Diamondrock Hospitality Co (DRH) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second quarter 2010 DiamondRock Hospitality earnings conference call. I will be your facilitator for today's call. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of today's conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I now like to turn the presentation over to your host for today's call, Mr. Mark Brugger, CEO. Please proceed, sir.

Thanks, Shantelay. Good afternoon, everyone and welcome to DiamondRock's second quarter 2010 earnings conference call. Today I am joined by John Williams, our President and Chief Operating Officer as well as Sean Mahoney, our Chief Financial Officer. As usual, before we begin I would just like to remind everyone many our comments are not historical facts 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. DiamondRock's second quarter results exceeded our original expectations as the lodging industry benefited from positive demand trends. We believe these demand trends, coupled with limited supply are the key ingredients for robust, multi-year recovery in lodging fundamentals.

Despite the recent release of mixed economic data, the positive momentum in lodging fundamentals appears to have a strong footing. The following data points are indicative of the early stages of a strong recovery. First, year-to-date domestic demand for upper upscale hotels has increased a healthy 10%. Second, hotel rate trends are improving as a result of positive business mix shift, particularly the resurgence of the most profitable customer; the business traveler who is displacing lower-rated leisure and contract business. Third, group booking paces continue to improve with relatively short booking windows. And lastly, industry forecasts show supply growth to be well below historical averages for the next several years. The positive operating trends are evidenced in our second quarter numbers. DiamondRock reported strong second quarter results with adjusted EBITDA of $35.8 million and adjusted FFO of $21.6 million. These results were derived from RevPAR growth of 6.1% on positive margin growth of 67 basis points as we continue to reap the benefits of cost containment efforts.

Seven of the Company's hotels recorded double-digit RevPAR improvements during the second quarter and almost half were ably to increase average daily rate. More significantly, Chicago surpassed expectations with RevPAR at the Chicago Downtown Marriott and Oak Brook Hills Marriott increasing over 30% in the last period of the quarter and over 8% for the entire quarter. In addition, RevPAR at the Conrad Hilton Chicago increased 28% in June, which will be reflected in our third quarter results. We are also excited about the exceptionally strong trends in New York with our two hotels achieving RevPAR gains above 20% during the quarter. Our Courtyard Fifth Avenue alone experienced RevPAR growth of over 31% in the last period of the quarter. Our hotels located just outside of San Francisco and Washington, D.C. were also strong performers in the quarter.

DiamondRock continues to execute on its business plan. The Company worked diligently during the last two years to navigate through the economic downturn. We focused on operating efficiencies and creating a conservative balance sheet that would give us an ability to seize upon acquisition opportunities that would inevitably arise from financial distress or simply for well-timed deals at the start of the recovery. Earlier this year, we begin uncovering these type of opportunities and during the second quarter, acquired the Hilton Minneapolis hotel and the senior notes on the Allerton Chicago Hotel. Additionally, we capped our Marriott sourcing relationship and recently entered into a binding contract to acquire the Renaissance Hotel in Charleston's Historic District. It's worth noting that two of these three transactions were sourced off-market. We're excited about the growth prospects of our announced acquisition. The 2010 RevPAR growth of the three hotels is above 10%.

Moreover, we believe that the pricing was attractive on all three transactions. But the Hilton Minneapolis and the Renaissance Charleston Hotel acquired for less than 11 times projected forward EBITDA. And the Allerton debt acquired an $8.5 million discount to par or stated alternatively, less than $140,000 per key. In total, DiamondRock was able to deploy over $0.25 billion through investments in these three hotels. Consequently, in keeping with our business strategy of maintaining a durable balance sheet with a competitive level of investment capacity, the Company successfully completed an overnight equity offering in the second quarter raising approximately $185 million. Today DiamondRock has one of the best balance sheets in the industry. By the end of 2010, even after closing on the Renaissance Charleston, we expect to have unrestricted cash of approximately $160 million pro forma net debt to EBITDA of only 4.4 times, with importantly, no preferred equity outstanding and no corporate debt.

And lastly, unsecured $200 million corporate revolver that is completely untapped. In short, we believe that our high quality portfolio, strong growth prospects, conservative capital structure and significant drive power all combine to create a powerful platform to drive shareholder value. DiamondRock will continue to prudently evaluate potential acquisitions to opportunistically grow our platform. I would note that we are seeing attractive opportunities and believe that we are at the point in the recovery where history has shown acquisitions yield the strongest returns. With that, I will turn the call over to John to discuss fundamentals and acquisitions.

Thanks, Mark. Let me begin by saying that we were pleased with the performance of our portfolio and the trends remain very strong. Specifically for DiamondRock's 20 hotel portfolio, the second quarter marked the first quarter of RevPAR growth in two years. Period six marked the first period of ADR growth since period ten in 2008. Even more encouraging were house profit margins, up 44 basis points in Q2 in the face of higher occupancies and relatively flat ADRs. The margins are even more encouraging when you consider that cancellation and attrition fees were down $1 million in the quarter, a 40 point house profit margin hit. For the second quarter, overall portfolio RevPAR was up 6.1%, driven by portfolio occupancy increasing 370 basis points to 72.7% and ADR increasing less than 1% to $160.29. Occupancy trends have been improving for the past three quarters and we appear to have reached the inflection point for rate. RevPAR comparison was positive in the quarter for 16 of our hotels.

