Diamondrock Hospitality Co (DRH) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2012 DiamondRock Hospitality Company earnings conference call. My name is Jasmine and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference, Mr. Mark Brugger, Chief Executive Officer. You may proceed.

Thanks, Jasmine. Good morning, everyone, and welcome to DiamondRock's second-quarter 2012 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 like to remind everyone that many of our comments today are not historical facts and are considered forward-looking statements under federal securities laws. They may not be updated in the future. These statements are subject to risks and uncertainties as described in our SEC filings.

Moreover, as we discuss certain non-GAAP financial measures it may be helpful to review the reconciliation to GAAP set forth in our earnings press release.

As you know, we have been very busy since our last earnings call. We have acquired a portfolio of four high-quality City Center hotels for $0.5 billion, issued $200 million in stock, and benefited from a $75 million strategic investment from Blackstone. These efforts are the latest examples of robust -- executing our strategy of improving portfolio quality, owning urban assets in target markets, increasing brand in operator diversity, and actively recycling capital.

Today, we own a terrific portfolio of 27 hotels concentrated in strong gateway markets such as New York City, Chicago, and Boston. Moreover, we maintain one of the strongest balance sheets in the industry. And the Company continues to be one of the most active players in the space, having completed over $750 million in deals year-to-date.

The Company is well-positioned for growth as our portfolio continues to benefit from the ongoing US lodging recovery and the implementation of our best practice asset management initiatives. Furthermore, with our solid balance sheet, we are well-positioned to take advantage of opportunistic acquisitions while selectively recycling capital through the disposition of non-core assets.

I would like to now spend a couple of minutes discussing the impact of the recent Blackstone portfolio acquisitions. As part of our capital recycling strategy, we created investment capacity through the disposition of three non-core suburban hotels earlier this year and redeployed that capital into four higher growth hotels in more attractive markets. Consider these six compelling facts about the transaction.

One, almost 90% of the entire portfolio either comes from hotels in City Center locations in Boston, Washington DC, and San Diego. Two, these hotels increased our overall portfolio RevPAR and profit margins. Three, each of the hotels is owned in fee simple. Four, the hotels are unencumbered by brand management, thereby increasing our ability to influence operations and increase potential exit value. Five, we have uncovered numerous asset management opportunities to create outsized growth. And six, we are making capital investments as an upside opportunity to reposition each hotel in order to gain market share over the next several years.

I would also note that as part of the acquisitions Blackstone made a significant strategic investment in the Company. We are pleased to welcome Blackstone as a shareholder and look forward to exploring opportunities for us to partner with them going forward.

Now let's turn to second-quarter results. Our portfolio's operating performance was strong and consistent with our expectations. We achieved second-quarter RevPAR growth of 6.5% with the majority of our hotels gaining market share during the quarter. The Company's second-quarter adjusted EBITDA improved 17% from 2011. Including Frenchman's Reef, our hotel adjusted EBITDA margins expanded 90 basis points.

Even more impressively, the year-to-date performance of our portfolio reflects RevPAR growth of 7.6%, hotel-adjusted EBITDA margin expansion of 115 basis points, and improved market share.

Turning to the balance sheet. We funded only 25% of the Blackstone portfolio acquisition with debt, a move consistent with our strategy of maintaining a low levered balance sheet. We expect to end 2012 with a debt to EBITDA ratio of just 4.5 times. Remarkably 16 of our 27 hotels are unencumbered by debt.

To give you an idea of how much borrowing power that provides the Company, our cost basis in those 16 unencumbered hotels is $1.7 billion. We feel very good about the balance sheet and fundamentally believe that conservative leverage is crucial for a lodging REIT to create exceptional shareholder value over this cycle. This conservative leverage strategy, along with strong operating results, allows DiamondRock to pay a well covered and competitive dividend yield of over 3%.

I would like to add that being an income company is another core tenet in our strategy to deliver outstanding shareholder returns.

Now, turning to guidance, lodging fundamentals continued to show strength and are generally meeting our high expectations. The balance of the year group booking pace remains strong, up 7.8% compared to the same time in 2011. Moreover, we expect to end the year in a stronger position than last year and anticipate achieving success during the 2013 corporate rate negotiations which will begin in a few months.

Our updated guidance incorporates our recent portfolio acquisition, equity offering, and [cherished links] to Blackstone. As well as the most recent hotel operating forecast for our current portfolio of 27 hotels. Based on these factors, our revised full year 2012 guidance is as follows.

RevPAR growth of 5.5% to 7.5%. Adjusted EBITDA of $193 million to $201 million and adjusted FFO per share of $0.76 to $0.80. The Company's third-quarter guidance is as follows. RevPAR growth of 3 to 4%, adjusted EBITDA of $44.5 million to $48.5 million and adjusted FFO per share $0.18 to $0.19.

As discussed in the press release, we expect more moderate growth in the third quarter than we experienced in the second, followed by strong growth during the fourth quarter. The Company's third quarter will be impacted by a few specific items. First, the facade project at the Worthington Renaissance is expected to create $2 million of disruption during the third quarter. This disruption is expected to negatively impact the Company's third-quarter RevPAR growth by about 60 basis points.

