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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________
FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-32514
DIAMONDROCK HOSPITALITY COMPANY
(Exact Name of Registrant as Specified in Its Charter)
Maryland
 
20-1180098
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
2 Bethesda Metro Center, Suite 1400, Bethesda, Maryland
 
20814
(Address of Principal Executive Offices)
 
(Zip Code)
(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. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
Emerging growth company o
 
(Do not check if a smaller reporting company)

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
The registrant had 207,840,943 shares of its $0.01 par value common stock outstanding as of August 6, 2018.
 



Table of Contents
INDEX
 
 
 
Page No.
 
 
 
 
 
 
 
Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017
 
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents


PART I. FINANCIAL INFORMATION
Item I.
Financial Statements

DIAMONDROCK HOSPITALITY COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
 
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Property and equipment, net
$
2,806,510

 
$
2,692,286

Restricted cash
41,564

 
40,204

Due from hotel managers
100,253

 
86,621

Favorable lease assets, net
46,395

 
26,690

Prepaid and other assets
33,168

 
71,488

Cash and cash equivalents
134,552

 
183,569

Total assets
$
3,162,442

 
$
3,100,858

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Mortgage and other debt, net of unamortized debt issuance costs
$
636,139

 
$
639,639

Term loans, net of unamortized debt issuance costs
298,383

 
298,153

Total debt
934,522


937,792

 
 
 
 
Deferred income related to key money, net
11,937

 
14,307

Unfavorable contract liabilities, net
74,297

 
70,734

Deferred ground rent
90,254

 
86,614

Due to hotel managers
68,693

 
74,213

Dividends declared and unpaid
26,561

 
25,708

Accounts payable and accrued expenses
44,879

 
57,845

Total liabilities
1,251,143

 
1,267,213

Stockholders’ Equity:
 
 
 
Preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued and outstanding

 

Common stock, $0.01 par value; 400,000,000 shares authorized; 207,840,943 and 200,306,733 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively
2,078

 
2,003

Additional paid-in capital
2,158,336

 
2,061,451

Accumulated deficit
(249,115
)
 
(229,809
)
Total stockholders’ equity
1,911,299

 
1,833,645

Total liabilities and stockholders’ equity
$
3,162,442

 
$
3,100,858







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
(in thousands, except per share amounts)
(unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
 
 
 
 
 
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Rooms
$
175,058

 
$
177,483

 
$
304,036

 
$
315,315

Food and beverage
51,572

 
52,762

 
92,364

 
97,540

Other
11,319

 
13,027

 
23,079

 
26,627

Total revenues
237,949

 
243,272

 
419,479

 
439,482

Operating Expenses:
 
 
 
 
 
 
 
Rooms
40,593

 
41,565

 
76,193

 
78,466

Food and beverage
31,701

 
33,064

 
59,155

 
62,530

Management fees
6,610

 
6,949

 
9,443

 
12,961

Other hotel expenses
89,243

 
78,608

 
162,706

 
150,267

Depreciation and amortization
26,033

 
25,585

 
50,935

 
49,948

Hotel acquisition costs

 
22

 

 
2,273

Corporate expenses
7,832

 
6,828

 
17,618

 
13,090

Gain on business interruption insurance
(2,000
)
 

 
(8,027
)
 

Total operating expenses, net
200,012

 
192,621

 
368,023

 
369,535

Operating profit
37,937

 
50,651

 
51,456

 
69,947

Interest and other income, net
(296
)
 
(192
)
 
(807
)
 
(551
)
Interest expense
10,274

 
9,585

 
20,151

 
19,098

Loss on early extinguishment of debt

 
274

 

 
274

Total other expenses, net
9,978

 
9,667

 
19,344

 
18,821

Income before income taxes
27,959

 
40,984

 
32,112

 
51,126

Income tax benefit (expense)
50

 
(4,389
)
 
235

 
(5,644
)
Net income
$
28,009

 
$
36,595

 
$
32,347

 
$
45,482

Earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
$
0.14

 
$
0.18

 
$
0.16

 
$
0.23

Diluted earnings per share
$
0.14

 
$
0.18

 
$
0.16

 
$
0.23














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
(in thousands)
(unaudited)
 
