Diamondrock Hospitality Co (DRH) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2011 Diamond Rock Hospitality earnings conference call. My name is Stacy, and I will be your conference moderator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of the conference.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to today's host for today to Mr. Mark Brugger, Chief Executive Officer. Please proceed.

Thanks, Stacy. Good afternoon everyone, and welcome to Diamond Rock's second quarter 2011 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. As usual, before we begin, I would just like to remind everyone -- many of our comments are not historical facts and are considered forward-looking statements under Federal Securities law. They may not be updated in the future. These statements are subject to risk and uncertainties described in our securities filings. Moreover, as we've discussed certain non-GAAP financial measures, it may be helpful to review the reconciliation to GAAP in our earnings press release.

Let me start the call today by saying that the lodging recovery is going well, as the industry is coming off 6 consecutive quarters of demand growth. We continue to be very optimistic about the future of the travel business. With recent mixed macro-economic indicators in headline news, it is understandable that some investors have grown more cautious. However, based on the trends we are seeing in our portfolio and the industry, comparisons to trough results, and constrained new hotel supply, it is our strong belief that we are setting up for a significant multi-year recovery in lodging. In particular, we are very optimistic about Diamond Rock during this cycle. Despite some unevenness in the first half of the year, booking pace and transient trends support a stronger second half of 2011.

More importantly, we expect our portfolio to perform very well in 2012 due to several factors, including, 1, strong citywide calendars in Chicago and Boston, our 2 largest group markets; 2, a renovated and re-positioned Frenchman's Reef back online; 3, increased exposure to New York City; and 4, strong growth from the Salt Lake City Marriott due to the opening of the $1 billion City Creek development surrounding the hotel. For the second quarter of 2011, Diamond Rock's portfolio of hotels generated RevPAR growth of 6.4%, and hotel adjusted EBITDA margin improvement of over 100 basis points. This RevPAR margin data is for our 25 owned hotels as of the end of the quarter, and excludes Frenchman's Reef

. For the quarter, Diamond Rock generated adjusted EBITDA of $41.1 million, and adjusted FFO of $0.15 per share. It is worth noting that the renovation disruption of Frenchman's Reef displaced approximately $5 million in revenues, and $3.5 million of EBITDA during the second quarter alone, which is modestly more than we originally estimated. Our second quarter results were led by outstanding performance at the Chicago Conrad, and the Marriott Atlanta Alpharetta, both of which grew RevPAR over 20%. We also experienced double digit RevPAR growth at five additional hotels, including our hotels in Charleston; Sonoma; South End, New York City; Oak Brook Hills, Chicago; and Salt Lake City. Our single hotel in the Washington, D.C market gained market share, with RevPAR increasing a respectable 6.1%. With all of that said, year-to-date group revenues, and in-particular group spend in the portfolio, has been behind our expectations; particularly at 2 of our largest hotels, the Westin Boston and Chicago Marriott.

Despite strong overall transient demand in both Boston and Chicago, the softness in second quarter citywides resulted in these two convention hotels being down 7% the last year in group overnights, and 9% in highly profitable banquet and AV business. Fortunately, both hotels expect stronger group business for the back half of 2011, with group revenue pacing up almost 8% to last year. Even better, for 2012, the Chicago Marriott and Westin Boston are collectively showing group pace up over 14%. We remain committed to, and excited about the Chicago and Boston markets going forward.

Turning to acquisitions, the company has been very active during 2010 and 2011. It's been a great time to buy. Since only last year, Diamond Rock has completed almost $900 million of hotel-related investments in 8 separate transactions. Since the start of the second quarter alone, the company acquired the Lexington hotel in midtown New York, the JW Marriott Denver, and the Courtyard by Marriott Downtown Denver. In addition, early this year, we agreed to acquire a hotel under development in Times Square. Each deal represents excellent value, provides significant upside over the next few years, and enhances the overall Diamond Rock portfolio.

Although John will discuss our recent deals in more detail, I did want to provide a few data points on the hotels acquired since early last year. First, the hotels were purchased at attractive valuations, averaging an 11.8 times multiple projected 2012 hotel EBITDA. Second, hotels increased our portfolio quality, raising portfolio RevPAR by $7, and increasing margins by 225 basis points. And third, we increased our exposure to markets with excellent long-term growth prospects, including increasing our profits derived from New York City from 9% in 2010, to over 25% beginning in 2013. On a related note, we continue to evaluate selling certain non-core hotels over the next 18 months, to create additional investment capacity to invest in high-growth opportunities.

Turning to our capital structure and balance sheet -- in our opinion, balance sheet strength doesn't get the focus it deserves at this stage in the lodging cycle. Since the company's inception, Diamond Rock has remained committed to low leverage and a straightforward capital structure. We believe that over an extended period, this will yield stronger returns for our shareholders, provide capacity to pay a predictable and sustained dividend, and prevent value destructive capital decisions under duress during the inevitable next cyclical slowdown. We believe that our balance sheet distinguishes us from a number of our peers. Moreover, providing income to our shareholders is very important to us. Our dividend yield is over 3%, is well covered, and substantially higher than many of our peers. Our projected 2011 net debt to EBITDA ratio is a moderate 5.4 times. This solid debt ratio should only get better in 2012 as hotel cash flows improve, and we regain the displaced renovation business at Frenchman's Reef. While we believe that this ratio is conservative in its own right, it is even more meaningful when taking into consideration that we do not have any preferred equity outstanding, and we have no complicated joint ventures.

