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Executives

Stephen A. Schafer – Vice President, Strategic Planning and Investor Relations

Richard A. Smith – President, Chief Executive Officer and Director

Andrew J. Welch – Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Charles P. Scholes – JP Morgan

Napoleon Overton – Morgan, Keegan & Company, Inc.

William Truelove – UBS

Chris Woronka – Deutsche Bank

Dennis Forst – KeyBanc

FelCor Lodging Trust Incorporated (FCH) Q1 2008 Earnings Call May 8, 2008 11:00 AM ET

Operator

Welcome to the FelCor first quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Steve Schafer, Vice President of Investor Relations.

Stephen A. Schafer

With me this morning are Rick Smith, President and CEO and Andy Welch, Executive Vice President & Chief Financial Officer. Rick will begin his remarks with some color on operations and then discuss the progress on our strategic plan. Andy will then discuss the results for the quarter and our outlook followed by your questions. I assume you've had the opportunity to review our Earnings Release and supplemental information issued last night. The supplement can be found on our web site under the financial reports tab on the investor relations page.

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 filings with the Securities & Exchange Commission. Although we believe our current expectations to be based on reasonable assumptions, we cannot assure you that our expectations will be attained or that actual results will not differ materially.

And with that, I will turn it over to Rick.

Richard A. Smith

This morning I want to give you some color on the quarter and trends we are seeing, the continued progress we're making, and what our focus is going forward this year. Then I'll turn the call over to Andy, who will give you some further detail.

First of all, for the quarter RevPAR group 4.6% across the portfolio and 6.9% at the 61 hotels that have completed their renovations coming into the quarter. This was far better than the industry as a whole, notwithstanding the fact that we had 19 hotels under renovation during the quarter. This led the market share growth of 3% across the portfolio and 6% at the renovated hotels.

The fact that RevPAR and market share continue to grow and are at the top of the industry will continue. Even if RevPAR trends for the industry drop to flat or slightly negative, we will still have positive RevPAR growth and therefore, positive earnings growth relative to the industry and our peers. We feel this speaks to the company's value relative to its peers as well.

Margins were also better than expected and led us to hitting the high end of our guidance from an FFO per share and EBITDA perspective. I would like to note that once again the EBITDA on the 61 renovated hotels exceeded budget and therefore we continue to exceed expectations on the returns from the renovation plan.

I'd like to give a special acknowledgment to Charlie Cahill and IHG, who have done a tremendous job turning things around for us operationally. During the quarter, they exceeded every metric as compared to budget. They outperformed the other brands that work for us, and we really appreciate the effort that they have put in. I would also like to point out that the two hotels that we acquired in December, the Renaissance Vinoy and the Renaissance Esmeralda exceeded their EBITDA budget in the first quarter and are ahead of pace for the year on group bookings.

Now let's take a look at trends. First thing, each hotel has its own specific contingency plan in place and each team is working closely with our asset managers to ensure that those plans are being activated and modified, where warranted, as quickly as possible as trends develop. We are actively and continuously looking for first-time indicators that will help us identify any negative trend and, generally speaking, we are not seeing a widespread softening in demand yet. In fact, our numbers bear that out, as we were above budget in total occupancy for the quarter. That is to say that unconstrained demand has not diminished. However, we have seen some softening in demand with regard to higher-rated corporate and leisure business.

Bar and consortia; we are down approximately 3% of budgeted room nights combined in these higher rated segments. As part of the contingency plans, we opened up other channels of business to replace that business at a slightly lower rates. This led to our being slightly above budget in occupancy and slightly below budget in rate. However, with margins being better than expected we were able to realize our budgeted profit. It is important to know that while collectively these segments were down to budget they were ahead of prior year so while growth was moderating it was not declining.

While the trends in the first quarter were reasonably good, the year is still young and we do not have great visibility with regard to what will happen with the economy and travel patterns for the remainder of the year. Obviously, we will continue to watch all relevant trends very carefully and, where warranted, implement contingency plans as quickly as possible. As far as being able to withstand what the economy may bring us, we feel very good. We are over the hump on renovations and therefore, our properties are in good shape and in the best position to compete in the marketplace.