Six Months Ended June 30,
 
2018
 
2017
 
 
Cash flows from operating activities:
 
 
 
Net income
$
32,347

 
$
45,482

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
50,935

 
49,948

Corporate asset depreciation as corporate expenses
106

 
32

Loss on early extinguishment of debt

 
274

Non-cash ground rent
3,478

 
3,164

Amortization of debt issuance costs
916

 
1,028

Amortization of favorable and unfavorable contracts, net
(979
)
 
(956
)
Amortization of deferred income related to key money
(2,370
)
 
(1,042
)
Stock-based compensation
4,413

 
3,340

Changes in assets and liabilities:
 
 
 
Prepaid expenses and other assets
6,861

 
(3,261
)
Due to/from hotel managers
(17,268
)
 
(20,258
)
Accounts payable and accrued expenses
(10,323
)
 
5,623

Net cash provided by operating activities
68,116

 
83,374

Cash flows from investing activities:
 
 
 
Hotel capital expenditures
(62,353
)
 
(58,911
)
Hotel acquisitions
(119,537
)
 
(93,795
)
Proceeds from property insurance
30,719

 

Net used in investing activities
(151,171
)
 
(152,706
)
Cash flows from financing activities:
 
 
 
Scheduled mortgage debt principal payments
(6,781
)
 
(5,870
)
Proceeds from sale of common stock, net
92,899

 

Repayments of mortgage debt

 
(170,368
)
Proceeds from senior unsecured term loan

 
200,000

Draws on senior unsecured credit facility
85,000

 

Repayments of senior unsecured credit facility
(85,000
)
 

Payment of financing costs

 
(1,579
)
Payment of cash dividends
(50,571
)
 
(50,360
)
Repurchase of common stock
(149
)
 
(529
)
Net cash provided by (used in) financing activities
35,398

 
(28,706
)
Net decrease in cash, cash equivalents, and restricted cash
(47,657
)
 
(98,038
)
Cash, cash equivalents, and restricted cash at beginning of period
223,773

 
289,164

Cash, cash equivalents, and restricted cash at end of period
$
176,116

 
$
191,126












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 - (CONTINUED)
(in thousands)
(unaudited)


Supplemental Disclosure of Cash Flow Information:
 
Six Months Ended June 30,
 
2018
 
2017
Cash paid for interest
$
18,969

 
$
18,015

Cash paid for income taxes
$
1,803

 
$
1,770

Non-cash Investing and Financing Activities:
 
 
 
Unpaid dividends
$
26,561

 
$
25,548

Loan assumed in hotel acquisition
$
2,943

 
$


The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheets to the amount shown within the condensed consolidated statements of cash flows:

 
June 30, 2018
 
December 31, 2017
Cash and cash equivalents
$
134,552

 
$
183,569

Restricted cash (1)
41,564

 
40,204

Total cash, cash equivalents, and restricted cash
$
176,116

 
$
223,773

_____________________________

(1)
Restricted cash primarily consists of reserves for replacement of furniture and fixtures held by our hotel managers and cash held in escrow pursuant to lender requirements.






























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” or “we”) is a lodging-focused real estate company that owns a portfolio of premium hotels and resorts. Our hotels are concentrated in key gateway cities and in destination resort locations and the majority of our hotels are operated under a brand owned by one of the leading global lodging brand companies (Marriott International, Inc. or Hilton Worldwide). We are an owner, as opposed to an operator, of the hotels in our portfolio. As an owner, we receive all of the operating profits or losses generated by our hotels after we pay fees to the hotel managers, which are based on the revenues and profitability of the hotels.

As of June 30, 2018, we owned 30 hotels with 9,949 guest rooms, located in the following markets: Atlanta, Georgia; Boston, Massachusetts (2); Burlington, Vermont; Charleston, South Carolina; Chicago, Illinois (2); Denver, Colorado (2); Fort Lauderdale, Florida; Fort Worth, Texas; Huntington Beach, California; Key West, Florida (2); New York, New York (4); Phoenix, Arizona; Salt Lake City, Utah; San Diego, California; San Francisco, California; Sedona, Arizona (2); Sonoma, California; South Lake Tahoe, California; Washington D.C. (2); St. Thomas, U.S. Virgin Islands; and Vail, Colorado. As of June 30, 2018, the Frenchman's Reef & Morning Star Marriott Beach Resort is closed as a result of damage incurred from Hurricanes Irma and Maria in September 2017.

