Filed with the SEC from Oct 2 to Oct 8 :
Strategic Hotels & Resorts (BEE)
Microsoft (MSFT) co-founder Bill Gates' investment firm, Cascade Investment, expects to consider alternatives for its stake in Strategic Hotels, a Chicago real-estate investment trust. Cascade previously had reported its holdings in the company as a passive investor in a 13G on Aug. 22. It later converted its filing status to that of an activist, by filing a Schedule 13D. Cascade currently owns 4,190,000 shares (5.63%).
Strategic Hotels & Resorts, Inc. (SHR) was incorporated in Maryland in January 2004 to own and asset manage upper upscale and luxury hotels that are subject to long-term management contracts. The terms upper upscale and luxury are classifications of hotels by brand that are defined by Smith Travel Research, an independent provider of lodging industry statistical data. We went public in an initial public offering in June 2004. Our accounting predecessor, Strategic Hotel Capital, L.L.C. (SHC LLC) was founded in 1997 by Laurence Geller, our President and Chief Executive Officer, Goldman, Sachs & Co.â€™s Whitehall Fund and others. We own our properties through our investment in Strategic Hotel Funding, L.L.C., our operating partnership, which we refer to herein as SH Funding, and its subsidiaries.
We operate as a self-administered and self-managed real estate investment trust (REIT) managed by our board of directors and executive officers and conduct our operations through our direct and indirect subsidiaries including SH Funding. We are the managing member of SH Funding and hold approximately 99% of its membership units as of February 28, 2008.
As of February 28, 2008, we:
wholly own or lease 17 hotels, own a 51% interest in affiliates that own two hotels where we asset manage such hotels and own a 45% interest in and act as asset manager for a joint venture that owns one hotel;
own land held for development, including the La Solana project adjacent to our Four Seasons Punta Mita Resort, which includes a 20.5- acre site for the development of hotel suites and a 27.0- acre site for the development of for-sale villas, a separate 60.0- acre oceanfront land parcel near the Four Seasons Punta Mita Resort and a 10.0-acre parcel adjacent to the Fairmont Scottsdale Princess; and
own a 31% interest in and act as asset manager for a joint venture with two unaffiliated parties that is developing the Four Seasons Residence Club Punta Mita, a luxury vacation home product that is being sold in fractional ownership interests on property adjacent to our Four Seasons Punta Mita Resort hotel in Mexico.
We do not operate any of our hotels directly; instead we employ internationally known hotel management companies to operate them for us under management contracts or operating leases. Our existing hotels are operated under the widely recognized upper upscale and luxury brands of Fairmont Â® , Four Seasons Â® , Hyatt Â® , InterContinental Â® , Loews Â® , Marriott Â® , Ritz-Carlton Â® and Westin Â® . The Hotel del Coronado is operated by a specialty management company, KSL Resorts.
We seek to maximize asset values and operating results through asset management. Although we have no imperative to grow, we will opportunistically seek to acquire additional properties that meet our disciplined investment criteria.
As used in this report, references to â€śweâ€ť, â€śourâ€ť, â€śusâ€ť, and â€śSHRâ€ť are to Strategic Hotels & Resorts, Inc. and, except as the context otherwise requires, its consolidated subsidiaries.
We are a preeminent owner of upper upscale and luxury branded hotels located primarily in the United States with select international hotels. We believe our future growth will be driven by the execution of our life cycle-based investment strategy. This strategy involves the acquisition of hotels with strong underlying real estate values, adding value through the application of managementâ€™s superior asset management skills, identifying redevelopment opportunities to enhance cash flow and value, and disposing of hotels upon completion of our value enhancement and cash flow generating strategies.
As a result of our ongoing research, the selection of target markets and individual property targets is updated continuously to foster a proactive acquisition strategy. We believe this acquisition strategy permits us to make disciplined investment decisions quickly and efficiently. Members of our management team have the skills and experience to acquire and asset manage hotels both domestically and internationally, which places us in a unique position among lodging REITs. Our acquisition strategy incorporates the following elements, each of which is supported by continuous research and disciplined investment evaluation processes:
Target upper upscale and luxury hotels in select urban and resort markets, including major business centers and leisure destinations, with strong growth characteristics and high barriers to entry.
Target hotels with management contracts with operators which we believe will be receptive to our asset management and redevelopment initiatives, or hotels with respect to which we can enter into value-enhancing management contracts.
Acquire properties that present redevelopment opportunities in which we can invest capital to create additional cash flow potential with relatively high returns.
Selected international opportunities. Members of our management team have the skills and experience to acquire and asset manage international hotels, which have permitted us to diversify our portfolio and take advantage of select international hotel investment opportunities.
Develop hotel condominiums, fractional ownership interests and other residential properties at certain of our properties where we believe these types of developments may create value. The goals of this residential conversion strategy include improving the return on an existing asset, liquidating an asset at a premium that would permit reinvestment into additional hospitality assets, and/or providing a mixed use opportunity that would be complementary to, and therefore increasing the revenue potential of, an investment.
Enter into joint ventures, allowing us to experience growth through the expansion of our portfolio, increase fee-based income, enhance the return on our real estate through fee and incentive income and foster closer relationships with the hotel management companies that operate our hotels. Entering into joint ventures also allows us to gain additional diversification of our capital and higher return on investment by investing in a larger number of properties, although through a smaller investment in each property.
Asset Management Strategy
We believe that we can enhance our cash flow and earnings growth through expert asset management, which will ultimately generate increased operating margins and higher investment returns. Our value-added asset management strategy has the following general components:
Working in partnership with the hotel management companies that operate our hotels, we build an asset management approach to enhance the cash flow and value of our properties. We have multi-property relationships with a select group of hotel management companies that in our opinion have strong brand recognition, superior marketing capabilities, management depth and an ability to work with our team to create efficient operations. We improve hotel operating performance through the application of value-added programs involving consumer and market research, competitive benchmarking, technology upgrades and systems development and upgrades.
