DiamondRock Hospitality Co - Quarter Report: 2008 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the quarterly period ended September 5, 2008

 

OR

 

 

Commission file number 001-32514

 

DIAMONDROCK HOSPITALITY COMPANY

(Exact Name of Registrant as Specified in Its Charter)

 

 

(240) 744-1150

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      x Yes o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No

 

The registrant had 90,050,264 shares of its $0.01 par value common stock outstanding as of October 15, 2008.

 

 

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INDEX

 

PART I. FINANCIAL INFORMATION

 

		Page No.
Item 1.	Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets as of September 5, 2008 and December 31, 2007	1
	Condensed Consolidated Statements of Operations
	For the Fiscal Quarters ended September 5, 2008 and September 7, 2007 and the Periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007	2
	Condensed Consolidated Statements of Cash Flows For the Periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007	3
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Results of Operations and Financial Condition	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.	Controls and Procedures	28
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 3.	Defaults Upon Senior Securities	29
Item 4.	Submission of Matters to a Vote of Security Holders	29
Item 5.	Other Information	29
Item 6.	Exhibits	29

 

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Item I. Financial Statements

DIAMONDROCK HOSPITALITY COMPANY

 

CONDENSED CONSOLIDATED BALANCE SHEETS

As of September 5, 2008 and December 31, 2007

(in thousands, except share amounts)

 

		September 5, 2008			December 31, 2007
		(Unaudited)
ASSETS
Property and equipment, at cost		$	2,129,552		$	2,086,933
Less: accumulated depreciation		(201,214		)	(148,101		)
		1,928,338			1,938,832
Deferred financing costs, net		3,476			4,020
Restricted cash		35,043			31,736
Due from hotel managers		68,316			68,153
Favorable lease assets, net		41,546			42,070
Prepaid and other assets		19,784			17,043
Cash and cash equivalents		23,642			29,773
Total assets		$	2,120,145		$	2,131,627
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Mortgage debt		$	822,563		$	824,526
Senior unsecured credit facility		76,000			—
Total debt		898,563			824,526
Deferred income related to key money, net		20,501			15,884
Unfavorable contract liabilities, net		84,933			86,123
Due to hotel managers		36,088			36,910
Dividends declared and unpaid		22,778			22,922
Accounts payable and accrued expenses		54,909			64,980
Total other liabilities		219,209			226,819
Shareholders’ Equity:
Preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued and outstanding		—			—
Common stock, $.01 par value; 200,000,000 shares authorized; 90,050,264 and 94,730,813 shares issued and outstanding at September 5, 2008 and December 31, 2007, respectively		901			947
Additional paid-in capital		1,099,066			1,145,511
Accumulated deficit		(97,594		)	(66,176		)
Total shareholders’ equity		1,002,373			1,080,282
Total liabilities and shareholders’ equity		$	2,120,145		$	2,131,627

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DIAMONDROCK HOSPITALITY COMPANY

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Fiscal Quarters Ended September 5, 2008 and September 7, 2007 and
the Periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007

(in thousands, except per share amounts)

 

		Fiscal Quarter Ended September 5, 2008			Fiscal Quarter Ended September 7, 2007			Period from January 1, 2008 to September 5, 2008			Period from January 1, 2007 to September 7, 2007
		(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Revenues:
Rooms		$	106,203		$	109,483		$	308,141		$	308,489
Food and beverage		45,512			47,655			141,126			143,377
Other		9,680			9,379			26,008			24,809
Total revenues		161,395			166,517			475,275			476,675
Operating Expenses:
Rooms		25,422			25,744			72,830			71,003
Food and beverage		32,961			33,837			98,266			98,069
Management fees		6,844			6,759			19,857			19,822
Other hotel expenses		54,116			53,557			155,758			151,393
Depreciation and amortization		18,257			17,205			53,013			50,374
Corporate expenses		3,241			3,271			9,546			9,692
Total operating expenses		140,841			140,373			409,270			400,353
Operating profit		20,554			26,144			66,005			76,322
Other Expenses (Income):
Interest income		(296		)	(484		)	(1,066		)	(1,744		)
Interest expense		11,632			11,704			33,757			35,084
Gain on early extinguishment of debt		—			(359		)	—			(359		)
Total other expenses		11,336			10,861			32,691			32,981
Income before income taxes		9,218			15,283			33,314			43,341
Income tax (provision) benefit		2,994			269			5,830			(1,311		)
Income from continuing operations		12,212			15,552			39,144			42,030
Income from discontinued operations, net of tax		—			316			—			1,141
Net income		$	12,212		$	15,868		$	39,144		$	43,171
Earnings per share:
Continuing operations		$	0.13		$	0.16		$	0.41		$	0.45
Discontinued operations		—			0.01			—			0.01
Basic and diluted earnings per share		$	0.13		$	0.17		$	0.41		$	0.46

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DIAMONDROCK HOSPITALITY COMPANY

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007

(in thousands)

 