We conduct our business through a traditional umbrella partnership real estate investment trust, or UPREIT, in which our hotel properties are owned by our operating partnership, DiamondRock Hospitality Limited Partnership, or subsidiaries of our operating partnership. The Company is the sole general partner of our operating partnership and currently owns, either directly or indirectly, all of the limited partnership units of our operating partnership.

2.
Summary of Significant Accounting Policies

Basis of Presentation

We have condensed or omitted certain information and footnote disclosures normally included in financial statements presented in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, in the accompanying unaudited condensed consolidated financial statements. We believe 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 audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2017, included in our Annual Report on Form 10-K filed on February 27, 2018.

In our opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments necessary to present fairly our financial position as of June 30, 2018, the results of our operations for the three and six months ended June 30, 2018 and 2017, and the cash flows for the six months ended June 30, 2018 and 2017. Interim results are not necessarily indicative of full-year performance because of the impact of seasonal and short-term variations.

Our financial statements include all of the accounts of the Company and its subsidiaries in accordance with U.S. GAAP. All intercompany accounts and transactions have been eliminated in consolidation. If the Company determines that it has an interest in a variable interest entity within the meaning of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation, the Company will consolidate the entity when it is determined to be the primary beneficiary of the entity. Our operating partnership meets the criteria of a variable interest entity. The Company is the primary beneficiary and, accordingly, we consolidate our operating partnership.

Use of Estimates

The preparation of the financial statements in conformity with U.S. GAAP 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.

Property and Equipment


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Following the adoption of Accounting Standards Update (“ASU”) No. 2017-01, investments in hotel properties, land, land improvements, building and furniture, fixtures and equipment and identifiable intangible assets are generally accounted for as asset acquisitions and recorded at relative fair value based upon total accumulated cost of the acquisition. Direct acquisition-related costs are capitalized as a component of the acquired assets. Property and equipment purchased after the hotel acquisition date is recorded at cost. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation are removed from the Company’s accounts and any resulting gain or loss is included in the statements of operations.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 5 to 40 years for buildings, land improvements, and building improvements and 1 to 10 years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets.

We review our investments in hotel properties for impairment whenever events or changes in circumstances indicate that the carrying value of the hotel properties may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse changes in the demand for lodging at the properties due to declining national or local economic conditions and/or new hotel construction in markets where the hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from the ultimate disposition of a hotel, less costs to sell, exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the related hotel’s estimated fair market value is recorded and an impairment loss is recognized.

We will classify a hotel as held for sale in the period that we have made the decision to dispose of the hotel, a binding agreement to purchase the property has been signed under which the buyer has committed a significant amount of nonrefundable cash and no significant financing or other contingencies exist which could cause the transaction to not be completed in a timely manner. If these criteria are met, we will record an impairment loss if the fair value less costs to sell is lower than the carrying amount of the hotel and related assets and will cease recording depreciation expense. We will classify the assets and related liabilities as held for sale on the balance sheet.

Revenue Recognition

Revenues from operations of the hotels are recognized when the goods or services are provided, and thereby the performance obligations are satisfied. Revenues consist of room sales, food and beverage sales, and other hotel department revenues, such as telephone, parking, gift shop sales and resort fees. Room revenue is generated through contracts with customers whereby the customer agrees to pay a daily rate for the right to use a hotel room. Our contract performance obligations are fulfilled at the end of the day that the customer is provided the room and revenue is recognized daily at the contract rate. Food and beverage revenue is generated through contracts with customers whereby the customer agrees to pay a contract rate for restaurant dining services or banquet services. Our contract performance obligations are fulfilled at the time that the food and beverage is provided to the customer or when the banquet facilities and related dining amenities are provided to the customer. We recognize food and beverage revenue upon the fulfillment of the contract with the customer. Other revenues are recognized at the point in time or over the time period that goods or services are provided to the customer. Certain ancillary services are provided by third parties and we assess whether we are the principal or agent in these arrangements. If we are the agent, revenue is recognized based upon the commission earned from the third party. If we are the principal, we recognize revenue based upon the gross sales price. Certain of our hotels have retail spaces, restaurants or other spaces which we lease to third parties. Lease revenue is recognized on a straight-line basis over the life of the lease and included in other operating revenues in our condensed consolidated statements of operations.