We provide rigorous oversight of the properties and the hotel management companies that operate them to ensure the alignment of the hotel management companiesâ€™ and our interests and to monitor the hotel management companiesâ€™ and our compliance with the management contracts relating to our properties. Typically, this oversight provides sustained increases in operating margins and enhances property values. Our growth strategies are incentives for hotel management companies to seek additional revenue opportunities and, in turn, provide us with opportunities to revisit our contractual relationships with hotel management companies in order to reduce costs and increase flexibility.
Our asset management team is integral to the planning of capital expenditures at each of our hotels, including both routine maintenance expenditures and more extensive capital improvements. Such capital expenditures are undertaken to improve the quality of our properties and ultimately enhance revenues.
Underpinning our redevelopment strategy is a consumer research driven, creative and forward looking master plan for each hotel in our portfolio designed to provide near-term earnings growth potential beyond mere cyclical growth. Many of our hotel master plans include capital expenditures designed to increase food and beverage and other non-rooms revenue to drive growth in total revenue per available room, or Total RevPAR, and bottom line metrics.
Typically, the application or our redevelopment strategy leads to increased, risk-adjusted returns and can result in meaningful improvements in cash flow and hotel value.
We recycle capital for future investments through opportunistic dispositions. We are likely to dispose of all or part of our investment in a property in circumstances where we believe our asset management strategy has maximized the propertyâ€™s value, the proceeds of the disposition are unusually attractive, the market in which the property is located is declining or static, or competition in the market requires substantial capital investment which will not generate returns that meet our criteria.
Proceeds from dispositions would generally be intended to be reinvested in redevelopment activities in our existing portfolio or the acquisition of additional hotel properties where the application of our life cycle-based investment strategy can begin again.
The hotel industry is highly competitive and the hotels in which we invest are subject to competition from other hotels for guests. Competition is based on a number of factors, most notably convenience of location, brand affiliation, price, range of services, guest amenities or accommodations offered and quality of customer service. Competition is often specific to the individual markets in which our properties are located and includes competition from existing and new hotels operated under brands in the upper upscale and luxury segments. Increased competition could have a material adverse effect on the occupancy rate, average daily room rate and room revenue per available room of our hotels or may require us to make capital improvements that we otherwise would not have to make, which may result in decreases in our profitability.
Because our hotels operate in the upper upscale and luxury segment of the market, we face increased competition from providers of less expensive accommodations, such as limited service hotels or independent owner-managed hotels, during periods of economic downturn when leisure and business travelers become more sensitive to room rates. As a result, there is pressure to lower average daily rates during such periods to compete for these guests.
We face competition from institutional pension funds, private equity investors, other REITs and numerous local, regional and national owners in each of our markets. Some of these entities may have substantially greater financial resources and may be able to accept more risk than we can prudently manage. Competition may generally reduce the number of suitable investment opportunities offered to us and increase the bargaining power of property owners seeking to sell their properties to us.
As of February 28, 2007, we had 62 full-time and 4 part-time corporate employees. We believe that our relations with our employees are good. None of our corporate employees are unionized.
Ownership of Hotels
Where we have an ownership interest in a hotel, the entity through which we hold such ownership interest (a Strategic Ownership Entity) will generally lease the hotel to one of our TRSs and the TRS will enter into a management agreement with an independent third party for such party to operate the hotel. A lease between a Strategic Ownership Entity and one of our TRSs (an Affiliate Lease) provides for the TRS to pay to the Strategic Ownership Entity a base rent plus a percentage rent (as more fully described below). An Affiliate Lease must contain economic terms which are similar to a lease between unrelated parties or, pursuant to the RMA, the Strategic Ownership Entity may have to pay a 100% penalty tax on some of the payments it receives from our TRS under such Affiliate Lease.
Each Affiliate Lease, other than the lease with respect to the InterContinental Prague, has a non-cancelable term of approximately five years, subject to earlier termination upon the occurrence of certain contingencies such as damage or destruction that renders the hotel unsuitable for our TRSâ€™ use and occupancy, condemnation or our sale or disposition of the hotel.
During the term of each Affiliate Lease, other than the lease with respect to the InterContinental Prague, our TRS is obligated to pay a fixed annual base rent and a percentage rent to the applicable Strategic Ownership Entity. With respect to the InterContinental Prague, there is an existing lease agreement between the applicable Strategic Ownership Entity and a tenant that has prepaid the rent which is being amortized on a straight-line basis over 15 years. Percentage rent is calculated by multiplying fixed percentages by gross room revenues and other revenues, subject to certain adjustments. Percentage rent is paid quarterly, except with respect to the Paris Marriott Champs Elysees where percentage rent is paid monthly. Base rent accrues and is paid monthly. Base rents and percentage rents are adjusted annually for changes in the consumer price index or similar indices.
Fixed charges, including real estate and personal property taxes, capital expenditures and a reserve for capital expenditures are obligations of the lessor under our Affiliate Lease. Our TRSs are required to pay rent, all costs and expenses and all utility and other charges incurred in the operation of the hotels we own. The party responsible for maintaining insurance on a property is dependent on the specific lease.
Third Party Lease Agreements
We are the tenant under leases with third-party landlords for the Paris Marriott Champs Elysees and the Marriott Hamburg. We are also the tenant under ground leases with third-party landlords where we lease the land for the Marriott Lincolnshire, the Marriott London Grosvenor Square and a parcel of land that is part of the Fairmont Scottsdale Princess hotel property. The terms of these third party leases, including renewal options, range from 46 to 78 years. These third party lease agreements require us to make annual rental payments comprised of a minimum rental amount (subject to indexation) and may also include additional rent comprised of a percentage of hotel operating profit, less minimum rent, or the greater of a minimum rental amount and a percentage of certain revenues.
Hotel Management Agreements
Most of our hotels are managed and operated by third parties pursuant to management agreements entered into between our TRSs and hotel management companies. These management agreements generally provide for the payment of base management fees between 1.25% to 4.00% of revenues, as defined in the applicable agreements. In addition, an incentive fee may be paid if certain criteria are met. Certain of the management agreements also provide for the payment by us of advisory fees or license fees. The remaining terms (not including renewal options) of these management agreements range from two to 50 years. A management agreement with one of our operators typically has the terms described below.
