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Diamondrock Hospitality Company (NYSE:DRH)

Q3 2009 Earnings Call Transcript

October 20, 2009 11:00 am ET

Executives

Mark Brugger – CEO

John Williams – President and COO

Sean Mahoney – EVP, CFO and Treasurer

Analysts

Jeffrey Donnelly – Wells Fargo

Will Marks – JMP Securities

Bryan Maher – Collins Stewart

Guillermo Garau – RBC Capital Markets

Smedes Rose – Keefe, Bruyette & Woods

Dennis Forst – KeyBanc

Justin Maurer – Lord Abbett

Nikhil Bhalla – FBR

Josh Attie – Citi

Dan Donlan – Janney Montgomery Scott

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 DiamondRock Hospitality Company earnings conference call. My name is Latrice. I will be your coordinator for today’s conference. At this time, all participants will be in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) At this time, I would like to turn the call over to your host for today’s conference, Mr. Mark Brugger, Chief Executive Officer. Please proceed, sir.

Mark Brugger

Thanks, Latrice. Good morning, everyone, and welcome to DiamondRock Hospitality’s third 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’d 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 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, it may be helpful to review the reconciliation to GAAP in our earnings press release.

Overall, US lodging fundamentals continue to be very difficult. Our quarterly results albeit staggering from a historical perspective exceeded our expectations, particularly with respect to profit margins. There are some signs in the quarter that demand is beginning to stabilize, a subject that we will touch on more during this call.

For the third quarter, our portfolio RevPAR contracted by 16.9%, led by approximately a 13% decline average rate and a 3 percentage point loss of occupancy. It’s worth noting, more than a third of our hotels actually gained occupancy during the quarter versus the comparable period. This is an improvement over the second quarter where only a single hotel had occupancy growth greater than 1%. We are encouraged by this trend. Occupancy will need to recover first in order for rates to eventually increase.

On another positive note, our portfolio of hotels continued to gain market share. During 2009, our hotels have increased the RevPAR market share by more than 7 percentage points. Margins were also a very good story in the quarter. Even with the significant loss in revenue, house profit margins declined only 342 basis points and adjusted EBITDA margins by only 421 basis points. The cost containment efforts of our asset managers and our hotel operators are continuing to maximize hotel profits despite the difficult operating environment. John will discuss these efforts in more detail in a moment.

Driven by our portfolio’s performance, the company generated third quarter revenue of $137.8 million, adjusted EBITDA of $27.5 million, and adjusted FFO per share of $0.19. Turning to the balance sheet, DiamondRock continued its efforts to build a durable balance sheet and to position the company to take advantage of future acquisition opportunities.

With these twin goals in mind, the company pursued several capital initiatives during the year, including one, raising over $150 million through the sale of common equity; two, paying of $90 million of debt, including all outstanding borrowings under our corporate revolver and the mortgage debt Griffin Gate and Bethesda Suites; three, completing the refinancing of the quarter Courtyard Midtown East; and four, paying up to 90% of this year’s dividend in stock.

After completing these capital initiatives, the company’s simple capital structure enjoys the following positives. A 20-hotel portfolio with no debt on 10 hotels and the other 10 encumbered only by long-term limited recourse mortgage debt; no debentures for five years; no corporate debt, including no draws under the corporate revolver, and unrestricted corporate cash of over $100 million.

We believe that DiamondRock is well positioned to create value for our shareholders. In particular, our management team is becoming more constructive on the coming acquisition environment. The lethal combination of dramatic declines in hotel cash flows and the use of excessive leverage during the last peak will inevitably lead to good acquisition opportunities. Just looking at hotel CMBS debt alone, nearly $30 billion of hotel CMBS debt is maturing through 2012 and about $8 billion in total is already unable to meet debt service. The open question remains, just when will these opportunities ripen?

As for the outlook, our visibility continues to be very limited. Based on our current trends, we expect 2010 to be another negative year for RevPAR with difficult profit margin comparisons. However, this lodging cycle, although more amplified and perhaps attractive, will likely play out similar to prior cycles where hotel room rates remain under pressure until occupancy recovers to a threshold level that allows operators to regain pricing power.

As the general economy improves, we anticipate that demand will follow its traditional path, tracking GDP growth, employment growth, and corporate profits. Another side of the supply/demand equation, supply, while not favorable short-term, is projected to be below historical averages beginning in 2011 and remain at constrained levels for several years. The positive supply future should lay the groundwork for solid RevPAR growth as demand recovers. DiamondRock, with its portfolio of high-quality hotels concentrated in gateway cities and desirable destination resorts, is well situated to benefit from the next growth cycle.

With that, I will turn the call over to John to get into more details on individual hotel results.

John Williams

Thanks Mark. We remain mired in this historic downturn as evidenced by continuing decline in sales across all market segments. But as the pace of decline moderates, we may be seeing the seeds of recovery beginning to sprout. With that said, it will take time to recover past profitability as demand has been so devastated and related occupancy loss has been so dramatic in this downturn.

For the third quarter, overall portfolio occupancy was down 3.2 percentage points to 73.3% and average daily rate was down 13.2% to $146.73. New York and Los Angeles continued to underperform, with the third quarter RevPAR at the New York Courtyard to down approximately 30% and Q3 RevPAR at the LAX and Torrance Marriotts down 24% and 22% respectively.