Hotel operating revenues are disaggregated on the face of the condensed consolidated statements of operations into the categories of room revenue, food and beverage revenue, and other revenue to demonstrate how economic factors affect the nature, amount, timing, and uncertainty of revenue and cash flows.

The following table provides information about trade receivables and contract liabilities (in thousands):
 
June 30, 2018
 
December 31, 2017
Trade receivables (1)
$
27,435

 
$
17,919

Advance deposits as deferred revenue (2)
13,336

 
14,754

______________________
(1)
Included within due from hotel managers on the accompanying condensed consolidated balance sheets.
(2)
Included within due to hotel managers on the accompanying condensed consolidated balance sheets.


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Advance deposits are provided when a customer or group of customers provides a deposit for a future stay or banquet event at our hotels. Advance deposits are converted to revenue when the services are provided to the customer or when a customer with a noncancelable reservation fails to arrive for part or all of the reservation. Conversely, advance deposits are generally refundable upon guest cancelation of the related reservation within an established period of time prior to the reservation.

Earnings Per Share

Basic earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period plus other potentially dilutive securities such as equity awards 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

We account for stock-based employee compensation using the fair value based method of accounting. We record the cost of awards with service or market 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.

Income Taxes

We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings during the period in which the new rate is enacted. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of all available evidence, including the future reversals of existing taxable temporary differences, future projected taxable income and tax planning strategies. Valuation allowances are provided if, based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

We have elected to be treated as a real estate investment trust (“REIT”) under the provisions of the Internal Revenue Code of 1986, as amended (the "Code"), which requires that we distribute at least 90% of our taxable income annually to our stockholders and comply with certain other requirements. In addition to paying federal and state taxes on any retained income, we may be subject to taxes on “built-in gains” on sales of certain assets. Our taxable REIT subsidiaries will generally be subject to federal, state, local, and/or foreign income taxes.

In order for the income from our hotel property investments to constitute “rents from real properties” for purposes of the gross income tests required for REIT qualification, the income we earn cannot be derived from the operation of any of our hotels. Therefore, we lease each of our hotel properties to a wholly owned subsidiary of Bloodstone TRS, Inc., our primary taxable REIT subsidiary, or TRS, except for the Frenchman’s Reef & Morning Star Marriott Beach Resort, which is owned by a Virgin Islands corporation, which we have elected to be treated as a TRS.

We had no accruals for tax uncertainties as of June 30, 2018 and December 31, 2017.

Fair Value Measurements

In evaluating fair value, U.S. GAAP outlines a valuation framework and creates a fair value hierarchy that distinguishes between market assumptions based on market data (observable inputs) and a reporting entity’s own assumptions about market data (unobservable inputs). The hierarchy ranks the observability of inputs used to determine fair value, which are then classified and disclosed in one of the three categories. The three levels are as follows:

Level 1 - Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities
Level 2 - Inputs include quoted prices in active markets for similar assets and liabilities, quoted prices for identical
or similar assets in markets that are not active and model-derived valuations whose inputs are observable
Level 3 - Model-derived valuations with unobservable inputs

Intangible Assets and Liabilities


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Intangible assets and liabilities are recorded on non-market contracts assumed as part of the acquisition of certain hotels. We review the terms of agreements assumed in conjunction with the purchase of a hotel to determine if the terms are favorable or unfavorable compared to an estimated market agreement at the acquisition date. Favorable lease assets or unfavorable contract liabilities are recorded at the acquisition date and amortized using the straight-line method over the term of the agreement. We do not amortize intangible assets with indefinite useful lives, but we review these assets for impairment annually or at interim periods if events or circumstances indicate that the asset may be impaired.

Accounting for Impacts of Natural Disasters

Assets destroyed or damaged as a result of natural disasters or other involuntary events are written off or reduced in carrying value to their salvage value. When recovery of all or a portion of the amount of property damage loss or other covered expenses through insurance proceeds is demonstrated to be probable, a receivable is recorded and offsets the loss or expense up to the amount of the total loss or expense. No gain is recorded until all contingencies related to the insurance claim have been resolved. Income resulting from business interruption insurance is not recognized until all contingencies related to the insurance recoveries are resolved.

