Diamondrock Hospitality Co (DRH) 2006 Q2 法說會逐字稿

Welcome to DiamondRock Hospitality First Quarter 2006 Conference Call. The press release was distributed this morning as well as furnished from Form 8-K to provide access to the widest possible audience. In the press release, the company has [reconciliated] all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Regulation G requirements. If you did not receive a copy, these documents are available on the company's website at www.drhc.com in the Investor Relation section.

Additionally, the company is hosting a live webcast of today's call which you can access in the same section. At this time, management would like me to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although DiamondRock Hospitality believes their expectations reflected in any forward-looking statement are based on reasonable assumptions, it can give no assurance that its expectations will be obtained.

Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements, are detailed in today's press release and from time to time in the company's filing with the SEC. The company does not undertake a duty to update any forward-looking statements. I would now like to welcome management. With us today are Mr. Bill McCarten, Chief Executive Officer, Mr. John Williams, Chief Operating Officer, and Mr. Mark Brugger, Chief Financial Officer.

At this time, I would like to turn the call over to Mr. Bill McCarten for his opening remarks. Sir, you may proceed.

Thanks Candice, good afternoon everyone, and welcome to DiamondRock Hospitality's Second Quarter, 2006 Earnings Conference Call. DiamondRock reported terrific results in the second quarter, and lodging fundamentals are very strong. RevPAR increased 11.6% during the quarter, 160 basis points more than the high end of our prior guidance. 10 of our 17 hotels turned in double digit RevPAR growth. Flow through was also outstanding. Performance was particularly impressive in New York, downtown Chicago, California, and the Caribbean. Leisure continues to be a bright spot for us, with year-to-date RevPAR at Vail, Frenchman's and Sonoma up an average of 15%.

Although we are bullish on hotel fundamentals for the balance of the year, we only modestly raised guidance for the full year, because results for the second half of the year will be impacted by three specific issues, higher property taxes, a slower than expected ramp up at the Oakbrook Hills Marriott Resort and the timing of renovations. Again, we expect fundamentals at our hotels to be quite strong for the next several years, and we continue to see positive macro trends with supply growth remaining historically low and very little rate resistance from hotel customers. Now back to the second quarter.

Early in the quarter, we completed a very successful secondary offering, issuing 19.3 million shares and raising net proceeds of 238 million. Our stock prices appreciated about 20% since that offering. We also marked our first acquisition of a Westin branded hotel with the acquisition of the Westin Atlanta North. Our sourcing relationship with Marriott remains solid.

Both Marriott and Diamond Rock have benefited significantly from this relationship and I'm confident that it will continue to provide value for both of us in the future. However, Marriott does recognize our obligation to successfully grow with attractive hotel acquisitions regardless of brand affiliation. Despite a very competitive acquisition environment, we continue to believe that we will find attractive acquisition opportunities and successfully deploy our remaining investment capacity, which we estimate at about 200 million. Our results thus far this year have been just terrific and we remain very optimistic about the rest of the year.

Now, I'd like to turn the call over to Mark Brugger, our Chief Financial Officer, who will review our second quarter operating results in detail and update guidance. Mark?

Thank you, Bill. Now I'll jump into the numbers. For the quarter ending June 16, 2006, the company reported total revenue of $125 million. Our results beat our second quarter guidance on every measure. RevPAR for the second quarter was 11.6% which is 210 basis points higher than the mid point of our prior guidance.

Adjusted EBITDA was $38.4 million, which is $4.4 million above the mid point of our prior guidance. Adjusted FFO was $27.3 million, which is $3.8 million above the mid point of our prior guidance, and FFO per share was $0.39, which exceeded the mid point of our prior guidance by $0.0045. We received very little pricing resistance. Most of the gains from RevPAR continued to come from rate increases, which is producing strong flow through. Hotel adjusted EBITDA margins for all of our hotels on a same-store basis, increased from 28.56% to 21.78% over the same period in the prior year.