Before turning the call over to John, I want to provide a quick update on a few other matters. First, property taxes. Property taxes are notoriously difficult to predict, due to the timing of reassessments and appeal settlements, as evidenced by our positive results in Chicago and Atlanta during last year's fourth quarter. We are currently actively managing tax appeals at 15 of our 26 hotels. The pilot tax program at the Boston Westin ended on June 30. We recently received our 2012 tax assessment, which, somewhat surprisingly, raised the hotel's annual property taxes. Although we are taking steps to appeal this new assessment, we will accrue for the higher property taxes in our forecast. The increase in property taxes will have a $1 million impact in the second half of 2011, which was not reflected in our prior guidance.

Second, the Allerton Chicago. As many of you know, we took advantage of this distressed debt opportunity last year by buying the note at a substantial discount, the equivalent of about $140,000 per key. Despite triggering a recourse guarantee, the owner put the hotel into bankruptcy last quarter. We intend to see the process through, and are vigorously pursuing our rights in bankruptcy as the secured creditor. We will have more to report in our next call, but we now anticipate the process will be completed in the next 6 to 12 months. In the meantime. we expect to collect $3 million in cash interest payments from the note this year. Additionally, we want to update you on the hotel being developed for Diamond Rock in Times Square. The demolition is complete, and construction is expected to start late this year. Hilton has approved the powerful Hilton Garden Inn brand for the hotel. As a reminder, the hotel is expected to open in 2013, and our price per key on this deal is fixed at only $450,000 per key. We remain very bullish on this deal.

With that I'll turn the call over to

Thanks, Mark.

For the second quarter, Diamond Rock's Pro Forma RevPAR, excluding Frenchman's Reef, increased 6.4% to just over $124. Our RevPAR growth was driven by a 4.2% increase in ADR, and a 1.5 percentage point gain in occupancy. We're pleased with the portfolio of room revenue performance, especially in light of the group challenges Mark mentioned in Boston and Chicago. Our RevPAR growth was propelled by a 9.3% increase in business transient revenue, which represents our most profitable segment. Our business transient revenue increased to 31% of total room revenue for the quarter, which is up from 29% in 2010. We're still below our historic business transient mix of 35% of total revenue. We're encouraged by the continuing demand growth from this segment, as this is the segment that is most susceptible to negative economic news.

Leisure revenue was flat, due to selling 5,400 fewer room nights, or 2.7% of total portfolio leisure rooms, as a result of displacement from the renovation of Frenchman's Reef. As Mark mentioned, our second quarter group room night production was lower than 2010. We sold 9,100, or 3.5%, fewer group rooms than last year, primarily as the result of difficult comps and city-wide challenges in Chicago, Boston, and our 2 Texas properties. The lower rooms-sold negatively impacted our high margin banquet sales for the quarter. These 4 hotels accounted for 100% of the portfolio banquet and AV sales shortfall to Q2 2010. It's encouraging that the portfolio group pace indicates a stronger second half of 2011, and a very good 2012. For the second half of the year, group booking pace by revenue is up about 2.7%, with Boston Westin pacing impressively at up over 15%. Most encouraging, 2012 booking pace is up a robust 10%, compared to the same time last year for the portfolio. Both Chicago and Boston, our two most significant group hotels, are expected to benefit from strong city-wide convention calendars in 2012. Boston Westin's pace is up over 16% for 2012; and Chicago Marriott's pace is up over 12% for the year.

In reviewing our portfolio performance, many of our hotels turned in strong quarterly results. I'll just point out a few top performers in Q2. Sonoma Renaissance's RevPAR increased almost 15%, as leisure was very strong and midweek group has improved. The JW Marriott Denver experienced RevPAR growth of almost 16%, due to strong production from both group and leisure. The Chicago Conrad's RevPAR increased over 20%, due to increased business transient and group. Acquired in 2010, the Charleston Renaissance continues to out-perform, with quarterly RevPAR growth over 13%. Boeing is generating mid-week business demand, and leisure continues to be strong on the weekends.

However, Chicago Marriott downtown, our largest asset by revenue, under-performed in the quarter, with RevPAR growing only 2.3%. These results materially impacted our consolidated results. The hotel sold 5,600 fewer group rooms than last year, because of a tough prior year comparison, and some implementation challenges with Marriott's sales transformation program. We're working closely with property level and senior management at Marriott to improve sales transformation by adjusting sales resources and responsibilities to improve booking pace at the hotel. We've already seen results from our combined efforts, as pace is up 5% up in the crucial fourth quarter, and as I mentioned 2012 pace is up over 12%. The 2012 citywide convention calendar in Chicago shows room nights up almost 30%.

The Boston Westin RevPAR grew only 2.5%, although the hotel gained 3 percentage points of market share during the quarter. Boston Westin is our second largest asset by revenue. The results were impacted by the BCEC convention calendar, which was down 38% in room nights in the second quarter, but will be up 10% for the balance of the year. The BCEC convention calendar shows 21 city-wide conventions in 2012, versus 17 this year; and a 46% increase in projected room nights.

Cost containment and profit margins were a bright spot in the second quarter, as we managed to improve EBITDA profit margins by over 100 basis points. The margin expansion was impressive in light of the challenging group results, in particular the $3 million year-over-year decline in food and beverage revenues, concentrated in high-margin banquet sales. Our entire team remains committed to cost containment, and is focused on maximizing profits. We believe that our focused asset management is one of the strengths of Diamond Rock. Let me give you a few examples of our successes in asset management. We've achieved tremendous returns by focusing on energy initiatives, ranging from installing energy efficient light bulbs, upgrading thermostats in the rooms to conserve energy when the room is unoccupied, investing in energy efficient kitchen equipment, and implementing green programs in the hotels to reduce housekeeping costs by helping the environment.