Additionally, our Embassy portfolio has historically gained share in down markets given the value play at those hotels. We also have significant EBITDA attrition from a covenant and cash flow standpoint. Thus, we have put ourselves in the best position we can be in to deal with whatever may happen with the economy.

Now let's talk a little bit about the progress we're making on other fronts. To date, we have completed renovations at 75 of our hotels and will complete the remaining eight over the course of the year. As I said in February, this puts us over the hump and back to a normal course renovation plan. While we will have some disruption as we complete the plans, it will not be nearly as significant as we have seen over the last 18 months.

Additionally, as I mentioned earlier, we continue to see results that surpass our expectations on the renovated hotels. Given the progress and the results to date I feel comfortable, and this is important, that the execution risk related to our comprehensive plan is behind us.

We have also now completed three of our announced redevelopment plans, the Hilton Convention Center, the Spa at Deerfield Beach and the meeting space at Doheny Beach were all completed in the first four months of the year. We also continue to make progress on the conversion of our Union Square San Francisco property to a Marriott, as well as our other unannounced plans.

On the last call, I mentioned that as part of our ongoing strategy of continuous improvement in the overall quality of the portfolio, we will always continue to evaluate our portfolio and that recycling of capital through asset sales would always be part of that plan. We also said that one component of that analysis would be post-renovation stabilization. To that end, we have identified an initial six hotels that we will be bringing to market for sale in the coming weeks. We are in the process of choosing brokers and preparing marketing materials.

Our pricing expectations are at a level that will be accretive to shareholders and this is also part of our plan to begin generating capacity to take advantage of future opportunities. There is no rush to sell these hotels and if the pricing does not meet our expectations, we will simply wait until we can achieve that pricing. We will keep you updated on that progress.

Before I turn the call over to Andy, I'd like to recap a few things. Three years ago, we put together an extremely aggressive plan to turn this company around. It was a change in philosophy across the board and was designed to put this company where it needed to be to compete as strongly as possible.

To date, we have accomplished every single thing that we set out to and in the timeframe we planned and we are now past any material execution risk related to that very aggressive plan. We are in a position where we have substantially improved the overall quality of the portfolio with a combination of the hotels we sold, the renovation and redevelopment plans and the value added there, and the acquisition of the two upper upscale hotels.

We also cleaned up the balance sheet by significantly reducing our debt, improving our flexibility, and lowering our cost of debt. Relative to our peers, we will have industry leading growth this year and above-market growth going forward as we finalize the renovation and redevelopment plan, get those projects online, and get the expected returns. We also continue to increase market share. We are very pleased with this progress and look forward to continuing it. As I said, this year our focus will be on the business trends and operations, completing the renovations, progressing on the redevelopments, and beginning the plan to recycle capital through asset sales and generating capacity for future opportunities.

And with that, I will turn the call over to Andy.

Andrew J. Welch

Adjusted FFO per share was $0.51 for the quarter compared to our guidance of $0.48 to $0.51. Our same store adjusted EBITDA increased to $71 million and was also at the high end of our guidance. Hotel EBITDA margins were slightly better than expected due to improved food and beverage margins, lower cost per occupied room resulting from controlled labor expenses and the implementation of some contingency plans.

On an overall basis, margins were down 18 basis points compared to last year's first quarter but primarily being due to 19 hotels being under renovation and the 12 hotels that completed their renovations in the fourth quarter and were in their initial wrap-up period but again, margins were better than our budgeted expectations. We anticipate positive margin comparisons for the rest of the year and I'll get into more detail when I discuss our guidance.

We continue to see positive ramp-up trends for the hotels that have completed their renovations. For the 61 hotels that completed their renovations by the end of 2007, RevPAR increased 7.9% during the first quarter. Hotels EBITDA for these 61 hotels increased 10% compared to the same period last year and was 3% better than budget. More importantly, market share for these 61 hotels increased 6% during the quarter compared to their respective competitive sets. The growth in market share accelerated throughout the first quarter as these hotels continue to ramp up. Bottom line, we are earning the 12% return on our renovation program.