Operational services . The manager has exclusive authority to supervise, direct and control the day-to-day operation and management of the hotel, including establishing all room rates, processing reservations, procuring inventories, supplies and services, and preparing public relations, publicity and marketing plans for the hotel. The manager receives compensation in the form of a base management
fee and an incentive management fee, typically calculated as percentages of gross revenues and operating profits, respectively. In some cases, the incentive management fee is paid only after we have received a certain level of income.
Executive supervision and management services . The manager supervises all managerial and other employees for the hotel, reviews the operation and maintenance of the hotel, prepares reports, budgets and projections and provides other administrative and accounting support services to the hotel. In some cases, we maintain authority to approve the appointment of the hotelâ€™s general manager.
Chain services . Our management agreements require the managers to furnish chain services that are generally made available to other hotels managed by such operators. Such services include: (1) the development and operation of computer systems and reservation services, (2) management and administrative services, (3) marketing and sales services, (4) human resources training services and (5) such additional services as may from time to time be more efficiently performed on a national, regional or group level.
Working capital . Our management agreements typically require us to maintain working capital for a hotel and to fund the cost of fixed asset supplies such as linen and other similar items. We are also responsible for providing funds to meet the cash needs for the hotel operations if at any time the funds available from hotel operations are insufficient to meet the financial requirements of the hotel.
Furniture, fixtures and equipment replacements . Our management agreements generally provide that once each year the manager will prepare a list of furniture, fixtures and equipment to be acquired and certain routine repairs to be performed in the next year and an estimate of the funds that are necessary therefore, subject to our review and approval. In addition, we are required to provide to the manager all necessary furniture, fixtures and equipment for the operation of a hotel (including funding any required furniture, fixtures and equipment replacements). For purposes of funding the furniture, fixtures and equipment replacements, a specified percentage of the gross revenues of the hotel is deposited by the manager in an escrow account (typically 3.0% to 5.0%).
Building alterations, improvements and renewals . Our management agreements generally require the manager to prepare an annual estimate of the expenditures necessary for major repairs, alterations, improvements, renewals and replacements to the structural, mechanical, electrical, heating, ventilating, air conditioning, plumbing and vertical transportation elements of a hotel. In addition to the foregoing, the management agreements generally provide that the manager may propose such changes, alterations and improvements to the hotel as are required by reason of laws or regulations or, in the managerâ€™s reasonable judgment, to keep the hotel in a safe, competitive and efficient operating condition.
Sale of the hotel . Most of our management agreements limit our ability to sell, lease or otherwise transfer a hotel unless the transferee is not a competitor of the manager, and unless the transferee assumes the related management agreement and meets specified other conditions.
Service marks . During the term of our management agreements, the service mark, symbols and logos currently used by the manager may be used in the operation of the hotel. Any right to use the service marks, logo and symbols and related trademarks at a hotel will terminate with respect to that hotel upon termination of the management agreement with respect to such hotel.
We lease one of our hotels, the Marriott Hamburg, pursuant to a lease agreement whereby rent is paid by the hotel management company that operates the hotel, as lessee, to us for an amount equal to a fixed base rent plus a specified percentage of profits in excess of the base rent. Otherwise, the terms of the lease are similar to the terms of our management contracts described above.
William A. Prezant
William A. Prezant (Chairman) has been a partner in the law firm of Prezant & Mollath, practicing law in California and Nevada, since 1990. He serves on the board of directors of MacGregor Golf Company, Torrey U.S. Strategy Partners and Torrey International Strategy Partners (both registered investment companies), Forward Management (a financial services company), and Reflow Management (an investment advisor). Mr. Prezantâ€™s community activities include serving on the California/Nevada Advisory Board for the Wilderness Society and the Advisory Council of the Nevada Museum of Art. Mr. Prezant holds a Bachelor of Arts Degree from the University of Southern California and a Juris Doctorate from Georgetown Law Center.
Robert P. Bowen
Mr. Bowen retired as a partner of Arthur Andersen LLP in 1999. From 1980 to 1998, he was partner-in-charge of the audit practice of Arthur Andersenâ€™s Memphis and Little Rock offices. For more than 25 years, he specialized in the hospitality and entertainment industry and was a member of Arthur Andersenâ€™s worldwide hospitality industry team. Mr. Bowen joined Arthur Andersen in 1968, after receiving his Master of Business Administration degree from Emory University. Until recently, Mr. Bowen was a director and chairman of the audit committee of the board of directors of Equity Inns, Inc., a publicly-traded hotel REIT, and of Gaylord Entertainment Company, a publicly-traded hotel company.
Michael W. Brennan
Michael W. Brennan is a co-founder of First Industrial Realty Trust, Inc., a real estate investment trust that has grown five-fold since its initial public offering in 1994. Prior to becoming its president and chief executive officer in 2000, he was chief operating officer of First Industrial. He is a member of the Presidentâ€™s Circle Real Estate Roundtable and the National Association of Real Estate Investment Trusts. Mr. Brennan is also a member of the Board of First Industrial and a member of the Chicago Public Library Foundation Board. Mr. Brennan holds a Bachelor of Science degree in finance from the University of Notre Dame.
Edward C. Coppola
Edward C. Coppola is one of the founders of The Macerich Company and has been a member of its board of directors since that companyâ€™s formation in 1994. In addition to his role as a director, Mr. Coppola has been Senior Executive Vice President and Chief Investment Officer of The Macerich Company since August 2004. He is responsible for directing the companyâ€™s acquisition activities and establishing the companyâ€™s strategic direction. He is also actively involved in the companyâ€™s capital market activities and in developing and maintaining relationships with joint venture partners and department stores. Previously, he was an Executive Vice President of The Macerich Company beginning in 1994. He has 30 years of experience with The Macerich Group and The Macerich Company. Mr. Coppola is a member of The International Council of Shopping Centers, PREA, National Association of Real Estate Investment Trusts, and The Real Estate Roundtable in Washington, D.C. Mr. Coppola is also a past member of The Urban Land Institute and currently serves on the advisory board of the St. Vincent de Paul Thrift Store in Dallas, Texas. Mr. Coppola holds a Bachelor of Science degree in finance from the University of Notre Dame and a Juris Doctorate from Drake University.