In 2007, we implemented a successful portfolio parking program to employ best-in-class strategies to maximize parking profits, including implementing automated self-parking systems, reviewing pricing practices and changing vendors. These initiatives have resulted in nearly a 70% increase in parking profits at our hotels. We've increased productivity at our hotels consistently over the past several years by increasing efficiency at all levels of management and hourly associates. We've combined management positions at many hotels. We've revamped housekeeping in several of our hotels by differentiating stayover versus checkout room cleaning procedures. We've improved food and beverage profitability by adjusting outlet hours, managing menu design to reduce food and labor costs, implementing banquet preparation efficiencies, and combining kitchens to reduce costs. These are permanent improvements and should lead to better profit flow through next peak.

Turning to capital spending, Diamond Rock will spend $65 million on capital to improve its portfolio in 2011, with the big focus on the dramatic renovation and repositioning of the Frenchman's Reef resort in St. Thomas. The reaction for group meeting planners has been better than expected. Groups are actively booking the hotel, and group revenue pace is up 20% in Q4, and is up substantially in 2012 at rates approaching peak levels. This project will solidify Frenchman's Reef's position as Marriott's flagship resort in the Caribbean.

The project has two major components. First we will be creating a new guest experience by creating a new luxury pool complex, luxury spa and fitness center, and completing a property-wide rooms renovation. Second we will upgrade the hotel infrastructure and energy system. This will dramatically improve the guest experience by replacing ineffective PTAC units, which allow very humid air to enter the rooms, with a new fan coil system, which will deliver more conditioned air, more efficiently cooled, into the guest room. We'll also generate our own power at the resort, allowing us to get off the grid of the extremely inefficient island energy provider. This phase of the renovation will significantly reduce our energy costs at the hotel, by reducing energy consumption by approximately 40%, and our cost per kilowatt hour over 20%, saving well over $1 million annually.

The project commenced May 1 and should be substantially complete by October 1. 2 of the 4 resort buildings are closed -- approximately 300 rooms -- and renovation disruption will impact full year 2011 EBITDA by approximately $6.5 million, which has increased by $1 million from our original disruption estimate. The variance is a result of incremental costs we've added to improve guest experience during the renovation, and higher energy costs.

Turning to acquisitions, 2011, like 2010 has been a very active period for Diamond Rock. I would like to touch on each of our 2011 acquisitions. Our first deal of 2011 was a take-out commitment for the Times Square Hilton Garden Inn. We feel that this represents a rare opportunity to own a newly developed hotel in one of the best locations in Manhattan. The Times Square area is among the most sought-after transient destinations in the world; and this site is adjacent to the former Knickerbocker Hotel, at the intersection of 42nd Street and Broadway, one of the highest-traffic intersections in Manhattan. The hotel will be less than one block from iconic Bryant Park. Over 5 million square feet of office space has been developed over the past several years within a half block of the hotel, including the new Bank of America tower and the Verizon building. Additionally, some of the highest per-square-foot retail rental locations surround the 42nd and Broadway intersection. We anticipate that the combination of the hotel's premier location, and significant demand generators, will allow the hotel to quickly generate an unlevered annual yield of more than 10% on our investment when it opens in 2013.

Our second deal was the acquisition of the 196 room JW Marriott Denver at Cherry Creek in an off-market transaction. The high-quality, newly renovated hotel is located in Denver's affluent, in-town neighborhood of Cherry Creek. The property has consistently been the market leader among its competitive set, which consists of the highest quality hotels in Denver, and was renovated in the first quarter. Denver has long been one of our target markets, because of its superior RevPAR growth rates over the past 25 years, and excellent growth prospects. The Denver market has been one of the top 5 lodging markets, measured by Rev PAR growth, since 1987, the first year Smith travel began keeping records; substantially out-pacing markets such as San Francisco, San Diego and Seattle. The hotel is the only Denver property to be featured on Conde Nast Traveler's 2011 Gold List. The purchase price represents 11.5 times multiple of 2012 forecasted EBITDA.

The third acquisition of 2011 was our largest, the 712-room Lexington Hotel in New York for $335 million, or $471,000 per key. The hotel's forecasted 2011 RevPAR of $198 is 70% above our portfolio average, and it's expected to generate hotel-adjusted EBITDA margins that are 12 percentage points higher than our portfolio average. We under-wrote, executed the purchase and sale agreement, and closed on this hotel in less than 8 weeks. We are currently evaluating the brand options for the Lexington Hotel, and are finalizing a new master plan to upgrade the hotel. Our most recent acquisition, the 177-room Courtyard in downtown Denver, was acquired in an off-market transaction from the seller of the JW Marriott at Cherry Creek. This $46 million investment brings Diamond Rock's total investment in the Denver market to 373 rooms, and approximately $130 million.

The Courtyard Denver is arguably the best-located hotel in the city. The hotel is consistently number 1 in its competitive set of upscale hotels in Denver. The hotel achieved a RevPAR premium to the nearest full-service Marriott for 7 consecutive years. The hotel, a re-developed historic department store, is centrally located on the 16th Street pedestrian mall in the heart of Denver's CBD. With its premier location, recently completed renovation, and strong brand, the hotel will continue to achieve full-service rates with a limited service cost structure, which is a model we have and will continue to seek. Including our 2010 acquisitions, we've invested approximately $900 million in well-priced and well-located hotels, which collectively dramatically increased portfolio RevPAR, profit margins and growth rates.

The acquisition market continues to be active, and we're evaluating a number of opportunities. While we will continue to work hard looking at all the potential acquisition opportunities, the company's primary focus over the summer is on maximizing the value of our existing portfolio by integrating the new hotels into our asset management program, evaluating potential rebranding options for the Lexington Hotel and the Conrad Chicago, evaluating and planning valuable renovation opportunities, and ensuring that best practices are implemented at our recent acquisitions.