The strongest performance came from hotels in the Chicago and New York markets. Oak Brook Hills Marriott RevPAR was up 32.5% in the quarter, and RevPAR at our Chicago Downtown Marriott was up over 8%, and was exceptionally strong in period six, which ended in mid-June. Both New York City Courtyards were up over 20% in RevPAR. Our Sonoma Renaissance continued to perform well with RevPAR increasing over 16%. Our Westin in Atlanta was up over 13% and Salt Lake City Marriott RevPAR was up 10% for the quarter. The Boston Westin RevPAR increased 6.3% in Q2. The portfolio did have a couple of laggers. The Orlando Marriott and the Atlanta Waverly Renaissance experienced RevPAR declines in Q2 of 11% and 9% respectively. The Orlando market will take time to absorb the large supply increases and Waverly had a weak group quarter.

For the portfolio, all three major segments continued to trend well in the quarter. Business transient revenue was up 7.2%, group revenue improved 5.4% and leisure transient revenue was up 1.8%. Lower-rated contract and other revenue was up 42% in Q2, but represents only about 4.7% of our portfolio's room revenue and the increases were concentrated at LAX, Orlando Airport and Torrance. As you'd expect, in the early stages of recovery, rate increases are the result of shifts in segmentation from lower-rated leisure and other to higher-rated business and group. But more importantly, from shifts to higher rate categories within the segments. In the second quarter, corporate and premium demand was very strong. Room nights in this category increased 13.2% at a rate 5.7% higher than Q2 2009, resulting in a 20% increase in room revenue coming from our highest transient rate category. In addition, special corporate revenue was up over 14% in the quarter. Q2 also continued the positive trend of accelerated short term bookings. In the quarter, for the quarter, group room nights booked increased 124% compared to Q2 2009. Portfolio grew booking pace for 2010 after adjusting prior year's definite revenue for cancellations and attrition is up 2.3% versus the same time last year as of Q2. Pace has improved sequentially in each of the last three quarters. Food and beverage was the great story in the quarter, particularly as our focus on profit maximization plans bore fruit. Total food and beverage revenue in Q2 was up 6.7% and after nine consecutive quarters of decline, margins were up 181 basis points. The margin improvement came from improved profitability in the property restaurant outlets and room service where revenues were up a modest 3% in the quarter, but margins were up over 500 basis points. As we've mentioned on prior calls, outlet profitability has been a particular focus of our asset managers for the past year. So, these results are very rewarding. Cost containment and profit maximization remains a high priority for our asset managers and operators. We've had big wins in changing staffing models, focusing on food and beverage profitability and portfolio-wide initiatives such as our energy conservation program, which ranges from efficiencies in lighting and thermostats to kitchen equipment. During this recent downturn, we were able to work with our operators to put in place new and creative staffing models to reduce cost and change the way hotels are managed. Some of these costs are temporary, such as wage freezes, utilizing PTO and reducing bonuses. However, a number of them should persist such as reduced remodels for smaller hotels as well new management models at larger hotels. Productivity initiatives and housekeeping have fundamentally reduced the time and thus the expense of cleaning stay over rooms and we will work hard to continue and expand food and beverage profit improvement. As a testament to our operators continuing focus on cost containment efforts in 2010, I wanted to share a few highlights. Portfolio labor and benefit costs in Q2 remained relatively flat from Q2 2009, in spite of higher occupancy. Sales per man hour improved 7% in Q2 versus Q2 of 2009. Man hours per occupied room improved 6.8%. However, support cost per available room including property level G&A, repairs and maintenance, utilities and sales and marketing were up 5.6% in the quarter, due mainly to bonus accruals and Marriott sales initiatives. These two cost categories negatively impacted house profit margins by 60 basis points. Turning to capex, we are fortunate that we entered the downturn with a mostly renovated portfolio and were able to appropriately curtail capital spending during this downturn to only necessary or truly value enhancing projects. We're budgeting to invest approximately $35 million in the portfolio in 2010. The owner-funded portion of 2010 capex is budgeted to be $7 million, with the balance coming from property level reserves.

In Q2, we invested $5.7 million in the portfolio. Our team continues to look for creative ROI capex projects. For example, in 2010 we're adding a pavilion to our Griffin Gate Marriott to capture more group rooms. Additionally, our team is spending considerable time in evaluating a major, multi-million dollar 2011 renovation and repositioning of the Marriott Frenchman's Reef Resort. We'll have more details on that project during our next earnings call. Turning to acquisitions, we've been very active this year. In June, we acquire the 821- room Minneapolis Hilton for $156 million, representing a 7.5 cap rate on actual forecasted 2010 NOI. We're very bullish on growth prospects at the hotel and some potential ROI opportunities.