Salt Lake City Marriott’s RevPAR was down almost 26% in the quarter, negatively impacted by the approximately $2 billion City Creek redevelopment project surrounding the hotel. The Boston Westin, on the other hand, was a relative star with RevPAR essentially flat in the quarter, as the hotel continues to gain market share through its RevPAR index up 16% year-to-date. Our Atlanta hotels had a relatively solid quarter with RevPAR decline of around 10%.

For the portfolio, all three major segments were negative in the quarter. Business Transient revenue was down 31% in the quarter, although the lost BT room nights were completely replaced by leisure and discount room nights. And overall transient room nights in the quarter were up slightly over Q3 2008, perhaps a sprout but tampered by the impact on transient average rate, which was down about 18% in the quarter.

Group revenue was down 16% in the quarter, with decline coming again in room nights, down about 12% with rate down less than 5%. Group room nights booked in the quarter were higher than both 2008 and 2007, perhaps seeds of recovery is sprouting or at least its validation of the theory that booking pace statistics overstayed future group revenue decline because Group bookings have such short lead-times today.

Cancellation fees were down 40% in Q3, while attrition fees doubled to $800,000, reflecting fewer cancellations in the quarter, but groups taking fewer rooms than they booked. Another small seed sprouting was sold-out days in the quarter, which was up a bit over Q3 2008, the first previous year-over-year comparison in a long time.

Group revenue pace for 2010 is off about 20% versus same time last year. The number is less meaningful because in addition to the shorter booking window, the pace reports don’t take into account last year’s cancellations or the significant hedging included in future bookings. Booking pace is not getting much visibility in the next year right now.

We are pleased that in spite of a 16.9% RevPAR decline, decline in food and beverage revenues and tougher cost comparisons in the second half of this year, we were able to limit house profit margin declines of 342 basis points. Our cost containment plans are expected to save approximately $10 million in 2009. 65% of the savings come from reduced labor costs, as positions are eliminated and hours reduced.

The $10 million in savings from 2009 cost containment initiatives is in addition to the $5 million in savings from the cost containment plans we implemented in 2008 as well as the substantial savings incorporated into the original 2009 operator prepared budgets. Our asset managers in conjunction with our hotel operators continue to work diligently to search for additional savings, knowing we face potentially negative RevPAR comparisons into 2010.

Areas of particular focus include items such as additional housekeeping efficiencies and food and beverage outlet efficiencies. As another example of good margin control, despite a 11% decline in food and beverage sales in Q3, food and beverage margins were actually up 87 basis points due to a combination of slightly higher catering sales as a percentage of total food and beverage sales and substantially better food cost and beverage cost, down 201 basis points and 86 basis points respectively.

Portfolio labor costs in Q3 were down almost 9%. Support costs, including property level G&A, repairs and maintenance, utilities and marketing, were down about 11% in the quarter. Many of our hotels have reduced management headcount by 20% or more. These cost reductions are evidence that our ongoing cost containment efforts continue to pay off.

Productivity at our hotels is better, as measured by cost per occupied room and man hours per occupied room, by 2% and 7% respectively. Our capital investment budget is $35 million for the year, including $5 million of energy ROI projects. Most of the work will be paid for out of property reserves. Because of our capital expenditures over the past five years, our portfolio remains in excellent shape and capital requirements will remain very manageable through 2010 and 2011.

On the acquisition front, sellers remained reluctant to bring institutional quality hotels to market in this environment and opportunities remain limited. Our observation on distressed assets is that many lenders are postponing the inevitable and many of these assets will reach the ticking point to become opportunities for us, hopefully beginning in earnest in 2010.

One of the great advantages of being a company with 20 hotels is it only takes a few deals to really move the needle. The momentum of distress is building. To give you an idea of the momentum, one servicer had, in special servicing -- i.e. fault [ph] -- in January of 2007 three hotels with debt of $27 million; in January of 2008, a year later, eight hotels with $44 million of debt; one year later in January of 2009, the number was 37 hotels with debt of $372 million; And today, in September of 2009, it was 106 hotels with $1.4 billion of debt. Clearly we will see very good buying opportunities, resulting from this epic downturn and we will have the balance sheet to capital on it.

With that, I will turn the call back over to Mark.

Mark Brugger

Thanks, John. We’d now like to open up the call for any questions you might have. Latrice?

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Jeffrey Donnelly with Wells Fargo. Please proceed.

Jeffrey Donnelly – Wells Fargo

Good morning, guys. Mark, I think in prior calls -- and you guys touched on this already, but in prior calls you indicated that you think you will eventually see that buyers’ market for assets. And I guess I’d say your peers are sounding a bit more enthusiastic about near-term acquisition opportunities, and we’re certainly seeing more headlines on buying rate activity. I guess, why do you think there is a disparity on the thinking about timing of acquisitions in the current depth of the acquisition market?