In September 2017, Hurricanes Irma and Maria caused significant damage to the Frenchman's Reef & Morning Star Marriott Beach Resort and the Havana Cabana Key West. We are pursuing insurance claims for the remediation of property damage and business interruption at these hotels. We received $12.5 million and $52.5 million of insurance proceeds under these claims during the three and six months ended June 30, 2018, respectively. For the three months ended June 30, 2018, we recognized a $2.0 million gain on business interruption insurance on our accompanying condensed consolidated statement of operations, which is in addition to $1.0 million of expense reimbursements from insurance recorded within other hotel expenses on our accompanying condensed consolidated statement of operations. For the six months ended June 30, 2018, we recognized a $8.0 million gain on business interruption insurance on our accompanying condensed consolidated statement of operations, which is in addition to $2.9 million of expense reimbursements from insurance recorded within other hotel expenses on our accompanying condensed consolidated statement of operations.

Recently Issued Accounting Pronouncements

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions of assets or business combinations. As a result of the standard, we anticipate that the majority of our hotel acquisitions will be considered asset purchases as opposed to business combinations. However, the determination will be made on a transaction-by-transaction basis and we do not expect the determination to materially change the recognition of the assets and liabilities acquired. This standard is effective for annual periods beginning after December 15, 2017. We adopted ASU No. 2017-01 effective January 1, 2018. This standard will be applied on a prospective basis and, therefore, it does not affect the accounting for any of our transactions prior to January 1, 2018. Refer to Note 9 for more information about our two hotel property acquisitions during the six months ended June 30, 2018, which were both asset purchases.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that the statement of cash flows explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This standard is effective for annual periods beginning after December 15, 2017. We adopted ASU No. 2016-18 effective January 1, 2018. The adoption of ASU No. 2016-18 changed the presentation of the statement of cash flows for the Company and we utilized a retrospective transition method for each period presented within financial statements for periods subsequent to the date of adoption. Restricted cash reserves are included with cash and cash equivalents on our consolidated statements of cash flows for all periods presented. There was no impact to the condensed consolidated statements of income or the condensed consolidated balance sheets.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which clarifies and provides specific guidance on eight cash flow classification issues with an objective to reduce the current diversity in practice. This standard is effective for annual periods beginning after December 15, 2017. We adopted ASU No. 2016-15 effective January 1, 2018 and it did not have an impact on our consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which affects virtually all aspects of an entity’s revenue recognition. The new standard sets forth five prescribed steps to determine the timing and amount of revenue to be recognized to appropriately depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,

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which deferred the effectiveness of ASU No. 2014-09 to reporting periods beginning after December 15, 2017 and permitted early application for annual reporting periods beginning after December 15, 2016. We adopted the new standard effective January 1, 2018 under the cumulative effect transition method. No adjustment was recorded to the Company’s opening balance of retained earnings on January 1, 2018 as there was no impact to net income for the Company.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which primarily changes the lessee's accounting for operating leases by requiring recognition of lease right-of-use assets and lease liabilities. This standard is effective for annual reporting periods beginning after December 15, 2018, with early adoption permitted. The primary impact of the new standard will be to the treatment of our ground leases, which represent a majority of all of our operating lease payments. We are continuing to evaluate the effect of ASU 2016-02 on our consolidated financial statements and related disclosures.

3.
Property and Equipment

Property and equipment as of June 30, 2018 and December 31, 2017 consists of the following (in thousands):

 
June 30, 2018
 
December 31, 2017
Land
$
617,695

 
$
602,879

Land improvements
7,994

 
7,994

Buildings and site improvements
2,538,664

 
2,414,216

Furniture, fixtures and equipment
458,667

 
423,987

Construction in progress
23,228

 
31,906

 
3,646,248

 
3,480,982

Less: accumulated depreciation
(839,738
)
 
(788,696
)
 
$
2,806,510

 
$
2,692,286


As of June 30, 2018 and December 31, 2017, we had accrued capital expenditures of $9.4 million and $11.7 million, respectively.

