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DiamondRock Hospitality Co., (NYSE:DRH)

Q1 2009 Earnings Call

May 5, 2009 10:00 am ET

Executives

Mark Brugger - CEO

John Williams - President and COO

Sean Mahoney - EVP, CFO and Treasurer

Analysts

Suzanne Kutiyas - JMP Securities

Yeremo Garro - RBC Capital Markets

Ken Ho - Keybanc

Nikhil Behl - FBR

Smedes Rose - KBW

Andrew Whitman - Robert W. Baird

Operator

Good day ladies and gentlemen and welcome to the First Quarter DiamondRock Hospitality Company Earnings Conference Call. My name is Denali and I will be your operator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s conference, Mr. Mark Brugger, Chief Executive Officer of the DiamondRock Hospitality Company. Please proceed, sir.

Mark Brugger

Thanks Denali. Good morning everyone and welcome to DiamondRock Hospitality’s first quarter 2009 earnings conference call. Today I’m joined by John Williams, our President and Chief Operating Officer; as well as Sean Mahoney, our Chief Financial Officer.

Before we begin I would just like to remind everyone that many of our comments today are not historical facts and are considered forward-looking statements under Federal Securities Laws and they may not be updated in the future. These statements are subject to numerous risks and uncertainties described in our securities filings. Moreover, as we discuss certain non-GAAP financial measures and may be helpful for you to review the reconciliation to GAAP in our earnings press release.

Not surprisingly the global economic downturn has continued to materially impact the travel industry and our first quarter results.

On a macro basis, we looked the trends in GDP growth, corporate profits and unemployment as they tend to correlate with lodging fundamentals.

We are also closely tracking group piece activities and transient rate trends for indications of changes in the velocity of decelerating lodging fundamentals. Overall we believe that the data is too inclusive at this point to provide clarity on operating trends and thus we are unable to provide our investors with meaningful guidance.

Turning to first quarter results, RevPAR for all 20 of our hotels declined in aggregate 16.5%, the Chicago Marriott Downtown had relatively easy comp due to it renovation last year and positively impacted the first quarter RevPAR change by approximately 2.4 percentage points. The quarterly RevPAR decline was result of 10.4% decrease in average rates coupled with a 4.8 % decrease in hotel occupancy.

Our first quarter results were the most directly impacted by loss of business trends in demand and to lesser extent group and leisure demand declines. Although our first quarter revenue results were slightly better than our internal expectations. The significant positive news for the quarter was a relatively modest margin deterioration in an environment with high teens RevPAR declines.

Our success to maximize the profit margins in this difficult operating environment is a result of implementation of successful asset management initiatives with our operators to contain cost. These initiatives resulted in a moderate house profit margin decline of only 373 basis points.

Hotel adjusted EBITDA margins decreased 438 basis points as they were negatively impacted by the 21% increase in property taxes during the quarter. On another positive note, we are pleased that our hotels overall gained market share in the first quarter a testament to the quality of the hotels and the power of the right branding strategy.

We reported first quarter adjusted EBITDA of $20.3 million and adjusted FFO per share was $0.16 which includes positive impact of $0.06 per share from income tax benefit.

DiamondRock has historically focused on attaining conservative balance sheet. Consistent with that focus we recently completed an over subscribed common stock offering which raised more than $82 million. We utilized the proceeds to completely pay off outstanding balance on our corporate revolver, consequently the company currently has over $60 million of cash including approximately $28 million of restricted cash.

Today DiamondRock is in the enviable position of having no corporate debt including no bonds, no convertible debt, no preferred equity. We also have nine high quality unencumbered hotels, our net debt-to-EBITDA is 4.6 times based on trailing four fiscal quarters, or $820 million of debt consistent was entirely of 11 individual property specific limited recourse mortgage loans.

With the simplest capital structure of any lodging REIT, we believe that we have a unique ability to weather the downturn and are well positioned to grow at the appropriate time.