As we have discussed on prior calls, they're in initial ramp-up period once renovations are completed and operating performance accelerates in the following quarters. To illustrate, we had 49 hotels that completed their renovations by the end of the third quarter last year, RevPAR for these 49 hotels increased 10.5% during the first quarter of this year.

EBITDA margins were up 120 basis points and EBITDA grew 16%. For the 12 hotels that completed their renovations in the fourth quarter, RevPAR grew 1% as they were in the initial stages of their ramp-up period. However, these 12 hotels grew their market share during the first quarter and operating performance continues to accelerate each month. For the month of April, RevPAR grew 12.5% for these 12 hotels.

During the quarter, we had 19 hotels under renovation with 35,000 room nights out of service and completed meeting space and public area improvements at a majority of these hotels. Rooms out of service and disruption related to our renovation program are down significantly in 2008 and are particularly concentrated in the first quarter. During the quarter, we spent approximately $50 million on renovation and redevelopment projects which is approximately one-third of the $150 million we plan to spend during 2008. With the renovation program now 90% complete disruption for the year should be less than $2 million per quarter.

We are leaving our full year guidance unchanged and continue to anticipate RevPAR growth of 6.5% to 8.5% for the full year. Our assumption for market growth for RevPAR remains between 1% and 3%, which is lower than Price Waterhouse Coopers’ recent forecast. By the way, yesterday Price Waterhouse Coopers lowered its RevPAR forecast for the industry to 3.5% to 4.5%.

For the second quarter we anticipate RevPAR to grow between 7% and 9%. Our RevPAR growth will continue to accelerate and be significantly higher than the industry average as we recapture the disruption from last year and earn the returns from renovations completed over the last 12 months. As a result of accelerated RevPAR growth, we expect our hotel EBITDA margin to improve during the second quarter by 150 to 200 basis points over the prior year. For the year, we continue to expect margin growth of between 50 and 100 basis points.

A note on our FFO guidance per share; our guidance for the year is between $2.29 and $2.42 per share and between $0.76 and $0.80 per share for the second quarter. For the second quarter, we are assuming a conversion of our Series A convertible preferred shares in the share count for FFO because it is more dilutive when quarterly adjusted FFO per share exceeds $0.63. This increases fully diluted shares outstanding to approximately $73 million for the quarter. Without this conversion our second quarter adjusted FFO per share guidance would be $0.79 to $0.83. Our full-year guidance does not exceed the annual conversion threshold of $2.52 per share. Therefore, fully diluted shares outstanding for the full year are soon to be approximately 63 million and for purposes of computing FFO per share you need to use the 63 million shares. In other words, the second quarter is impacted by the [inaudible] conversion, but the full year is not.

A final comment on our second quarter guidance, as a testament to the positive results from the strategic plan we put into place, the mid-point of our guidance as compared to last year and on a same store basis represents a 12% increase in EBITDA and a 28% increase in FFO per share.

We spent the last two years strengthening our balance sheet. We are focused on preserving and creating capacity for future opportunities. We have cash of $70 million and access to our $250 million line of credit. We have no material debt maturing during 2008 and we've begun discussions regarding refinancing the $130 million of debt that matures during 2009. We're having very positive conversations with a number of secured and unsecured debt providers and I am comfortable with our options and refinancing expectations.

However, from a downside perspective and assuming the capital markets are completely closed throughout 2009 we have availability under a line of credit to pay up all 2009 maturing debt. Our fixed charge coverage remains over two times; our leverage ratio is just over five times and in the range of our long-term goals. We expect to use asset sale proceeds to pay down debt which will provide us with capacity for future opportunities. Our weighted average cost of debt is 6.3% compared to 7.6% for 2007. Approximately 45% of our debt is at floating rates which we view as a natural hedge given the cyclical nature of the lodging industry. However, given the reduction in LIBOR we continue to analyze swapping a portion of our floating rate debt to a fixed rate.