Mark Brugger

Jeff, as you know, the transaction volume is way down and we are starting to see some more deals these days. But I think it’s just too early to call that there is more of a buyers’ market yet maturing. I think everyone kind of sees the pig in the python, if you will, that it’s coming. And obviously people are trying to call the time. I think some of it is just world perspective how optimistic people are about the future deals versus what they may have in hand today. We are not seeing a tremendous volume of deals coming through our doors at the moment.

John Williams

Jeff, this is John. Just to add to that, if you think about it, in most cycles, and this is no different, the first opportunities to come out are the ones that really don’t fit also in most public companies. They are either limited service or in treachery markets or possibly with negative cash flow, none of which meet our strategic needs. But I think if you add it up all these opportunities that are out there, whether they are strategic fits or not, you can make a case that there is a growing number of potential acquisitions. But the way we characterize our pipeline and we tend to focus on strategic assets that are cash flowing and have a greater growth rate than the portfolio in general, we are just not seeing that kind of volume.

Jeffrey Donnelly – Wells Fargo

Do you think the caliber of assets that you are looking for is more of a late 2010 event? And I guess, where do you think those deals will be coming from? Are they going to be coming out of the hands of banks or, call it, distressed owners or private equity funds? How do you, I guess, identify those?

Mark Brugger

Jeff, this is Mark. The initial opportunities are really coming in two flavors, as John was saying, First, our hotels with negative operating cash flow where the banks are kind of forced to take them, the Stanford Court Hotel in San Francisco is probably a good example of those kind of deals. And you will see those more in the hardest hit markets like Hawaii and San Francisco. Some of those deals are difficult to deal with a public company with a negative cash flow, unless there are really compelling valuations. So we will see some more of those deals and we’ve seen those increase in volume over the last couple months.

The second type of deals that we are starting to see are the ones in markets that haven’t fallen this far, markets like Washington DC where there still might be some equity left with some of the private equity players, but they have a loan that matures in the next year or two, and they are looking to capture their promote. Those are probably more interesting for the public companies like us as early deals. But as far as the big volume from the special servicers, we are not seeing it yet. But you can look at some of the macro trends -- you know, looking at some special servicers like LNR, CWCapital Crestline just between April and August, the value of commercial loans in special servicing has doubled almost $50 billion. So you are looking at some pretty big macro trends, and you see the momentum gaining there. But I think it’s too early to say we are at that inflection point for deals.

Jeffrey Donnelly – Wells Fargo

Just two other questions actually, switch gears. In the third quarter, the absolute and percentage decline in EBITDA margin softened, as you moved from Q2 into Q3. Can you talk a little bit about why that’s difficult to control decline in margin erosion? And what maybe we should be thinking about as we go forward?

Mark Brugger

Sure, Jeff. From a RevPAR standpoint, as you well know, Leisure and Discount business more than made up in room nights, but we are lost in Business Transient on a quarter-over-quarter basis. The third quarter is a little bit different than certainly the second and fourth. In the Business Transient, levels are down generally. Leisure and Discount are up in general. So it’s -- what we are really looking for is a fourth quarter indication that Business Transient has in fact returned to some degree and we’re watching that very carefully.

From a margin standpoint, as I think I said, we’re really very pleased with the 342 basis point house profit decline in the face of the substantial RevPAR decline and the tougher comparisons, which we’ve all anticipated for the second half of this year. I think going forward, we see a lot of work to be done in order to harvest additional savings. I think there is a certain amount of battle fatigue out there, if you will, among the operators that they have cut so much for so long, it’s difficult to see additional cost-cutting opportunities. We do see additional cost-cutting opportunities, and the challenge is going to be to convince the operators that these are cost measures that make sense in the short-term, and in the long-term, it will be too damaging for their brand. So we’ve got to work it out for us given the success we’ve had in the second half of ’08 and all of ’09, but we are certainly continuing to redouble our efforts.

Jeffrey Donnelly – Wells Fargo

Just one last question because Mark touched on in his comments. You mentioned that at least for 2010 that your RevPAR will be negative and profit comparisons will be challenging until occupancy recovers to a threshold level. I guess the question is, where do you feel that level is for your markets? And I guess -- and how does that compare to where your occupancy is in the trailing, say, 12 months?

Mark Brugger

Speaking more generally in the industry, there is a big difference between what’s going on in New York and what might be going on in LA about where we need to get you to hit that inflection point or break point, what’s the occupancy to get the pricing power back. But I think generally the industry is kind of lost seven, eight, nine points of occupancy depending on how you slice it in the segment. And you probably need to recover at least half that to circuit the pricing power back. So for the industry, not necessarily for our portfolio, I think you need to get to kind of between that 60% and 61% of occupancy to see the industry turn and really regain some pricing power.

John Williams

And Jeff, this is John. Within our portfolio, we’re looking very carefully at days of the week, individual markets, resort versus corporate hotels. And the answer is going to be different in each case. But traditionally, coming out of these downturns, and this one obviously had been so much more tragic. The impact will be magnified. Operators are reluctant to push prices until they feel quite certain that their demand has grown to a point that they are comfortable doing -- pushing prices. And that’s our job as well, is to kind of get them through the shell shock of the downturn and getting some confidence based on facts, based on demand by day of the week, by season of the year, by type of property, et cetera. So it’s a collaborative effort, I think. But it’s hard to say in any general terms what exactly we need to get to before pricing power returns. It will vary dramatically by market and by time.