That 322 basis points of emerging growth was much better than we anticipated when providing our prior guidance of 110 to 150 basis points. Adjusted EBITDA and margin [outperformance] benefited by $1.1 million and at 87 basis points respectively, from yield support associated with the Oakbrook Hills Marriott Resort. The resort's revenues were well below expectations, but we maintained the bottom line profitability with the yield support from our hotel manager. Even ignoring the benefit of this yield support, we significantly outperformed guidance.

Now, turning to the balance sheet and financing activities, during the second quarter, the company completed a secondary equity offering raising net proceeds of $238 million. The company used a portion of these proceeds to acquire the Westin Atlanta North for $61.5 million, and pay off two loans, the $33 million loan outstanding on our corporate line of credit, as well as the $79.5 million bank term loan that was obtained in connection with the recent acquisition for the Chicago Marriott Downtown.

The company also completed two refinancings during the quarter. First, we refinanced the existing $220 million floating rate loan assumed in connection with the acquisition of the Chicago Marriott Downtown, with a $220 million fixed rate loan that matures in 10 years and bears interest at 5.98%. Secondly, the company's refinanced existing $23 million floating rate loan on the Courtyard Fifth Avenue in New York with a $51 million fixed rate loan that matures in 10 years and bears interest at 6.48%. The new loan proceeds allowed us to finance out more than 150% of our total equity investment in this hotel.

As of the end of the second quarter, the company had a total debt of [$665] million. Our net debt is less than 35% of our enterprise value. The debt is comprised entirely of fixed rate, property specific mortgages with a weighted average interest rate of 5.7% and a weighted average maturity of nine years. Moreover, seven of the company's 17 hotels are unencumbered by mortgage debt. We would also note that the company's liquidity is enhanced by a $75 million secured line of credit, which is completely uncapped. At any time, the company can expand a line of credit of $250 million with lender consent.

As of the end of the second quarter, the company had total assets of approximately $1.5 billion, including 109 million of cash, which we can use for owner funded cap ex needs and future acquisitions. We currently earn about 5.2% on our cash. Our balance sheet is in great shape and is among the best in the industry. The overall capital structure also continues to be very straightforward and transparent. We have 100% ownership in all of our hotels, in other words, no joint venture interest. We have not issued any operating partnership units and we've not issued any preferred stock. We believe that our capital structure is a competitive advantage.

Now, as Bill mentioned, our balance sheet today provides us the flexibility to acquire another $200 million of hotels. At arriving at our investment capacity, we do not base it on a single factor, but instead, take into account a number of factors such as fixed charge coverage, net debt to enterprise value, and net debt to EBITDA. After looking at all of these metrics, $200 million is a number that the company is very comfortable with. Turning to dividends, during the second quarter, the company paid a dividend of $0.18 per share. The annualized dividend of $0.72 per share is well covered and represents a competitive yield.

The level of future dividends will be determined by our operating results, expected capital expenditure requirements, and our ability to create value with alternative uses of our capital. However, we generally tend to provide a well-covered and regularly increasing dividend. Guidance. The company provides the following guidance for the full year and third quarter 2006. For the full year 2006, the company is modestly raising guidance. RevPAR for our same-store hotels is expected to increase in the range of 9 to 11%. This is a 50 basis point increase from our prior guidance.

Hotel adjusted EBITDA margins are expected to grow by approximately 180 to 220 basis points. The mid point of this new guidance is an increase of 15 basis points over the mid point of our prior guidance. We now expect adjusted EBITDA of 124 to $126 million, and adjusted FFO of 84 to $86 billion or $1.27 to $1.30 a share. This is a slight increase from prior guidance. Total capital expenditures will approximate $89 million for the full year of 2006. More than 14.5 million was spent in the second quarter, and $26 million year to date. Now, some of you may think that the company is being overly conservative in our guidance below the top line.

Admittedly, the [lively] fundamentals are fabulous and our properties are well positioned to benefit, but as Bill mentioned, there are a few factors effecting in the bottom line in the second half of the year. There is an additional $1.6 million expense from unbudgeted property tax increases. The biggest culprits of property tax increases are the Chicago Marriott, LAX Marriott, and the Renaissance Worthington. Moreover, when we bought the Oakbrook Hills Resort last year, we converted it to a Marriott.