Second, the citywide group meeting calendar in Chicago is weighted toward the second and fourth quarters, resulting in third-quarter group booking pace at the Chicago Marriott being down approximately 6%. Our Chicago hotels will negatively impact our third-quarter RevPAR growth by about 70 basis points. And third as discussed earlier this year the Hilton Minneapolis 2012 RevPAR growth is challenged by a difficult convention calendar, particularly in the third quarter. The Minneapolis Hilton will negatively impact our third-quarter RevPAR growth by about 50 basis points.

The Company expects strong RevPAR growth during the fourth quarter as a result of several catalysts. Our fourth quarter will benefit substantially from favorable timing of citywide meetings in Chicago as evidenced by the fourth-quarter group booking pace for the Chicago Conrad and Chicago Marriott, up 46% and 14%, respectively. Moreover, our fourth quarter will benefit from the strong convention activity at the Boston Convention and Exhibition Center with our Westin Boston's fourth-quarter group booking pace up almost 11%.

We also expect the LAX Marriott to outperform during the fourth quarter. The group booking pace at this hotel is up over 50%. Additionally we expect strong fourth-quarter performance from our well-located hotels in New York City.

I will now turn the call over to John to review our results in further detail and discuss our recent acquisitions.

Thanks, Mark, and good morning, everyone. Second-quarter results showed continuation of positive demand trends with RevPAR up 6.5% led by ADR, and ADR increase of 4.6%. We saw good demand growth in the quarter as revenue gains in group [was] up over 10.5% and leisure up 10% accounted for 85% of the revenue gain. The balance of the revenue gain was a result of some well priced contract business we put in at the Lexington Hotel in New York.

Business transit rate was up over 5% in the quarter with slightly lower room nights as demand from other segments displaced some BT rooms.

We continue to focus on revenue management strategies as a means of maximizing the total revenue potential of our hotels. We encourage our operators to take calculated risk to maximize rates. We have seen great successes at several of our hotels. We implemented a strategy this year at the Conrad in Chicago of not renewing low rated special corporate accounts in anticipation of rate potential from the strong convention calendar and resulting compression in the city, which contributed to the BT results.

The revenue management strategy turned out to be too aggressive in Q2 because the city experienced less group pickup than expected. But we anticipate stronger rates at the Conrad for the balance of the year and believe our strategy will pay off.

The Conrad's new Ballroom will open August 2 and group pace at the Conrad as Mark mentioned is up 46% in the fourth quarter.

Food and beverage revenues were up almost 11% in the quarter with increases in banquet sales related to higher group volume. Food and beverage margins would have been even better, but were held back by higher cover counts and lower average checks and one large convention hotel and higher wages and benefits due to higher volumes. Group pace for the balance of the year including the recent acquisitions remains robust up 7.8%. The profit flowthrough for the quarter resulted in 90 basis points of EBITDA margin expansion.

Our asset management group remains very focused on getting every incremental dollar of revenue to the bottom line. We were encouraged by productivity gains. Overall productivity for the portfolio was good with manhours per occupied room down 4.6% and sales for manhour up 13.1% for the quarter.

Gross margins were impacted by the cost of employee benefits and travel agent commissions which were up 10.8% and 21% respectively this quarter. Support costs in the quarter were well controlled and were up 4.2%. Sales and marketing and G&A costs were higher, partially from increased occupancies, up 7% and 6.2%, respectively. These costs were partially offset by modest increases in R&M and utilities, which were lower by 3.6% reflecting lower rates, the $4 million we invested in energy saving initiatives across the portfolio and energy contracts we've negotiated in the past year.

I would like to spend some time addressing our current significant capital projects. As we discussed we are in the final planning stages for a $32 million renovation at the Lexington Hotel. The renovation will reposition the hotels, an autograph collection by Marriott and will touch every guest experience at the hotel. Rooms, bathrooms, and the hotel lobby will be completely reinvented.

This project will begin in late December and be completed in mid-2013. The project will be phased to minimize disruption.

The Manhattan Courtyards are also in the final design for guestroom renovation in the first half of 2013. The lobby at the Fifth Avenue Courtyard was completed in the first quarter of this year and the lobby of the Third Avenue Courtyard is being redesigned and will enable us to move the fitness center off of a rooms floor to the lobby and gain an additional floor key.

In June we began the renovation of the Worthington Renaissance façade. The project will be phased over two years in order to minimize disruption. We are also finalizing a lease for the restaurant, lobby lounge, and room service at the hotel which will reconfigure a portion of the lobby and dramatically improve food and beverage margins as well as guest satisfaction.

Construction has begun on the 42nd Street Hilton Garden Inn and is scheduled for completion in mid-2014. This 286 room hotel is at 42nd and Broadway, the heart of Times Square. The Conrad Ballroom addition will be open in a week and the booking pace is a testament to the market demand for the space.