Kenneth Fisher has been a senior partner in Fisher Brothers, a New York City commercial real estate firm, since April 2003, and was a partner of Fisher Brothers from 1991 to April 2003. Mr. Fisher has been the chairman and chief executive officer of Fisher House Foundation, Inc., a not-for-profit organization that constructs homes for families of hospitalized military personnel and veterans, since May 2003, and served as vice chairman of Fisher House Foundation from May 2001 to May 2003. Mr. Fisher was previously a director of Reology Corporation. Mr. Fisher is a 26-year veteran of the real estate industry. Mr. Fisher also is a member of the executive committee of the City Investment Fund, LP, a real estate investment fund, and a member of the Real Estate Board of New Yorkâ€™s Board of Governors. Mr. Fisher has also been appointed to the Presidentâ€™s Commission on Care for Americaâ€™s Returning Wounded Warriors.
Laurence S. Geller
Laurence S. Geller is our President and Chief Executive Officer and the founder of Strategic Hotel Capital, L.L.C., or SHC LLC. Prior to founding SHC LLC in 1997, Mr. Geller was Chairman and Chief Executive Officer of Geller & Co., a gaming, tourism and lodging advisory company he founded in 1989. Geller & Co. specialized in major hotel, corporate and real estate development, financing and structuring on an international scope. Previously, Mr. Geller held positions as Executive Vice President and Chief Operating Officer of Hyatt Development Corporation, Senior Vice President of Holiday Inns, Inc. and Director of Grand Metropolitan Hotels in London. Mr. Geller is a former Vice Chairman of the Commercial and Retail Council of the Urban Land Institute and the immediate past Chairman of the Industry Real Estate Financing Advisory Council of the American Hotel & Lodging Association. Mr. Geller also sits on the board of Childrenâ€™s Memorial Hospital and serves as a member of its finance committee and facilities sub-committee. Mr. Geller is Co-Chairman of the Board of Trustees of the Churchill Centre and Ambassador for North America for the Hotel and Catering Institutional Management Association of the U.K. Mr. Geller is a graduate of Ealing Technical Collegeâ€™s school of hotel management and catering. Mr. Geller has over 40 years of experience in the lodging industry and has received numerous awards for his service to the lodging industry.
James A. Jeffs
James A. Jeffs served as the chairman of the board of directors of Whittier Energy Corporation, an oil and gas exploration and production company headquartered in Houston, Texas and listed on the NASDAQ, from 2003 to 2006. Since 2005, he has served as a director and executive chairman of Max Petroleum Plc, a company listed on both the London Stock Exchange and the Frankfurt Stock Exchange. Mr. Jeffs was also a director of Magnum Oil from 2001 to 2006 and has been a director of South Oil Company since 2005, both based in Russia. Mr. Jeffs has served since 1994 as Managing Director and Chief Investment Officer of The Whittier Trust Company, a trust and investment management company headquartered in South Pasadena, California. Previously, Mr. Jeffs was Co-Chairman of the Board from 1999 to 2002, Chairman and Chief Executive Officer of Chaparral Resources, Inc. in 2002. Mr. Jeffs was Chief Investment Officer and Senior Vice President of Trust Services of America from 1988 to 1992, and also President and Chief Executive Officer of TSA Capital Management during that time. Mr. Jeffs also served on the board of investments of The Los Angeles County Employees Retirement Association from 1994 to 1998.
Sir David M.C. Michels
Sir David M.C. Michels currently sits on the board of directors of The British Land Company plc, easyJet plc, Marks & Spencer plc., RAB Capital and Jumeirah Hotels. From June 1, 2000 until February 28, 2006, Sir David M.C. Michels was Chief Executive Officer of Hilton Group plc and from April 1, 1999 to May 29, 2000 he was Chief Executive Officer of Hilton International. Sir David M.C. Michels was a non-executive director of Hilton Hotels Corporation from November 9, 2000 to December 29, 2005. He served as Chief Executive officer of Stakis plc from May 1, 1991 to March 30, 1999. Sir David M.C. Michels has spent 37 years in the leisure industry, primarily in hotels. He was also with Grand Metropolitan for 15 years, culminating in a board position as worldwide Marketing Director.
MANAGEMENT DISCUSSION FROM LATEST 10K
Strategic Hotels & Resorts, Inc. (SHR or the Company) was incorporated in Maryland in January 2004 to own and asset manage upper upscale and luxury hotels. Our accounting predecessor, Strategic Hotel Capital, L.L.C. (SHC LLC) was founded in 1997 by Laurence Geller, our President and Chief Executive Officer, Goldman, Sachs & Co.â€™s Whitehall Fund and others. We made an election to be taxed as a real estate investment trust (REIT) under the Internal Revenue Code of 1986, as amended (the Code). On June 29, 2004, we completed our initial public offering (IPO) of common stock. Prior to the IPO, 21 hotel interests were owned by SHC LLC. Concurrent with and as part of the transactions relating to the IPO, a reverse spin-off distribution to shareholders separated SHC LLC into two companies, a new, privately-held SHC LLC, with interests, at that time, in seven hotels and Strategic Hotels & Resorts, Inc., a public entity with interests, at that time, in 14 hotels. See â€śItem 8. Financial Statements and Supplementary Dataâ€”Note 1 Generalâ€ť for the hotel interests owned by us as of December 31, 2007.
We operate as a self-administered and self-managed REIT, which means that we are managed by our board of directors and executive officers. A REIT is a legal entity that holds real estate interests and, through payments of dividends to stockholders, is permitted to reduce or avoid federal income taxes at the corporate level. For us to continue to qualify as a REIT, we cannot operate hotels; instead we employ internationally known hotel management companies to operate our hotels for us under management contracts. We conduct our operations through our direct and indirect subsidiaries including our operating partnership, Strategic Hotel Funding, L.L.C. (SH Funding), which currently holds substantially all of our assets. We are the managing member of SH Funding and hold approximately 99% of its membership units as of December 31, 2007. We manage all business aspects of SH Funding, including the sale and purchase of hotels, the investment in these hotels and the financing of SH Funding and its assets.