The property results continue to improve with room revenue up nearly 30%, total revenue up 22% and house profit up 30% in June, compared to June of 2009. The forecast for July, August and the fourth quarter are strong. Moreover, 2011 is shaping up nicely with group booking pace at the Hilton up 8.5%. In-group revenue represents 0.6 of annual room revenue at the hotel. Continuing on the acquisition front, we have the Charleston Renaissance under contract and expect to close the transaction in August. This 166 room hotel enjoys an excellent location in the coveted historic district. The $39 million purchase price reflects approximately an 8 cap on actual forecasted 2010 NOI. This opportunity was a result of our special sourcing relationship with Marriott International. It was facilitated by leveraging a contractual right of first offer Marriott enjoyed under its management agreement. Marriott presented us this opportunity at one of our regularly scheduled acquisition pipeline meetings which enabled us to negotiate a deal with the owner to buy the hotel before it was marketed to other potential buyers. Lastly, we purchased the first mortgage on the Allerton Hotel, which enjoys an A+ location on North Michigan Avenue in Chicago. This was another off-market transaction.

The mortgage, which is in default, and came due last January was acquired from Wells Fargo for $60.5 million, a significant discount from face value. Our cost basis is less than $140,000 per key and compares very favorably with recent trades in Chicago. We're pursuing our rights by foreclosing on the hotel to either get repaid at far, with default interest, or alternatively, gain fee simple ownership of the hotel. If we gain fee simple ownership, we're likely to convert the hotel to a global brand in order to maximize its value. Our acquisition pipeline continues to be strong as higher quality deals are coming to market.

However, we remain very disciplined. We've either passed or been outbid on numerous opportunities where we felt the pricing was too rich. After we close on the Charleston transaction, we will have invested $250 million this year. We still project to have a year-end cash surplus of $160 million plus our undrawn $200 million line of credit. So, we will continue to look for acquisitions that drive shareholder value. With that, I'll turn the call back over to Mark.

Thanks. As John noted, operating trends continue to show positive momentum and visibility is improving. As previously announced, we revised our outlook to reflect these trends and incorporate our recent acquisitions. For the full year 2010, the Company now expects its portfolio to experience RevPAR growth of 2% to 4%. Accordingly, we expect adjusted EBITDA of $132 million to $136 million and adjusted FFO of $83 million to $85 million, which assumes income tax expense to range from $3.5 million to $5.5 million. Consequently, adjusted FFO per share is expected to be between $0.57 and $0.59. Let me conclude by saying that with our high quality portfolio enhanced by our recent acquisitions, along with the Company's acquisition pipeline and related investment capacity, DiamondRock is well situated to take advantage of both the lodging recovery and the acquisition environment going forward. Now we would like to open up the call for any questions you might have.

(Operator Instructions) And our first question comes from the line of David Loeb of Baird. Please proceed.

Good afternoon, gentlemen. I have just a couple. Probably both for John. In Charleston, when you did your underwriting, and certainly when you were talking to Marriott, how big a consideration was the pending conversion of the Holiday Inn to a Courtyard and expansion of that hotel as well? Was that something that you took into consideration? Was it something that Marriott shared during that process?

Yes, David. When we underwrite these things, we try and capture all of the potential supply increases, obviously. What really impressed us in Charleston was a, the location of the Renaissance. You can make arguments for the potential Courtyard location, but because of the central location closer to the Historic District, or in an Historic District, closer to some of the historic attractions as well as all the revenue and retail available on meeting and society streets, we just feel this Renaissance location is going to get first crack at Marriott business that comes into the city because of the location. Number two, when we went down to Charleston, we were pleasantly surprised to find that not only it is a stable asset that really didn't have a big pique to trial swing, but there's actually great growth potential down there with the new Boeing 787 assembly plant that's under construction out by the airport, which is just a few miles from the hotel and Southwest entering the market next May. Both bode very well for hotel demand. One of the great things about this market and this brand for this location is that even the business that's working out at the airport would prefer to be done in the Historic District for all the amenities that it affords. So, increased commercial business will obviously help our growth rates, but -- and then obviously, the tourist business which is a staple in Charleston is a very reliable return business.

So, sounds like both hotels have very good prospects for growth then?

That's our feeling, yes.

Second question, John. Your discussion of margins was very thorough and I appreciate that. And clearly, looking at hotel by hotel results there's a lot of up and down in the portfolio. A lot of likes it corollates fairly tightly to where ADR increased or where most of the rough part was from occupancy. But you talked about some other factors. What about cancellation fees a year ago? Was that a significant factor at any of your larger group houses?

Yes it was, David. It was particularly impactful at the Chicago Downtown Marriott. Right offhand I don't remember the percentage of the total roughly $1 million of attrition and cancellation fees coming from Chicago, but it was obviously disproportionate. Boston had the same phenomenon and both the Renaissance hotels were other big contributors. As you might guess, the major group houses take the bulk of that hit.

Yes. That makes sense. And LA as well?

LAX to a lesser extent. And your observations on margins are correct. Food and beverage were big drivers of margin this quarter, which we're really excited about. But where you saw occupancy gains at the expense of rate, margins were challenged and vice versa where you saw average rate gains in slightly lower or flat occupancies, margins tended to improve.

Okay. Great, thank you very much.

Your next question comes from the line of Chris Woronka of Deutsche Bank. Please proceed.

Hey. Good afternoon, guys. Thanks for the color on the cost. On the support cost that you mentioned, can you give us a picture of how they compare to peak levels or some other metric? Just how should we benchmark those going forward?