Turning to our recent acquisition of the high-quality Blackstone portfolio. We acquired four hotels from Blackstone for $495 million representing a discount to replace from cost at $339,000 a key. The acquisition expanded our portfolio into three strategic target markets -- Boston, Washington, DC, and San Diego. It expanded our strategic relationship with Hilton and Starwood and increased our third-party management exposure. The acquired hotels will improve portfolio RevPAR by $2.00 and margins by 140 basis points. We see margin improvement opportunities at the hotels because revenue potential at these hotels come from rate gains as we enhance revenue strategies and put capitals into the hotel to capture higher-rated visits.

Let me give you a little more background on the deal on the upside opportunities.

Blackstone reacquired control of this portfolio in December of 2010 from Columbia Sussex. Columbia Sussex had acquired, renovated, and rebranded and assumed management of the hotels in 2006. The Columbia Sussex brand and management strategy relied almost exclusively on the brands for marketing and focused on extremely tight and unsustainable cost controls. Let me just say that in our experience this is not a recipe for maximizing value.

When Blackstone converted the hotels to third-party management in 2011, interstate and LXR began the process of reinstituting marketing and more appropriate staffing levels into the hotel, an effort which has just started to bear fruit and should accelerate going forward. Now that we own the hotels, we have the ability for our asset management teams to implement our best practices initiative that were either not fully implemented or not yet initiated at all at the hotel. Areas of opportunities at all four hotels relate to product repositioning, revenue management, marketing, parking, food and beverage profit maximization and labor forecasting.

We consider this portfolio acquisition central to our strategy in using smart capital recycling to enhance DiamondRock's portfolio through the disposition of lower quality, slower growth assets and redeploying the capital into assets such as these concentrating on high-growth, Gateway urban markets with numerous upside opportunities.

The Hilton Boston Downtown is a AAA four-diamond hotel with 362 keys including 66 suites and 10,000 square feet of functional meeting space. It's Boston and financial district location is one block from the Waterfront and Samuel Hall and 10 minutes from Logan Airport. The hotel is a 1920s era Art Deco building, one of Boston's first high-rise office buildings. The building was converted to a hotel and fully renovated in 1999. All food and beverage operations are leased, making the operation essentially rooms only, resulting in very high [GLP] and EBITDA margins supplemented by the significant lease income. Lease income from existing tenants provides $1 million in stable annual NOI.

We see several opportunities for asset management to significantly improve revenue and profitability at the Hilton. We intend to lease 4,000 square feet of prime street access retail space, currently vacant. We are evaluating proposals for management companies who would like to assume management of the hotel. We will develop a revenue management strategy tailored to Boston demand patterns to orient our experience at the Westin Waterfront. We will integrate the marketing efforts of Hilton's citywide marketing team and Boston Convention City Authority into the hotel's marketing plan. We will divide some of the 66 suites to gain additional keys and, longer term, we will investigate the feasibility of relocating Northeastern's lease space to add up to 50 rooms and or additional meeting space. And we will design and implement a hotel renovation in order to improve RevPAR penetration.

The Westin DC City Center has 406 rooms and 13,000 square feet of meeting space. The hotel's 14th and M Street location is central to the Washington CBD office concentration and five blocks from the DC Convention Center and the White House. Asset management initiatives here will include, as in Boston, we will develop the marketing plan and revenue management strategy to improve RevPAR penetration and close the unjustified $50 RevPAR gap with the Westin West End. We will design and government a hotel renovation plan including a reconfiguring the lobby and food and beverage space to enhance functionality and profitability. And we will renegotiate a higher-yielding profit parking contract and outsource laundry operations.

The Hilton Burlington is the 258-room hotel with 16,000 square feet of indoor and outdoor meeting space which benefits from its CBD locations with views of Lake Champlain and the Adirondack Mountains and with convenient access to downtown shops and restaurants. The Hilton is the only full-service hotel in the Burlington CBD, which is the center of a vibrant and growing regional commercial heart.

We have identified asset management opportunities at Burlington as well. We will rejuvenate the marketing team and redirect marketing strategy to penetrate local transient and group accounts which are not currently solicited. We will develop relationships with the University of Vermont, a major local demand generator, who has not been paid attention to bite the hotel marketing staff.

We will refresh the guest [and softness] package to regain lost RevPAR index and develop seasonal amenity packages to further penetrate in season leisure demand. We will reclaim existing office space to add Waterview meeting rooms and we will renegotiate the parking agreements and significantly increase profit. Overall this is a very profitable hotel that generates over $18,000 per key in EBITDA and has continued growth potential.

Finally, the Westin San Diego is a 436-room hotel with 22,000 square feet of meeting space. This iconic mixed-use building opened in 1991 and is a landmark in the San Diego skyline. Its CBD location on Broadway is approximate to downtown demand generators and within walking distance to San Diego's Convention Center and Gaslamp District. A new federal courthouse and expanded county courthouse surround the hotel.

We have identified several asset management initiatives at the Westin. The hotel will also benefit from development of a rational pricing strategy and better coordination with Starwood's citywide marketing team. We will improve the hotel's interaction and cooperation with the San Diego Convention center sales force. We will develop legal research and mock trial meeting space in the hotel to captured demand from the federal and county courthouses.