Throughout this â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operationsâ€ť section, references to â€śwe,â€ť â€śourâ€ť and â€śusâ€ť are references to SHR and, except as the context otherwise requires, its consolidated subsidiaries, including SH Funding.
When presenting the dollar equivalent amount for any amounts expressed in a foreign currency, the dollar equivalent amount has been computed based on the exchange rate on the date of the transaction or the exchange rate prevailing on December 31, 2007, as applicable, unless otherwise noted.
Factors Affecting Our Results of Operations
We define our Total Portfolio as properties that are wholly or partially owned or leased by us. We present certain information about our hotel operating results and statistics on a comparable hotel basis, which we refer to as our Same Store analysis. We define our Same Store Assets as those hotels (a) that are owned or leased by us, and their operations are included in our consolidated operating results, and (b) for which we reported operating results throughout the entire reporting periods being presented.
Our Same Store Assets for purposes of the comparison of the years ended December 31, 2007 and 2006 exclude the Hotel Le Parc, the Four Seasons Washington, D.C., the Westin St. Francis, the Ritz-Carlton Laguna Niguel, the InterContinental Prague, the Marriott London Grosvenor Square, the Fairmont Scottsdale Princess, the Hotel del Coronado, which we account for using the equity method of accounting, and all sold properties included in discontinued operations.
Our Same Store Assets for purposes of the comparison of the years ended December 31, 2006 and 2005 exclude the InterContinental Chicago and Miami hotels, the Fairmont Chicago, the Four Seasons Washington, D.C., the Westin St. Francis, the Ritz-Carlton Laguna Niguel, the InterContinental Prague, the Marriott London Grosvenor Square, the Fairmont Scottsdale Princess, the Hotel del Coronado, which we account for using the equity method of accounting, and all sold properties included in discontinued operations.
We present these Same Store Asset results because we believe that doing so provides useful information for evaluating the period-to-period performance of our hotels and facilitates comparisons with other hotel REITs and hotel owners. In particular, these measures assist in distinguishing whether increases or decreases in revenues and/or expenses are due to operations of the Same Store Assets or from acquisition or disposition activity.
Revenues. Substantially all of our revenue is derived from the operation of our hotels. Specifically, our revenue for the years ended December 31, 2007
Rooms revenue. Occupancy and average daily rate are the major drivers of rooms revenue.
Food and beverage revenue. Occupancy, local catering and banquet events are the major drivers of food and beverage revenue.
Other hotel operating revenue. Other hotel operating revenue consists of ancillary revenue such as internet access, telephone, parking, golf course, spa, space rentals, retail and other guest services and is also driven by occupancy.
Lease revenue. We earn lease revenue from the Marriott Hamburg and the Marriott Champs Elysees Paris (Paris Marriott). In accordance with our lease agreements, we earn an annual base rent plus additional rent contingent on these hotels meeting performance thresholds.
Changes in our revenues are most easily explained by performance indicators that are used in the hotel real estate industry:
average daily occupancy,
average daily rate (ADR)
revenue per available room (RevPAR), which is the product of ADR and average daily occupancy, but does not capture food and beverage revenues or other hotel operations revenue such as telephone, parking and other guest services, and
total revenue per available room (Total RevPAR) which captures food and beverage and other hotel operating revenue.
Fluctuations in revenues, which, for our domestic hotels, tend to correlate with changes in the U.S. gross domestic product, are driven largely by general economic and local market conditions as well as general health and safety concerns, which in turn affect levels of business and leisure travel. Guest demographics also affect our revenues. For example, a greater percentage of transient guests, which includes corporate and premium business travelers who generally pay the highest average room rates, will generate higher rooms revenues. However, a greater percentage of certain group guests, which do not include the highest corporate premium but do consume larger relative amounts of food and beverage and other services, may contribute to higher total revenue. In addition to economic conditions, supply is another important factor that can affect revenues. Room rates and occupancy tend to fall when supply increases unless the supply growth is offset by an equal or greater increase in demand. One reason why we target upper upscale and luxury hotels in select urban and resort markets, including major business centers and leisure destinations, is because they tend to be in locations that have greater supply constraints such as lack of available land, high development costs, long development and entitlement lead times and brand trade area restrictions that prevent the addition of a certain brand or brands in close proximity. Nevertheless, our hotels are not completely insulated from competitive pressures and our hotel operators will lower room rates to compete more aggressively for guests in periods when occupancy declines.
Overall, our Total Portfolio RevPAR, excluding leased properties and unconsolidated joint ventures, increased by 10.6% to $188.35 during the year ended December 31, 2007 from $170.28 during the year ended December 31, 2006. With respect to Same Store Assets, RevPAR, excluding leased properties, increased by 9.5% to $172.05 for the year ended December 31, 2007 from $157.15 for the year ended December 31, 2006.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Comparison of Six Months Ended June 30, 2008 to Six Months Ended June 30, 2007
The following table presents the operating results for the six months ended June 30, 2008 and 2007, including the amount and percentage change in these results between the two periods of our Total Portfolio and Same Store Assets, as defined on page 27.
We sold the Hyatt Regency Phoenix hotel during the third quarter of 2008 and the Hyatt Regency New Orleans hotel during the fourth quarter of 2007. The results of operations for these sold hotels are included in income (loss) from discontinued operations, net of tax and minority interests for the six months ended June 30, 2008 and 2007.
Operating income. Operating income for the Total Portfolio decreased by $3.1 million, or 4.7%. This decrease in operating income is primarily due to the following:
(a) a $3.7 million decrease attributable to the Same Store Assets, other than the Paris Marriott, as described below and
(b) a $1.5 million decrease attributable to losses at the Renaissance Paris, which we purchased in July 2007, partially offset by
(c) a $2.1 million increase attributable to consolidating the operations of the Paris Marriott effective January 1, 2008.