		Period from January 1, 2008 to September 5, 2008			Period from January 1, 2007 to September 7, 2007
		(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net income		$	39,144		$	43,171
Adjustments to reconcile net income to net cash provided by operating activities:
Real estate depreciation		53,013			51,193
Corporate asset depreciation as corporate expenses		115			119
Non-cash ground rent		5,321			5,422
Non-cash financing costs as interest		557			531
Gain on early extinguishment of debt, net		—			(359		)
Amortization of debt premium and unfavorable contract liabilities		(1,190		)	(1,278		)
Amortization of deferred income		(383		)	(245		)
Stock-based compensation		2,620			2,842
Yield support received		797			1,742
Non-cash yield support recognized		—			(601		)
Changes in assets and liabilities:
Prepaid expenses and other assets		(2,741		)	(808		)
Restricted cash		(1,935		)	(226		)
Due to/from hotel managers		(1,782		)	(9,232		)
Accounts payable and accrued expenses		(7,799		)	582
Net cash provided by operating activities		85,737			92,853
Cash flows from investing activities:
Hotel acquisitions		—			(331,325		)
Receipt of deferred key money		5,000			5,000
Hotel capital expenditures		(49,703		)	(36,245		)
Change in restricted cash		(1,372		)	776
Net cash used in investing activities		(46,075		)	(361,794		)
Cash flows from financing activities:
Repayments of credit facility		(23,000		)	(52,500		)
Draws on credit facility		99,000			91,000
Proceeds from mortgage debt		—			5,000
Repayments of mortgage debt		—			(18,392		)
Prepayment penalty on early extinguishment of debt		—			(1,972		)
Scheduled mortgage debt principal payments		(1,963		)	(2,277		)
Payment of financing costs		(13		)	(1,236		)
Proceeds from sale of common stock		—			317,935
Payment of costs related to sale of common stock		—			(380		)
Share repurchases		(49,434		)	(2,720		)
Payment of dividends		(70,383		)	(59,506		)
Net cash (used in) provided by financing activities		$	(45,793	)	$	274,952

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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		Period from January 1, 2008 to September 5, 2008			Period from January 1, 2007 to September 7, 2007
		(Unaudited)			(Unaudited)
Net (decrease) increase in cash and cash equivalents		$	(6,131	)	$	6,011
Cash and cash equivalents, beginning of period		29,773			19,691
Cash and cash equivalents, end of period		$	23,642		$	25,702
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest		$	33,089		$	34,180
Cash paid for income taxes		$	861		$	430
Capitalized interest		$	183		$	143
Non-Cash Financing Activities:
Unpaid dividends		$	22,778		$	22,922

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DIAMONDROCK HOSPITALITY COMPANY

 

Notes to the Condensed Consolidated Financial Statements

(Unaudited)

 

1.    Organization

 

DiamondRock Hospitality Company (the “Company”) is a lodging focused real estate company that owns twenty hotels and resorts.  The Company is committed to maximizing shareholder value through investing in premium full service hotels and, to a lesser extent, premium urban limited service hotels located throughout the United States.  The Company’s hotels are concentrated in key gateway cities and in destination resort locations and are all operated under a brand owned by one of the top three national brand companies (Marriott International, Inc. (“Marriott”), Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”) or Hilton Hotels Corporation (“Hilton”)).

 

The Company owns, as opposed to operates, its hotels.  As an owner, the Company receives all of the operating profits or losses generated by its hotels, after paying the hotel managers a fee based on the revenues and profitability of the hotels and reimbursing all of their direct and indirect operating costs.  As of September 5, 2008, the Company owned twenty hotels, comprising 9,586 rooms, located in the following markets: Atlanta, Georgia (3); Austin, Texas; Boston, Massachusetts; Chicago, Illinois (2); Fort Worth, Texas; Lexington, Kentucky; Los Angeles, California (2); New York, New York (2); Northern California; Oak Brook, Illinois; Orlando, Florida; Salt Lake City, Utah; Washington D.C.; St. Thomas, U.S. Virgin Islands; and Vail, Colorado.

 

The Company conducts its business through a traditional umbrella partnership REIT, or UPREIT, in which the Company’s hotel properties are owned by subsidiaries of its operating partnership, DiamondRock Hospitality Limited Partnership. The Company is the sole general partner of its operating partnership and currently owns, either directly or indirectly, all of the limited partnership units of the operating partnership.

 

2.    Summary of Significant Accounting Policies

 

Basis of Presentation

 

Certain information and footnote disclosures normally included in financial statements presented in accordance with U.S. generally accepted accounting principles, or GAAP, have been condensed or omitted in the accompanying unaudited condensed consolidated financial statements. The Company believes the disclosures made are adequate to prevent the information presented from being misleading. However, the unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto as of and for the year ended December 31, 2007, included in the Company’s Annual Report on Form 10-K dated February 28, 2008.

 

In the Company’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments necessary to present fairly the Company’s financial position as of September 5, 2008, and the results of the Company’s operations for the fiscal quarters ended September 5, 2008 and September 7, 2007 and for the periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007 and cash flows for the periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007.   Interim results are not necessarily indicative of full-year performance because of the impact of seasonal and short-term variations.

 

The Company’s financial statements include all of the accounts of the Company and its subsidiaries in accordance with U.S. generally accepted accounting principles. All intercompany accounts and transactions have been eliminated in consolidation.