Jeffrey Donnelly – Wells Fargo

The supply up next year, that would imply that -- just to hit the midpoint of what you’re saying, we did 400 basis points to 500 basis points growth in demand. We get to that threshold level potentially.

Mark Brugger

It’s probably right. I mean, supply in our market is going to be up a little over 2%, I think. So you need pretty good demand recovery next year to get close to that inflection point.

Jeffrey Donnelly – Wells Fargo

Great. Thank you.

Operator

And our next question comes from the line of Will Marks with JMP Securities. Please proceed.

Will Marks – JMP Securities

Thank you. Good morning, everyone. I had a question to start with on, John, that you had mentioned the New York and Los Angeles underperforming. Were you saying relative to the portfolio or versus competitors in those markets, and maybe expand on how you expect them to -- those markets to come back versus competitors if that’s the case?

John Williams

Yes. My comments were related to -- in relation to the portfolio. I have to look up individually, but in general, I think Mark pointed out that our RevPAR index is up about 7 points year-to-date. That’s in keeping with our strategy that brands hold up better in downturns. I can talk about each market and each property in deal, but generally, New York, we are starting to see trends improve in the fourth quarter, which is very encouraging. And the operators are feeling somewhat more bullish about the fourth quarter than they were two months ago.

LAX, we have done a complete shift in our strategy. When we bought that hotel, we wanted to move out contract and increase the Group component. We’ve had to reverse that and go back to the contract strategy because the Group just simply isn’t there and so many sub-markets in Los Angeles are competing for the same groups. Torrance, we have a lot of international contract business down there, and that too has been much more competitive. I think our outlook for LA is a little bit clouded right now. It’s really hard to see that market coming back. Particularly with new supply coming in downtown, it’s hard to know what that’s going to do. But I think in New York, in spite of the increased supply, because it’s so far away from our properties, we are feeling pretty good about the fourth quarter at this point.

Will Marks – JMP Securities

Great. Okay. That’s all from me. Thank you.

John Williams

Thanks, Will.

Operator

And our next question comes from the line of Bryan Maher with Collins Stewart. Please proceed.

Bryan Maher – Collins Stewart

Hi, guys.

Mark Brugger

Hello, Bryan.

Bryan Maher – Collins Stewart

Couple of quick questions. When and if you actually get some acquisitions that you want to move forward on, what kind of leverage are you seeing, your ability to put on those would be in one-off mortgages or whatever?

Mark Brugger

Yes. This is Mark. The share mortgage market remains very constrained, and that’s how we closed on one-one in the third quarter. There was very little leverage in New York City of 8.8% interest rate, and I think it was about 35% of its separated value. So the market there is still very difficult. For DiamondRock, our next acquisitions, unless there is assumable debt and likely to be 100% equities, we continue our deleveraging strategy over the next couple of years. So it’s not going to be a constraining factor for us in finding the deals. And quite frankly, the worst of the secure debt market remains probably the better pricing we’re going to deal with it again by paying 100% cash for acquisitions.

Bryan Maher – Collins Stewart

Yes. I’m just thinking from a modeling standpoint, I mean, obviously it’s not ideal they have no debt on them forever.

Mark Brugger

But we think about debt as a company, not individual assets. Sean, can you comment on secured market?

Sean Mahoney

Generally speaking, the secured markets, although still constrained, have loosened over the last couple months, but although the -- only the best sponsors as well as the best assets are getting serious consideration from lenders. I’ll tell you that the borrowing costs are coming a little bit even from when we -- from (inaudible) Midtown East mortgage that we just closed. But it’s still very constrained with relatively low on LTVs.

Bryan Maher – Collins Stewart

Okay. But generally, 50% or below is -- going to look for?

Sean Mahoney

Correct.

Bryan Maher – Collins Stewart

Okay. You guys talked a lot about the CMBS issues, and that’s really helpful. And we are all paying attention to that. But can you kind of walk us through how an asset ends up with a CMBS servicer and then gets into somebody’s hands, like yours? What is that process? How long does it take? Are you plugged into that market? How should we be thinking about that?

Mark Brugger

I think the reason you’re hearing a lot about the CMBS debt, which is only a minority of all the debt out there on hotels, is because it’s easy to get good statistics and talk about credibly. But it only represents less than 40% of the debt on hotels that’s out there. I think the process is still being defined. We are talking to a lot of people that are -- we don’t have anything with special servicing, but we are talking to a lot of people that are either experts in it or law firms or going through the process in the industry. It’s different. You know, it’s different with CW than it is with LNR or Centerline. And I think that there is no uniformity yet, and everyone is kind of waiting for those rules to be laid out. We are staying close to -- we are tracking the number of hotels that are non-performing right now. But they have a kind of an obligation -- a fiduciary obligation, if you will, to not tell them on a one-off basis to try to maximize value. So we anticipate a lot of those are going to end up as broker deals eventually.

Bryan Maher – Collins Stewart

Okay. And just one housekeeping item. What was the weighted average share count during the quarter?

Sean Mahoney

It was about 111.4 million shares for the third quarter.