4. Favorable Lease Assets

In connection with the acquisition of certain hotels, we have recognized intangible assets for favorable leases. Our favorable lease assets, net of accumulated amortization of $3.0 million and $2.7 million as of June 30, 2018 and December 31, 2017, respectively, consist of the following (in thousands):
 
June 30, 2018
 
December 31, 2017
Westin Boston Waterfront Hotel Ground Lease
$
17,534

 
$
17,643

Hotel Palomar Phoenix Ground Lease
19,913

 

Orchards Inn Sedona Annex Sublease
8,841

 
8,925

Lexington Hotel New York Tenant Leases
107

 
122

 
$
46,395

 
$
26,690


Favorable lease assets are recorded at the acquisition date and are generally amortized using the straight-line method over the remaining non-cancelable term of the lease agreement. We recorded $0.2 million and $0.1 million of amortization expense, respectively, for the three months ended June 30, 2018 and 2017. We recorded $0.3 million and $0.2 million of amortization expense, respectively, for the six months ended June 30, 2018 and 2017.

In connection with our acquisition of the Hotel Palomar Phoenix on March 1, 2018, we recorded a $20.0 million favorable lease asset. We determined the value using a discounted cash flow of the favorable difference between the contractual lease payments and estimated market rents. The market rents were estimated with the assistance of a third-party valuation firm and the discount rate was estimated using a risk adjusted rate of return. See Note 9 for further discussion of this favorable lease asset.

5. Capital Stock

Common Shares

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We are authorized to issue up to 400 million shares of common stock, $0.01 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 of our common stock are entitled to receive dividends out of assets legally available for the payment of dividends when authorized by our board of directors.

We have an “at-the-market” equity offering program (the “ATM program”), pursuant to which we may issue and sell shares of our common stock from time to time, having an aggregate offering price of up to $200 million. During the six months ended June 30, 2018, we sold 7,472,946 shares of common stock at an average price of $12.56 for net proceeds of $92.9 million under the ATM program. As of June 30, 2018, there is $34.4 million remaining under the ATM program.

Our board of directors has approved a share repurchase program authorizing us to repurchase up to $150 million in shares of our common stock. Repurchases under this program are made in open market or privately negotiated transactions as permitted by federal securities laws and other legal requirements. This authority may be exercised from time to time and in such amounts as market conditions warrant, and subject to regulatory considerations. The timing, manner, price and actual number of shares repurchased depends on a variety of factors including stock price, corporate and regulatory requirements, market conditions, and other corporate liquidity requirements and priorities. The share repurchase program may be suspended or terminated at any time without prior notice. We have not repurchased any shares of our common stock during 2018 and we have $150 million of authorized capacity remaining under our share repurchase program.

Dividends

We have paid the following dividends to holders of our common stock during 2018 as follows:
Payment Date
 
Record Date
 
Dividend
per Share
January 12, 2018

December 29, 2017

$
0.125

April 12, 2018

March 29, 2018

$
0.125

July 12, 2018
 
June 29, 2018
 
$
0.125


Preferred Shares

We are authorized to issue up to 10 million shares of preferred stock, $0.01 par value per share. Our 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 June 30, 2018 and December 31, 2017, there were no shares of preferred stock outstanding.

Operating Partnership Units

Holders of operating partnership units have certain redemption rights, which would enable them to cause our operating partnership to redeem their units in exchange for cash per unit equal to the market price of our common stock, at the time of redemption, or, at our option for shares of our common stock on a one-for-one basis. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of stock splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have the effect of diluting the ownership interests of the limited partners or our stockholders. As of June 30, 2018 and December 31, 2017, there were no operating partnership units held by unaffiliated third parties.

6. Stock Incentive Plans

We are authorized to issue up to 6,082,664 shares of our common stock under our 2016 Equity Incentive Plan (the "2016 Plan"), of which we have issued or committed to issue 846,517 shares as of June 30, 2018. In addition to these shares, additional shares of common stock could be issued in connection with the performance stock unit awards as further described below. The 2016 Plan replaced the 2004 Stock Option and Incentive Plan, as amended (the "2004 Plan"). We no longer make share grants and issuances under the 2004 Plan, although awards previously made under the 2004 Plan that are outstanding will remain in effect in accordance with the terms of that plan and the applicable award agreements.