 

Reporting Periods

 

The results reported in the Company’s condensed consolidated statements of operations are based on results of its hotels reported by hotel managers. The Company’s hotel managers use different reporting periods. Marriott International, the manager of most of the Company’s properties, uses a fiscal year ending on the Friday closest to December 31 and reports twelve weeks of operations for each of the first three quarters and sixteen or seventeen weeks for the fourth quarter of the year for its domestic managed hotels. In contrast, Marriott, for its non-domestic hotels (including Frenchman’s Reef), Vail Resorts, manager of the Vail Marriott, Noble Management Group, LLC, manager of the Westin Atlanta North at Perimeter, Hilton Hotels Corporation, manager of the Conrad Chicago, and Westin Hotel Management, L.P, manager of the Westin Boston Waterfront Hotel report results on a monthly basis. Additionally, the Company, as a REIT, is required by U.S. federal tax laws to report results on a calendar year basis. As a result, the Company has adopted the reporting periods used by

 

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Marriott International for its domestic hotels, except that the fiscal year always ends on December 31 to comply with REIT rules. The first three fiscal quarters end on the same day as Marriott International’s fiscal quarters but the fourth quarter ends on December 31 and the full year results, as reported in the statement of operations, always include the same number of days as the calendar year.

 

Two consequences of the reporting cycle the Company has adopted are: (1) quarterly start dates will usually differ between years, except for the first quarter which always commences on January 1, and (2) the first and fourth quarters of operations and year-to-date operations may not include the same number of days as reflected in prior years.

 

While the reporting calendar the Company adopted is more closely aligned with the reporting calendar used by the manager of most of its properties, one final consequence of the calendar is the Company is unable to report any results for Frenchman’s Reef, Vail Marriott, Westin Atlanta North at Perimeter, Conrad Chicago, or Westin Boston Waterfront Hotel for the month of operations that ends after its fiscal quarter-end because neither Westin Hotel Management, L.P., Hilton Hotels Corporation, Noble Management Group, LLC, Vail Resorts nor Marriott International make mid-month results available. As a result, the quarterly results of operations include results from Frenchman’s Reef, the Vail Marriott, the Westin Atlanta North at Perimeter, the Conrad Chicago, and the Westin Boston Waterfront Hotel as follows: first quarter (January, February), second quarter (March to May), third quarter (June to August) and fourth quarter (September to December). While this does not affect full-year results, it does affect the reporting of quarterly results.

 

Revenue Recognition

 

Revenues from operations of the hotels are recognized when the services are provided. Revenues consist of room sales, golf sales, food and beverage sales, and other hotel department revenues, such as telephone and gift shop sales.

 

Earnings Per Share

 

Basic earnings per share is calculated by dividing net income, adjusted for dividends on unvested stock grants, by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income, adjusted for dividends on unvested stock grants, by the weighted-average number of common shares outstanding during the period plus other potentially dilutive securities such as stock grants or shares issuable in the event of conversion of operating partnership units. No adjustment is made for shares that are anti-dilutive during a period.

 

Stock-based Compensation

 

The Company accounts for stock-based employee compensation using the fair value based method of accounting under Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123R”), Share-Based Payment.  The Company records the cost of awards with service conditions based on the grant-date fair value of the award.  That cost is recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render the requisite service.  No awards with performance-based or market-based conditions have been issued.

 

Key Money

 

Key money received in conjunction with entering into hotel management agreements is deferred and amortized over the term of the hotel management agreement. Key money is classified as deferred income on the accompanying condensed consolidated balance sheets and amortized against management fees on the accompanying condensed consolidated statements of operations.

 

Yield Support

 

Marriott has provided the Company with operating cash flow guarantees for certain hotels to fund shortfalls of actual hotel operating income compared to a negotiated target net operating income. The Company refers to these guarantees as “yield support.” Yield support received is recognized over the period earned if the yield support is not refundable and there is reasonable uncertainty of receipt at inception of the management agreement. Yield support is recorded as an offset to base management fees.

 

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Intangible Assets

 

Intangible assets are recorded on non-market contracts assumed as part of the acquisition of certain hotels. The Company records intangible assets at fair value on the acquisition date.   Intangible assets with definite lives are amortized using the straight-line method over the remaining non-cancelable term of the contract.  The Company does not amortize intangible assets with indefinite useful lives, but reviews these assets for impairment if events or circumstances indicate that the asset may be impaired.

 

Favorable Lease Assets and Unfavorable Contract Liabilities

 

The Company reviews the terms of agreements assumed in conjunction with the purchase of a hotel to determine if the terms are favorable or unfavorable compared to a market agreement at the acquisition date.  Favorable lease assets or unfavorable contract liabilities are recorded at the acquisition date and amortized over the term of the agreement.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents. The Company maintains cash and cash equivalents with various high credit-quality financial institutions. The Company performs periodic evaluations of the relative credit standing of these financial institutions and limits the amount of credit exposure with any one institution.

 

Straight-Line Rent

 

The Company records rent expense on leases that provide for minimum rental payments that increase in pre-established amounts over the remaining term of the lease on a straight-line basis as required by U.S. generally accepted accounting principles.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

3.    Property and Equipment

 

Property and equipment as of September 5, 2008 (unaudited) and December 31, 2007 consists of the following (in thousands):

 

 

As of September 5, 2008 and December 31, 2007, the Company had accrued capital expenditures of $3.8 million and $10.8 million, respectively.