Bryan Maher – Collins Stewart

Okay. Thanks a lot.

Mark Brugger

Thanks, Bryan.

Operator

And our next question comes from the line of Guillermo Garau with RBC Capital Markets. Please proceed.

Guillermo Garau – RBC Capital Markets

Good morning, guys. I’m here with Michael Salinsky. First, looking at your customer segments, do you know any notable changes in Business Transient during the quarter I guess with regards to demand versus rate or maybe during the past month?

Mark Brugger

I’m sorry. Did you discernible changes during the quarter?

Guillermo Garau – RBC Capital Markets

Yes. Any notable changes in the mix of Business Transient during the quarter and the past month?

Mark Brugger

Well, it’s been a uniform trend across the year and part of last year. And Business Transient was down dramatically. Last quarter was 37%. This quarter was 31%. Last quarter we almost made up the difference in Leisure and Discount. This quarter, we completely made up the room night difference, but at the expense of rate. It’s a little early to tell what the trend in the fourth quarter is going to be. But if that trend holds, obviously we’re hoping that Business Transient decline will be lower than it has been much far this year.

Guillermo Garau – RBC Capital Markets

But within the actual Business Transient, do you see any pickups, I guess in occupancy versus rate, or you’re still not seeing that change in the mix within Business Transient?

Mark Brugger

Yes. In terms of corporate rate, special corporate rate, that sort of thing?

Guillermo Garau – RBC Capital Markets

Yes.

Mark Brugger

Yes. I think the trend is still towards special corporate and below, and we suspect that some of the business transient is actually switching over to Internet rates and some other non-traditional channels, but that’s pretty hard to pressure. But clearly there is still depreciation in the rate categories.

Guillermo Garau – RBC Capital Markets

Okay. And then looking at the Group booking phase for 2010, can you provide any color on that?

Mark Brugger

Yes. For 2010, our revenue, as of the third quarter, our pace is down about 21%. It’s continuing to decelerate, if you will. In the first quarter, it was down about 11%; second quarter about 16%. So we are continuing to see the deceleration. Having said that, we are clearly seeing better pickup in the quarter for the quarter. We had 20,000 room nights booked in the quarter for the quarter in the third quarter, which is dramatically more than last year and even more than 2007. So there is a couple of things that says, first of all, the booking is more short-term. And it probably also says there is more inventory to book, and therefore groups have a wider choice of dates. So it’s a positive trend, but overall the pace continued to decline. I also would make the point over again, it’s not giving us great visibility in our minds because in addition to the shorter term nature of the booking pace, last year’s numbers don’t include cancellations. And this year’s numbers also had a fairly conservative approach in terms of what we are actually putting on the books in definite room nights given our recent history of attrition.

Guillermo Garau – RBC Capital Markets

Okay. And then lastly, going into acquisitions, the takeaways that you guys are actually not bidding on anything right now and then can you provide any color with regards to your recent discussions without Marriott (inaudible) first group that you guys have there?

Mark Brugger

This is Mark. I guess it’s an overstatement to say we are not looking at it. We are actually looking at a number of -- a couple of opportunities right now. I wouldn’t say they are high possibility, but we are actively looking. With the Marriott international relationship, we’ve resumed our acquisition pipeline meetings, which essentially a group of our executives and a group of their senior executives get together periodically and go through a list of anything that might fit our parameters that might be coming through their system. So that’s restarted. That’s very active. They are not seeing a ton of volume of deals coming through their system, but we expect that to be fruitful over the next year or so.

Guillermo Garau – RBC Capital Markets

Okay, perfect. Thanks a lot, guys.

Operator

And our next question comes from the line of Smedes Rose. Please proceed.

Smedes Rose – Keefe, Bruyette & Woods

Thanks. I just wanted to ask you a little bit more about -- you mentioned New York trends were picking up in the fourth quarter. Is there anywhere in particular you’re seeing there? Is it more Group or Leisure or Business Transient? And then is that -- you mentioned you really supply in Chicago and I think Fort Worth and Austin coming online. So New York has such a tremendous amount of supply coming on over the next couple of years. I’m just curious as to why you don’t see that as kind of more of a risk to your New York hotels.

John Williams

Yes. Smedes, this is John. You know, the nature of our hotels in New York were transient hotels exclusively; very, very little Group business. So the trend that we think we are seeing or hope of seeing is on a transient basis. And keep in mind that our hotels in New York are running in the high 80s, approaching 90% occupancy. So the demand is there. The question is, at what rate? And so, as we begin to see strengthening -- if we see strengthening in the higher rated segments, we would see that uptick in rate. As for the new supply, the bulk of the new supply is south and west of our two hotels. We are pretty well located on Third Avenue and 40th and Fifth. And there is not much new supply coming in in those two particular sub-markets a little bit, but more of it is coming on in west down in Soho and downtown, as you know. And so it’s less impactful than the sheer numbers would indicate.

Smedes Rose – Keefe, Bruyette & Woods

Okay, thank you.

Operator

And our next question comes from the line of Dennis Forst with KeyBanc. Please proceed.