This is a significant new revenue opportunity. We will activate the lobby area and reconfigure food and beverage space to drive revenue and profitability. And we will lease the street pace in food and beverage outlets to increase profitability. And we will design and execute a rooms' renovation to further improve RevPAR penetration.

So the Blackstone acquisition is the execution of our strategy to redeploy capital from lower gross secondary markets, to gateway urban core markets and into assets that can benefit from aggressive asset management. Now I'll turn the call back over to Mark.

Thanks, John. Overall, we remain bullish on the growth potential for our portfolio. I believe that DiamondRock means an outstanding investment for our shareholders. To that point, we would like to leave you with story you may take away today. The first takeaway is that our portfolio has tremendous (technical difficulty) potential, just looking at our legacy portfolio (technical difficulty) [2,300] hotels. These hotels possess a great deal of upside potential and profit margin and in profit.

It is important to observe that our portfolio has plenty of room to run as it is nowhere near prior peak. In fact, the profit margin of our legacy hotel portfolio would need to expand approximately 500 basis points from last year just to hit higher prior peak profit margins.

In terms of profits, our legacy portfolio would need to increase $80 million from last year just to reach prior peaks. We regard these gaps as the big opportunity.

The second takeaway is that we have purposefully maintained a conservative balance sheet and have structured our investments in such a way as to reduce risk to our enterprise by creating maximum flexibility. With more than half the portfolio unencumbered, we have a myriad of financing options.

For a lodging REIT balance sheet management is [already believed] the number one driver of value to shareholders.

The final takeaway relates to our platform. Simply put, we have a great team. Our asset management team continues to employ best practices and investigate opportunities to cut costs and increase profit margins at our hotels. Our finance group has done a great job putting together a spectacular balance sheet and continually lowering our cost of capital. And our team overall has successfully executed more than $750 million in acquisitions and dispositions this year alone.

In conclusion, our team remains committed to delivering shareholder value through a focused and well executed strategy. With that we would now like to open the call for any questions.

(Operator Instructions). Josh Attie, Citi.

Good morning. Can you tell us what the implied RevPAR guidance is for the fourth quarter?

Sure. The implied fourth quarter is between 5% and 10% depending on what end of the range we hit for the third quarter.

And what -- when you look at the high end of that range, what gives you the confidence that you can hit the high end? When I look at the third quarter, it seems like even if you add back 180 basis points you outlined, that would put the portfolio at 5% to 6%, which still seems a little bit light, given that includes the end of June which is very strong. So the 5% to 6% seems like it is below where the industry is trending. Is there anything else that is weighing on the portfolio in the third quarter that you expect to reverse that would help you go from 5% to 6% to closer to 10%?

In the third quarter one of the primary drivers is the group pace which is about 3.4% against almost 12% in the fourth quarter. And that is driven by basically all of the major convention hotels -- Boston, Chicago, Salt Lake and Minneapolis -- all have soft convention calendars in the third quarter. However they have very strong convention calendars in the fourth quarter. As an example, Boston is up almost all of them percent. Chicago Downtown 14%, Frenchman's Reef 34%, Salt Lake City is 6% and Minneapolis is up 2%. So that is a major driver of the revenue forecast.

How much of the business for the fourth quarter today is locked in or booked?

I can't give you that number off the top of my head. Let us get that for you.

Well, roughly, is it less than 50%? Is it less than 30%?

Well, if you look at our group business in the quarter, it is probably going to be about 35% and probably 90% of that is booked. Then, there are transit bookings across particular in the resorts that are already on the books but I just don't know that number.

And, John, you outlined qualitatively what some of the opportunities are at the acids that you just bought. Can you tell us financially what you think the upside is? Is there an EBITDA number that you think you can get in excess of market growth related to all the things that you spoke about?

Well it varies by hotel, obviously; there are tremendous opportunities and a couple of the hotels and good opportunities in the others. I couldn't quantify it for you. I can tell you that the [BX] portfolio this year and the third and fourth quarter are going to be up in RevPAR 8% and 10% roughly. And then, the profit margins as you know are already pretty strong and we see some continued improvement opportunity there.

In terms of quantifying the EBITDA between now and what two years from now is that what you're driving at?

Yes, just when you underwrote this, you know, how did you think about what the financial upside was or how the value of the assets were going to increase? Is it that you are going to get EBITDA growth? It sounds like you think you are going to get EBITDA growth in excess of the market growth based on all the things you outlined. And I just wanted to know if there was if you can quantify what that EBITDA opportunity was.

On our underwriting, we get to on a five-year hold, we get to a double-digit unlevered [IRR]. We look at the growth rate and generalized for the portfolio, but the CAGR versus the expectation for the market was about 2% better per annum than the market. And that had to do with both implementation of the best practices, but also the capital that we are going to put in we think we'll have a lot more market penetration from that strategy.

And what did you assume for the exit valuation compared to what you bought at?

It was about 100 basis points above our acquisition price.

It varied by property obviously but 100 basis points over all.

Thank you very much.

Eli Hackel, Goldman Sachs.