This resort is a group house and is taking longer than anticipated to ramp up the group bookings. Although we negotiated for yield support from Marriott during the transition, we now forecast that this low ramp up will cost us about $1 million in EBITDA during the second half of the year. Also, there are timing issues related to renovations at some of our hotels that benefit the second quarter and create more disruption in the second half of the year. Lastly, we wanted to be cautious with guidance and take into account the fact that we still need to complete both of our extensive 2006 capital plan during the second half of this year.

Now, looking at third quarter guidance. The third quarter results will be particularly impacted by renovations of several properties, primarily LAX and Frenchman's Reef. Despite this impact, we are expecting the following results, RevPAR to increase approximately 11 to 12%, adjusted hotel EBITDA margins to increase approximately 200 to 220 basis points, adjusted EBITDA of 25 to $27 million and adjusted FFO of 15.5 to $17.5 million or $0.22 to $0.25 per share. To sum up, we had a great first two quarters and our outlook for 2006 is positive.

With that, I'd like to turn it over to John Williams, our Chief Operating Officer.

Thanks, Mark. We're in the midst of a strong recovery cycle in the lodging industry as I can remember. This confluence of strong demand growth, exceptional pricing power, relatively modest wage and benefit increases, real profit flow through, and most importantly, benign supply growth, particularly in primary markets, is extremely positive. The challenges we face in property tax, property insurance, energy and intermediary costs are overwhelmed by the overall industry strengths. So it's not surprising that our second quarter performance was excellent.

We saw a particularly strong performance at our two Manhattan Courtyards, both of which have been fully renovated, our two LA hotels, our Downtown Chicago Marriott, and our Frenchman's Reef Resort at St. Thomas. These hotels represent 54% of our portfolio of EBITDA. Our most recent acquisition, the Westin Atlanta North, was off to a good start under new management, with a 12.4% RevPAR increase and nearly a 16% increase in EBITDA despite the inevitable cost associated with change of management.

We did experience slow growth at some of our properties. We had very little growth at our Lexington, Kentucky and Salt Lake City hotels. Business [transient] demand continues to soften in Lexington, impacting our Griffin Gate Marriott Hotel. But the hotel has had success in pricing and in booking short-term corporate groups, which should improve the numbers in Q3 and Q4. We recently approved the reconfiguration of public space at Griffin Gate, which will result in an additional 2,500 square feet of excellent meeting space and the elimination of a food outlet.

This will make the entire food and beverage department much more efficient. We're also adding a spa in some existing non-revenue producing space which will be a key amenity in attracting corporate group business, as well as weekend leisure customers. At the Salt Lake City Marriott, demand was low in the second quarter after a very strong first quarter, but city-wide bookings were strong in Q3 and Q4, which should allow the property to finish on budget for the full year. I will add that these hotels are each delivering double-digit, unlevered deals to our investors.

The Oakbrook Hills Marriott got off to a very disappointing start. We converted this hotel from [Adulche] brand to a Marriott in mid 2005, and group bookings are off base for 2006 and 2007. The Oakbrook market has also been somewhat soft in business transient in Q2. As a result, the performance of the hotel is meaningful behind our underwriting projection for 2006. Now, full service group-oriented hotels that change brand and management sometimes struggle in the transition and that's why we negotiated significant yield support for Marriott. None of the fundamental reasons we bought this hotel has changed.

It remains an excellent product in a strong sub-market of Chicago with the right brand. We are dedicating significant asset management resources to getting this hotel on the right track, and we have the commitment of senior management at Marriott to make it a high priority to make this hotel the success we all know it will be. These three hotels, Griffin Gate, Salt Lake City and Oakbrook Hills represent less than 16% of our portfolio EBITDA. Excluding Oakbrook Hills, food and beverage sales were up 8.5% for the portfolio in the quarter. Because of the increased volume, together with a shift in revenue from restaurants to [inaudible], flow through was good, with margins moving up 320 basis points over Q2 last year.

On the expense side, some good news and some challenges. Our wage and benefit costs increased only 3.4% across comparable hotels. As a result, wages and benefits as a percent of sales dropped from 31.2% to 29% among comp hotels for the quarter. That's a 220 basis point improvement over Q2 last year. Energy costs seem to be moderated. Across the portfolio, they only increased 7.6% in the quarter, which is significantly down from the prior double-digit run rate. For the full year, barring a shock, we estimate the same average rate of increase.