Dennis Forst – KeyBanc

Yes, good morning. I got on a little late, so I may have missed some of this comments. But -- the mortgage debt expense in the quarter was about how much? I know that the total was 11.1, but I’m curious how much of that was mortgage debt versus facility fees versus the financing costs -- non-cash financing costs.

Mark Brugger

Dennis, why don’t we follow up --

Dennis Forst – KeyBanc

Okay.

Sean Mahoney

This is Sean. The interest expense for the quarter, 32.6 was related to mortgage debt. $0.6 million was deferred financing costs, and then the unused facility on the credit facility was $0.5 million. That’s on a year-to-date basis.

Dennis Forst – KeyBanc

That’s nine months, yes.

John Williams

It’s nine-month basis.

Dennis Forst – KeyBanc

Okay. Good, Sean. And then a follow-up on the weighted average shares at 111.4 in the third quarter. What will it be in the fourth quarter?

Sean Mahoney

118.1 million shares.

Dennis Forst – KeyBanc

Okay. Which is similar I think to -- in the press release you said the share outstanding were, what, 118.3 or something like that?

Sean Mahoney

That’s the kind of shares outstanding. That’s correct.

Dennis Forst – KeyBanc

Right. Okay. Then the last --

Sean Mahoney

(inaudible) interest expense real quick for the quarter only --

Dennis Forst – KeyBanc

Yes.

Sean Mahoney

$10.8 million related to mortgage debt, $0.2 million related to deferred financing costs, and credit facility, unused fees is $0.1 million.

Dennis Forst – KeyBanc

Okay, great. Thanks. The last question was, looking for bright spots in the quarter, did you notice anything that stood out to you that you can consider a harbinger of better times or any bright spots of upside surprises in the quarter?

Mark Brugger

I’ll take a crack at that. Yes, the ones I pointed out were in the quarter for the quarter Group bookings were up. All of these things have kind of a double edged sword. And you have to be careful not to over-read them. But in the quarter for the quarter group bookings being higher than they have been in the last two years is a positive trend. However, there was more inventory available. So groups had more dates to pick from. And it also validates the theory that pace reports are little understated because of the shorter nature of the Group bookings. And the other piece of good news was that the overall transient room nights in the quarter were actually higher than they were last year in the third quarter. They were obviously more weighted towards Leisure and Discount, but this is the first quarter in a while we have had higher overall transient room nights booked. Again, offsetting that, because they were in leisure and transient, it was about 18% transient rate reduction in the quarter versus same quarter last year.

Dennis Forst – KeyBanc

Okay. The transient room nights bookings were up or actual occupied rooms were up?

Mark Brugger

Room nights.

Dennis Forst – KeyBanc

Room nights occupied?

Mark Brugger

Yes.

Dennis Forst – KeyBanc

Okay. Not just booked for future orders, but actually occupied in the quarter.

Mark Brugger

That’s correct.

Dennis Forst – KeyBanc

Great. Thanks.

Operator

And our next question comes from the line of Justin Maurer with Lord Abbett. Please proceed.

Justin Maurer – Lord Abbett

Good morning, guys.

Mark Brugger

Good morning, Justin.

Justin Maurer – Lord Abbett

Just some random stuff. First, Mark, your point on CMBS and kind of functionally how it works, how much is more qualitative, how much more difficult though is it to kind of break apart a property, if you will, to kind of get at it whether by them or by you guys and/or a broker to get the process moving?

Mark Brugger

Lot of the CMBS debt, we spent the time over the last year studying whether it made sense to go try to purchase some CMBS debt to kind of the loan-to-own strategy. And what we found in the CMBS debt is still much of it is crossed and you’re buying strips across multiple properties if you want institution type properties that we want to buy. So it wasn’t an effective strategy to get one hotel. But what we are seeing now is --

Justin Maurer – Lord Abbett

Sure. I guess, all right.

Mark Brugger

What’s that?

Justin Maurer – Lord Abbett

You’d have made some good money I guess this year by owning some.

Mark Brugger

Yes, yes. It could’ve gone the other way, I guess. But what we are seeing now is hotels are again turned back to special servicers that are performing, and then what we need to understand over the next year is how the special servicers are going to handle those. Are they going to put an ROE and hold it for a year or two till pricing rebound? Are they going to go more to the auction method? And we are talking to servicers now trying to figure out how to get access to those one-off deals.

Justin Maurer – Lord Abbett

Okay, okay. And just kind of somewhat tangential to that, the shelf filed last night, is that just to have so when you guys are hopefully enabled to shake something lose? You got that available to you or --?

Mark Brugger

Yes, the controlled activity program has not been very cost-effective liquidity tool. And so we think it makes sense just to have it in place. And as you know, we talked about -- turn to facilitate our twin goals, building a durable balance sheet and position the company to buy hotels at the right now. It’s a great way to achieve those goals.

Justin Maurer – Lord Abbett

Okay. But would you anticipate -- of course, everything is functional price, but additional creep in that as time goes on to the next six months, and you really -- do you want to have that loaded ready to go?

Mark Brugger

The decision to issue equity is never taken lightly, so it’s balance of valuation, as you mentioned. Overall deleveraging goals and then use of proceeds and some of that’s going to be our business judgment of how we are -- near-term pipeline is going to be.