Hi, Chris, this is John. That's kind of a tough question. If you look at peak support cost as a percentage of revenue, you're in the 22% to 24% range and it's higher now, but obviously, you target to get there or lower again. We have some unusual things, bonus accruals coming back into the equation for the first time in probably two years, had a fairly significant impact on A&G as well as some of the departmental profits, but to a much lesser extent. And then the Marriott sales initiative, Sales Force One, which is being rolled out in a couple of our regions and impacting our -- particularly our Chicago hotels and some others, had a -- the start up costs associated with that had a measurable impact on support cost, sales and marketing. If you take those two out, the quarter-over-quarter growth, year-over-year I should say, is only about 2% in support cost, which is pretty defensible. And as I said in the remarks, it's about 60 basis points on total margin hit.

Okay. That's helpful. And does that, since you've begun accruing some of those bonus expenses, does that mean we shouldn't necessarily look for a big ramp up or what drives that really?

They're, based on their forecast, they're estimating their bonus accrual requirement, so we -- as volume increases and profits improve throughout the year, you'd anticipate that process to continue. It's a one year phenomenon. It should not disproportionately impact next year's numbers.

Okay. Great. Just on the few you mentioned that were a little bit -- underperformers, Orlando, LAX, you mentioned the pricing environment's pretty strong in terms of sales. Do you look to sell those, or how do you look at recycling at this point?

Hey, Chris, this is Mark. I'll take that one. On the dispositions, I think we are going to look over the recycle -- be more active in the capital recycling business over the cycle. This doesn't seem like the ideal time to sell those kind of assets. Where we're seeing the most activity and the most froth, a lot of the markets -- things that are in bid today are in urban CBDs. Maybe in LAX it would make sense, but we think we'll probably get a better price for it if we hold onto it for a couple more years and let the cash flows really return closer to where they were last peak and then try to sell assets like that.

Okay. Very good. Thanks.

Your next question come from the line of Jeff Donnelly of Wells-Fargo. Please proceed.

Mark. Hey, this is Jeff. Actually, if I could just build off the answer to your last question. When you think about that hold versus sell analysis, are you able to share with us how you put a discounting back into the those future values versus selling today. I think that's the debate in everybody's mind. Is it good to take advantage of the pricing today even though cash flows are low versus waiting?

It's a balance. As you know, certain markets are attracting more attention than others. And then, for each individual asset we've come up with a long term view of where we think cash flows are going. Some are going to return clearly, we think, past peak. Some aren't going to get back to peak because of their supply in the market or other things that may have shifted. So, it's a different story for different assets. And what we try to do is take it one asset at a time.

While we go through the assets that are probably at the top of our list to dispose of probably are not the ones that would get the most attention in the marketplace today. So, we think it will be more optimal and we'll get a better return for our shareholders on those type of assets if we wait out. Now with that said, we may decide to test the market with one or two assets over the next 12 months, just to see what the level of interest would be and see if we could clear our whole price if you will.

Okay. And just backing up and looking at guidance, Mark back in -- way back in the fourth quarter 2009, I think DiamondRock was arguably towards the -- I'll call it the low end of guidance among your peers, for RevPAR growth that is. And today you're, I guess I'd say you're more towards the midpoint, which, I'd suspect we'd characterize you guys as someone who's initially cautious and has become more confident. Beyond just the absolute result certainly we've seen thus far, are there underlying details that may be invisible to folks like us that really led you to become more believer or more confident in this recovery?

Well, I think just the demand levels that we saw over the first half the year, you're continuing to we're all had a budget, we keep exceeding forecast on a period over fourth period basis. You can see the trend lines firming up. Although things like group booking windows remain short, you can see the trends are increasing and the solid line continues which give us you more faith in it. We see the corporate spend up at the hotels. There's a lot of things going on here which are typical of what you see in the beginning of a recovery and there are things that we're focused on that give us greater confidence.

And Jeff, if I could just add -- this is John. We said beginning third or fourth quarter last year that what we were looking for was operators to outperform budgets on a periodic and quarterly basis and at the same time raise forecasts for the balance year. We didn't see that at all in 2009. It was not apparent early this year. But we've begun seeing that. So, that combined with what's called in the funnel in the group business or tentatives that look like they're going to be able to be converted into definites going forward. Some lead time statistics have led us, over the last probably quarter and a half, to become more convinced that this is an enduring recovery. Having said that, we're all reading the economic news and it's a little scary. But it's not showing up in our numbers yet.

Just one or two last questions. John, on the acquisitions front, are you able to talk a little bit about what your pipeline looks like, maybe for the back of the year? How likely the next few months could look like what we've seen out of you guys for the last few months for acquisitions?

Well, the marketed pipeline is definitely built in volume and quality. What we're little taken aback by is the pricing that we're seeing or at least hearing from price expectation direction given by wither brokers or sellers. We've seen a couple transactions that did close at those very high prices and we're waiting to see what some of those portfolio deals are going to look like, which we have passed on. So, quality and volume definitely higher. I think there's a certain amount of price testing going on in the marketplace. We've been able to find the ones we've been able to find have been comfortable with the cap rates, but we're not comfortable with really low cap rates. So, I don't know what activity you'll see from us in the future. We are fairly close on one asset that we think may materialize in a top five MSA that looks good, but that was another one that we really worked pretty hard to get close to.