And finally, as we discussed on previous calls our dividend policy has been to increase our dividend over time and stabilize it at a level that could be maintained through a moderate down-turn in the economy. At the current level of $0.35 per quarter, we have reached a stabilized level. Although based on our guidance the annual dividend for 2008 is slightly outside our payout range we expect the payout ratio to be more in line with our stabilized cash flows in 2009. When we set the dividend, we have always considered the continued growth in operating performance for the renovation program. If you'll look to 2009 when we will have earned the returns from renovations, recaptured the remaining disruption, and Union Square is online, our payout ratio should be at the low to middle end of our targeted range of 75% to 85%. So we are comfortable with the current dividend coverage and the level.

And with that, thank you, and we're ready to address any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Charles P. Scholes – JP Morgan.

Charles P. Scholes – JP Morgan

Just a quick question here on the 18 basis point decrease in margin, with 4.6% RevPAR, I would have thought that the margin would have been a little bit higher. Can I just get a little more color on that?

Andrew J. Welch

Yes, Patrick. When I talked in my comments that it was related to the 19 hotels that have been under renovation and the 12 hotels that completed their renovations in the fourth quarter with their initial ramp-up period. So when you look at second quarter our guidance says is plus 150 to 200 basis points so I hope that illustrates the impact having 25% of the portfolio under renovation has on our margins.

Charles P. Scholes – JP Morgan

And then, can I get a little bit of color as far as what your real estate taxes and insurance are looking like going forward? It looks like they were pretty much flat year-over-year, but what are your expectations for the remainder of the year and next year?

Andrew J. Welch

That's an area we have continued focus on; we have a vice president level that is very active in that. We are assuming some positive results this year and we would expect a slight reduction in total tax of this year versus last year.

Operator

Your next question comes from Napoleon Overton – Morgan, Keegan & Company, Inc.

Napoleon Overton – Morgan, Keegan & Company, Inc.

I was wondering if you could share with us a little bit of color on the selection or identification of the six additional potential disposition hotels in terms of the selection criteria. If you would be willing to identify any of those hotels, and any color on any pricing expectations that you might have.

Richard A. Smith

I can answer part of that now. Let me start with what I can't answer and tell you why. We're not prepared to identify the hotels yet for various internal reasons. From a pricing standpoint, because this portfolio is so small compared with the 45 that we sold before we think it gives too much kind of leading information to potential buyers, so we're not really discussing pricing expectations. I can tell you that we're happy with where the expectations are, and if we don't get there, we simply won't sell them.

As far as the criteria, that's the part I can answer. We look at a number of things Nap, when we're looking at this and all of it goes back to the overall strategy of continuous improvement and the quality of the portfolio of course, but we look at supply and demand factors very very carefully for markets. We look at concentration risks, we look at future capital and what the returns are going to be on that, what the hold IORs are versus what we think we can generate outside of that if we do something separate with the hotels. So all of those things go into the criteria and obviously, one thing I mentioned in my comments was that it needs to be post-stabilization so that we're getting to a stabilized value of EBITDA so we can realize the value from that work that we did.

Napoleon Overton – Morgan, Keegan & Company, Inc.

Could you share with us anything about if you were to sell all six properties, what kind of gross proceeds might those six properties, in a range, produce?

Richard A. Smith

Sorry, Nap I’m just not going to give any pricing expectations. I mean, sorry about that, but the portfolio is very small and once two or three of them are gone and there's publicized pricing on it, it just leaves the market too much and I'm not prepared to do that.

Operator

Your next question comes from William Truelove – UBS.

William Truelove – UBS

You mentioned about the sale being accretive to shareholders in your prepared remarks so I just want to clarify what you mean by that. Is it because you say in the Press Release that, I knew you took the impairment charge with the $17 million, but now there's still going to be a positive number? Or do you mean that you're also going to repurchase shares with the proceeds or do 1041 exchanges? Could you sort of tell us what your game plan is post sale and what you meant by accretive to shareholders?