Justin Maurer – Lord Abbett

Okay. And just operationally, John, the earlier question about margin degradation being less this quarter obviously than prior, trying to kind of put that with your comments all about it getting tougher as we look forward, suites are more costly and I know you guys are still focused on that. Was this past quarter more of a mix issue at all, whether by the different hotels and their different margin contributions and/or it’s for some reason leisure traveler less costly than this business or is there any noise like that that comes into play?

John Williams

You know, on the room side, Justin, I think there is a little bit of that. I think the service provided for Leisure and Discount is the expectation is lower. You don’t have as many premium rewards players, for example.

Justin Maurer – Lord Abbett

Yes.

John Williams

And then on the food and beverage side, there was a mix element to it. In that catering -- the more profitable catering sales were a larger percentage of total food and beverage than they were in the last year’s third quarter. But a lot of it, frankly, was labor and pretty effective food and beverage cost control. So it’s a mixed bag. And our challenge going forward is, as the comps get tougher to continuing to plum for new cost containment possibilities. And we see some, but it’s not going to be easy to harvest them.

Justin Maurer – Lord Abbett

Okay. And then just lastly, you dropped a few comments about seeing some more positive things, which I almost fell out of my chair because you’ve not ever been the most optimistic guy, recognizing so in last year, but you’re your thing specific about the fourth quarter? Sorry if I missed, you mentioned LA a little bit, and what were kind of the drivers there?

John Williams

About the fourth quarter or the third quarter?

Justin Maurer – Lord Abbett

Yes, yes, fourth quarter, sorry, more specifically.

John Williams

Yes. We are not seeing clear enough trends. I only mentioned that New York is voicing some hopeful noises that we -- as I said, we hope to see a continuation of the trend.

Justin Maurer – Lord Abbett

Okay, all right. Great job. Thanks, guys.

John Williams

Thanks, Justin.

Operator

And our next question comes from the line of Nikhil Bhalla with FBR. Please proceed.

Nikhil Bhalla – FBR

Hi, good morning, guys. I had a quick question, and trying to get some clarity on some of the booking pace that you talk about in your release about 2009. And you kind of say that the booking pace is behind by 20% as of the end of third quarter for 2009. So does that mean maybe the fourth quarter booking pace is a lot better given that the first three quarters’ booking pace was probably much worse in some ways? Am I thinking about this correctly?

John Williams

I think we might be mixing some numbers here. The 20% relates to the 2010 pace as of the end of the third quarter. As far as quarterly booking pace for 2009, there is not a clear trend. The most important quarters, the second quarter and the fourth quarter in the Group segment, are down the most; 24% in the second quarter versus about 16% in the third quarter and the fourth quarter -- as I say, the visibility on these things is difficult. So it’s down in the 20% to 25% range right now as well.

Nikhil Bhalla – FBR

Okay. Okay, yes. I think -- and the release just says, as of the end of the third quarter, the company’s 2009 Group booking pace was 20% lower than at the same time last year.

John Williams

That’s for -- you're right. That’s for all four quarters.

Nikhil Bhalla – FBR

Okay, okay. I got you. Okay, thank you.

Operator

(Operator instructions) And our next question comes from the line of Josh Attie with Citi. Please proceed.

Josh Attie – Citi

Thank you. I thought maybe you could just comment on -- or give us some color on what Octobers look like from a business travel perspective? And I know there have been a lot of holiday comparisons and it makes it difficult to read too much into the results, but just any color you’re seeing on corporate travel so far in October?

John Williams

Go ahead.

Mark Brugger

Josh, this is Mark. I think the October numbers, it’s too early for us. We are just starting to get some of that. So I think it would be premature in giving you color. Obviously it’s going to be helpful that if somehow they shift really the next couple weeks we are looking towards to firm up what we think the trend is going to be.

Josh Attie – Citi

Okay, thank you.

Operator

And our next question comes from the line of Jeffrey Donnelly with Wells Fargo. Please proceed.

Jeffrey Donnelly – Wells Fargo

Yes. Just one follow-up, and I apologize if you have touched on this. I have been jumping on and off. But -- you mentioned in your comments that you might see the opportunity for further expense reduction. Where specifically do you see those future cuts? And do you think, I guess, hopefully those cuts could be significant enough that we could keep expense growth going forward flat to even down as we go into next year?

John Williams

That would be the target, of course. Where we are concentrating is obviously rooms and food and beverage. And we’ve analyzed, for example, our food and beverage outlet profitability and we’ve identified what we think are some opportunities. But in order to harvest those opportunities, we are going to have to get agreement among our operators that it’s -- that these are acceptable costs to go after, probably not traditionally the way food and beverage business in hotels has operated. And so that’s not going to be easy, but we are in the midst of that. On the room side, we are doing what I think a lot of our peers are doing. And that is, trying to revisit the overall kind of philosophy of cleaning a room, if you will. A dirty room is not a dirty room in all cases. If someone is staying over versus someone is checking out, the way you clean rooms, do you put things back in the same place you wanted them or do you leave them where the guests put them. You know, they are pretty mundane things, but they actually result in some pretty good cost efficiencies when you look at man hours per room on the housekeeping side.