We have only two near-term debt maturities the first is loan on the Courtyard Midtown East that matures in December 2009 but can be prepaid without penalty in September, which is our targeted time for refinancing the hotel.

I am pleased to report that we have recently agreed on loan terms with a major life insurance company to provide up to $43 million of limited recourse mortgage debt on the Courtyard Midtown East and locked in the interest at 8.81%. The new loan which is still subject to approval of the lenders' credit committee, will have a five year term.

The only other significant maturity over the next five years is a $28 million loan on the Griffin Gate Marriott Hotel due January 2010. Although we anticipate being able to address this maturity with corporate cash the company may also consider refinancing the loan. Which has close to a three times fixed charge coverage. Again apart from these maturities we have no other material maturities until 2015.

As I mentioned earlier the macro economic environment lacks sufficient clarity at this time to provide accurate guidance. However we did want to update you on as much relevant information as possible to assist investors and the analysts in driving their own estimates for 2009.

Here is what we can tell you for the full year 2009 we project approximately $51 million of total debt service, $10 million of owned or funded capital projects. $10.5 million of cash, corporate G&A. And lastly a weighted average share count for the full year to be approximately 103.3 million shares which reflects our recent equity offering.

We hope that this information is helpful. And with that I will turn the call over to John.

John Williams

Thanks Mark. We continue to see operating trends worsen across the portfolio in the first quarter. But in the interest of viewing that glass as a quarter full we were pleased to see the results of our operators cost containment efforts.

In the teeth of negative 16.5% RevPAR win our portfolio has profit margins decline just 373 basis points. On a comparable basis total portfolio revenue for the quarter was off about 14.5% resulting in a 32% drop in quarterly EBITDA.

Results benefited from 5 extra days in the 2009 first quarter and a favorable comp at the Chicago Marriott which was under renovation in Q1 2008. Excluding the Chicago Marriott portfolio RevPAR for Q1 was down 18.9%. Comp revenue was up 18% and comparable EBITDA was up 34%.

As we said last quarter DiamondRock's total organization is focused on improving on already strong balance sheet and intensifying our already aggressive asset management. For the quarter RevPAR was negative in all of our markets. Due to it's favorable Q1 '08, comp the Chicago Marriott RevPAR was up 6.7%.

The New York market continued to see a precipitous drop in all segments. At our Courtyard Hotels, room revenue was up 28% in the quarter, with ADR off over 20%.

The Atlanta and Salt Lake markets were off around 20% in RevPAR for the quarter and in Vail, we effectively replaced business loss from our traditional source markets of the Northeast Texas and International, with regional demand but at a heavy cost and rate which was down 21% in the quarter.

The Conrad Hotel in Chicago lost a 7.4% in RevPAR. Frenchman’s Reef, LAX and Griffin Gate were off about 11% RevPAR for the quarter.

Revenue deterioration in our portfolio market segment shows a clear and accelerating trend with business transient hit the hardest. Business transient revenue was down 28% for the quarter, split roughly equally between rate and occupancy. The lost business transient room nights were partially replaced by opening discounted rate categories and increasing contract room nights, particularly at our airport hotels.

Group revenue was down about 9.2% in the quarter, with the decline spread evenly between room nights and rate.

Leisure and other discount demand was up slightly but an average rate approximately 12% lower than Q1 2008. With a reduced volume across the portfolio on a comparable day count basis, food and beverage sales were off 12.6% for the quarter. Despite a significantly lower volume, margins were off only 12 basis points for the quarter.

On the cost front, we are carefully evaluating each of our hotels and their specific markets, to make sure that we have the right cost structure in place for the environment.

In addition of the cost savings introduced in 2008, and a significant cost initiatives included in our 2009 budgets, we have worked on our operators to identify additional full year 2009 savings of approximately $8 million across our portfolio.

For the quarter; salaries, wages and benefits were down 8% from Q1, 2008.