Among the challenges we face, property taxes, fortunately only 3.7% of revenue, increased $1 million or 27% over the last year. For the full year, we anticipate a $3.2 million increase or 25% over 2005, with 2.2 million of that coming in the second half of the year. Property insurance increased 43% in the quarter, from $620,000 to $887,000. The insurance increases at Frenchman's Reef, LAX, and Torrance were the main drivers. For the year, we expect a $1 million or 38% increase over 2005, with 700,000 of that coming in the second half of the year. As our hotels continue to outperform, we're paying incentive management fees to our managers sooner than we anticipated. Not a bad problem to have.

Incentive management fees were 2.6 million, a 59% increase in the quarter over the same period last year. For the year, we anticipate paying our managers 8.4 million of IMF, a $2.5 million increase from 2005. I wanted to talk about our ongoing capital program. As we told you, we will complete almost $90 million of capital improvements in our portfolio this year. We are renovating guest rooms, renovating and reconfiguring meeting space, and creating a number of ROI opportunities by converting under-utilized space into profitable meeting space and spas.

We're very excited about the prospect of entering 2007 with a mostly renovated portfolio. However, renovations and repositioning activities displays business. The second quarter was subject to the least displacement of any quarter in 2006. LAX was the only major capital project under way during the quarter with an extensive guest room and bathroom remodeling. LAX actually experienced less disruption than anticipated in the quarter, because fewer rooms were out of service to accommodate the extensive work in the bathrooms. Naturally, this will cause greater disruption in the second half as the schedule is adjusted.

For the full year, we estimate total portfolio lost EBITDA of $3 million with more than 70% of the displacement impacting the second half. Thus far, we and our managers have managed the cost and displacement of our substantial capital program very successfully, although timing is always a challenge. I also wanted to touch on our pipeline of acquisition opportunities. Year to date, we've acquired over $360 million of hotels. Some examples of our current pipeline are a Marriott conversion opportunity in the Northeast, an urban hotel in the Midwest, a Marriott branded hotel where Marriott brought the opportunity to us because their management agreement was at risk, and a warm weather resort opportunity.

We continue to see many opportunities through our network of contacts, our first-look relationship with Marriott International, and through the hotel broker community. Although competition is tough, we remain optimistic about finding good real estate opportunities and we'll continue to resist the temptation to change our underwriting requirements.

So in summary, our portfolio hotels performed well in the second quarter and we benefited by our high exposure to strong markets like New York, Los Angeles, and Chicago. We will continue to work hard to maximize values through asset management, and continue to look for more hotel acquisitions that can deliver results similar to our most recent acquisitions in Downtown Chicago and Atlanta.

And with that, I'll turn things back over to our Chairman.

Thanks, John. Just to sum up, we had just a terrific second quarter and we feel really good about the balance of the year. Lodging fundamentals and the outlook remain great, really strong, and our portfolio overall is just doing a great job.

With that, we'd like to open it up to questions.

[OPERATOR INSTRUCTIONS]

Our first question comes from the line of Amanda Bryant of Merrill Lynch. Please proceed, ma'am.

Great, thank you very much. I just wanted to ask you with respect to the slower than expected ramp up at your Oakbrook property, do you expect that that property will meet your initial expectations once the renovation is complete? And then just kind of an add-on to that, when you talk a little bit about weaker than expected business transient in the Oakbrook market, does that have any kind of spillover effect in terms of how you view the potential of your Downtown Chicago location? Thanks.

Okay, starting with the first, will it get back to our underwriting criteria, yes, I think it will. I think the issue is just taking longer to put room nights on the books and combined with the second quarter weakness and business transient in the marketplace. We really benefited late last year from very strong turn-away demand from the other Marriott's in the area, and that just didn't materialize in the second quarter as we expected.

But the bottom line is we just have to get the right marketing people going after the right markets and get the right kind of regional and corporate focus for Marriott International to make sure this thing is being marketed the way we know it can be. With respect to the business transient demand in Oakbrook in the Southwestern suburbs, that really is unrelated to downtown. Downtown has its own demand generators and the convention center really drives downtown in a major way.