Before turning the call back over to Mark, let me just say that in spite of the macro headwinds, I still feel good that the lodging market recovery is continuing, as demonstrated by the continuing positive trends in the industry and within our portfolio. It's been my experience that even with some choppiness, these recovery stages last for several years. I think Diamond Rock is in a great position today as we can selectively grow and refine our portfolio to maximize investor returns.

Mark?

Thanks. As John noted, we remain constructive on lodging fundamentals. Demand continues to improve. Supply remains very limited, dropping below 1% in the second quarter. Accordingly, our outlook for the lodging industry is for full-service hotels to generate RevPAR increases in 2011 of 68%. We expect Diamond Rock's portfolio to deliver RevPAR growth in the range of 68% as well, with our current operator forecast around the middle of that range.

Adjusted EBITDA is expected to be $172 million to $177 million. This range incorporates both the incremental $1 million disruption of Frenchman's Reef, and the incremental $1 million in property taxes at the Westin Boston. Based on our EBITDA expectations, adjusted FFO per share will range from $0.66 to $0.69 for 2011. In concluding the prepared remarks, let me say that Diamond Rock is well-positioned to deliver shareholder value for several reasons.

1, our portfolio has tremendous upside in this recovery. If hotel EBITDA returns just to prior peak, EBITDA at Diamond Rock's comparable hotels will increase more than 45% over 2010. 2, our acquisitions are creating shareholder value. Diamond Rock not only bought at attractive prices with assets that have value-add opportunities, these deals have improved our portfolio quality and positioned the company for even higher growth going forward. 3, there are numerous value-add opportunities to be mined within our existing portfolio. We've demonstrated our ability to create value with repositionings, rebrandings, parking initiatives, cost containment efforts, and energy programs. Going forward, we have significant upside opportunities that include the Frenchman's Reef repositioning and energy project that is underway, the repositioning and rebranding opportunities at the Lexington Hotel and the Conrad Chicago, and the expansion parcel at our Westin Boston. Lastly we believe that our capital structure continues to distinguish Diamond Rock from many of its peers with our conservative debt level, no preferred equity issuance, and a significant and well-covered dividend.

With that, we would now like to open up the call for any questions you might have.

(Operator Instructions)

Your first question comes from the line of Will Marks with JMP securities. Please Proceed.

Thank you. Good afternoon, Mark, John, Sean. The first question I want to ask, a clarification. So the change in guidance, the $1 million from Frenchman's Reef already has taken place, and the $1 million property tax has not yet; is that correct?

Substantially the $1 million property tax is the back half of the year. We just got that assessment, so that will kick in starting in July. Most of it disruption -- the incremental $1 million in disruption was in the second quarter.

Okay. In terms of the second quarter, what else came as a surprise to you, if anything?

I think the group F&B contribution was lower than we anticipated. We mentioned particularly at the Boston Westin and Chicago Marriott. So we would have anticipated -- we originally anticipated that the group spend of the groups coming to the hotels was going to be stronger than what actually came through.

Okay. A few other things. 1, you mentioned the 3 recent acquisitions in the 2012 multiples individually and in the aggregate. Can you give us a sense of what kind of growth assumptions you have for those?

I'm trying to do the math. I don't have it on a consolidated basis. I'll have to get back to you on that one.

A couple other things. Just in glancing at the margins in the press release, it looks like the 3 hotels with the most negative performance, Austin, Fort Worth and Vail; any sense, was there anything going on in any of these 3 markets that stands out?

Will, this is John. Yes, in Austin there's been a tremendous increase in the number of rooms in downtown Austin. So where we used to get compression on a fairly common basis from city-wide conventions, we no longer get that because of the increase in supply, and there's more coming. So the hotel has had to do much more in-house booking, which was a little bit of an adjustment in their marketing efforts. We think they're making progress, their 2012 pace is very good -- very, very good, and the back half of the year, I think, has promise. In Fort Worth, as you know, the city subsidized the Omni to be built next to the convention center. That's thinned things out for everyone, and the hotel is still adjusting to that and the Omni is still in the stabilization process. In Vail, we had a first quarter issue. We had new supply in the market to the tune of about 38% of the Vail supply. It was a new Four Seasons, and it was a rebranding of a hotel, the Sebastian, which also added rooms. That and the typical [front-end] generators on the East Coast and Dallas were not as strong as the hotel had anticipated. So we didn't have a big enough group base. So we lost some business there.

Okay. Thank you. One final question. Can you explain the issue with the Conrad? You had a great quarter, and just what's going on exactly there?

Yes. The Conrad is having a great -- had a great second quarter, and a lot of that has to do with the fact it is closer to the luxury segment than the big Marriott. Of course, they went down harder than the downtown Marriott, so their comeback is a little stronger. Also, the hotel has focused very effectively on corporate transient and small group, and so they've done a very good job in the last several months of booking small groups and thereby compressing the hotel and getting better rates on the corporate transient.

This -- Mark, just to add, on the brand itself, Hilton failed its performance test under the management agreement, so they're operating currently under a 30-day management at our option. So we're currently evaluating, talking to Hilton and another global operator about the best way forward for that hotel.

Okay. That's clarified. Thank you very much. That's all from me.

Well, just to look back on -- I know you dropped off your question earlier on the acquisitions. That's assuming the 18% EBITDA increase in 2012 over '11, and also I would note that the 2 Denver deals both were renovated in Q1 of 2011. So that's an easy comp in part for them.