Mark Brugger

Jeff, this is Mark. We are obviously working very hard on cost containment, but it’s probably overly optimistic to think that cost would be down next year versus this year.

Jeffrey Donnelly – Wells Fargo

And just actually another question and maybe just, John, I guess your knowledge after coming out of the last cycle, a lot of brands always move to defer tip programs and relax brand standards. I guess the question is, what happens when the cycle starts to come back? I mean, how quickly do they begin reinforcing those standards again and I guess how suddenly? How quickly do they expect to be able to catch up to the deferred to work?

John Williams

Well, from a capital standpoint, Jeff, it depends how deferred it is. I mean, if you are postponing a room’s renovation for two or three or four years beyond its kind of lifecycle, then the brands are going to want you to get on that as soon as it’s practical to do so. But I think on the operating side, what we’ve seen in the last couple of cycles is, these cost efforts have persisted into the up-cycle fortune. And so we would fully expect that the savings we have enabled to harvest thus far to some degree and hopefully some significant degree will translate into higher margins once we get the revenue back. That’s what happened in the last two cycles, and we expect that will happen in this cycle. This is a perfect example. We are going into next year in a potentially negative RevPAR environment, after all the work that’s been done on the cost side, trying to find new costs and we will find new costs. And some of that’s going to be redoing the way business has traditionally been done.

Jeffrey Donnelly – Wells Fargo

Great. Thank you.

Operator

And our final question comes from the line of Dan Donlan with Janney Montgomery Scott. Please proceed.

Dan Donlan – Janney Montgomery Scott

Hi. It’s actually Dan Donlan. Just real quick on the capital expenditures, your forecast is $35 million for the year. You’ve only spent about $17.7 million. Is there a large project that’s going to be happening in the fourth quarter that’s driving that?

John Williams

No, not per se. We do have projects in the fourth quarter. Obviously they are underway. There also could be some slippage of projects, as there always is every year, into the problem year in terms of when bills are paid and things like that. But generally, we are on budget and on pace for the $35 million.

Dan Donlan – Janney Montgomery Scott

Okay. And then just from a labor cost standpoint, if occupancy is just about slightly, let’s say, year-over-year next year, would you anticipate labor being able to stay roughly the same with just slightly contractual increases, maybe from union contracts and things like that? Or would you have to add a decent amount of labor to facilitate that increase in occupancy?

John Williams

It really depends on the volume if it’s a slight increase. And hopefully we could hold cost if it’s a substantial increase, which we’d all hope for, then your variable cost would go up. But hopefully the fixed costs can be maintained for the foreseeable future.

Dan Donlan – Janney Montgomery Scott

Okay. And then just lastly on the dividend, it says that you are going to -- you could pay up to 90% of your dividend in the form of stock. Are you leaning towards paying up 90% or is there any type of split or could you maybe give some color on that, please?

Mark Brugger

Yes. This is Mark. The mortgage rate that we are going to pay, the RevPARs will let us pay up to 90%. There is a process where you send out a proxy that’s associated with whether to declare a dividend as of the end of the year. We think that’s going to be in the amount of $35 million to $45 million depending on where taxable income ultimately turns out to be. But as a process, my guess is it’s going to be closer to that 90% level.

Dan Donlan – Janney Montgomery Scott

Okay, great. Thank you very much.

Operator

And we have one final question from the line of Smedes Rose with KBW. Please proceed.

Smedes Rose – Keefe, Bruyette & Woods

Hi, thanks. Just curious. Renaissance Worthington loan, it looks like it started to amortize in the third quarter. Was that scheduled to do so or is there some reason why that started to amortize in the quarter?

Sean Mahoney

Smedes, this is Sean. And that was the scheduled start of the amortization per the loan agreement we had, I believe, five years -- I'm sorry, 3.5 or four years, I forget exactly how much of our interest-only period outrun them.

Smedes Rose – Keefe, Bruyette & Woods

Okay, thank you.

Operator

And a follow-up from the line of Dennis Forst with KeyBanc.

Dennis Forst – KeyBanc

Yes. A question about the dividends. If I just use the midpoint, $40 million divided by 118 million shares, that’s somewhere around 4 million shares at 90%. Does that sound right?

Sean Mahoney

Sure.

Dennis Forst – KeyBanc

Yes. So you will probably start off and those will be paid by December 31, so those new shares will be outstanding for the full year when we are trying to figure FFO per share?

Sean Mahoney

We are going to declare the dividend on December 31st, but that may not be paid until shortly after into 2010.

Dennis Forst – KeyBanc

Okay. But essentially those shares will be outstanding the whole year?

Sean Mahoney

Correct.

Dennis Forst – KeyBanc

Yes. Okay, thanks a lot.

Operator

And there are no further questions in queue at this time. I would like to turn the call back over to your host, Mr. Mark Brugger, for closing remarks.

Mark Brugger

Thank you, Latrice. To everyone on this call, we’d like to express our continued appreciation for your interest in DiamondRock and look forward to updating you next quarter.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. And everyone, have a great day.

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Source: Diamondrock Hospitality Company Q3 2009 Earnings Call Transcript
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