Good morning. Just two questions. One on the portfolio and general acquisitions and general -- as you get further into the cycle how do you change your assumptions? Obviously five years from now is different from five years one, two or three years ago. So how do you change your underwriting assumptions as you go through a cycle? And then second question just on expense growth, just looking on the pro forma expense growth.

It is a little bit higher than I saw some (inaudible) fees 8% or so in the quarter just overall. What are you expecting just on expense growth as we go out go throughout the rest of the year and maybe just some more general comment there would be great. Thank you.

I will take the first question on underwriting. Basically we use third-party market estimates for growth and then we apply either a discount or a premium based on work we are going to do at the hotel or outside potential or issues that we see at each hotel individually. And then on a flow-through basis, we use standard flow-through measures and that results in the NOI that we use to underwrite the hotels. That changes as the -- obviously as the cycle progresses. It changes both for third parties' perspective of market potential growth and our own perspective of hotel individual hotel growth potential against the market.

So hopefully we are smart enough to spot within the cycle coming supply or a slow down in growth.

On the expense question, I guess I would say that we expect labor cost to go up in the 4% range, 4% to 5% range this year although they were a little bit higher in the second quarter because of some comparability issues. And we expect various other costs to go up at inflation or with volume, depending on the category. But generally, we are still shooting for roughly 55% flow-through from increased revenue mix between rooms and food and beverage.

There's a couple expense items that are probably worth talking about specifically. But you mentioned IMF for the quarter up [8]% percent. And that is certainly driven by Chicago which makes up 90%, 95% of our total incentive management both in the quarter as well as for the year. Our Chicago Marriott had a very strong quarter. So the incentive management fees are up accordingly for that hotel.

The other item that should be worth mentioning is property taxes for our portfolio are up about $5 million year over year, and that is really driven by Chicago as well as Boston and, to a lesser extent, Worthington. Chicago had their triannual reassessment for 2012 which we are assuming roughly a 40% increase in the assessment. The reason why we think it is going to be so significant is because the last reassessment was 2009 which was a very difficult year. Was a very difficult year for the industry.

So we are assuming that there is going to be significant increases in Chicago that are going to hit this year. Boston is coming off of a pilot program, which is going to be about $1 million of increased property taxes that hit this year. And then Worthington had a favorable property tax appeal when last year, which had a positive impact of about $1 million on our property taxes.

That's great. Thank you very much.

Ian Weissman, ISI Group.

Good morning. Maybe just a couple of specifics on your New York City portfolio which came in below our expectations. Are you seeing any fallout yet from, I guess, troubles in Europe given your exposure in New York?

I'll take that. The New York market in general, in the second quarter, our portfolio went up about 3.6% in RevPAR and it lost about 90 basis points in margin for the second quarter. And there's a degree of that at the Lexington and certainly from European travel, but I don't think it has been so measurable that it has been highlighted.

But inevitably that -- both the Olympics and the issues with the European economies are inevitably going to impact the visitation.

Overall though, I think there were portions of the second quarter that were a little bit weaker than anticipated, but then there were also portions of the second quarter that were pretty strong. And when it comes to transient business it is very difficult to pinpoint and forecast those levels. So we still feel good about the city. We feel good about our location, locations within the city, and we think the supply continues to be absorbed. But we do anticipate that there could be some hiccups as we go through the year.

So, are you modeling a deceleration from the 3, 6, or so that you did in New York in the second quarter in the balance of the year?

No.

You're not. Okay. And just a housekeeping issue. Your tren -- your closing costs, I guess associated with the Blackstone deal modeled for the third quarter of about $8 million that is considerably higher than what we expected. What is in that $8 million number?

A lot of that is driven by transfer taxes particularly Washington, DC, has very expensive transport tax when you buy an asset there. And then also there's legal costs that are portfolio transactions, it is just more expensive to get done than a single asset acquisition.

Okay. All right. That's fine. Thank you very much.

Jeff Donnelly, Wells Fargo.

Good morning. John, thanks for the color on the Blackstone asset. Just curious how do you think about EBITDA growth of those four assets versus your own core portfolio rather than just the market? And I guess would that mirror your outlook for the asset value growth of that portfolio as well?

Yes, it definitely would. We see outsize growth in certainly three of the four hotels in terms of RevPAR. We also see margin improvement opportunities because frankly the hotels have added the costs back since Blackstone took them over in 2011 and they are just beginning to reap the rewards of enhanced marketing.

We have some more marketing staff to put into the hotel and we have significant renovation to put into, particularly, two of the hotels. But we see outsized RevPAR growth potential, food and beverage margin potential. We see a lot of potential both in revenue and profit growth. Outsized to our portfolio.

That's very -- I guess my question and maybe I am -- it's a little apples and oranges to deduce this, but if the core portfolio -- if the portfolio you have bought you think is going to outstrip the market and you think it is going to outstrip your port -- your own core portfolio, does that sort of imply that a good number of the assets you already own in your existing portfolio are going to have some market average type performance? Does that maybe leave you guys to think you might be selling more assets in the future or am I stretching too far on that?

