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Executives

[Mr. Daily]

Tom Hewitt – Chief Executive Officer

Bruce Riggins – Chief Financial Officer

Analysts

David Loeb – Robert W. Baird & Co.

[Will Marks – JMP Securities]

[Tony Cammon – Eastman Partners]

Interstate Hotels & Resorts (IHR) Q2 2008 Earnings Call August 6, 2008 10:00 AM ET

Operator

Welcome to the Interstate Hotels & Resorts second quarter 2008 earnings conference call. (Operator Instructions) Please go ahead Mr. Daily.

[Mr. Daily]

This morning, Interstate released results for the second quarter ended June 30, 2008 and I hope you've had a chance to review the press release. If you did not receive a copy of the release, please call my office at 703-435-6293. We'll be happy to email one to you, or you may view a copy of the release at Interstate's web site, www.ihrco.com by first clicking on Investor Relations at the top of the page and then on press releases.

Today's conference call is transferred live telephone and by web cast over Interstate's web site at extremeevents.com. Interested parties may visit the company's web site www.ihrco.com and click on Investor Relations and then second quarter conference call. A replay of the conference call will be available by phone until midnight on Wednesday, August 13, 2008 by dialing 800-405-2236 with a reference number 11117346.

An archived web cast of the conference call will be posted on Interstate's web site through September 6, 2008. The conference call is the property of Interstate Hotels & Resorts and any re-distribution, retransmission or rebroadcast of this call in any form without the express written consent of Interstate is prohibited.

Before we begin, management has asked me to remind you that in keeping with the SEC's Safe Harbor guidelines, today's conference call may contain forward-looking statements about Interstate Hotels & Resorts including statements regarding future operating results and the timing or composition of revenues among others.

Except for historical information, these forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially, including the volatility of the national economy, economic conditions generally, and the hotel and real estate market specifically, international and geopolitical difficulties or health concerns, governmental actions, legislative and regulatory changes, availability of debt and equity capital, interest rates, competition, weather conditions or natural disasters, supply and demand for lodging facilities in our current and proposed market areas, and the company's ability to manage integration and growth.

Additional risks are discussed in the company's filings with the Securities and Exchange Commission. In accordance with Regulation G, any non-GAAP financial measures that are used in the company's oral presentation today is required to be reconciled to the most directly comparable GAAP measure. Any required reconciliation will be made available to investors on the company's web site under the heading Investor Relations, additional information regarding non-GAAP financial measures.

Now to provide you with insights to Interstate's second quarter 2008 results, I'd like to introduce Tom Hewitt, Chief Executive Officer and Bruce Riggins, Chief Financial Officer. Let me turn it over to you Tom.

Tom Hewitt

Needless to say, we along with all the other companies in our industry are confronted with challenging times. Considering the economic pressures we have faced during the second quarter, I could not be more pleased with the results produced by our associates.

While we believe things will become more difficult in the second half of the year, we do have positive news and many areas to include the progress on our large renovations on two of our wholly owned hotels, the recent addition of our forty-ninth joint venture property located in Lexington, Kentucky, the increase in our hotel count for the third quarter in a row and REV par growth and margin improvement we have realized across the portfolio.

Today we reported the following overall results for the quarter; adjusted EBITDA of $10.2 million, adjusted net income of $126,000 and REV par gains for our total managed portfolio were 4%, nearly 3 percentage points ahead of the industry.

First regarding our seven wholly owned properties, REV par for the quarter excluding the two properties undergoing significant renovations increased by 2.9% over last year. These five hotels continue to perform well in these challenging economic environments with four out of the five exceeding budget to date. Our operating team continues to drive strong bottom line results despite weaker top line growth as evidenced in our year to date margin improvement of 100 basis points for these five hotels.

As discussed on prior calls, we have two properties undergoing significant renovations; the Westin Atlanta Airport Hotel and the Sheridon Columbia Hotel in Maryland. I'm very pleased to report that we are schedule and on budget with both of these projects, however, we have encountered more disruption that we originally anticipated. We are reminded that it is never easy to budget operating results in a year when a hotel is undergoing a major renovation. Of course, this has been compounded by the weakening economy.

