned this hotel to be that dominating force.

Operator

Your next question comes from the line Chris Woronka with Deutsche Bank. Please proceed.

Chris Woronka – Deutsche Bank Securities

Just a quick question on the Four Seasons DC, had a very good quarter, how should we think about 08 there? And, where are you – have you done everything you’d like to do with that product? Or, just how should we think about that for this year particularly with the elections coming up?

Laurence S. Geller

Well, let me say we couldn’t be more delighted and pleased with the original acquisition and the results so far. Our room rate performance there as you can see from the results has been exceptional and we see no reason that it shouldn’t continue to be so. Having said that, we have gone through all of our master planning activities for the hotel and are currently on the way with the pre-execution stage, or we’re in the purchasing stage for 60 rooms upgrade, three major suites upgrade amongst the existing portfolio. What we’re doing is bringing what is known as the old tower if you will back up to the same level of the brand new rooms that opened up in 2006 so, we’re doing that. Equally we have planned the start date for the conversion of the food and beverage space and will be opening a Michael Mina restaurant there as well. At the same time we’ve vacated the retail and office building and are commencing a project with 11 rental units including a super suite but they’re all oversized units where the office space was above the retail and we are currently reconfiguring the retail with a view to letting it out to a very complimentary tenant plus in the townhouse area that we have control off and own two of them we will be building an ENO at the same time. That will be done in conjunction with a lobby upgrade this year prior to the elections and then next year we will go down and do the social space and other restaurant activities in the space currently operated by the restaurant. So, it’s an 18 month process.

At the end of it all, although we currently have by far the highest market penetration in DC, this hotel will step even further ahead in terms of room rate penetration against our anticipated target of measuring against a New York rate. So, we see giving this hotel by the middle of 2009 will have stepped up a whole notch in terms of its quality. It still leaves us 7,500 feet of unused FAR which we’re planning for a second phase which again, we’ll see how all these first phase goes.

James E. Mead

Chris, of the displacements we have in our numbers, $1.5 comes from our activities in DC this year.

Operator

Your next question comes from the line of Michael Salinsky with RBC Capital Markets. Please proceed.

Michael Salinsky – RBC Capital Markets

Actually most of my question have been answered but I just had a couple quick follow ups. First, in your guidance for fiscal year 08 you mentioned the consolidation of the Marriott Champs-Elysees, what is the driver behind that?

James E. Mead

We reorganized the employment company through the year. One of the things – we had about a $1.4 million charge against our operations this year which are in the comparable numbers that we provided for reorganization of the employee management company there. As a result of the reorganization from an accounting perspective we’re going to have to start consolidating the revenues and expenses and balance sheet from the hotel.

Michael Salinsky – RBC Capital Markets

Okay. Secondly, in terms of your ROI projects, can you refresh us at what the IRR you’re looking at on those? And, if you’ve seen any decrease in those now with the slowing economy?

James E. Mead

IRR, we look at IRR but the numbers are extraordinarily high. If you think about investing at a 20% return on cash-on-cash return and then capitalize it at any reasonable exit cap and within the next five years you’re going to get an enormous IRR. So, IRR thresholds aren’t typically the issue. What we look at generally are how long it takes to get to a reasonable cash-on-cash return and on that front we’re certainly north of 15 on most of our projects and kind of in the 15 to 25 range generally. But again, those IRRs always come out to be tremendously high numbers because in our lifecycle strategy at the end of the day, there’s a sale of our assets as they get to the end of their growth strategies and reinvestment in something else. So, there is a realization value in our strategy at some point within the next five years.

Michael Salinsky – RBC Capital Markets

Okay. And then finally, I think on a couple of previous calls you mentioned really looking into acquisition targets more in Europe as proposed to the US, being a net seller in the US and looking to build your portfolio up more in Europe. Are you still looking at acquisitions at this point? Or, has that kind of been put on hold with the turmoil we’re seeing both in the US and overseas right now in the financial markets?

Laurence S. Geller

I think we’re at the stage now where we’re unlikely to want in the immediate future to export substantial dollars to Europe for acquisitions. While we do see and will see attractive opportunities we will only take advantage of those opportunities in the context of a partnership one way or another which does not entail exporting substantial dollars overseas. Right now is a time to be modulating our activities to focus our capital expenditure on these 20% plus or minus yielding projects with these very high overall returns. So, while we continue to have incredibly strong interest it will be in partnership format should we go forward with minimal dollar exportation.

Operator

We’re currently showing no more audio question in queue. I would like to turn the call over for closing remarks.

Laurence S. Geller

Thank you and thank everybody for the questions. They were very good and somewhat challenging. Let me thank you also for your continued interest in Strategic Hotels and Resorts and for your time today. We’ve got a very talented, an extremely talented executive management team here. We’ve got a proven track record and a team that knows how to manage through good times and bad. We’ve been there several times and we’ve seen most of the stuff that can be thrown at us. We’re proud and we’re very careful stewards of our great assets and we continue to enhance their value and deliver ROI and increase value to our shareholders. This is going to be an interesting year for us all but, rest assured your management team here are working hard and to be nimble, flexible and current with trends and anticipation. So, we thank you again and we look forward to talking to you after the completion of this quarter’s activities. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect. Have a good day.

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Source: Strategic Hotels & Resorts Q4 2007 Earnings Call Transcript
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