I think that is a little bit of a stretch, Jeff. I think what we are saying to you is that there are unusual opportunities in the Blackstone portfolio just because of the way they were run in the past and the capital that we see can be very profitably put into the hotels. I think from our existing portfolio standpoint we are consciously repositioning the portfolio, as you know, and as we have said several times into the higher growth core urban markets and that is part of what this strategy -- this acquisition bid.

But that is an overall strategy for the Company. So, yes, there are some other hotels that we will move within the next couple of years that will follow that same strategy and, hopefully, the acquisitions will be available in the core markets and target markets we are looking for. And all that strategy is 100% geared towards increasing overall growth and profitability of the entire portfolio.

And specific to Westin San Diego can you talk about, I guess, how RevPAR index compares there maybe versus the Westin Gaslamp and or even perhaps the W because they are both a few blocks away. I was just wanted to make sure that was a --.

Yes, it has historically trailed both of those hotels and, as you know, the Gaslamp just had a significant renovation. So until we do our renovation we will be at a little bit of a product disadvantage. I would say that the potential for our hotel has a lot to do with the completion of the federal courthouse. The more effective marketing to the legal concentration that is already there and will grow dramatically. Which I think we outlined as some plans that we have for that. And then increasing penetration with the San Diego Convention Authority and sales force is a major effort.

And finally, this hotel has been virtually left out of the citywide marketing efforts of Starwood because they haven't marketed themselves to the team which is a gross error, in our opinion. So we think we will gain share. I think that, relative to the W and the Gaslamp, we haven't looked specifically at those because we don't know their shares. But relative to the comp set, we believe we will gain significant share.

But it's more of a sort of call it late 2013 event if you will in that it was nearer than that I would presume?

Yes, that is certainly fair.

And just a last question is just more of the acquisition market. I've been hearing that there is more deals in the marketplace in the second half of the year than there have been in the first. I don't know if you agree with that, but everyone asks about cap rates. I was curious if you have a sense about the trend has been in the unlevered IRRs that you guys underwrite on deals over the last few quarters. Have you seen them coming down? How do you think about that?

We've --. I would say on the general volume of deals we're seeing it slightly up from what it was the first half of the year, one of the reasons we were so excited to do the off market transaction with Blackstone. But I tell you we missed out on a deal very recently because the pricing was well inside of what we were willing to pay.

So, there is still a lot of appetite for product -- for the core market product that comes out there. And that bidding is fairly intense. So we have seen, at least on this one recent deal, we saw cap rates come lower than they were earlier in the year.

Okay. Thanks, guys.

[Neil Malkin], RBC.

Good morning, this is Wes Golladay with Neil. Quick question on the travel commissions. I was under the impression they were beginning to moderate in the first quarter; it looks like they're ticking higher. Was this due to mix or is it going to be higher going forward?

It was considerably higher than the first quarter. It came as a little bit of a surprise and it was very concentrated in group and very concentrated in five top producing group hotels. So we are looking into each one of those situations as to whether or not there is an opportunity to refocus the way these groups are being booked.

But in general, the trend is negative, because a lot of these companies and associations have taken the meeting planner out of their organization. So they've contracted out. And the hotel has to pay the fee for it.

Okay so probably a little less impactful third quarter and maybe another uptick in the commissions in the fourth? Would that be a good way to look at it?

That's probably fair because the third-quarter group volume is lower, the fourth quarter is much higher.

And your recent deal you guys put a lot of equity -- 75%. Would that be how you are looking at it going forward just to get to the lower leverage that you guys cited earlier? Or is it target capital structure I guess for new deals?

I'll take that one. Our strategy is to stay low leveraged overall. So right now we will end the year about 4.5 times debt to EBITDA with very low corporate debt. That feels pretty comfortable. That is on its way to going sub 4 during this cycle. And so it will depend on each deal on the size of the deal. These individual hotels can range from a small deal, $45 million to $350 million. So often, the size of the individual deal will influence how we finance it in, and what we want to do.

But certainly we remain firm in our conviction that low leverage is the way to go. So we will continue to run our Company with that strategy.

The other point worth noting on the funding of the Blackstone acquisition is that we had about $100 million of capacity on our balance sheet that was created by the disposition of three hotels to Inland. So part of the 75% of -- that we funded with equity was $100 million of that I'll say of cash from the [given] disposition.

Thanks.

Will Marks, JPM Securities.

Good morning, everyone. I just wanted to ask about next year's convention calendars and some key markets you did some good dialogue on third and fourth quarter of this year.

Yes, I can take you through a few of them. I mean, in San Diego, they have a number of conventions. They are up 10%. Room nights are up or flat. Chicago, they are -- they're -- excuse me they are down in total number of conventions by about 8%, about half of that in rooms. Minneapolis is up 4% and conventions, down a little bit in rooms, and Boston is down in 2013.

And so, as a result -- and Salt Lake City, excuse me, is up in 2013. Denver is also up in 2013. So I guess from our perspective where we see softer citywide, we have to work that much harder at in-house groups and that is why, at the Boston Western for example, we added that meeting space a couple of years ago because when you at this kind of situation where the citywides are down, you have to be able to defend yourself with in-house groups. And that is the focus at each of the hotels where the citywide base is not as good. The good news is we can see it coming.