 

4.    Capital Stock

 

Common Shares

 

The Company is authorized to issue up to 200,000,000 shares of common stock, $.01 par value per share. Each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders. Holders

 

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of the Company’s common stock are entitled to receive dividends out of assets legally available for the payment of dividends when authorized by the Company’s board of directors.

 

Share Repurchase Program

 

On February 27, 2008, the Company’s Board of Directors authorized a program to repurchase up to 4.8 million shares of its common stock.  As of September 5, 2008, the Company had purchased the full 4.8 million shares under the program at an average price of $10.15 per share.  The Company retired all repurchased shares on their respective settlement dates.

 

Preferred Shares

 

The Company is authorized to issue up to 10,000,000 shares of preferred stock, $.01 par value per share. The Company’s board of directors is required to set for each class or series of preferred stock the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, and terms or conditions of redemption. As of September 5, 2008 and December 31, 2007, there were no shares of preferred stock outstanding.

 

5.    Stock Incentive Plans

 

As of September 5, 2008, the Company has issued or committed to issue 1,712,473 shares of its common stock under its 2004 Stock Option and Incentive Plan, as amended, including 605,809 shares of unvested restricted common stock and a commitment to issue 454,763 units of deferred common stock.

 

Restricted Stock Awards

 

As of September 5, 2008, the Company’s officers and employees have been awarded 1,551,012 shares of restricted common stock, including those shares that have vested.  Shares issued to the Company’s officers and employees vest over a three-year period from the date of the grant based on continued employment, with the exception of one grant made in 2008 that vests in its entirety three years from the grant date.  The Company measures compensation expense for the restricted stock awards based upon the fair market value of its common stock at the date of grant. Compensation expense is recognized on a straight-line basis over the vesting period and is included in corporate expenses in the accompanying condensed consolidated statements of operations.

 

A summary of the Company’s restricted stock awards from January 1, 2006 to September 5, 2008 is as follows:

 

		Number of Shares		Weighted- Average Grant Date Fair Value
Unvested balance at January 1, 2006		747,000		$	10.04
Granted		197,360		15.91
Vested		(482,833	)	10.02
Unvested balance at December 31, 2006		461,527		12.57
Granted		199,885		17.99
Vested		(314,787	)	11.27
Unvested balance at December 31, 2007		346,625		16.88
Granted		406,767		10.92
Vested		(147,583	)	16.31
Unvested balance at September 5, 2008		605,809		$	13.02

 

The remaining share awards will vest as follows: 197,076 shares during 2009, 131,296 shares during 2010 and 277,437 during 2011.  As of September 5, 2008, the unrecognized compensation cost related to restricted stock awards was $6.7 million and the weighted-average period over which the unrecognized compensation expense will be recorded is approximately 26 months.  For the fiscal quarters ended September 5, 2008 and September 7, 2007, the Company recorded $0.7 million of compensation expense related to restricted stock awards. For the periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007, the Company recorded $2.1 million and $2.8 million, respectively, of compensation expense related to restricted stock awards.

 

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Deferred Stock Awards

 

At the time of the Company’s initial public offering, the Company made a commitment to issue 382,500 shares of deferred stock units to the Company’s senior executive officers.  These deferred stock units are fully vested and represent the promise of the Company to issue a number of shares of the Company’s common stock to each senior executive officer upon the earlier of (i) a change of control or (ii) June 1, 2010 (the “Deferral Period”). However, if an executive’s service with the Company is terminated for “cause” prior to the expiration of the Deferral Period, all deferred stock unit awards will be forfeited.  The executive officers are restricted from transferring these shares until the end of the Deferral Period.  As of September 5, 2008, the Company has a commitment to issue 454,763 shares under this plan.  The share commitment increased from 382,500 to 454,763 since the Company’s initial public offering because current dividends are not paid out but instead are effectively reinvested at the dividend payment date’s closing price of the Company’s common stock.  No expense has been recognized during 2008 or 2007 for these awards.

 

Stock Appreciation Rights and Dividend Equivalent Rights

 

Beginning in 2008, the Company’s corporate officers were awarded stock-settled Stock Appreciation Rights (“SARs”) and Dividend Equivalent Rights (“DERs”).  The SARs/DERs vest over three years based on continued employment and may be exercised, in whole or in part, at any time after the instrument vests and before the tenth anniversary of issuance.  Upon exercise, the holder of a SAR is entitled to receive a number of common shares equal to the positive difference, if any, between the closing price of the Company’s common stock on the exercise date and the “strike price.”  The strike price is equal to the closing price of the Company’s common stock on the SAR grant date.  The Company simultaneously issued one DER for each SAR.  The DER entitles the holder to the value of dividends issued on one share of common stock.  No dividends are paid on a DER prior to vesting, but upon vesting, the holder of each DER will receive a lump sum equal to the cumulative dividends paid per share of common stock from the grant date through the vesting date.  The DER will terminate upon exercise or expiration of each SAR.  The Company measures compensation expense of the SAR/DER awards based upon the fair market value of these awards at the grant date.  Compensation expense is recognized on a straight-line basis over the vesting period and is included in corporate expenses in the accompanying condensed consolidated statements of operations.