Support costs including property level G&A, repairs and maintenance, sales and marketing and utilities were down 8% per available room in the quarter, reflecting stringent cost control in the hotels.

For the quarter hotel level G&A cost per available room were down 11%. R&M costs, PAR were down 6%, sales and marketing PAR were down 11% and utilities were up slightly at a PAR basis, but those costs were impacted by the new meeting space in Boston. With our Boston utility cost were 3.5% lower in the quarter.

As Mark indicated we will not provide specific guidance this year due to the unprecedented lack of visibility on the economy. Clearly the trends indicate a challenging year.

Our group revenue pace for the portfolio at the end of Q1 is down about 14.5% versus the same time last year. We continue to see the pace drop off. Pace was down 6.9% at the end of 2008. The drop off is primarily in room nights as rate continues to be relatively flat. The Boston Westin continues to benefit from the meeting space we added at the hotel. With group revenue pace up 10.1% versus the same time last year.

The group revenue on the books for the portfolio at this point represents about 75% of 2008 group revenue. The group revenue pace for 2010 is down 11% versus the same time last year, although, it is not as meaningful because it represents only 40% of 2008 group revenue and booking windows are significantly shorter at this stage of the cycle.

We have and will continue to closely monitor capital expenses of the hotels as well. As I mentioned our portfolio is generally renovated and we have minimized future CapEx spending.

In addition, we have identified approximately $5 million of potential energy projects. Energy projects approved to-date have paybacks of under 18 months. CapEx expense including delayed payment of some projects completed in 2008 will be approximately $35 million in 2009, including the energy projects. Approximately $10 million of that will be owner funded, with the balance coming from the property level of FF&E escrows. We anticipate no material disruption from 2009 capital projects.

In summary our company and asset management is focused on preserving hotel profits through revenue management strategies, aggressive cost containment and reduced capital spending.

With that I will turn it back over to Mark.

Mark Brugger

Thanks John, operator at this time we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of [Suzanne Kutiyas] with JMP Securities. Please proceed.

Suzanne Kutiyas - JMP Securities

Hi I was just wondering if you could discuss where you are in terms of leverage and fixed charge coverage again at the quarter relative to your covenants?

Sean Mahoney

Sure thanks Suzanne this is Sean. In the quarter our leverage was approximately 43% compared to the covenant of 65% and our fixed charge of coverage is 2.7 times compared to the covenants of 1.6 times.

Suzanne Kutiyas - JMP Securities

Okay thank you

Operator

Your next question comes from the line of Yeremo Garro with RBC Capital Market, please proceed.

Yeremo Garro - RBC Capital Markets

Good morning. With regards to operating trends you said that on the data solubility conclusive is there any way that you can give us a little bit of color on what happened April with regards to the quarter?

John Williams

This is John. In April the comps were difficult because you have holiday disruption. So they are not really comparable numbers. But I would have to say that we have seen a continued deterioration from January to February to March and probably interpolating in the April.

Yeremo Garro - RBC Capital Markets

Okay thank perfect. And then with regards to your progress in the disposition side, you said that basically you are the same way that you were at the end of the quarter. What about the interest that you are seeing from potential buyers, are you seeing now any increased beeps that are closer to your expected values?

Mark Brugger

This is Mark Brugger. We started the process on assets sales several moths ago went through a bidding process, received some bids but none that we felt were attractive. At this point, we still have some hotels that if we got a compelling offer we would entertain but I think since we are not going through an active bid process it’s a little difficult to ascertain the difference in interest today than30 days ago or 60 days ago.

Yeremo Garro - RBC Capital Markets

Okay perfect and then lastly with regards to the debt markets, I know that you guys were working with Manhattan and Midtown properties, what are you seeing differently in terms of our coverage and LTVs out there right now?