Your next question comes from the line of Sule Sauvigne with Barclay's Capital. Please proceed.

Hi, it's Sule. I was wondering as you think about future acquisitions, which markets are most attractive right now in terms of pricing, and on the flip side, are there any markets that are not obvious that are getting too pricey?

Let's see. I think, at this point, the cap rates that we have seen in 2011 versus 2010 have been materially lower this year. I think everyone is focused on the coastal cities, and I think that's compressing cap rates. We have looked at a couple of deals recently where the pricing just got out of our range. So if that sort of thing continues, then cap rates will continue to compress. But I think what we're seeing with stock prices doing what they're doing, I think we're going to see a slowdown in the price escalation for the short term anyway. In terms of markets where the pricing is attractive, they tend to be markets we're not looking at, because they're lower growth markets.

Okay. I noticed the Courtyard on Fifth Avenue under performed the New York City hotels by a bit. I'm wondering if there is anything specific driving that.

Yes. They had some comp set issues. The Algonquin hotel close to the Fifth Avenue Courtyard became an Autograph Collection, a Marriott Autograph Collection, and that impacted the hotel somewhat. The Hotel Tudor became a Hilton affiliated hotel. That also had a bit of an impact.

Okay. Thank you.

Your next question comes from the line of Eli Hackel with Goldman Sachs. Please proceed.

Thanks. Just a few questions. I'll shoot them off. First, just going on the Allerton, can you talk about a third option, such as maybe selling the loan? Maybe you don't want to deal with it for the next 6 to 12 months if that is an option. With the loan, it seems like you collected a little over $1 million year-to-date, but you still expect to receive $3 million by the end of the year. Is there seasonality with that?

Sure. This is Mark. As far as what we're going to do with the note, our current plan is to pursue the process. We're the secured creditor in bankruptcy. We have a series of hearings scheduled over the next several months, and that's the current course. Would we consider selling the note if we got a par offer? I think we've always indicated that we would be sellers of the note or we would be fine being satisfied with the note close to its face amount. So those options remain. As far as the collectibility or what we're getting paid on the interest, I'll let Sean answer that.

Sure. With respect to the seasonality of Chicago, Chicago is a very seasonal market. The first quarter is a very slow quarter. So that -- the Allerton is cash-flow negative during that quarter -- during the first quarter, rather, so we didn't collect much, if any, interest, as we entered into late spring and the summer and the fall, the cash flows are much more positive with the hotel which generates cash sufficient to pay us our interest.

Great. And then just -- you touched on a little bit in the prepared remarks; but on sales transformation, it sounds like you've made a lot of headway with Marriott there. Do you think there's more to be done, or are the issues with the program behind it, or what's your latest thought on the sales transformation?

This is John again, Eli The sales transformation process is in different stages in different markets. So while in Chicago we hope that we've gone a long way toward solving the problem, we're not finished working on that yet, so we'll continue that. In some of the newly introduced hotels into the system, we have a little better understanding of what some of the pitfalls are, and we are trying to work with Marriott to minimize those pitfalls. But I would say -- in established markets, they're also making some adjustments even where the hotels have been in for a period of time and have shown RevPAR index increases, they're still trying to refine the program and make it better. If you look at sales transformation in general, it was a huge program that required huge adjustments not only in strategy, but also just in the jobs of individual salespeople. It created a lot of uncertainty. So everyone knew it was not going be a simple transformation, and it's proven to be as difficult as everyone thought, but I think, as we refine it, and as we get more experience with it, I think everyone will be more comfortable with it, and we have every expectation that the program will be very successful.

And then just finally on the Radisson, it sounds like you're getting close to making a decision. Do you know when you'll have something by? Also it sounded like you were planning on at least putting some more money into it. Are you definitely -- are you going to go ahead with some type of rebranding or maybe upgrade the rooms, but won't do any type of rebranding? And that's it. Thanks.

We haven't made the branding decision yet. We're right in the middle of the process. It's a master planning process. It's an investment analysis process and, of course, a pro forma process. So we're doing all of those things as we speak. We anticipate that by late fall, we'll make an internal decision as to what to do, and then we'll finalize the planning process to get it done by spring or soon thereafter.

Eli, this is Mark. Our original under-writing on the deal has about $25 million to capital over the first several years for not only a rooms re-do but a general upgrade in repositioning of the hotel itself. So that's in our original underwriting. We've engaged designers, and have a team of architects and project managers currently working on different options for the hotel, and we're engaged in detailed discussions with several brands about what's going to be the best ROI for our investment at the hotel. So we'll get through that over the next several months, as John indicated. We'll hopefully have something to announce, perhaps as early as the fourth quarter.

Great. Thanks

Your next question comes from the line of Josh Attie with Citigroup. Please proceed. Please proceed.

Hi, thanks. Can you talk about your RevPAR growth assumptions for the back half of the year? It seems like the first half the portfolio is running about 5.5%, and that in order to achieve the higher year-end guidance of 7% to 8%, you'd probably need to do 10% to 12% in the fourth quarter, and I heard your comments on group bookings accelerating in Boston and Chicago, but is that the magnitude of the RAM that you're anticipating?

Josh, this is Sean. No. For the back half of the year, to hit the low end of our guidance, we'd need 6.3% RevPAR growth, at midpoint approximately 8%, and the high end a little under 10% RevPAR growth, and the reason why the math is a little different is because the weighting of our year is so weighted toward the fourth quarter that that time is just so much more impactful.

It seems like -- and I know you didn't give specific third and fourth quarter guidance, but it seems like more companies are guiding to a weaker third quarter and a stronger fourth quarter, so it seems like toward the high end, you probably would be over 10% in the fourth quarter if the third quarter was a little lighter.