 

On March 4, 2008, the Company issued 300,225 SARs/DERs to its executive officers with an aggregate fair value of approximately $2.0 million.  The strike price of the SARs is $12.59.  For the period from January 1, 2008 to September 5, 2008, the Company recorded approximately $0.4 million of compensation expense related to the SARs/DERs.  A summary of the Company’s unvested SARs/DERs as of September 5, 2008 is as follows:

 

		Number of SARs/DERs		Weighted- Average Grant Date Fair Value
Balance at January 1, 2008		—		$	—
Granted		300,225		6.62
Vested		—		—
Balance at September 5, 2008		300,225		$	6.62

 

6.     Earnings Per Share

 

Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted-average number of common shares outstanding.  Diluted earnings per share is calculated by dividing net income available to common shareholders, that has been adjusted for dilutive securities, by the weighted-average number of common shares outstanding including dilutive securities.  No effect is shown for securities that are anti-dilutive.  The Company’s unvested SARs were not included in the computation of diluted earnings per share because to do so would have been antidilutive.

 

The following is a reconciliation of the calculation of basic and diluted earnings per share (in thousands, except share and per share data):

 

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		Fiscal Quarter Ended September 5, 2008			Fiscal Quarter Ended September 7, 2007			Period from January 1, 2008 to September 5, 2008			Period from January 1, 2007 to September 7, 2007
		(unaudited)			(unaudited)			(unaudited)			(unaudited)
Basic Earnings per Share Calculation:
Numerator:
Net income		$	12,212		$	15,868		$	39,144		$	43,171
Less: dividends on unvested restricted common stock		(151		)	(83		)	(389		)	(324		)
Net income after dividends on unvested restricted common stock		12,061			15,785			38,755			42,847
Less: discontinued operations		—			(316		)	—			(1,141		)
Net income from continuing operations after dividends on unvested restricted common stock		$	12,061		$	15,469		$	38,755		$	41,706
Weighted-average number of common shares outstanding—basic		92,425,801			95,086,709			94,261,449			93,760,776
Basic earnings per share:
Continuing operations		$	0.13		$	0.16		$	0.41		$	0.45
Discontinued operations		—			0.01			—			0.01
Total		$	0.13		$	0.17		$	0.41		$	0.46
Diluted Earnings per Share Calculation:
Numerator:
Net income		$	12,212		$	15,868		$	39,144		$	43,171
Less: dividends on unvested restricted common stock		(151		)	(83		)	(389		)	(324		)
Net income after dividends on unvested restricted common stock		12,061			15,785			38,755			42,847
Less: discontinued operations		—			(316		)	—			(1,141		)
Net income from continuing operations after dividends on unvested restricted common stock		$	12,061		$	15,469		$	38,755		$	41,706
Weighted-average number of common shares outstanding—basic		92,425,801			95,086,709			94,261,449			93,760,776
Unvested restricted common stock		36,392			57,085			163,168			58,557
Unvested SARs		—			—			—			—
Weighted-average number of common shares outstanding—diluted		92,462,193			95,143,794			94,424,617			93,819,333
Diluted earnings per share:
Continuing operations		$	0.13		$	0.16		$	0.41		$	0.45
Discontinued operations		—			0.01			—			0.01
Total		$	0.13		$	0.17		$	0.41		$	0.46

 

7.    Debt

 

The Company has incurred limited recourse, property specific mortgage debt in conjunction with certain of its hotels. In the event of default, the lender may only foreclose on the pledged assets; however, in the event of fraud, misapplication of funds and other customary recourse provisions, the lender may seek payment from the Company.   As of September 5, 2008, twelve of the Company’s twenty hotel properties were secured by mortgage debt. The Company’s

 

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mortgage debt contains certain property specific covenants and restrictions, including minimum debt service coverage ratios that trigger cash management provisions as well as restrictions on incurring additional debt without lender consent.  As of September 5, 2008, the Company was in compliance with the financial covenants of its mortgage debt.

 

The following table sets forth information regarding the Company’s debt as of September 5, 2008 (unaudited), in thousands:

 

Property		Principal Balance			Interest Rate
Courtyard Manhattan / Midtown East		$	41,581		5.195%
Marriott Salt Lake City Downtown		34,867			5.50%
Courtyard Manhattan / Fifth Avenue		51,000			6.48%
Marriott Griffin Gate Resort		28,615			5.11%
Renaissance Worthington		57,400			5.40%
Frenchman’s Reef & Morning Star Marriott Beach Resort		62,500			5.44%
Marriott Los Angeles Airport		82,600			5.30%
Orlando Airport Marriott		59,000			5.68%
Chicago Marriott Downtown Magnificent Mile		220,000			5.975%
Renaissance Austin		83,000			5.507%
Renaissance Waverly		97,000			5.503%
Bethesda Marriott Suites		5,000			LIBOR + 0.95 (3.41% as of September 5, 2008)
Total mortgage debt		822,563
Senior unsecured credit facility		76,000			LIBOR + 0.95 (3.42% as of September 5, 2008)
Total debt		$	898,563
Weighted-Average Interest Rate					5.44%

 

The Company is party to a four-year, $200.0 million unsecured credit facility (the “Facility”) expiring in February 2011.  The Company may extend the maturity date of the Facility for an additional year upon the payment of applicable fees and the satisfaction of certain other customary conditions.

