Diamondrock Hospitality Co quarterly report, Q2 FY2010

DiamondRock Hospitality Company — Q2 2010 Form 10-Q

Business context and reporting period. DiamondRock is a lodging REIT that owns branded hotels and resorts rather than operating them. At June 18, 2010, it owned 21 hotels with 10,407 rooms and held a senior mortgage loan secured by a separate hotel. The fiscal quarter ended June 18, 2010; comparatives ended June 19, 2009. Year-to-date periods ran from January 1 to those respective dates. Hotel managers use different reporting calendars, so some properties’ quarterly results cover March through May rather than the company’s exact fiscal-quarter dates. Interim results may be seasonal and are not necessarily indicative of full-year performance.

Financial and operating performance

Amounts below are in millions of dollars unless otherwise noted.

Metric	Q2 2010	Q2 2009	YTD 2010	YTD 2009
Revenue	$151.1	$143.6	$264.0	$262.2
Operating profit	$14.7	$10.1	$12.8	$10.3
Net income (loss)	$0.8	$2.5	($7.5)	($2.8)
EPS, basic and diluted	$0.01	$0.02	($0.06)	($0.03)
EBITDA, company-defined non-GAAP	$34.1	$30.0	$51.2	$48.9
FFO, company-defined non-GAAP	$19.9	$22.2	$30.5	$35.6

• Q2 revenue increased 5.2%; room revenue rose 6.1% and food-and-beverage revenue rose 6.7%, while other revenue declined 11.4%.
• Q2 occupancy was 72.7%, up 3.7 percentage points; ADR was $160.29, up 0.6%; RevPAR was $116.53, up 6.1%. For YTD, occupancy rose 2.8 points to 69.2%, ADR fell 2.4% to $153.53, and RevPAR increased 1.7% to $106.31.
• Q2 operating expenses increased 2.2% to $136.4 million, slower than revenue growth. Operating margin, calculated as operating profit divided by revenue, was approximately 9.8% versus 7.0%. YTD operating margin was approximately 4.8% versus 3.9%.
• Q2 net income declined despite higher operating profit, primarily reflecting a $3.1 million income tax expense versus a $3.3 million tax benefit in Q2 2009. YTD net loss increased; the prior-year comparison included a $9.3 million tax benefit versus $1.5 million tax expense in 2010.
• YTD interest expense declined to $19.2 million from $22.6 million, principally because the company reversed $3.1 million of Frenchman’s Reef penalty interest in Q1 2010.

Cash flow, balance sheet and liquidity

• YTD operating cash flow was $13.8 million, down from $30.3 million. Investing cash outflow was $234.2 million, including $156.5 million for Hilton Minneapolis and $60.3 million to purchase the Allerton mortgage loan. Financing cash inflow was $198.4 million, primarily from equity issuance.
• Cash and cash equivalents were $155.4 million at June 18, 2010, down from $177.4 million at year-end; restricted cash was $40.8 million. YTD hotel capital expenditures were $10.4 million.
• Total debt was $783.8 million, all property-specific fixed-rate mortgage debt, at a weighted-average rate of 5.86%. The company reported no borrowings on its $200 million unsecured credit facility and no corporate-level debt. It had 11 unencumbered hotels and reported no mortgage covenant defaults.
• The existing credit facility expires in February 2011, with a possible one-year extension subject to conditions. A proposed replacement $200 million revolving facility was under negotiation and remained subject to due diligence, definitive documents and closing; no assurance was given it would be obtained on the proposed terms or at all.
• Facility covenant measures were within limits: leverage ratio 44.2% versus a 65% maximum; fixed-charge coverage 1.84x versus a 1.60x minimum; tangible net worth $1.8 billion versus a $1.05 billion minimum.

Material changes versus comparable periods

• Q2 lodging performance improved, driven mainly by higher occupancy; YTD RevPAR growth was more modest because lower ADR partially offset occupancy gains.
• The company completed a 23.0 million-share follow-on offering at $8.40 per share in May, raising approximately $184.8 million net. It also raised $25.1 million net through its controlled equity offering in Q1. Shares outstanding rose to 154.6 million from 124.3 million at December 31, 2009.
• On June 17, the company acquired a leasehold interest in the 821-room Hilton Minneapolis for approximately $156 million. Its operations were not included in reported Q2 or YTD results because of the acquisition timing.
• In May, DiamondRock bought the $69.0 million Allerton Hotel senior mortgage loan for approximately $60.5 million. The loan was already matured and in default.
• The company amended the Frenchman’s Reef mortgage terms, obtained waiver of accrued penalty interest, and extended deadlines for specified capital projects. It funded $5.0 million into escrow and paid a $150,000 modification fee.

Outlook, commentary and risks

• Management said lodging conditions improved in Q2, with stronger demand and stable ADR, and expected rates to improve through 2010 as demand strengthened. No quantified earnings or full-year financial guidance was provided.
• Management described short-term liquidity as supported by hotel operating cash flows, cash on hand and, if needed, credit-facility borrowings. It expected to fund longer-term needs through operating cash flow, borrowings and potential equity or debt issuance.
• Management’s 2010 capital-improvement budget was $36 million, of which approximately $7 million was expected to come from corporate cash; the balance was expected from hotel escrow reserves. The company emphasized cost controls and said it had curtailed capital spending after substantial renovations in 2006–2008.
• The Courtyard Manhattan/Midtown East mortgage cash-trap provision was triggered; the lender held approximately $1.1 million at quarter-end. The company said it remained compliant with mortgage covenants.
• The Allerton loan was on non-accrual; approximately $1.8 million of accrued interest was unrecorded. Foreclosure proceedings could take 8–10 months and might not succeed. A subsequent $0.8 million default-interest payment was received and was to reduce the loan’s carrying basis, not be recognized as income.
• The USVI tax agreement that had reduced the Frenchman’s Reef subsidiary’s tax rate to approximately 4% expired in February 2010. If not extended, the subsidiary is subject to a 37.4% rate; management was seeking an extension, with no assurance of success.
• On July 1, the company signed an agreement to acquire the 166-room Renaissance Charleston Historic District Hotel for $39 million plus customary closing costs, subject to customary closing conditions.
• Management identified economic conditions, hotel demand, competition, new supply, brand performance and the ability to access capital as factors that could affect results. It reported no material change to the other risk factors in its 2009 Form 10-K. Disclosure controls were assessed as effective, with no material change in internal control reported.

Important facts for investors to verify

• Whether the proposed replacement revolving credit facility closed, on what terms, and how the February 2011 maturity of the existing facility was addressed.
• The status and recoverability of the Allerton loan, foreclosure timing and outcome, and any subsequent interest or principal collections.
• Whether the USVI tax agreement was extended and the resulting tax expense for Frenchman’s Reef.
• Actual Hilton Minneapolis contribution after acquisition, final purchase-price allocation, and progress on the proposed Charleston acquisition.
• Whether occupancy and RevPAR gains translate into sustained ADR growth, cash generation and improved FFO, given YTD FFO declined despite higher EBITDA.
• Future cash-trap restrictions, capital-spending needs and dividend capacity, including the effects of equity issuance and share-count dilution.