And just the last question, how do you guys think feel about bringing back your dividend in 2010 and 2011? I know a lot of unknowns ahead, but obviously it's the important part of the story for people. How do you think about its growth?

Hey, Jeff, this is Mark. The dividend's obviously very important. What we've talked to with our Board, particularly the last meeting, is we're going to make a final evaluation as we move towards the end of the year and have better visibility into next year and then we'll see where we are from a cash and acquisition standpoint. And then how confident we are in the 2011 and 2012 performance in the hotels and then we'll make a decision at the end of the year. But it's something we're very focused on.

Thanks guys.

Thanks Jeff.

Your next question come from the line of Shaun Kelley of Bank of America. Please proceed.

Hey, guys, good afternoon. Just really wanted to ask a couple questions about a couple core markets. First of all, was on Chicago since you saw some pretty significant growth there. Pretty good, it sounded like, in period six. Could you even just talk to us a little bit about obviously it's a big convention town, could you talk to us a little bit about the calendar there, how you guy think about the back half and then probably, more importantly, how you think about 2011 on that side?

Yes. There are a couple things going on here. This is John. One of the drags on-- you're right it's a huge convention town and it drives the whole city -- McCormick Place does. One of the drags on the booking process in Chicago was the work rules and the associated labor issues that they had for several years and we're really causing some big groups to either cancel or threaten to cancel. The state and the city and the convention business bureau and the convention bureau all got together and they basically solved the work rule issues associated with McCormick Place and therefore, they've made it a much more user friendly environment for the exhibitors and therefore, the meeting planners are feeling much sanguine about booking groups into McCormick place. That has huge implications for the city. It's going to take time for that to translate into increased bookings.

The second quarter was stronger than we anticipated in Chicago. The third quarter had some tough comps last year, but it looks pretty good. In Chicago, in particular downtown Chicago, at the Marriott we're really pushing rates just to test the market and so far, the results are pretty good, not great, but pretty good. So, we would anticipate that the convention contribution for the balance of this year and 2011 would still be average, if you will, by historic standards. The next big year appears to be 2012. There may be some short term bookings in 2011 that improve that. But right now it looks pretty similar to 2010 which is pretty average by Chicago standards.

Got it. Thanks, John, I appreciate that. And then the second question was really on the New York assets that you guys, the two Courtyards obviously posted some pretty phenomenal RevPAR and margin growth. Wondering how do you guy think about those assets and have you seen any other deals on the limited service side in major metro MSAs that might fit the portfolio since that's a segment that you guys have tapped into some of the other guys have not yet?

Yes, there are some limited service urban assets for sale. Some of them don't look too bad on a cap rate basis, but when you begin to look at per key and replacement cost, they get to be a little bit disconcerting. So, there's one big one in a mid-Atlantic urban area that's trading that looks like a decent cap rate, but then when you look at the price per key, it scares you away. There are some in New York that are being marketed. And yes, we are pursuing more of those, but they have to be major urban areas where these hotels can act like full service hotels with a limited service cost structure.

Got it. John any sense on just general range of per key values right now in New York City on some of those assets?

Well the recent trades have been in low to mid 300 per key range for limited service hotels. That's New York and then in Washington there haven't been too many, but the one we've heard about is sort of in the same range, which is a little unusual.

Got it. That's helpful. And then, just one last question, you mentioned in your response to a prior question that obviously some of the cap rates are extremely low in some of these urban areas. How important is cash flow when you underwrite relative to what you think that end of cycle valuation is? Because we have seen some assets, obviously the Sir Francis Drake in San Francisco being the most obvious one where it was a very low, front end cap rate, but obviously somebody seeing some value there.

Yes. I guess I'd put it this way. We find certain markets to be kind of yield challenged if you will. They are great capital gains opportunities frequently, if your timing is good. We kind of view our role as a public real estate investment trust to be more yield-focused than capital gain focused. This was a call to San Francisco specifically that we made last cycle when all of these assets were trading in pre-cash and we made sort of the macro call that that was not going to be a market we were going to play in. We looked carefully at San Francisco transactions that have and shortly will transact in San Francisco and we're sort of making the same macro call at this point that we're going to search for yield before we search for capital gains. Not exclusively, but in these cases, we came to those conclusions.

Great. That's helpful. Thanks, guys.

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

Thank you. Hello, everyone. I have a question just on the share count. You gave it in your guidance $144 million average. If you take the third quarter, the current one's 156 and you average that over the second half the year, I think you come up with a higher number than the 144. Can you explain or give anymore detail?

Hello, this is Sean. The second quarter number, the shares came in at the very end of the quarter which was due to calculation, but we're comfortable with that $144 million weighted average share calculation.

Maybe you can help me, what should the third and fourth quarter approximate share numbers be? Lower than the 156?

No, we're in the mid 150 for the third and fourth quarter. The weighted average number of shares at the end of the quarter.

Okay. Got it. One final question on -- you gave plenty detail on Chicago. Related to that, how much of Chicago is transient versus group?

The whole market?

Or let's say for your assets and the whole market, if you can offer that.

For our assets, I can say that the big Downtown Marriott is 55% to 60% group business. The Conrad is only 25% to 30% group business. It's a function of both size and meeting space. That's pretty much where we come in year after year.