Rooms . For the Total Portfolio, rooms revenue increased $28.5 million, or 11.4%. RevPAR from our Total Portfolio for the six months ended June 30, 2008 increased by 5.9% from the six months ended June 30, 2007
The primary drivers of the increase in Total Portfolio rooms revenue included the acquisition of the Renaissance Paris, which generated approximately $4.8 million of rooms revenue and RevPAR of $226.87 during the six months ended June 30, 2008, and the consolidation of the Paris Marriott, which generated $19.6 million of rooms revenue and RevPAR of $560.50 during the six months ended June 30, 2008. The remaining properties contributed to a 0.9% increase in RevPAR, which is more fully explained below as part of our rooms revenue Same Store Asset analysis.
For the Same Store Assets, rooms revenue increased $23.7 million, or 9.5%. RevPAR from our Same Store Assets for the six months ended June 30, 2008 increased by 5.8% from the six months ended June 30, 2007. The components of RevPAR from our Same Store Assets for the six months ended June 30, 2008 and 2007
The 5.8% increase in RevPAR for the Same Store Assets resulted from an 8.8% increase in the ADR partially offset by a 2.09 percentage-point decrease in occupancy. The increase in the Same Store RevPAR was primarily due to the consolidation of the Paris Marriott operations, which we included in our Same Store Asset analysis because we continue to hold a leasehold interest in the hotel. The Paris Marriott generated RevPAR of $560.50 for the six months ended June 30, 2008. The remaining Same Store Assets contributed to a RevPAR increase of 0.9%. The Four Seasons Mexico City hotel had RevPAR growth of 8.2%, which was primarily due to the weakening of the U.S. dollar against the Mexican peso as well as increases in ADR due to strong, corporate demand in the market. The RevPAR increase at the Four Seasons Mexico City was partially offset by a 12.6% decrease in RevPAR at the Fairmont Chicago due to displacement at the hotel between January and April 2008 from extensive renovations, and a 9.1% decrease in RevPAR at the Marriott Lincolnshire due to occupancy decline of 15.8% for group rooms.
Food and Beverage. For the Total Portfolio, food and beverage revenue increased $9.8 million, or 6.1%. Approximately $2.1 million of the increase related to Renaissance Paris. Food and beverage revenue for the Same Store Assets increased $7.7 million, or 4.8%. The increase was primarily due to the consolidation of the Paris Marriott operations, which generated food and beverage revenue of $4.1 million. In addition, food and beverage revenue increased at the Four Seasons Punta Mita Resort due to business generated from the addition of 23 rooms. Food and beverage revenue also increased at the Four Seasons Mexico City primarily due to increased occupancy and more corporate group business during the six months ended June 30, 2008 when compared to six months ended June 30, 2007. The InterContinental Prague experienced increases in food and beverage revenue due to the weakening of the U.S. dollar against the Czech crown. These increases were offset by lower food and beverage revenue at Marriott London Grosvenor Square, which closed a hotel restaurant that is now leased to a third party and had displaced business due to extensive renovations, and lower food and beverage revenues at the Marriott Lincolnshire due to the 5.2 percentage-point decrease in occupancy as well as new supply in the market.
Other Hotel Operating Revenue. For the Total Portfolio, other hotel operating revenue increased $3.2 million, or 6.0%. The increase was primarily attributed to a $1.1 million increase in cancellation fees during the six months ended June 30, 2008 when compared to the six months ended June 30, 2007. Additionally, fees earned as a result of increased usage of the villa rental program at the Four Seasons Punta Mita increased $1.3 million and the reversal of a liability assumed with the purchase of La Solana contributed $0.4 million during the six months ended June 30, 2008 when compared to 2007.
Lease Revenue. For the Total Portfolio and Same Store Assets, lease revenue decreased $7.4 million, or 73.4%. The decrease in lease revenue was primarily related to the Paris Marriott. Effective January 1, 2008, we no longer sublease the operations of the Paris Marriott to a third party and no longer record lease revenue. We now record the operating results of the Paris Marriott in our consolidated statement of operations, including operating revenues and expenses.
Thank you. Good morning, everyone. Welcome to Strategic Hotels and Resorts Second Quarter 2008 Earnings Conference Call. Our press release and supplemental financials were distributed yesterday, and are also available in the company's web site at StrategicHotels.com within the investor relations section.
We are hosting a live webcast of today's call which can be accessed from the same section of the site, and a replay of today's call will also be available for one month.
Before we get underway, I would like to say 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 and 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 within 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 here today. Laurence Geller, President and Chief Executive Officer, and Jim Mead, Executive Vice President and Chief Financial Officer, who will lead today's discussions. Also available during the Q&A session will be Richard Morrell, Executive Vice President, Head of Asset Management.
I would now like to turn the call over to Jim Mead.
Thank you, Ryan, and good morning, everyone. Yesterday evening we reported $0.49 FFO per share and EBITDA of $74.1 million, both at the top end of our guidance range. Our results reflect market weakening beginning last May. We saw it most acutely at our Fairmont Scottsdale Hotel where occupancy was down 9% year-over-year as a result of not filling group vacancy with our typical short-term group business. I will come back to Scottsdale in a moment.
Excluding this property, our quarterly results were relatively strong, and we were able to combine some aggressive cost measures with modest top line improvements to grow our EBITDA by 9.5%, clearly demonstrating the leverage that can be created through operating efficiencies.
Let me start with some overall observations about demand indicators during the quarter. A weakening trend has developed on the group side and appears to be continuing. Short-term group bookings during the quarter slowed, and an increase in attrition in part due to meeting planners compressing meetings into a smaller number of nights caused us to be down 4.5% in group occupancy.
Group cancellations are running about the same rate as prior years, and the revenue performance of groups once they get in house has been relatively on track. Our group ADR was up almost 8% during the quarter and group ancillary spend on food and beverage was up 7% for occupied group room nights. Therefore, the results would indicate that the propensity of groups to spend per occupied room hasn't fallen once they arrived.
Our revenue pace for the remainder of the year is about even to last year at this time, and contracted groups now represent about 90% of our expected group revenues to the last half of the year. Considering the lack of pace in short-term bookings, we still have some hard work ahead to fill the gaps.