Richard A. Smith

Well, let me discuss two things. First of all, on the impairment, I think it's important to note that there was basically one hotel that drove that, there were two hotels that had some level of that participation, but one hotel drove it. And for the six hotels, all told, we will have a gain based on our expected pricing versus the, it's just the way the accounting rules work; you have to state the impairments now and the gains later on. So globally there would be a gain on the other four that would be in excess of the $17.2 million going forward, would be our expectations.

As far as the accretive, I don't want to get into too much, I mean everybody knows what the analysis is, I don't want to get into too much of the detail on what our internal modeling and scenarios kind of convey, but I can tell you that the pricing is set based on all sensitivities to produce an accretive result for our shareholders. I'm sorry that I can't get into any more detail than that but there's a number of different sensitivities and I don't want to lead the market to something that may or may not happen based on circumstances later on. I don't know if that helps, Will.

Operator

Your next question comes from Chris Woronka – Deutsche Bank.

Chris Woronka – Deutsche Bank

When you talk about the hotels that have been completed for one or more quarters, is that defining that as a full quarter or a calendar quarter? In other words, does that mean the ones that were done at the end of the third quarter or does it mean three months?

Richard A. Smith

What Andy alluded to in his, and that we both kind of alluded to, the 61 that we were referring to they were done at the end of the fourth quarter. So that was done, meaning they were out of renovation for one full quarter as of the end of the first quarter. The 49 hotels that Andy referred to that gives you one month of ramp-up were completed at the end of the third quarter, so they would have two full quarters at the end of March or at the end of the first quarter. Does that clear it up?

Chris Woronka – Deutsche Bank

And those 49 are where RevPAR was up 10, 10.5% right?

Richard A. Smith

Right.

Chris Woronka – Deutsche Bank

One other one, on the Renaissance, just trying to get a sense, how can we kind of bake back into how much the Renaissance hotels are contributing? I mean, I know they have a much larger food and beverage and out-of-room component. Is there any way you can kind of quantify that?

Richard A. Smith

I think a lot of that stuff is in the release.

Andrew J. Welch

I think it'll give you a better data point when I talked about same store increases for the second quarter. The same store EBITDA for 85 hotels which would include the two Renaissances was $78.5 million for the second quarter of last year. If you look at the Q, we always reconcile to get back to same store and that will give you the two Renaissances' impact.

Stephen A. Schafer

Chris, we put the expected EBITDA for this year in the fourth quarter release when we gave our initial guidance.

Operator

Your last question comes from Dennis Forst – KeyBanc.

Dennis Forst – KeyBanc

First of all, if we can just try and understand April. I think you mentioned, Andy that the 12 most recently completed properties, those were completed in the fourth quarter, and they were up 12.5% in the month of April. But what about that whole portfolio of 61 properties that were completed? What did that look like in April?

Andrew J. Welch

We're trying to get away from too many RevPAR sets, but the two we gave for the portfolio of 85 was 6.6% which is in the Release, and the 12 improved 12.5%. The other one I can give you is the 61 improved about just under 11%.

Dennis Forst – KeyBanc

And the two new Renaissances, do you pay any franchise fee on those two or are those just management?

Richard A. Smith

We pay a fee for management and franchise.

Dennis Forst – KeyBanc

It's a combined fee? Who manages those two properties for you?

Richard A. Smith

Marriott.

Dennis Forst – KeyBanc

So it's a combined management franchise fee?

Richard A. Smith

Yes.

Operator

There are no further questions at this time.

Andrew J. Welch

I need to clarify something, I thought I said increase but I've been told I said decrease in property taxes. We are hopeful in our aggressive approach to keep the increase to 10% which is, we think, pretty aggressive given the environment of spending of the renovations dollars we spent over the last 12 months.

Richard A. Smith

If there are no other questions, thank you for joining us today, and we will talk to you next quarter.

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Source: FelCor Lodging Trust Incorporated Q1 2008 Earnings Call Transcript
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