Is the transient pick up there in line with national averages? Below? Above?

It's started out in the first quarter below, I would say. As the second quarter rolled through, it improved dramatically and it was above towards the end of the second quarter. I'm not sure in period seven where it came in.

Okay. That's helpful. That's all for me thank you.

You as well.

Your next question come from the line of Ryan Meliker of Morgan Stanley. Please proceed.

Good afternoon, guys. A couple quick questions. The first thing is that you spoke a little bit earlier about improving trends. I know the actual number might not be relevant, but I I wanted to talk a little bit about group rates for your portfolio and really how it's trended from maybe the start of the year to now, both in terms of room nights and rate. Add any color on that?

Sure. It basically has improved the definite pace of revenue for group has improved the last three quarters. Just by way of example -- for the next two quarters, one statistic I've got in front of me, as of the first quarter of this year, the group pace was down about 16%, it's currently down about 2.2%, that's Q3 of this year. Q4 was down after the first quarter about 1% and it's up about 5.7% as of the second quarter. And that's a fairly consistent trend that we've seen going back to third quarter of last year. It's mainly room nights, the improvement is mainly room nights, but rate has pretty much flattened out now too.

Great. That's helpful. I don't know what you guys can comment on and what you can't, so obviously you be the judge of that. But, as you know with regards to the Allerton Hotel, can you give some color on what's going on there and what the potential outcomes are? It seems odd to me to see a borrower funding debt service during a foreclosure period. I know there's a lawsuit, so maybe you can't provide much information. But just what's going on, or what they've said they're looking for as an outcome? Not necessarily that you agree with it or that it's going to come out. Just trying to give any color on that situation will be helpful. Thank you.

Sure, this is Mark. On Allerton Hotel we obviously own the senior note. There was a cash management agreement that was put in place when they did the original loan. We put in place what they call lock boxes or a cash management system there. So, the cash is getting swept from the hotel, and the excess cash the hotel's generated now, and it is cash flow positive, is getting used to pay interest on the debt that's in default. So, that's why we're talking about interest being realized on that hotel during this year.

Now, as far as potential outcomes, they have the right to pay off the loan in part. We'd realize a gain and it would be an IRR north of 25% for us if we got paid this year. That's one outcome. We understand that the junior piece to us or the people behind us are in the process of trying to market their interests and if they do, we presume that we would get paid off. If they're unsuccessful, we file for foreclose or the process of filing for foreclosure starting in April. That's usually nine month, 9-12 month process, that's getting prosecuted in the state courts and we're moving forward with all due speed on that process. So, potential outcomes are we get paid off at par and realize a big gain, or we move forward with the foreclosure and potentially get control of the hotel on a relatively inexpensive basis. Sometime middle of next year.

And from a time line standpoint I guess it really comes down to the foreclosure proceedings, so they have until you guys actually are successful in foreclosure to pay off the note in full? It that correct?

Yes.

One last question regarding the other acquisitions, the Hilton Minneapolis and the Renaissance Charleston. I don't know if you've looked into it, I'm assuming you have, are there additional opportunities for cost savings at those properties? Particularly maybe complexing? I know you've looked at complexing support costs at some of your other properties. Is this something that you'd look into in these markets? Do you think you've got other owners that might be open to that type of idea to help maximize cash flows of those properties?

I'll take them one at a time. The Minneapolis Hilton is an extremely well-run property. We think the opportunity there is from recently added meeting space and some potential new meeting space that we think maybe potentially to be added which would really help the group base there. Historically, they kind of peaked out in the mid 135,000 group room nights. We think with the new meeting space, what they did was they added 5,000 square feet, combined it with another space and have a nice 10,000 square foot junior ballroom. We think that 135 can go to more like 155 which helps not only the overall occupancy, but with the compression on the remaining 70,000 or so transient room nights pricing power.

And then, on the Charleston asset, we do see some opportunities on the cost side of things. Particularly in food and beverage. It's been a thrust of our asset management across the portfolio and we see some of the same opportunities there. There may be those opportunities at the Hilton, we haven't uncovered them yet. So, yes, we see potential cost saving there. And then SFO at the Charleston hotel will reduce total sales and marketing costs by about $83,000 this year. So, it's been a very successful program there.

All right. That's helpful. Thank you very much guys

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

KBW. I'm just wondering, looking back at 2007 where you had peak margins of around 29% and given, you've talked fairly extensively about changing the business model. Is if fair to assume then, that you can return to those kinds of margins without getting the same kind of absolute RevPAR numbers on a same-store basis. I'm just sort of wondering could you kind of quantify like how many -- if you had this business model in place now in 2007 would the margin have been more like 31% instead of 29%? What's your sense of how much you've taken out of the business?

It's hard to answer that question because there are so many moving parts. Things like utilities, things like just overall wage increases that are inevitable, benefit increases that are unfortunately inevitable. There have been cost increases just in the normal inflation -- cost inflation that offset some of the functional savings that we found. I would say without the RevPAR recovery, it would be difficult to get back to those margins again. I think the RevPAR recovery's critical. I think we've saved the costs we're going to be able to save in these hotels and the next step is to gain revenue. But I do think the margin, well, speaking historically, coming out of the last downturn which was supposed to be the worst ever, we all found out it can always get worse. The margins were, at peak, were better than the previous peak and we would expect that to happen again, assuming we get the revenue recovery we all anticipate.