We've had a change in the complexion of our transient business at the same time. Room sales at the undiscounted rack rate dropped during the quarter by 8.8% or about 5,000 room nights. In order to replace these room nights and the group vacancy, our hotel opened up additional lower rated channels such as selected internet based reservation sites.
While we are holding the integrity of pricing within our segments, the shift in business to lesser profitable segments impacted our total ADR, and transient ADR was roughly flat year-over-year.
As I said, the Fairmont Scottsdale led the decline in our operating numbers for the quarter with RevPAR off 10.3%. The group pace numbers had indicated a gap in June bookings and the Fairmont corporate and local management teams were unable to fill the holes.
Scottsdale, in particular, seems to be at the nexus of a number of market factors, including lower airlift, a heavy weighting in currently weak corporate high rated business, and competition from Las Vegas.
Our bold and innovative upgrading and repositioning of this resort has enabled us to increase market share penetration against the competitive set, and we are optimistic that these improvements will provide added leverage to the hotel's performances as the cycle evolves.
However, given the market dynamics we are making the planning assumptions that the property will be in a defensive position for several quarters. Without this property, our corporate RevPAR growth would have been 3.3%, and our margin growth would have been more than double at 150 basis points.
During the quarter, we had several standout hotels in which the combination of group of growing top lines and cost controls provided operating leverage. These included our two Mexican properties in general, particularly, our Four Seasons Mexico City, which had an increase of 20% in EBITDA, the Intercontinental Miami with a 28% increase in EBITDA, a 37% increase at our Hyatt Regency La Jolla, and a 29% increase at our Ritz-Carlton, Half Moon Bay.
Our cost containment programs had a priority focus on reductions in what are typically thought of as fixed overhead costs, and the further tightening of our food purchasing and labor management programs. We successfully expanded GOP and EBIDTA margins by 10 and 60 basis points respectively despite lower than expected top line growth.
Our labor costs, including benefits were up only 2.6% during the quarter. Included in these costs were about $350,000 in severance to reduce salaried positions at several of our properties which should result in over $4 million in cost savings during the second half of 2008.
Although food costs rose 5% during the quarter, we were able to effectively offset 3% of these costs through better compliance with our food purchasing programs and thus manage to increase our actual food costs by only 2%. Not surprisingly, utilities were up 12% which cost us 25 basis points in margin. Our insurance policy was renewed on May 1 at a significant reduction to last year's premium.
Performance in Europe continues to be driven by London and Paris where the markets, although slightly weaker than in prior quarters are still relatively strong, and our locations and market positions give us a distinct competitive advantage.
Our Marriott Grosvenor Square completed the first phase of its rooms renovation program and the conversion of further food and beverage operations over to management by Gordon Ramsay. This took about 13% of the rooms out of service for most of the quarter.
So adjusted for this displacement, we saw strong RevPAR and EBITDA growth during the quarter. In fact, with a significant renovation in progress, we were able to beat last year's EBITDA during the quarter.
Our Hotel Le Parc in Paris was rebranded to a Renaissance during the first quarter and is just beginning to ramp up. We are meeting our forecast at this hotel. The Marriott Paris Champs Elysees RevPAR was up 23%, and we earned $1.6 million from our leasehold here during the quarter.
The InterContinental Prague Hotel has been challenged with the strengthening Czech crown against the euro and increasing decline in U.S. business and competition in the marketplace. Since revenues are in euros, hotel's operating results will be impacted so long as the crown is strengthening.
Turning to our capital program, those programs that were in process at the beginning of the year will be completed. Projects are now complete in many of our properties, and I encourage you to visit our Web site where we keep an ongoing updated collection of pictures and videos of our projects as they are placed in the service.
Certain elements of our hotel master plans have been deferred for a future time when we can see signs of an improving market. We took this into consideration when we provided guidance at the beginning of the year and continue to expect our total ROI capital investment this year to be approximately $125 million.
In the first half of the year the company recorded $6.9 million in reduced revenues and $3 million in EBITDA from displacement related to capital projects at the Fairmont Chicago and London Marriott Grosvenor Square.
The largest planned capital outlay beginning later this year is approximately $130 million acquisition and build out of the Aqua Building Hotel expansion of our Fairmont Chicago Hotel. Although this acquisition is under contract, given the current market conditions, we are evaluating our options to defer or modulate this project to better time its delivery into a recovering market.
We successfully closed the sale of our Hyatt Regency Phoenix Hotel for $96 million in early July, providing an 11% unlevered IRR from the time of its acquisition in January of 1998, and providing additional liquidity to the company.
Concurrent with the sale, we announced our Board of Directors had authorized up to $50 million in a leverage neutral share repurchase.
The first window that would be available to us to repurchase shares is after we file our 10-Q this quarter. Although our shares present a compelling investment option and in many ways, more compelling than other uses of our capital, we also value liquidity very highly in these current uncertain markets, and we will therefore be measured and delivered in executing any share repurchase.
Turning to our balance sheet, our liquidity position is very strong and we have approximately $400 million available on our $500 million line of credit. Reporting this credit is a collection of debt-free hotels which represent some of the best assets in our portfolio such as our three Four Seasons hotels, the Ritz-Carlton Laguna Niguel and the Renaissance Le Parc. As a result, our team is comfortable that adequate liquidity will continue to be available to us as we go through the trough of the cycle.
Considering recent weak demand indicators which appear to be â€“ continue into the third quarter and given the uncertainties in the economy, we are lowering our guidance for FFO per share by 10% to the mid point of $1.46 to $1.56 range.
Inferred in our guidance is negative RevPAR growth for the second half of the year and third quarter guidance assumes a negative 1% to negative 3% RevPAR growth rate versus 2007. As a result, our full year RevPAR guidance is in the range of plus 1% to minus 1%.
Our assumptions built into guidance include second half displacement of $3 million in revenues, and $2 million in EBITDA as we finish the renovation of the Four Seasons Washington, DC, and no share repurchase activity or additional asset sales.
Now, I would like to turn the call over to Laurence.