These factors have caused us to lower our full year EBITDA forecast for our own hotels to a mid point of $27 million. The good news is that looking ahead; we have heard from many customers that they will definitely return when the renovations are completed. This is evident in our booking pace for 2009 which is up significantly over 2008 for both hotels. We expect to generate incremental EBITDA of approximately $4.5 million to $5 million in 2009 from these two hotels.

Now concerning joint ventures, during the quarter our share of EBITDA from our joint venture properties was $2.5 million, more than twice as much as the second quarter last year. We opened the first Aloft Hotel in the United States in Rancho Cucamonga, California with our second in Cool Springs, Tennessee expected to open in the third quarter.

Last week we acquired a 5% interest in the Lexington Downtown Hotel and Conference Center and the adjacent office building through a new joint venture partnership formed with Madison W Properties. This hotel was formerly a Radisson which Interstate managed for affiliates of the Blackstone group. The partnership will invest $13 million and convert the hotel to a Hilton in 2009. With this transaction, we now have joint venture interest in 49 properties which will increase to 50 with the opening of the Aloft Cool Spring in September.

We continue to court new venture deals. However, we are seeing fewer opportunities for ground up development due to the current financing environment. We will continue to be frugal with our available dollars as we except there to be many attractive investment opportunities as pricing expectations moderate.

As I said earlier, I'm very proud of the performance of our overall portfolio which achieved 4% REV par growth for the quarter, well ahead of the industry average of 1.2%. We continue to see strength in the gateway cities such as New York City and San Francisco. Houston and New Orleans were also strong markets this quarter while other markets throughout the country have experienced some softness.

Our operating group has taken a critical look at the second half of the year, and like others, we are forecasting slower REV par growth than we were three months earlier. As such, we are lowering our REV par guidance to 1% to 3% for the year.

Year to date through June we have realized margin growth of 70 basis points year over year. With the cost containment programs we have put in place at all hotels, we will continue to focus heavily on margin improvement throughout the remainder of the year.

Another positive for the third quarter in a row, we have increased our hotel count and now we have 223 hotels in our portfolio. Since the end of the quarter, we assumed management of four Hyatt Place hotels owned by FFC Capital an owner for which we now manage 29 properties.

In the third quarter, we expect to open several of our hotels currently under construction including the Hilton Garden Inn in Melville and the [inaudible] Sweet Albany, both in New York, and the Hilton Leningrad Hyatt property in Moscow which will be our sixth managed property in Moscow. Our seventh Moscow property, the Renaissance Moscow is expected to open in early 2009.

Early in the quarter our Indian join venture, JHM Interstate Hotels India, signed its first management contract to operate a five star hotel in Vizag expected to open in the fourth quarter of this year. We continue to explore additional opportunities in India as we actively ramp up our presence there. The joint venture has hired key staff and we have invested $6.25 million in the duet hotel India fund which has a pipeline of opportunity throughout India.

We remain committed to the growth of our Mexico and Central America platform and are developing a pipeline of potential management opportunities in that region also.

To conclude, while we have lowered our forecasted adjusted EBITDA for the full year based on the softness in the economy and the renovation disruption at the two hotels, we are very confident in the fundamental and positioning of the company. The investments we are making this year provide for significant embedded growth in 2009 and beyond. Our dedicated associates will continue to focus on maximizing profits for our owners. I want to thank them for their continued hard work and commitment to the success of the company.

With this, I will turn it over to Bruce Riggins, our CFO for his comments.

Bruce Riggins

First I'd like to update you on the status of our two major renovations. As Tom mentioned, we are on schedule and on budget with our comprehensive renovation programs at both the Western Atlanta Airport and the Sheridan Columbia. As of June 30, we have spent $16 million of our total capital budget of $35 million. The majority of this spending relates to these hotels.