 

Interest is paid on the periodic advances under the Facility at varying rates, based upon either LIBOR or the alternate base rate, plus an agreed upon additional margin amount. The interest rate depends upon the Company’s level of outstanding indebtedness in relation to the value of its assets from time to time, as follows:

 

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		Leverage Ratio
		60% or greater		55% to 60%		50% to 55%		Less than 50%
Alternate base rate margin		0.65	%	0.45	%	0.25	%	0.00	%
LIBOR margin		1.55	%	1.45	%	1.25	%	0.95	%

 

The Facility contains various corporate financial covenants. A summary of the most restrictive covenants is as follows:

 

				Actual at
		Covenant		September 5, 2008
Maximum leverage ratio*		65%		40.0%
Minimum fixed charge coverage ratio		1.6x		2.9x
Minimum tangible net worth		$738.4 million		$1.2 billion
Unhedged floating rate debt as a percentage of total indebtedness		35%		9.0%

 

*           “Maximum leverage ratio” is determined by dividing the total debt outstanding by the net asset value of the Company’s corporate assets and hotels. Hotel level net asset values are calculated based on the application of a contractual capitalization rate (which range from 7.5% to 8.0%) to the trailing twelve month hotel net operating income.

 

The Facility requires that the Company maintain a specific pool of unencumbered borrowing base properties. The unencumbered borrowing base assets are subject to the following limitations and covenants:

 

				Actual at
		Covenant		September 5, 2008
Minimum implied debt service ratio		1.5x		9.97x
Maximum unencumbered leverage ratio		65%		10.3%
Minimum number of unencumbered borrowing base properties		4		8
Minimum unencumbered borrowing base value		$150 million		$737.8 million
Percentage of total asset value owned by borrowers or guarantors		90%		100%

 

In addition to the interest payable on amounts outstanding under the Facility, the Company is required to pay an amount equal to 0.20% of the unused portion of the Facility if the unused portion of the Facility is greater than 50% and 0.125% if the unused portion of the Facility is less than 50%.  The Company incurred interest and unused credit facility fees on the Facility of $0.6 million and $0.7 million for the fiscal quarters ended September 5, 2008 and September 7, 2007, respectively and $1.2 million and $1.7 million for the periods from January 1, 2008 to September 5, 2008 and January 1, 2007 to September 7, 2007, respectively.  As of September 5, 2008, the Company had $76.0 million outstanding under the Facility.  Subsequent to September 5, 2008, the Company drew an additional $74.0 million under the Facility.

 

8.    Discontinued Operations

 

On December 21, 2007, the Company sold the SpringHill Suites Atlanta Buckhead for $36.0 million, resulting in a gain of approximately $3.8 million, net of $0.1 million of income taxes.  The following table summarizes the components of discontinued operations in the condensed consolidated statements of operations for the periods presented (in thousands):

 

 

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9.    Dividends

 

The Company pays quarterly cash dividends to common stockholders at the discretion of its Board of Directors.  The following table sets forth the dividends paid to common stockholders since January 1, 2008:

 

 

10.    Transactions with Hotel Managers

 

Key Money

 

Marriott has contributed to the Company certain amounts in exchange for the right to manage hotels the Company has acquired or for the completion of certain brand enhancing capital projects.  The Company refers to these amounts as “key money.”  Marriott has provided the Company with an aggregate of approximately $22 million of key money in connection with the acquisitions of six of its hotels, $10 million of which was offered for the Chicago Marriott in exchange for a commitment to complete the renovation of certain public spaces and meeting rooms at the hotel.  The Company received $5 million during the third fiscal quarter of 2007 and the remaining $5 million in January 2008 and completed the required renovation in 2008.

 

11.    Commitments and Contingencies

 

Litigation

 

The Company is not involved in any material litigation nor, to its knowledge, is any material litigation threatened against the Company.  The Company is involved in routine litigation arising out of the ordinary course of business, most of which is expected to be covered by insurance and none of which is expected to have a material impact on its financial condition or results of operations.

 

Income Taxes

 

The Company had no accruals for tax uncertainties as of September 5, 2008 and December 31, 2007.  As of September 5, 2008, all of the Company’s federal income tax returns and state tax returns for the jurisdictions in which the Company’s hotels are located remain subject to examination by the respective jurisdiction tax authorities.

 

12.    Fair Value Measurements

 

The Company implemented the provisions of Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), on January 1, 2008 for financial assets and liabilities recognized or disclosed at fair value.  The implementation of SFAS 157 did not have a material impact on the Company’s results of operations, financial position or cash flows.  There were no assets or liabilities that would have been measured differently had the unimplemented provisions of SFAS 157 deferred by FASB Staff Position No. 157-2 been implemented as of January 1, 2008.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and includes this statement for purposes of complying with these safe harbor provisions. These forward-looking statements are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions, whether in the negative or affirmative. Forward-looking statements are based on management’s current expectations and assumptions and are not guarantees of future performance.  Factors that may cause actual results to differ materially from current expectations include, but are not limited to, the risk factors discussed herein and other factors discussed from time to time in our periodic filings with the Securities and Exchange Commission. Accordingly, there is no assurance that the Company’s expectations will be realized. Except as otherwise required by the federal securities laws, the Company disclaims any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained in this report to reflect events, circumstances or changes in expectations after the date of this report.