Good morning, everybody. Although we had a relatively strong second quarter, we are now seeing the impact of the increased velocity of decline in lodging demand which is clearly caused by a combination of weaker economic growth, limited credit availability, rapidly increasing and volatile energy prices, airline price increases with anticipated cuts in passenger seat availability and a diminution in business and consumer confidence. The resultant weakness across most of the segments of our business caused a lower than expected top line result for us in the second quarter.
We have been predicting declining demand in our market since our conference call at the end of the third quarter of last year, although we could not forecast the speed and extent of the decline given the multidimensional and complex market dynamics that have contributed to overall economic conditions to which lodging demand is inextricably linked.
You will recall we spoke about having commenced the implementation of the first phases of our property cost contingency programs as early as August of 2007. And we are seeing the benefits of these actions today. There is one thing different in this cycle, and I've been remarking on this consistently for quite a while and that is the supply is almost nonexistent in our specific competitive markets.
From a historical perspective we had 16% new luxury rooms delivered in the years around the recession in the early '90s, and we had 30% new luxury rooms delivered in the market in the three years surrounding 9/11. And I can compare this to approximately 3.7 cumulative new rooms being delivered into our direct competitive marketplace for the next five or more years. All of this is for good reason.
Construction costs are growing at a far greater rate than inflation. The length of time to develop a project in the high end market is increased by over 20%. Those residential markets that were supporting the economics of certain high end hotel developments have all but disappeared. And as you all know, financing is scarce and certainly relatively more expensive than in the recent past.
We continuously reevaluate the replacement cost of our hotels. And in today's dollars, it is fairly common sense that the numbers indicate a replacement cost of approximately $700,000 a unit for our type of infill urban resort hotel in North America alone.
Considering the extremely high barriers to market entry in most of our markets, and that is if one could even find and acquire the land you then have to assume in some of these most restrictive zoning locations, that entitlement might be obtained to permit a hotel of the size and quality level we have in our portfolio. By way of example, it took approximately 12 years to obtain the entitlements and develop our Ritz-Carlton, Half Moon Bay.
So we look at this type of value rising in the future with construction costs as a relatively proxy for where terminal values in our high end properties need to go before supply becomes a real factor. Whether or not we are at the bottom of the market today, from an intellectual perspective alone, the return on holding a hotel investment of our quality and location levels through this cycle must be outsized relative to today's public market valuations.
As we look at potential competitive supply in those markets in which we operate our conclusion is simple. If a property is not being built today, then we are unlikely to see any more supply coming in before the end of 2011 at the very earliest.
This gives us a strong data point for planning our future property levels activities as we emerge from the current cyclical downturn. If the history of previous cyclical recoveries is any indication of the future, we are likely to be the benefit of a very healthy demand rebound, which when combined with our significant productivity enhancements and operating systems improvements augers exceptionally well for our future growth in margins, profitability and asset values.
During our last call, I outlined for you our roadmap that we determined will successfully guide us through this cycle and which will both ensure adequate liquidity and growth in shareholder value.
I'd like to give you an update on our progress against this roadmap. First, our experience from past cycles and our well-developed approach to revenue management through market vicissitudes and demand cycles places us in a far stronger position than our peers.
One measure of this is head-to-head comparison, and this quarter we outperformed our competition as demonstrated by 0.6% increase in our RevPAR penetration as computed by Smith Travel. Next I outlined the benefits of using the operating systems of each property and our multi-tiered contingency plans to streamline operations contain and reduce costs.
As our results clearly demonstrate, our expenses are well controlled against a flattening revenue performance, and we still believe we have room to improve as the execution of our cost containment efficiency measures improves and our productivity increases even further.
While there is clearly potential for additional cost reductions in the fixed areas of overhead at our hotels, the choices from this point on become increasingly difficult. And we have thus far yet to significantly impact guest facing services and amenities as determined by guest satisfaction measurements. Should demand decline to predetermined trigger levels we naturally have measured plans and options for such exigencies.
We said that we would rationalize and manage down our corporate overhead expenses, and we have thus far made insignificant inroads. Our corporate overhead is now at a run rate of approximately $26 million, a reduction of 14% from 2007.
Our final two strategies focus on liquidity. We have completed our initiative to rationalize our capital programs to current and our hopefully conservative assessment of future market conditions. I expect that we will spend approximately $50 million in the second half of this year to complete the projects we have in process. And Jim has already discussed our ongoing review of options to potentially modulate or defer the significant contract expansion of the Fairmont Chicago Hotel.
We also spoke about strategic sales of our hotels in the context of our lifecycle strategy. And we announced the sale of our Hyatt Regency Phoenix in early July for $96 million. This was a well executed deal for us in a very difficult market, and we are satisfied with the results which met our expectations.
This is especially so considering the property had competitive physical limitations required $20 million to $30 million in new capital just to maintain its current competitiveness. And we took all of that into account in the context of a city of Phoenix subsidized 1,000 rooms Sheraton that comes online later this year and is directed at filling the newly expanded convention center as compared with the goal of making money.
We continue to test an increasingly thin, slow and wary market for additional sales although it's difficult to have any certainty or predictability about any transaction or even if or when one might occur.
As I look at it, in this environment, I think about our strengths. Our management team is seasoned and has experience in successfully managing through the ups and downs of economic cycles as far back as the petrodollar driven downturn of the early '70s.
We have taken and will continue to take prudent and thoughtful measures which during this downturn protect our assets, maximize margins, increase liquidity and won't harm the assets or the potential for exponential gains as the cycle invariably turns upward and this company benefits from unusually favorable supply dynamics.
So while economic conditions are overall challenging and there is a decline in demand for lodging project, we are comfortable that we are in the best segment of the market, have a unique group of well-positioned high end properties, a series of well researched plans and systems in place to manage through this part of the cycle, a thoughtful, disciplined, experienced management team and a culture based on consumerism, professionalism, flexibility, nimbleness and foresight, which will enable us to weather this situation and take maximum advantage of the opportunities that occur as the economy improves.
As always, we thank you for your continuing interest and support and I would like to now open up the call for questions. Operator, please.