Okay and with the Blackstone deal, what is now -- it probably hasn't changed, but what is group as a percentage of total?

Blackstone group as a percentage of total is lower than our portfolio. So it will bring it down just a little bit. It is about 25% group. Our portfolio is closer to 33%. So it will reduce a little bit.

Okay, great. That's all for me. Thanks.

Ryan Meliker, MLV & Co.

Good morning, gentlemen. And first of all congratulations on getting the portfolio deal closed.

Thank you.

Just a few questions here. First with regards to your full-year outlook. You mentioned that the Blackstone portfolio is going to be up 8% in 3Q and 10% in 4Q. Can you just give us some color on what your guidance really implies for your legacy portfolio? And what trends you have seen from last quarter to this quarter that I guess what seems like it has caused you to pull back on your legacy portfolio guidance and whether that is more one-time in nature or more trending in general?

I think the main issue in terms of the full-year guidance is the third quarter. We tried very hard in the first half of the year to fill some of the holes in the third quarter and were not successful in some cases. So, the third-quarter is a little bit of a slowdown from what we had originally anticipated. The fourth quarter, however, was stronger than we had anticipated. So it is -- on balance it is a fairly minor adjustment. Does that answer your question?

If we look at the year to date where we came in and you look at where we came in Q2 which met our expectations and met our forecast quite frankly in the middle of the range for the second quarter, we updated the full-year guidance to reflect coming in the middle there. So if we didn't update the guidance, I think that the implied balance of the year would have been unrealistic. So we wanted to build for Q2, was actual middle of our guidance, into the full-year range. So if you just do the math that requires some adjustment in where we set the full-year numbers.

Okay, and then as I think about EBITDA, maybe you can give us some color on the seasonality of the Blackstone portfolio I guess but when you issued your press release about the acquisition you indicated around where you were anticipating full-year EBITDA of that portfolio to come out --. Are we assuming that about $20 million of your full-year guidance now incorporates Blackstone? Does that sound about accurate?

The roll forward or EBITDA guidance as well as FFO guidance incorporates about $16 million back half of the year EBITDA and FFO for the Blackstone portfolio, which is essentially the change in our guidance.

Right. That was what I was getting at. Wonderful. That is helpful. Second thing I wanted to talk about was can you give us some color on maybe additional color, I guess, on property margins? Looks like excluding Frenchman's Reef, your legacy portfolio basically had flat marches on 6% RevPAR growth. Is that kind of what we have to see going forward in the current environment that we need 5% to 6% RevPAR growth just to keep margins flat or were there anomalistic points that we should factor in going forward?

I think the answer to your question is, no, I don't think you need to factor in we need 6% RevPAR to achieve flat margins. I think this quarter there were some unique things. One of which was labor and benefits, and part of that problem was some of the positions that were filled in the second half of last year are showing up in terms of a comp issue in the second quarter. Labor and benefits were up just over 6 -- I'm sorry, wages and salaries and wages was up just over 6% in the second quarter. Benefits were up 10%.

So, that is much higher than we anticipate for the year which is 4% to 5% total for wages and benefits. So, I think we had some [compability] issues in this quarter. We have -- we have gone back and looked at headcount and that seems to be under control from one quarter to the next. But compared to last year it's slightly higher.

And then finally, if you look at the productivity numbers we gave you manhours per occupied room and sales per manhour. Those are still positive. So those are FTEs at the hotels. So the focus for us is on salaries.

And then, the last point is on the property taxes I mentioned earlier impact our margin growth by 30 basis points.

Right but unfortunately -- I guess we can all be hopeful the property tax increases will moderate at some point. But, given the state of a lot of municipalities, it doesn't seem like we see an end in sight and that was why I was getting to that 6% growth number. But all that information was very helpful.

And then a couple of last quick questions. You mentioned earlier and maybe I missed it, but on group pace it is up 7.8%. Is that inclusive of Frenchman's Reef or exclusive of Frenchman's Reef?

That includes Frenchman's Reef.

What is it outside -- excluding Frenchman's Reef? I know it is a number you have given in the past.

It is a little over it -- it is over 6%.

And how much of that is occupancy versus rate?

Rooms is about 2% and ADR is about 4.5.

And then one last quick housekeeping question. Marriott next year obviously is going to a calendar quarter as they have announced. Should we expect you guys will follow suit as a result?

Yes, we will follow suit next year. It is really -- it is not going to impact our fiscal year which is already on a calendar year but will impact the comparability of the quarters next year and we will be able to provide -- we won't restate prior quarters. We will provide the operating statistics on an apples to apples basis and report next year.

Wonderful. Thanks you all very much for answering my questions.

William Crow, Raymond James.

Good morning. Thanks for all the color. Three very quick topics here for you.

First of all the group commission increase that you referenced that hurt the second quarter. Is that any sort of an indictment to Marriott's Sales Force One or whatever you want to call it, the realignment they did last year?