Okay, great. Thank you.

Amanda, this is Bill, just a follow-up. Just to make sure we put this in perspective, we clearly do have an issue with Oakbrook, but it is literally the only soft spot in our whole portfolio right now. And I think we'll have a lot more visibility about Oakbrook at the next quarter. We're going to be spending a great deal of time with senior Marriott execs working this through in the next few weeks.

Okay, well, thank you very much.

Sure.

Our next question comes from the line of David Loeb with Baird. Please proceed.

Hi. On these three factors that you talked about, why you're pulling back guidance a little bit for the second half, how many of those are new this quarter as opposed to stuff that you had either baked into the guidance prior, or at least we're aware of being on the horizon?

David, this is Bill. I mean, essentially all of those items we articulated were in fact new. One item for example that we didn't indicate was insurance. We had visibility on insurance when we revised guidance at the end of the first quarter. But the property tax impact was new. We really weren't aware of that until some of the new estimates were coming in. Oakbrook we've talked about. I mean, Oakbrook in the first quarter is seasonally so low that you just don't have much visibility about full year results.

Can you talk a little bit more about the yield support and are you expecting that to burn off or not be sufficient to match the numbers that you were hoping for?

Hi David, this is Mark. The yields for -- we negotiated with Marriott to get $2.5 million of yield support for this very reason, that during transitions with these group houses. It takes a lot to put the groups on books and there are often transitional issues, so we do anticipate going through the $2.5 million of yields for this year, and as we get the groups on for next year [inaudible], hopefully we'll hit ultimately our underwriting [in there], but we feel good about the long-term prospects about asset.

So that's probably not sufficient to make up for the shortfalls in the next two quarters then?

It probably will be for Q3, and it will be about $1 million shy in Q4.

Okay.

That's one of the reasons we raised guidance for.

And on the renovations, you did actually move some projects up. I guess LAX was one that was accelerated a bit?

It wasn't so much moved up as we didn't take as many rooms out of service in the second quarter. That will all balance out in the second half. There was just so much construction work, we even let the contractor take rooms out basically. We didn't think he could get them back in on schedule, so what that will do is push it deeper into the - actually, it looks like now he's going to catch up in the third quarter, so the fourth quarter will be about what we anticipated.

And in terms of Orlando, which is the other shift if you will, Orlando, we just couldn't get design and procurement done in time to get it completed by mid to late September, which was our goal, because that's soft time in Orlando Airport. So we're going to have a little more disruption in the fourth quarter because we're carrying into the fourth quarter with the renovation and that's the same story with Torrance.

David, Bill. I mean, essentially we benefited some in the second quarter through the shift and essentially shifted some of the disruption impact into the third and fourth quarters.

I see. It's hard to not conclude that you're also being quite concerned with this in your guidance and that I know how much you enjoy exceeding your expectations.

And don't enjoy the latter out of the [office].

Oh yes, I'm sure you don't. One more topic if you will. John, on the acquisition pipeline, can you give us an idea about the magnitude of all that you're looking at and about how big some of these projects that you mentioned were?

Well, I mean, the magnitude of all that we're looking at is kind of a preposterous number, it's huge. The ones that we're seriously looking at I would say that are on the agenda are in the five to $600 million range. Order of magnitude, I'd say -- well, probably the average is about 75 to $100 million, with one being substantially larger.

And what's the timing? I guess if you were far enough along, you'd announce contracts and the like, but are any of these far enough along that you could see closings prior to the end of the third quarter, or are these likely at the earliest fourth quarter?

Yes, I think it's very unlikely we'll close anything in the third quarter and hopefully the fourth quarter we'll see closings.

Okay. Any comments on pricing trends in the last quarter?

Well, we just saw a transaction go down which is kind of astounding, but it's still a very frothy market out there and as I said, we're [inaudible] to change our underwriting criteria. So if that means we sit on the sidelines for a while, that will be the case.

Great.

David, there is a great deal of product out and the competition remains very challenging.

Great, thanks again for your candor.

Our next question comes from the line of Will Marks of JMP Securities. Please proceed.