Okay. And then -- oh, go ahead. Sorry.

We've done some analysis and modeled it out. If we returned, but we haven't done variations of what if we don't return to next peak. But assuming that we return back to '07 levels of RevPAR, with a similar ratio of occupancy and rates, a number of these programs, especially with the new operating models and some of the consolidation of costs of the sales program across the portfolio, we'd envision that margins could potentially be 100 to 150 basis points better than they were last week. Obviously, there's a lot of moving pieces, as John said, depending on what happens with labor costs and other things across the industry in return of some brand standards. But, based on some preliminary analysis, that's what we're projecting.

Okay. No, that's very helpful. That's exactly what I was looking for. On the credit line, you announced some incremental detail. I'm just wondering, do you still have to hold back four assets unencumbered? And are there four assets - if so, are there four that are specified or is it any four that you choose?

Smedes, this is Sean. The new facility does have a minimal number of unencumbered borrowing based assets. As you know from our capital structure, we have currently 12 unencumbered assets after the Charleston deal. So, we're not going to have an issue with respect to holding back their assets. Under the new facility, there are certain assets within our unencumbered pool that have title restrictions on them and others, Boston being the largest one of those assets. But generally speaking, we have great flexibility under the new facility to take assets in and out of the unencumbered borrowing base.

Okay. And then my final question, just on Chicago, there's a JW Marriott opening later this year. I'm just wondering, are you starting to -- when you talk to your guys mainly at the Downtown Marriott, are you hearing any competitive impact from that in terms of going after groups?

Yes, we anticipated, this is John, we anticipated that we would feel more than that we have. We asked the question, if not hourly, daily, and we've been pretty pleased that we have not been impacted on the group side according to our local management by that JW Marriott. It's in the loop. It inevitably will have some impact when it opens. It's a little late opening. But, it's a lot of rooms, a lot of meeting space and at some point, I would anticipate that we would feel the competitive pressure.

Do you know when it's supposed to open?

I haven't heard a recent estimate. It certainly is not June as it was originally scheduled. So, maybe September. I think September was the last date we heard, but that was quite a while ago.

Okay. Thank you very much.

Your next question come from the line of Michael Salinsky of RBC Capital Markets. Please proceed.

Good afternoon, guys.

Hey Mike.

First question, just going back to your pipeline there. How much that's coming via the Marriott relationship? You've got the Charleston there, but I'm just curious as to how much you're seeing coming through that relationship at this point versus how much is marketed transactions?

We're having an increasing level of conversation with Marriott about opportunities. But it's not, I wouldn't say it's a particularly robust portion of the pipeline at this point. We were thrilled to get Charleston and that was clearly a result of that relationship. We're talking about a couple of others that are very complicated and pretty far down the line. But I would say it's not robust at this point.

Did you guys do anything on the debt side? Acquire a discount note similar to Allerton through the Marriott relationship there to take over?

At this point, Marriott doesn't own, it owns virtually no debt positions, unlike when we came out the last downturn. So, I don't think that there's a lot of opportunity. Allerton was really a unique situation where we were able to get the deal off market. We knew what the brand alternatives were. Obviously, we own a lot of projects in Chicago, so it was easy for us to underwrite the potential (inaudible) on that. But those opportunities are relatively unique in the marketplace. So, yes, if we had one that came through that had all those unique characteristics, we would look at it, but it's clearly not our core mission.

Okay, that's fair. Switching gears here, just going back to the dividend question, based upon your current guidance there's no special dividend or anything required at this point, correct?

Right. What we said before is we anticipate paying out at least our taxable income and based on our latest projections, we don't think we'll have taxable income in 2010. Now, the board may always decide to pay out a dividend above that level, but that's not where we're guiding to currently.

Okay. And then I apologize if I missed this, did you talk about your group pace for 2011 at this point? And also how ADR stacks up for those at this point?

We did not mention that and it's a little -- it's not exactly comparable to the 2010 pace, because we have not adjusted, obviously 2010 for some of the later years' cancellations that we may get. But, at this point, we're down in revenue about 10% versus same time last year as of Q2. Because of the trends we're seeing in short term bookings and pick up, the pick up in the last few quarters has been 100% and 125% greater than last year. As that continues, and we anticipate it will, we expect that we'll cross over into next year with our target number of group room nights and revenue. But we had some work to do in the third and fourth quarter.

How much of that revenue is ADR driven versus how much is occupancy at this point?

Room night is about 5% and rate is just over 5%.

Okay. That's helpful. Then finally, the Charleston acquisition seems like it's going to be paid for with cash. I'm assuming beyond this you guys are going to work down the cash balance. At what point in the cycle do you guys feel comfortable starting to look to the debt markets again to start putting mortgage debt on some of these properties to increase your purchasing power?