Mark Brugger

Sure, the current debt market has quite elusive in the fourth quarter 2008. That being said, capital is still very scarce and lenders are being selective in choosing what projects to underwrite, potentially only the best assets with sort of a strongest sponsorship are receiving underwriting attention today. With respect to the LTV, we are seeing anywhere from 50% to 55% at the high of 60% LTVs available today, but albeit at rates that are approximately what we announced which is in the 8% to 9% range.

Yeremo Garro - RBC Capital Markets

Okay. Perfect, that’s great. Thank you.

Mark Brugger

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Ken Ho with Keybanc. Please proceed.

Ken Ho - Keybanc

Hi good morning.

John Williams

Good morning, Ken.

Ken Ho - Keybanc

Just a good quick question, it looks like you, were able to negotiate the management fees down, could you talk a little bit about how your relationship with Marriot is going right now?

Mark Brugger

This is Mark Brugger, on the management fees, yeah there is two major components to the way that these are structured with the operators. One is the base fee which is a percentage of revenue generally 3% and most of our hotels and obviously revenues have declined so that base management fee has declined in relationship. The second fee is an incentive management fee which is down considerably, those are after certain return to the owner and we have seen dramatic turndown in what we are paying in incentive management fees. Those are under the contracts we already have operators have not made any special concessions in this environment. The way the results play out under our current contract.

I will take that the question about our relationship with our operators is excellent, our relationship with Marriot and Starwood and Hilton is very strong. I think we are generally pleased with the job they are doing with cost cutting. We are working very closely with them to make sure that we have the right contingency plans in place and we are taking aggressive enough action to contain the cost that the hotel is given the revenue environment we are in.

Ken Ho - Keybanc

Okay good, that's good to hear. And just one question on the income statement. The other hotel expenses, can you tell me what components make that up. Is it property tax is included in that?

Sean Mahoney

This is Sean. Those costs include things such as hotel sales and marketing, hotels other apartment costs, repairs and maintenance, utility, property tax is essentially is the bulk of the non-departmental expenses of the hotel. But again to answer your question, property tax is included within that number.

Ken Ho - Keybanc

Is that going to be broken down in the the Q?

Sean Mahoney

Yes we include a footnote disclosure within the MD&A that breaks out that line item.

Ken Ho - Keybanc

Okay perfect. All right thank you.

Operator

Your next question comes from the line of Nikhil Behl with FBR. Please proceed.

Nikhil Behl - FBR

Yeah hi good morning guys. I was just wondering you seem to have had a huge tax benefit this quarter. I was just wondering what we should assume for the remaining three quarters of the year in terms of tax run rate?

Sean Mahoney

Thanks. I guess tax’s are very difficult to model. The company's taxes are calculated based on the pre tax earnings of our taxable REIT subsidiaries. Our taxable REIT subsidiaries pre tax earnings includes most of the operations of our owned hotels, less real estate expenses such as property taxes, ground rate, property insurance, but also include the deduction from the lease expense generated from the operating lease between our tenant and our operating partnership which is actually owns the real estate. Rents under our operating leases are calculated in accordance with what our estimated revenues are at the inception of the lease, which is either five year leases and most of our lease’s are close to the tail end. Unfortunately, since we are not providing 2009 guidance, we really can't provide an estimate of our 2009 tax benefits because it’s so it’s so integral with our 2009 results.

Nikhil Behl - FBR

Okay. Thank you.

Operator

Your next question comes from the line of Smedes Rose with KBW. Please proceed.

Smedes Rose - KBW

Hi. Good morning. My question is just, can you just talk about sustainability of the current cost cutting efforts and when RevPAR does level out, and eventually does turnaround, what sort of levels of RevPAR growth would you need to see in order to see extended operating margins?

John Williams

Well, Smedes, we haven't gotten that far. I would say, from a sustainability standpoint, where we are now on cost, we have cut pretty severely. If you think about beginning in the second quarter of '08, we instituted the initial contingency planning, followed up by 2009 budget process which included substantial cost savings. Now, we have identified another $8 million new to this quarter or beginning next quarter.