Yes, although we don't give specific quarterly guidance, we would expect the trends to accelerate as the year progress.

And can you clarify, did you say the portfolio was 45% below peak?

The 2010 EBITDA, if we return to prior peak, you would have to increase the 2010 hotel EBITDA by 45%.

And when you did that analysis for the hotels you owned, did you use 2007 EBITDA? How did you treat the hotels there already operating close to that number?

We did the same thing. We took all the hotels. It was either 2007 or 2008 was their prior peak. So we took whatever the prior peak level was, whether it was good or bad, it didn't matter. We were consistent through the portfolio, and just averaged out.

Thank you.

Your next question comes from the line of Dennis Forst with KeyBank. Please proceed.

I have a few unrelated questions. First of all, the Marriott Cherry Creek, who's the manager of that property?

Sage out of Denver is the manager of the property.

Were they the manager prior to acquiring it?

Yes. They've been the manager since its opening in 2001.

And what were the available room nights at Frenchman's Reef during the quarter?

We'll look that up. Do you have another question to ask?

I'm trying to come with what the actual RevPAR was for quarter.

The available rooms at Frenchman's Reef were 34,614 for the second quarter.

34,614?

Yes.

Thanks Sean. And lastly you were talking -- I think maybe it was John talking about the business transient business was up 9.3% and composed 31% of room revenue. I wonder if you could give us the same numbers for leisure and group?

Oh, sure. For the second quarter, excluding Frenchman's Reef, group revenue was up 1.1%, leisure and discounts was up 5%, and other was up 47.6%, which makes them as a percentage of total revenue, I'll have to get you that number -- here it is. I'll have to get you that number.

The numbers for all 3 of those components, so adds up to a hundred?

Yes.

Okay. Thank you.

Your next question comes from the line of Enrique Torres with Green Street Advisors. Please proceed.

Good afternoon. I wanted to see if you can give us a little more color on the booking window. I know you mentioned the group pace. Are you seeing -- the last quarter, one of the trends you mentioned was in the quarter, for the quarter, booking was also increasing. Are you continuing to see that, or would you also categorize the booking window as lengthening?

Enrique, this is Mark. In the quarter, for the quarter, obviously we had some issues in Chicago and Boston, given what the city-wide trends were at those 2 hotels. But we are seeing a lengthening out of some of the group bookings. Particularly we're seeing in 2012 very good pace in groups, so we are seeing that window get a little wider. I wouldn't say that it's back to anywhere near normal, but we are seeing positive trends in that it's lengthening out.

Okay. And I was wondering if you could provide what the RevPAR growth was for the calendar quarter. Was there a big difference versus your reported numbers?

It was roughly the same, Enrique.

Okay. Great. That's it for us. Thanks, guys.

Dennis, in response -- I know you're off; but in response to your question, the room segmentation -- and this is without Frenchman's Reef, group is this quarter 38% of total. Last year same quarter it was 40%. Business transient 33% against last year's 32%. Again this is without Frenchman's, so it's a little different from the 31% we gave you with Frenchman's. The leisure and discount, 25% in both years. Contract and other, 4% this year, 3% last year. Hopefully those total 100%.

(Operator Instructions)

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

Good afternoon, guys. Just a couple of quick questions here. First, sounds like, John, from what you just mentioned with regard to the group segment that volumes were down about 3.5%, but revenues were up about 1.1%, indicating that you had group rates up 4.5%. Did I understand that correctly?

Rates in group were up 3.1%.

Out of the 2.7% growth you have for the back half of the year, and the 10% for 2012, can you break that down between room nights and room rates, for the group segment that is?

Yes. Just a second. I can break it done for the balance of this year. For the third quarter rates, excluding Frenchman's are up about 3.8%. And they're down slightly in the fourth quarter. For 2012, the rates are -- the ADR for next year on the books is about 4.3% up.

All right. That's helpful. Thanks a lot. And as you guys think about the group segment a little bit and some of the challenges that you've encountered with Sales Force One this year and probably, the last couple of years, I'm wondering do you have any properties that Sales Force One has not yet rolled out into, and are you being proactive to make sure you don't encounter the same kind of startup challenges that you've encountered in Chicago this quarter?

Yes. We have hotels in Texas and some others that just got implemented in June of this year, and that's the last batch. We are trying very hard to adjust the sales resources and the focus of the group sales effort to make sure that we don't encounter some of the problems; but, you know, some of the problems are a little intractable in that so many people are changing jobs. They are going from the property level to the regional level, that it's very difficult to get immediate focus. Hopefully the training process and the training process have been more effective in the recent rollouts.

All right. And just one last question as I looked at Austin being down 4% this quarter, and seeing in the press the last couple of weeks that it seems like both convention center hotels are breaking ground and planning to go ahead. Is that a property that you're still interested in? Is that still considered a good market that you want to stay in, or does it make sense to exit that property before those properties ramp up?

Well, the impact of the new supply in downtown has already been felt. We get virtually no compression out of downtown Austin. So the impact of the citywide convention loss of compression has already been felt at the hotel. It really can't get any worse. What the new hotels and the existing supply -- where they'll challenge us is the in-house bookings when there aren't city-wides. So inevitably there will be some impact. Austin is a great growth market. There's no question about that. But it's clearly a hotel that faces some challenges coming in the near future -- in the distant future.

All right. Thanks a lot.

Your next question comes from the line of David Katz with Jefferies. Please proceed.

Hi. Afternoon. I wanted to ask, how soon -- what kind of timing would you expect to get back to what your normal group mix of 40% of revenues is? Is that something you think is maybe a next-year dynamic or beyond?