 

Overview

 

We are a lodging focused real estate company that owns, as of October 15, 2008, twenty premium hotels and resorts which contain approximately 9,600 guestrooms.  We are committed to maximizing shareholder value through investing in premium full service hotels and, to a lesser extent, premium urban limited service hotels located throughout the United States.  Our hotels are concentrated in key gateway cities and in destination resort locations and are all operated under a brand owned by one of the top three national brand companies (Marriott, Starwood or Hilton).

 

We are owners, as opposed to operators, of hotels.  As owners, we receive all of the operating profits or losses generated by our hotels, after we pay the hotel managers a fee based on the revenues and profitability of the hotels and reimburse all of their direct and indirect operating costs.

 

As owners, we create value by acquiring the right hotels with the right brands in the right markets, prudently financing our hotels, thoughtfully re-investing capital in our hotels, implementing profitable operating strategies and approving the annual operating and capital budgets for our hotels, closely monitoring the performance of our hotels, and deciding if and when to sell our hotels.  In addition, we are committed to enhancing the value of our operating platform by being open and transparent in our communications with investors, monitoring our corporate overhead and following corporate governance best practices.

 

We differentiate ourselves from our competitors because of our adherence to three basic principles:

 

·                  high quality urban and resort focused real estate;

·                  conservative capital structure; and

·                  thoughtful asset management.

 

High Quality Urban and Resort Focused Real Estate

 

We own twenty premium hotels and resorts in North America.  These hotels and resorts are primarily categorized as upper upscale as defined by Smith Travel Research and are generally located in high barrier to entry markets with multiple demand generators.

 

Our properties are concentrated in five key gateway cities (New York City, Los Angeles, Chicago, Boston and Atlanta) and in destination resorts (such as the U.S. Virgin Islands and Vail, Colorado).  We believe that these gateway cities and destination resorts are high growth markets because they are attractive business and leisure destinations.  We also believe that these locations are better insulated from new supply due to relatively high barriers to entry and expensive construction costs.

 

We believe that higher quality lodging assets create more dynamic cash flow growth and superior long-term capital appreciation.

 

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Conservative Capital Structure

 

We are committed to maintaining a conservative and flexible capital structure with prudent leverage levels.  During 2004 through early 2007, we took advantage of the low interest rate environment by fixing our debt rates for an extended period of time.  Depending on the outlook for interest rates in the future, we maintain the flexibility to modify these strategies.

 

As of September 5, 2008, 91.0% of our debt carried fixed interest rates, with a weighted-average interest rate of 5.44%, and a weighted-average maturity of 6.5 years.  As of September 5, 2008, we had $898.6 million of debt outstanding, representing a net debt-to-enterprise value ratio of 50.6%, which is calculated as our net debt (debt less unrestricted cash) divided by our enterprise value, which is our market capitalization plus net debt.

 

We prefer a relatively simple but efficient capital structure.  We have not invested in joint ventures and have not issued any operating partnership units or preferred stock.  We endeavor to structure our hotel acquisitions so that they will not overly complicate our capital structure; however, we will consider a more complex transaction if we believe that the projected returns to our stockholders will significantly exceed the returns that would otherwise be available.

 

Thoughtful Asset Management

 

We believe that we are able to create significant value in our portfolio by utilizing our management’s extensive experience and our innovative asset management strategies.

 

Our senior management team has established a broad network of hotel industry contacts and relationships, including relationships with hotel owners, financiers, operators, project managers and contractors and other key industry participants.

 

We use our broad network to maximize the value of our hotels.  Under the regulations governing REITs, we are required to engage a hotel manager through one of our subsidiaries to manage each of our hotels pursuant to a management agreement.  Our philosophy is to negotiate management agreements that give us the right to exert significant influence over the management of our properties, annual budgets and all capital expenditures, and then to use those rights to continually monitor and improve the performance of our properties.  We cooperatively partner with the managers of our hotels in an attempt to increase operating results and long-term asset values at our hotels.  In addition to working directly with the personnel at our hotels, our senior management team also has long-standing professional relationships with our hotel managers’ senior executives, and we work directly with these senior executives to improve the performance of our portfolio.

 

We believe we can create significant value in our portfolio through innovative asset management strategies such as rebranding, renovating and repositioning. We are committed to regularly evaluating our portfolio to determine if we can employ these value-added strategies at our hotels.  During 2006, 2007 and the period from January 1, 2008 to September 5, 2008, we completed a significant amount of capital reinvestment in our hotels – completing projects that ranged from room renovations (Courtyard Manhattan/Midtown East, Los Angeles Airport Marriott, Bethesda Marriott Suites, Orlando Airport Marriott, Frenchman’s Reef & Morning Star Marriott Beach Resort and Westin Atlanta North at Perimeter) to a total renovation and repositioning of the hotel (Torrance Marriott South Bay and the Oak Brook Hills Marriott Resort) to the addition of new meeting space, spa or restaurant repositioning (Westin Boston Waterfront, Chicago Marriott and Marriott Griffin Gate Resort).  By the end of 2008, we expect to have fully renovated nearly all of the hotels in our portfolio.  In connection with our planned renovations and repositionings, our senior management team and our asset managers are individually committed to completing these renovations on time, on budget and with minimum disruption at our hotels.