So, it is getting pretty deep. But at the same time, it is sustainable for the duration of this downturn. Some of it has to comeback in with volume. Some of it has to comeback in the form of wage adjustments for middle management for example. And I think that from a percentage increase in RevPAR, we really have not done that model. But clearly it is going to need to be, there is going to be a period where we are going to need significant growth to begin to recapture that acceleration and earnings that we had in 2006 and 2007. I am sorry to be bad guy but we really haven’t run those numbers yet.

I would point out that beginning in the next quarter, because we instituted our initial contingency plans in the second quarter of '08. It's going to be harder and harder to maintain the margin control that we have seen in the last three or four quarters. So I would just point out that, although, our efforts continue and in fact are accelerating. The comps are going to get little more difficult because some of the cost containment efforts began in the second quarter of '08.

Smedes Rose - KBW

Okay. So so they start to anniversary?

John Williams

Right.

Smedes Rose - KBW

The other thing I just want to ask you, in the markets, in your markets are you seeing any supply that you thought was coming online that's maybe been delayed or cancelled, or are there any markets where supply continues to come on line as they got their financing well in advance since August craziness? And that will kind of impact certain markets more than other or any kind of updates on that?

John Williams

Yes, this is John. We do see in New York for example a pause in the construction of some of the previously assumed new supply. We see it really across the country where projects are being delayed at least if not postponed indefinitely, but we still see fairly significant amount of supply coming into the market, for example Chicago. And there is additional supply coming in New York. So, I can't give you percentage but there has been a meaningful slowdown if not postponement. But at the same time we are seeing a substantial proportion of the anticipated supply coming into the market.

Smedes Rose - KBW

Alright. Thank you.

Operator

The next question comes from the line of Andrew Whitman with Robert W. Baird. Please proceed.

Andrew Whitman - Robert W. Baird

Good morning, guys.

John Williams

Good morning.

Andrew Whitman - Robert W. Baird

Just a question probably I guess for John. I was looking out at acquisition opportunities with (inaudible) offering and number of unencumbered assets combined clearly there could be potential on your balance sheet to maybe take down an asset or two depending on how you want to manage the capital structure. Can you just talk about your willingness to put some capital out and maybe this year or may be towards the end of this year and what you’re seeing in terms of the acquisition market and specifically for distressed opportunities?

John Williams

Yeah Andrew this is John. I think clearly it’s too early for us to anticipate potential acquisition opportunities number one. We are not seeing attractive opportunities on the market. Number two, I think we have said in the past we want to be pretty confident we see the bottom in the rear view mirror before we start playing offence with our balance sheet. And I think from our perspective seeing that bottom in the rear view mirror means that we are consistently outperforming our forecasts and our forecasts are not deteriorating any further going forward. So we are seeing a little of that but not enough to give us confidence to play offence with our balance sheet but more importantly probably the opportunities we have there are not compelling at this point. So it’s clearly too early from our standpoint and probably from the market standpoint.

Andrew Whitman - Robert W. Baird

Okay good thank you.

Operator

And your next question is a follow-up from the line of Yeremo Garro with RBC Capital Markets. Please proceed.

Yeremo Garro - RBC Capital Markets

Thanks I'm sorry guys but I have missed this or do you provide a preliminary April RevPar figure?

John Williams

We do not and quite frankly we usually get that information on a delayed basis from our operator so we don’t have an update on April at this point.

Yeremo Garro - RBC Capital Markets

Okay well thank you again alright

Operator

You have no further questions. So at this time I would now like to turn the call back over to Mark Brugger for closing remarks, please proceed.

Mark Brugger

Thank you everyone for your continued interest in DiamondRock that concludes our call.

Operator

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

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Source: DiamondRock Hospitality Co., Q1 2009 Earnings Call Transcript.
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