David, it's different by market and hotel. I think, if we looked overall at the portfolio, it's probably closer to 2013 until we get the normalized levels of segmentation, still ramping up on the group particularly.

And how aggressive, on a scale of 1 to 10 or in some other subjective measure, do you feel rates are being pushed? I ask the question specifically related to Marriott. Quite frankly there's been a lot of discussion in the investment community about that and about them being aggressive in terms of pushing rates at this stage.

David, this is Mark. They've been very aggressive about pushing rates, and we've encouraged them to do that. It hasn't always worked out immediately. The Chicago Marriott for instance they pushed too hard earlier in the year, and we lost some business. And the 2 New York Courtyards, they pushed rate early in Q1, and left some holes, anticipating that the strength would be there to allow them to do that. We're encouraging them to continue to take those chances, because we think it's important to the industry and our properties that we have price integrity and that we move the rates forward. They are clearly trying to be a market leader in that segment though, in pushing rates.

Got it. And if I can just go back to Sales Force One briefly, am I hearing correctly, John, that we are sort of past whatever issues or challenges the implementation has brought with it, or do we perhaps have another quarter or so where it will still be a point of discussion?

It's hard to tell, David, exactly how effectively they'll do in this most recent round of implementations. As I said, we have tried to focus hard on what we've learned in the earlier rounds, and I would just have to say time will tell. It may very well continue to be an issue in some markets, because there is a lot of disruption for people in the program. Salespeople are completely changing their responsibilities, and it's kind of a somebody moved my cheese type of phenomenon. They have to get used to the new environment, and as I said, there's been a lot of work going into training and into sales resources, but time will tell. I wouldn't make the prediction that the problems are all solved at this point.

All right. And if I can -- thank you for that. If I can follow that up quickly. It sounded from your commentary that most of the cheese was in Chicago, but is that -- is there lesser amounts elsewhere, or did I mischaracterize what your comment was?

I would not say most it was in Chicago. Chicago was an immediate problem we're facing in the second quarter. As we pointed out the balance of the year next year looked pretty good. The problem in Chicago was a pull-through problem, it was a conversion problem. So the leads are great. But there was an issue with converting the leads into definite room nights. I think we've made great progress toward correcting that. That's inevitably going to be a problem to the extent that we haven't effectively addressed it at the new properties, but I think we have effectively addressed it. But it's not unique to Chicago. Chicago had a particular problem with its stage in the turnover, and it was -- literally it was a conversion. The funnel is great and looks great throughout the portfolio. It's converting those tentatives to definites, which has to be back to prior averages.

Okay. Thank you very much. Appreciate it, guys.

Your next question comes from the line of Shaun Kelley with Bank of America Merrill Lynch. Please proceed.

Hi, good afternoon, guys. I just wanted to -- I guess we'll beat that dead horse a little bit more on Sales Force One. But specifically, we've heard mixed views from people as to whether or not Marriott at some of the bigger properties is allowing additional people to be added back at the property level. Is that something that you guys -- when you talked about some of the adjustments they've worked on, specifically at the Chicago Marriott, an important property like that, are they adding people back to the sales effort at the hotel level?

We are not at Chicago Marriott. I'm not going to give you the long answer. We have made adjustments at the sales office level. So there's now a -- Chicagoland -- as it's called, sales force, that is addressing only the Chicagoland hotels. You have to keep in mind that the Sales Force One is a program that's set up to book less than 300 room nights on peak groups. The over 300 room nights on peak are still handled at the property level. So the performance of the Chicago Marriott at above 300 peak room nights has been very, very good. It's been an improvement over the last year. It's been the sub-300. The problem was, as I said, conversion. So we had to get specific resources at the sales office to address the conversion problem. The other advantage that a big hotel has that is potentially a problem at a smaller hotel is a big hotel has event planners that service the group once they're booked, and as they project the group spend, they make sure that the meeting space is properly allocated, they make sure that they're available to make changes the group may have. These are resources the big hotels have that small hotels don't. So at a small hotel the problem is a different set of problems, I should say, than the big hotels. So on property resources, it becomes very important in smaller hotels, less so at the big hotels that have the resources to handle some of the pull-through issues.

Thanks, John. That's helpful. My second question was just on the group side. I apologize if I don't have the right numbers here, but it looks like your group pace is actually pretty similar right now as it was last quarter. So I guess what I'm wondering, academically, is most of the deltaed expectation for this quarter anyways, was it primarily by just in the quarter for the quarter that didn't materialize? Is it as simple as that, given particularly Boston and Chicago, or was there anything else we should think about? The reason I'm asking is I'm just trying to think about the visibility or confidence levels that you have or that we should in have in the back half.

That's a great question, and it's something we watch really carefully. For probably 8 quarters consecutively, in the quarter for the quarter group bookings have improved, and they did again on a revenue basis this quarter. We were up about 9% in total revenue booked in the quarter for the quarter; but it was really a rate-driven game. Room rates were up mid 20s whereas the room nights were down fairly substantially in the quarter for the quarter. You can read that 2 ways, and we're in the process of analyzing it. That could be great news, because they could be selective in the groups that they booked, because they had to have a good base of business, and at 76% of occupancy, they have a pretty good load, so that could be 1 answer. The other answer could be that the volume of groups was down, but they were able to charge more money for the groups. We're in the process of trying to understand that. But in general we take it as good news that the rate was so effectively increased in the quarter for the quarter.

Hi Shaun, this is Sean. The other issue on the group side of the business was the food and beverage contribution for the groups was not as high this quarter as it would have been in the past, and it was a little below our expectations, which also impacted our quarter.