At the Westin Atlanta Airport, we recently completed the renovation of all 500 guest rooms which includes the addition of 5 rooms. The ballroom and new business center were also recently completed. We are underway with the remainder of the renovation which will capture the remaining meeting spaces and public spaces including the restaurant and lobby bar as well as the central arrival and exterior of the hotel. We expect the hotel to be fully renovated by early December.

At the Sheridan Columbia, we have the renovation of one half of the guest rooms completed early in the second quarter. The renovation of the remaining guest rooms in the tower section of the hotel began last month and is scheduled to be completed in the fall. One of the ballrooms was completed last week and the other will be finished by the end of August. Remaining meeting space is on target for completion in September and as noted last quarter, the remainder of the work on the public spaces, bar and restaurant will take place in the fourth quarter and will be finalized by year end.

Regarding our capital structure, as of June 30 we had $8 million of unrestricted cash on hand and $230 million of total debt outstanding consisting of $113.5 million on our senior credit facility term loan, $34 million on our senior revolving credit facility and $82.5 million on non recourse mortgage debt.

During the quarter we completed the mortgage for the Sheridan Columbia hotel. The initial proceeds of the loan were $25 million and we can borrow up to $10 million of additional funds through the end of 2009 upon achieving certain analog thresholds and renovation hurdles. We used the net proceeds from the loan to pay down our revolving credit facility. The five year loan has a variable interest of [live] plus 200 basis points or 4.8% as of today.

Now under our full year guidance, as Tom discussed, we along with the entire industry are seeing softness in leisure and discretionary transient business and to a less extent, group business except for gateway cities such as New York and San Francisco which continue to perform very well. In addition there are two owned hotels that have experienced greater disruption than originally anticipated.

Based on these factors, we are providing you with the following updated guidance for the year. REP par on a same store basis is projected to increase 1% to 3% both portfolio wide and our owned hotels excluding the two hotels under renovation. Adjusted EBITDA is projected to be $15.2 million to $52.5 million including the following: EBITDA from wholly owned hotels of $26.5 million to $27.5 million. Our share of EBITDA from our unconsolidated joint ventures of approximately $8.5 million and EBITDA from the management business of $15.5 million to $16% million which includes termination fees of approximately $7 million.

Adjusted net income is projected to be $8.3 million to $9.7 million or $025 to $0.29 per share. In our pro forma share of existing joint venture debt is approximately $70 million.

And finally, to highlight a couple of key items to consider for 2009, as Tom mentioned, we expect approximately $4.5 million to $5 million of additional EBITDA in 2009 from our fully renovated properties. And related to our management fees for properties under construction, we have 16 hotels currently under development which together with the two hotels that have already opened this year, will generate approximately $6.5 million of annualized management fees. We expect incremental feels of $3.5 million in 2009 related to those hotels that will open by the end of 2009.

This concludes our remarks. We're ready to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Loeb – Robert W. Baird & Co.

David Loeb – Robert W. Baird & Co.

The $3.5 million incremental from the 1600 construction, does that include the two Moscow hotels?

Bruce Riggins

Yes that would include those, and that's incremental fees to what we would earn in '08 on the one hotel opening this quarter.

David Loeb – Robert W. Baird & Co.

How big is the international component of that $3.5 million next year? I guess the international is primarily those two.

Bruce Riggins

That's a pretty large portion of it, roughly half I would say.

David Loeb – Robert W. Baird & Co.

Can you give a little detail on the Lexington transaction? The release really didn't have a lot. Could you talk about the economics, what your percent interest is, what your cash investment is?

Tom Hewitt

We invested $1 million for a 5% interest in the joint venture which owns the hotel and the adjacent office building.

David Loeb – Robert W. Baird & Co.

Is that total you'll have to put out, or is that just for your ownership interest now?

Tom Hewitt

It's the total which covers the CapEx.

David Loeb – Robert W. Baird & Co.

How come the office building was a part of that?

Tom Hewitt

I believe going back, they were developed together. They're adjacent to each other and connect and it is being managed. That section of the project is being managed by an existing partner in the ownership entity.

David Loeb – Robert W. Baird & Co.