No, not in any way I don't think. It is really a function of -- in the downturn which was obviously so severe a lots of companies and associations just eliminated their in-house meeting planning function, outsourced it and, unfortunately, hotels are the -- suffered the fees associated with that. And it's interesting, as you go through the travel agent commissions, they are actually lower for individual travel, but so much higher for group travel which is 100%, almost 100% focused on the big group of hotels within our portfolio. So, unfortunately, that is a phenomenon that we probably have to live with going forward.

Second topic is Washington, DC, labor union negotiations. If you can give us any update and I don't know whether the Westin that you just acquired from Blackstone is a union hotel or not.

Yes, we are nonunion at the Westin so we are not involved in the citywide negotiations.

Are you hearing anything about that?

I haven't heard anything specific about it.

Okay. And then final topic is the government per diem topic and obviously that has been a hot topic the last few weeks. Any thoughts there? Have you built anything into your assumptions for Washington, DC or San Diego, a couple of markets that could be particularly hard hit, as you think about the growth opportunities?

Right. We have not built anything in because no one knows what it is going to -- what the outcome is going to be. We are pretty sure it is going be lower, but I think in some of the key markets, I think they are trying to find ways to keep their travelers and their contractors in decent hotels as opposed to having go out to the suburbs and stay in Best Western.

So, we anticipate that some of the negotiations are going to take a little different format. We don't know what the overall format is going to be but the rumor is they are going to drop upper upscale from the calculations. That doesn't really make sense. The rumor is in Washington they are going to segregate CBD hotels and suburban hotels. That is going to be awful tough on suburban hotels.

Overall, the business is only about 2.5% of our overall rooms revenue and in Washington, DC, it's about 4.5%. So it's not critical.

What we are nervous about is kind of a spillover effect and we are going to have to be pretty discreet about what business we take. And if a customer by contract has to get government rate, that is probably somebody we have to move out if it's a draconian change. If people historically have gotten government rate even though it is not part of their contract, we are going to have to charge more money. So there are lots of moving parts and I am not sure where it all winds up.

What are you -- I agree with the spillover effects, could be important. What do you think the total demand is in somewhere like Washington, DC, from government-related rates? Only 4.5% from you. What is it for the market?

I don't know what it is for the market.

All right. That is it for me. Thank you.

Enrique Torres, Green Street Advisors.

Good morning. So, the Boston Westin, you got pretty strong RevPAR growth there but margins actually shrank. Can you comment on what are the cost issues of that hotel?

Yes, a couple of things. There was a union audit there which resulted in about -- we had to accrue about $200,000 for potential liabilities. There was -- that was the hotel I referred to in my prepared remarks that had a higher cover count and a lower average check. So that hurt food and beverage margins. I think sales and marketing was also an issue there. Boston -- I'm sorry, Starwood has recently instituted a citywide marketing effort.

They had some positions that were unfilled last year that are now staffed, which is I suppose good for coverage but not so good for comps. So I would say those three areas in general and, of course, the union wage increase that went into effect at 8% this year, it was backloaded.

And there are a couple of other factors below house profit. The property taxes year over year are up by $350,000. Plus there's the ground rent which is now cash ground rent which historically we have not had to pay cash ground rent of another $100,000. So it's a total impact cost $0.5 million, which is purely an increase to the cost.

Okay and some of it is in the house profit margin and some of it is out like below the line as well.

Correct.

That should only be more of a one-time issue. Well, if it's [leased] then those won't be one-time.

Well, the property taxes and the ground rent are not one-time issues.

Okay.

On a comparable basis it will be less impacted (multiple speakers).

And just to point out the RevPAR growth for the back half of this year at the hotel looks to be very strong and we expect the margins will get better.

Okay. That helps with that. Thank you. And then you have got to give some color on the group pace. I -- you had mentioned that it's -- while it is still strong at 8% it did come down from 13% last quarter, though, the forward pace for the rest of the year. How should I interpret that change?

I think there are two ways. I think, over the last year, we have seen booking windows lengthen and so I think we have more on the books as a percent of the ultimate forecast than we have in the past. So I think availability is an issue. As overall occupancy increases in the other segments of the business gets stronger there's less need for group.

And I think, other than that, it is sort of related to the convention calendars in the city and where they sit, particularly for the third quarter.

So how is production in the second quarter?

Second quarter was, in the quarter for the quarter and in the quarter for the year, were both down fairly significantly in the quarter for the quarter. But that was a huge impact from the State Farm group in Chicago, a $1 million group that canceled which, obviously, nets out the net bookings in the quarter for the quarter. So we were up a little bit in the quarter for the quarter ex State Farm and we were up for the year ex State Farm. But it clearly moderated. Again part of that is because of the -- simply the availability of the inventory.

Great. Thanks for the color.

Ladies and gentlemen, this concludes our question-and-answer session for today's conference. I would now like to turn the call back over to Mr. Mark Brugger for closing remarks.

Thank you, Jasmine. To everyone on this call we would like to express our continued appreciation for your interest in DiamondRock. I look forward to updating you next quarter.

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