Right. Okay. My third question is just thinking about how the acquisitions are layering into the portfolio. To think about it this way, at the beginning of the year, your RevPAR expectation was for up 6% to 8%. But you've added in some hotels, particularly the Denver J.W. and now the Denver Courtyard in markets that seem to be out performing the average. So my question is, would you still be at 6% to 8% if you excluded the acquisitions, or is the core portfolio doing a little less well than you would have expected? Any specific call-outs on why that might be the case if so?

Shaun this is Mark. If you look at our acquisitions, the 2 Denver deals both had renovations in Q1, so the full year numbers aren't going to be substantially above the portfolio average. The Lexington hotel in New York had the Q1 New York issue, like all of New York it wasn't that strong, so it's not going to move the average substantially either. So those are the 3. I don't think it will be a material difference with or without the acquisitions in the full-year RevPAR numbers.

Okay. Thanks, Mark. I appreciate it.

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

Good afternoon. Most of my questions have been answered. Just had a couple quick follow ups here. John, in your comments, you talked about planning for what seemed like a lot of renovations. Do you have any idea in terms of what the spend could look like for 2012 at this point, relative to 2011.

Yes. We're right in the middle of that, I would say, for the existing portfolio, it will be on par with the last couple of years, maybe a little bit higher. For the acquisitions, particularly the Lexington -- there won't be anything in the Denver properties abnormal -- but in the Lexington property there will be significant capital probably going in -- certainly going in next year, so that will impact the overall spend.

Okay. Also in your comments you talked about expecting to out-perform the industry from a RevPAR standpoint next year because of Frenchman's Reef. If you take Frenchman's Reef out, just to make sure we're comparing apples to apples, is that still the case?

It's hard to know with all the properties with the visibility we have now. We know that Chicago and Boston have excellent city-wide calendars and the group pace for the whole portfolio looks very strong for next year. We're very encouraged for 2012.

Okay. That's helpful. And finally not to leave you out, Sean. A quick question in terms of capacity here for the second half as you guys are looking at investment opportunities. Would the plan be at this point to lock in a mortgage on an additional property if you see acquisition properties that meet your underwriting standards?

Sure. That's one of the capital sources that we would look at. We also still have capacity on a line of credit. As Mark mentioned in his prepared remarks, there's still the possibility -- and this is more long term, to recycle some capital within our portfolio through disposition. So all of those options are available to us.

That's helpful. Thanks, guys.

Your next question comes from the line of Josh Attie with Citigroup. Please proceed.

Hi, thanks. If I could just follow up on that question, could you talk about what you think your financial capacity is today, the size of the acquisition pipeline? And also eventually how you plan to turn out the revolver; if you're considering issuing preferred stock, or you want to incur more mortgage debt at this point?

Josh, this is Mark. Sure, I'm happy to answer that question. I think our investment capacity today, we would be comfortable with putting perhaps another $100 million in acquisitions. As far as the line of credit, we have about $115 million outstanding on it today. We don't view that -- although it's very expensive, we don't view that as long-term financing. The most likely outcome is we would explore doing permanent financing on the Lexington hotel, but we would want to make sure we determined the brand and the capital plan before we proceeded along that path. We keep all our options open. Obviously, the market changes every day.

Have you given more thought to adding preferred stock to the capital structure?

That's one of the options we have. We have a preference toward a very simple capital structure for a number of reasons. That's on the table, but that's probably not at the top of the list right now.

Okay. Thank you.

Your final question comes from the line of Bill Crow with Raymond James. Please proceed.

Hi, guys. 3 quick questions for you. Can you help me understand the failure to convert the leads? Is that a loss of market share, or were those meetings that never came to the market at all?

No. Those were meetings that had been put in the tentative funnel, if you will, that the property didn't effectively -- or the sales team didn't effectively convert into definite room nights could be any number of issues. The problems we've seen have tended to be a lack of focus on that conversion process.

So they still come to the market, they just didn't come to that hotel, likely?

They may or may not have come to the market. They may have been looking at multiple cities and went somewhere else, or they went somewhere else within the market.

Right, okay. And the disappointment in the food and beverage and the group business, is that a sales transformation issue; is that specific to the groups that were there in the second quarter? Or is there something we should read into the economy and the willingness of groups to spend at this point in the cycle?

It's really hard to explain that one, because we were seeing the opposite trend last year. So I would say that it was unique to the groups that were in the hotel this year is our hope -- or this quarter, excuse me, is our hope. We have to do a better job of what we call -- qualifying the groups -- ahead of time so that it gets our forecast rather than our final numbers at lower numbers than we anticipated. So there are a number of steps that we can take to minimize the effect if, in fact, it is not a unique thing to our couple of hotels. But I tend to think that trends would tell us that it was unique to the quarter and to our hotels.

Bill, this is Sean. The lack of F&B was really felt in 4 hotels across our portfolio, it wasn't system-wide across the entire portfolio. I think that answers the question of whether we think it's systemic, or whether it's specific to those particular markets.

Bill, a big chunk of it was at Frenchman's Reef obviously, because of the disruption.

Okay. So that's included in that $1 million in the food and beverage area. And then specific to Frenchman's Reef then, when do you put that back into your RevPAR statistics when you start reporting? Is that going to be excluded throughout next year?

The plan, Bill, is we report it both ways currently, and we'll continue to report it both ways next year as well.

Okay. Great. Thank you very much.

You've got it.

And at this time I would like to turn the call back to Mr. Brugger for closing remarks.

Thank you, Stacy. To everyone on this call we would like to express our continued appreciation for your interest in Diamond Rock and look forward to updating you next quarter. Enjoy the rest of your summer.

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect and have a great day.