 

A core tenet of our asset management strategy is to leverage national hotel brands.  We strongly believe in the value of powerful national brands because we believe that they are able to produce incremental revenue and profits compared to similar unbranded hotels.  Dominant national hotel brands typically have very strong reservation and reward systems and sales organizations, as a result, all of our hotels are operated under a brand owned by one of the top three national brand companies (Marriott, Starwood or Hilton) and all but two of the hotels are operated by the brand company directly.  Generally, we are interested in acquiring only those hotels that are operated under a nationally recognized brand or can be converted into a branded hotel.

 

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Key Indicators of Financial Condition and Operating Performance

 

We use a variety of operating and other information to evaluate the financial condition and operating performance of our business. These key indicators include financial information that is prepared in accordance with GAAP, as well as other financial information that is not prepared in accordance with GAAP. In addition, we use other information that may not be financial in nature, including statistical information and comparative data. We use this information to measure the performance of individual hotels, groups of hotels and/or our business as a whole. We periodically compare historical information to our internal budgets as well as industry-wide information. These key indicators include:

 

· Occupancy percentage;

· Average Daily Rate (or ADR);

· Revenue per Available Room (or RevPAR);

· Earnings Before Interest, Income Taxes, Depreciation and Amortization (or EBITDA); and

· Funds From Operations (or FFO).

 

Occupancy, ADR and RevPAR are commonly used measures within the hotel industry to evaluate operating performance. RevPAR, which is calculated as the product of ADR and occupancy percentage, is an important statistic for monitoring operating performance at the individual hotel level and across our business as a whole. We evaluate individual hotel RevPAR performance on an absolute basis with comparisons to budget and prior periods, as well as on a company-wide basis. ADR and RevPAR include only room revenue. Room revenue comprised approximately 66% of our total revenues for the fiscal quarter ended September 5, 2008, and is dictated by demand, as measured by occupancy percentage, pricing, as measured by ADR, and our available supply of hotel rooms.

 

Our ADR, occupancy percentage and RevPAR performance may be impacted by macroeconomic factors such as regional and local employment growth, personal income and corporate earnings, office vacancy rates and business relocation decisions, airport and other business and leisure travel, new hotel construction and the pricing strategies of competitors. In addition, our ADR, occupancy percentage and RevPAR performance is dependent on the continued success of Marriott and its brands as well as the Westin and Conrad brands.

 

We also use EBITDA and FFO as measures of the financial performance of our business. See “Non-GAAP Financial Matters.”

 

Our Hotels

 

The following table sets forth certain operating information for each of our hotels for the period from January 1, 2008 to September 5, 2008.  The percent change from 2007 RevPAR for the period from January 1, 2007 to September 7, 2007 includes the results of the Westin Boston Waterfront Hotel for the period prior to our acquisition of the hotel.

 

Property		Location		Number of Rooms		Occupancy (%)		ADR($)			RevPAR($)			% Change from 2007 RevPAR
Chicago Marriott		Chicago, Illinois		1,198		73.2	%	$	205.07		$	150.03		(7.5	)%
Los Angeles Airport Marriott		Los Angeles, California		1,004		86.7		114.98			99.68			4.2
Westin Boston Waterfront Hotel (1)		Boston, Massachusetts		793		69.9		197.74			138.28			(0.4	)
Renaissance Waverly Hotel		Atlanta, Georgia		521		70.2		142.63			100.08			0.1
Salt Lake City Marriott Downtown		Salt Lake City, Utah		510		70.6		135.56			95.68			(3.1	)
Renaissance Worthington		Fort Worth, Texas		504		73.8		176.59			130.38			(0.1	)
Frenchman’s Reef & Morning Star Marriott Beach Resort (1)		St. Thomas, U.S. Virgin Islands		502		85.6		253.42			216.90			2.2
Renaissance Austin Hotel		Austin, Texas		492		69.8		158.71			110.84			(7.4	)
Torrance Marriott South Bay		Los Angeles County, California		487		82.3		125.81			103.52			8.2
Orlando Airport Marriott		Orlando, Florida		486		74.2		121.79			90.42			(5.7	)
Marriott Griffin Gate Resort		Lexington, Kentucky		408		65.1		139.56			90.84			2.9
Oak Brook Hills Marriott Resort		Oak Brook, Illinois		386		52.7		133.19			70.18			(10.8	)
Westin Atlanta North at Perimeter (1)		Atlanta, Georgia		369		61.8		142.77			88.20			(6.8	)
Vail Marriott Mountain Resort & Spa (1)		Vail, Colorado		346		69.5		254.23			176.69			4.5
Marriott Atlanta Alpharetta		Atlanta, Georgia		318		61.8		148.83			92.00			(2.5	)
Courtyard Manhattan/Midtown East		New York, New York		312		90.5		289.03			261.43			8.8
Conrad Chicago (1)		Chicago, Illinois		311		75.7		229.61			173.75			(0.7	)
Bethesda Marriott Suites		Bethesda, Maryland		272		72.2		191.47			138.28			2.3
Courtyard Manhattan/Fifth Avenue		New York, New York		185		89.3		288.70			257.78			8.0
The Lodge at Sonoma, a Renaissance Resort & Spa		Sonoma, California		182		70.3		225.20			158.36			2.5
TOTAL/WEIGHTED AVERAGE				9,586		73.8	%	$	176.35		$	130.12		(0.4	)%

 

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