Michael, this is Mark. I think from our preliminary strategy is obviously to use the cash that we have on our balance sheet because that's the most efficient use in the capital structure , then probably to use the line of credit to some level and then as the secured debt market improves, which we anticipate it will over the next 12 and 24 months, potentially use the secured markets on individual and non-recourse basis as a financing strategy going forward. Obviously, that needs to remain flexible and depends where rates go and how the secured market

Okay, so then you're telling me you're still not comfortable with the secured market where it stands?

Well, I think, clearly having $160 million in cash on your balance sheet, it's more efficient to deploy those in good acquisitions. That makes the most sense for the initial funding for the next acquisition. And then line of credit is pretty well priced, so that's a attractive, and it's got four years including the one year extension as soon as we get this new line closed. So, it's got decent term on it. And I think on the secured market, we'd also like to see the term lengthen out. Right now the market has five years and we'd prefer to see it lengthen out to ten years so we could lock in some lower rates assuming that the spreads continue to come in.

Mike, this is Sean. Another comment on the secured financing market. Rates have come in quite a bit. They're in the sixes now for hotel financing. Where we're still struggling a little bit is that their still being part -- the proceeds are being arisen from trailing 12 cash flows. So, unfortunately in today's market, you're getting attractive rates, but you're still not getting the proceeds that you want to get to have efficient, secured financing on a deal. As you look forward, you'll see those proceeds would feel like 55% LTV today quickly turn into 35% LTV on more normalized earnings, which we don't think is efficient for individual assets.

That's very helpful, guys. I appreciate the color. Thank you.

Thanks, Mike.

Your next questions come from the line of Dennis Forst of Keybanc. Please proceed.

Yes. Good afternoon. I wanted see if I could flush out, get a little more color on a comment about acquisitions being attractive on a cap rate basis, but not on a per key basis. How do you go about lining up those two different factors?

Well, when we're looking at an acquisition, obviously we're looking at target cap rate ranges depending upon the market. And I think we tend to be a little more conservative until we see the market tell us we need to consider it otherwise. But in a couple of cases, one was limited service and one was full service. The cap rates led you to numbers where the -- actually the hotel operators were kind of victims of their own successes. But it led you to numbers that were significantly over our view of replacement cost. And that's sort of where we begin to think twice about the attractiveness of the apparently good cap rate.

Why is that?

Because if the trades over replacement cost then the likelihood of new supply increases dramatically.

Okay thanks.

(Operator Instructions) Your next question comes from the line of Bill Crow of Raymond James. Please proceed.

Good afternoon, guys. Couple of questions. On the acquisition philosophy I guess, you talked about being more yield-oriented buyers. Do you think about what the CAGR on EBITDA your core portfolio is? Are you sensitive to whether it's an acquisition be accretive or dilutive to your existing portfolio's growth potential?

No. This is Mark. I think the first metric you need to look at is an IRR basis. So, we need to make sure it meets a minimum hurdle rate and we look at unlevered IRR in the low double-digits. So, that's the first screen. The second screen, and there's other things out there, price per key and other things you need to use in your judgment about determining the validity of that IRR calculation, but we're looking for assets that generally improve the portfolio quality and improve the average growth. So, to your comment the CAGR of the portfolio over the next five to ten years. So, that's an important consideration. Now, you would balance that (inaudible) slightly slower growth, but if you get a great price on it, you'd consider that because you'd have the higher IRR.

Conversely, you might do a lower cap rate deal that has greater growth, because you're still going to get your IRR and you're going to get the better than average growth rates going forward. So, it's always a balancing act, but it's certainly something we take into consideration.

Okay. Good. Seems like the market's paying for growth potential as much as anything else right now. The other question I had really was on brands and as we go through this cycle, how much you're going to push expenses down to the owners. The reason I ask the question is because you eluded to a Marriott sales initiative and a higher cost coming from that. Could you kind of describe what that initiative is and the benefits you think you're going to derive from those additional costs?

That question merits a very long response which I'm not going to give you here, because we don't have time for it. But basically the Sales Force One initiative is an initiative by Marriott to centralize their sales efforts into enterprise offices and regional sales offices, taking salespeople out of the hotel. In terms of -- it's being rolled out across the country. It's been rolled out in the mid-Atlantic region, being rolled out in the northeast region, being rolled out in the Midwest as we speak and then on the West Coast, I think it starts very shortly. There are initial start up costs associated with that, office space, hiring people for the central offices. There are also some savings as you take people out of the hotel. But the benefit is that the customer is receiving fewer sales calls, but more targeted sales calls. So, the enterprise accounts, the largest accounts that Marriott faces, one person at Marriott is in charge of that relationship.

So, that customer is not being called on by eight or ten group sales people from various hotels across the country. That's the idea. So, it's intended to be cost neutral. At the start up phase, it's proving to be not cost neutral. But, I don't think that was completely unexpected. And on the revenue side it's extremely difficult to measure because of the wild ride we've had in the overall economy and the lodging space.

And then, just a housekeeping question, your quarterly RevPAR, if you put that on a calendar basis, do you have that number?

It's roughly the same as what it would be for the second quarter. Within 25 basis points one way or the other.

Okay. Great. Thanks guys.

No more calls?

At this time, we have no further questions in the queue, and I would like to turn the call back over to Mr. Mark Brugger for closing.

Thank you, Shantelay. We would like to express our appreciation for your continued interest in DiamondRock. Enjoy the rest of your summer.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.