Thank you. Hello Bill and John and Mark. My question is on some specific properties, on [RA], I was amazed at the occupancy in the RevPAR where they are versus last year given the renovations. Had you not started the room renovations in July, or any comment there?

They were under way in April actually, they started. I think what you're seeing there is with the shrunken inventory, they were able to charge much higher rates for the [inaudible] and the rooms, so the displaced rooms tended to be the contract rooms and the cheaper rooms.

Okay. And then on an earlier call today, another REIT mentioned some slowing in leisure travel in the Southeast and not necessarily in historical quarters, but looking ahead to the summer, are you seeing any of that in Atlanta or potentially Texas?

Well, keep in mind, it's difficult to identify leisure business. I mean, we tend to be in most of our hotels, weekend, weekday oriented, and in our resorts of course, transient business is my definition of leisure. Leisure grew over 10% in our portfolio. That was the slowest grower, except for contract, that was the slowest grower of the three segments, but it's still grown at a pretty healthy pace in our portfolio.

Okay.

Orlando in the third quarter for example, we're not really seeing any kind of fall off versus our original expectations in the third quarter.

And we're an airport hotel, so the resort quarter might be different [ianudible].

Yes, so [inaudible] at this point.

But we do get Vail or Frenchman's Reef or Sonoma -- the three kind of more leisure-oriented hotels. I think all three of those hotels are going to have record years this year and they continue to show great strength throughout the balance of the year.

Okay, and then just a final question. This is something you probably mentioned and I just missed, but on [techincal difficulty] the reason for that underperformance some of your other assets? Not [inaudible]. Griffin Gate, I know you said in that comment, Griffin Gate?

Yes, Griffin Gate is kind of flat performance if you will, and what that is -- and have been for some time, we're trying to make up for the loss of the Lexmark business basically, which is impacting the entire market. Also, the hotels downtown in Lexington have not renovated as planned, so it's not going anywhere from a downtown convention estimation, so we're sort of our own rooms generator if you will at Griffin Gate. So that's why we're increasing the meeting space, and that's why we're building a very low-cost spa because it gives us the amenities and the meeting space that we need to increase the group business to overcome the loss of business transient.

Okay, great. That's all for me, thank you.

[OPERATOR INSTRUCTIONS]

Our next question comes from the line of Jeff Donnelly at Wachovia. Please proceed, sir.

Good afternoon guys. I was wondering if you could just share with us your insights on advanced bookings that you see by I guess guest type, whether it's group business or leisure, and do you have any insights on where you see the negotiating rate business for '07? I know it's a little early right now, but [inaudible].

Yes, it is early. What we're seeing though in terms of the rooms booking page from a group standpoint is we're up about almost 12% for 2006, definite on the books again at the same time last year. In '07 terms, which is somewhat relevant in Chicago, right now we're up about 8% for '07, and that's again, against same time last year. For business transient and such short-term bookings that we don't really get much visibility on that, but our forecast from the properties indicate that they expect a normal slowdown in the summertime with business transient and it's too early to tell for the fall.

From a leisure standpoint, we really don't see any change at this point in the trends we've seen so far. It may turn out that in the Caribbean, as we get later into this third quarter, we may see some kind of hurricane pull back, but we don't see it yet.

Okay, just one other question. I think I actually asked this on one of your last calls, but can you talk about whether or not there's a gap fill, if you will, between the rate and occupancy, between the two corporate assets in New York City? Has that narrowed from a -- I think it was like $20?

Actually, this was the first period of -- I'm not allowed to say it's period seven , they're very close. As a matter of fact, Fifth Avenue I suspect will surpass Third Avenue this period.

Okay, great. Thanks guys.

[OPERATOR INSTRUCTIONS]

Ladies and gentlemen, this concludes the question and answer portion of today's conference. I will turn it back to management for any closing remarks.

Great. Thanks Candice. Well, thanks again to all of you for your continued interest in our company. We're certainly committed to consistent and open communication with all of you, and we look forward to talking with you at our third quarter call if not before.

Thank you.

Ladies and gentlemen, this concludes the conference call. You may now disconnect and have a great day. `