So you're 5% ownership in that as well, but no fees coming off it.

Tom Hewitt

No management fee.

Operator

Your next question is from [Will Marks – JMP Securities]

[Will Marks – JMP Securities]

Can you just big picture talk a little bit about what we should expect to see or what your view is longer term, over the next 18 months and what makes this different from last time? I know there's not quite as much supply but why couldn't things stay bad for awhile?

Tom Hewitt

I do think we're going to remain challenged certainly the rest of this year and into 2009. There are some bright spots though. The majority of the thought seems to be coming from leisure discretionary travel which I don't think surprises anybody. Some good news lies in group business holding up fairly well and the group pace for the rest of the year and into '09 and 10 for the longer term stuff seems to be holding up again fairly well, although we've seen a little bit of contraction in the corporate group verses the major association business.

Our July held up pretty well in line pretty much with what we've reported for the second quarter and year to date. If anything, it gives us a little comfort as to the second half of the year.

Operator

You have a follow up questions from David Loeb – Robert W. Baird & Co.

David Loeb – Robert W. Baird & Co.

Can you talk a little bit about the incentive management fee impact embedded in your guidance and what you think happens to IMF given the expected lower REV par less leisure, and also as a part of that, the potential for group attrition or slower group booking.

Bruce Riggins

Regarding the incentive fees, we do have a large percentage that comes from Moscow and international in general so our incentive fees this year we think will still be ahead of last year which was roughly $21 million. They are down a little bit from our previous guidance but overall, holding up pretty well and let's say 85% or so, the incentive fees come from either Moscow or key gateway cities in the U.S.

David Loeb – Robert W. Baird & Co.

And how about the outlook for group and attrition in bookings?

Bruce Riggins

You're just asking in general not as it relates to incentive fees?

David Loeb – Robert W. Baird & Co.

Yes. It sounds like the incentive fees are so heavily weighted towards Moscow and gateway cities that that's less of a factor. If you could talk a little bit about it at the owned hotels if that's another thing that you're worried about, if that's another shoe that could drop.

Bruce Riggins

We're concerned but as of this point, we're very pleased and encouraged with the group booking pace, both the short and medium term and I think we'll be fine for the long term booking pace. We spent a lot of time talking with key customers in the last two to three weeks and we've heard very clear signals that they are going to continue to support their group efforts, especially client related.

I think we might see some contraction in internal group meetings where companies will want to shorten it from three to two days or they might send a few less people, or they may cut back on some of the food and beverage and some of the parties and what not. But as far as we're concerned, all indications are that the company's, the corporations that do, and associations that do sponsor major group business dedicated toward client relationships is going to be there.

Operator

Your next question is from [Tony Cammon – Eastman Partners]

[Tony Cammon – Eastman Partners]

As you look forward in terms of capital spending, you obviously had a lot of renovation related capital spending this year, but have you thought in terms of where you're going to use your cash flow going forward, and I'm wondering if it's towards trying to pay down debt or continue to joint ventures. Where do you anticipate cash being spent?

Bruce Riggins

You're right. We've had very significant capital programs this year. We don't anticipate anywhere near that once we get these two projects completed toward the end of the year. I think we go into a more normal mode as far as capital spending whether it be 4% or 5% of revenue at a given hotel. That includes the owned hotels and the joint ventures. So we're not planning anything close to the scope of capital that we did this year.

[Tony Cammon – Eastman Partners]

With the shares trading at about a 40% of book value, do you think the shareholders might be better served by trying to find a buyer for the company as a whole at some point?

Bruce Riggins

I can tell you that at every Board meeting we have and interim calls that we have with the Board and internally with management we discuss all strategic opportunities to [inaudible] shareholder value on an ongoing basis. I can assure you that nothing is going to be left unanalyzed.

Operator

There are no further questions.

Bruce Riggins

Thanks again for joining us on the call today. We'll look forward to communicating with you in early November if not sooner. Have a great day.

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Source: Interstate Hotels & Resorts Q2 2008 Earnings Call Transcript
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