Restricted Stock Awards

Restricted stock awards issued to our officers and employees generally vest over a three-year period from the date of the grant based on continued employment. We measure compensation expense for the restricted stock awards based upon the fair

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market value of our 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 our restricted stock awards from January 1, 2018 to June 30, 2018 is as follows:
 
Number of
Shares
 
Weighted-
Average Grant
Date Fair
Value
Unvested balance at January 1, 2018
630,962

 
$
10.66

Granted
349,091

 
10.19

Vested
(338,209
)
 
10.94

Unvested balance at June 30, 2018
641,844

 
$
10.25


The remaining share awards are expected to vest as follows: 310,117 shares during 2019, 215,368 shares during 2020, and 116,359 during 2021. As of June 30, 2018, the unrecognized compensation cost related to restricted stock awards was $5.5 million and the weighted-average period over which the unrecognized compensation expense will be recorded is approximately 26 months. We recorded $0.8 million of compensation expense related to restricted stock awards for each of the three months ended June 30, 2018 and 2017. We recorded $2.1 million and $1.5 million, respectively, of compensation expense related to restricted stock awards for the six months ended June 30, 2018 and 2017. The compensation expense for the six months ended June 30, 2018 includes $0.6 million related to the accelerated vesting of awards in connection with the departure of our former Chief Financial Officer. Subsequent to June 30, 2018, we entered into a settlement agreement with our former Chief Financial Officer, in which he forfeited certain of his equity awards. As a result, the compensation expense previously recorded related to the forfeited awards will be reversed.

Performance Stock Units

Performance stock units (“PSUs”) are restricted stock units that vest three years from the date of grant. Each executive officer is granted a target number of PSUs (the “PSU Target Award”). For the PSUs issued in 2015 and vesting in 2018, the actual number of shares of common stock issued to each executive officer is subject to the achievement of certain levels of total stockholder return relative to the total stockholder return of a peer group of publicly traded lodging REITs over a three-year performance period. There will be no payout of shares of our common stock if our total stockholder return falls below the 30th percentile of the total stockholder returns of the peer group. The maximum number of shares of common stock issued to an executive officer is equal to 150% of the PSU Target Award and is earned if our total stockholder return is equal to or greater than the 75th percentile of the total stockholder returns of the peer group. For the PSUs issued in 2016 and vesting in 2019, the calculation of total stockholder return relative to the total stockholder return of a peer group over a three-year performance period remained in effect for 75% of the number of PSUs to be earned in the performance period. The remaining 25% is determined based on achieving improvement in market share for each of our hotels over the three-year performance period based on a report prepared for each hotel by STR Global, a well-recognized and universally accepted benchmarking service for the hospitality industry. For the PSUs issued in 2017 and 2018 and vesting in 2020 and 2021, respectively, the calculation of total stockholder return relative to the total stockholder return of a peer group over a three-year performance period applies to 50% of the number of PSUs to be earned in the performance period. The remaining 50% is determined based on achieving improvement in market share for each of our hotels over the three-year performance period.

We measure compensation expense for the PSUs based upon the fair market value of the award at the grant date. Compensation expense is recognized on a straight-line basis over the three-year performance period and is included in corporate expenses in the accompanying condensed consolidated statements of operations. The grant date fair value of the portion of the PSUs based on our relative total stockholder return is determined using a Monte Carlo simulation performed by a third-party valuation firm. The grant date fair value of the portion of the PSUs based on improvement in market share for each of our hotels is the closing price of our common stock on the grant date.

On March 2, 2018, our board of directors granted 264,509 PSUs to our executive officers. The grant date fair value of the portion of the PSUs based on our relative total stockholder return was $9.52 using the assumptions of volatility of 26.9% and a risk-free rate of 2.40%. The grant date fair value of the portion of the PSUs based on hotel market share was $10.18, the closing stock price of our common stock on such date. On April 2, 2018, our board of directors granted 28,602 PSUs to our new Chief Financial Officer. The grant date fair value of the portion of the PSUs based on our relative total stockholder return was $9.00 using the assumptions of volatility of 26.9% and a risk-free rate of 2.37%. The grant date fair value of the portion of the PSUs based on hotel market share was $10.32, the closing stock price of our common stock on such date.


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A summary of our PSUs from January 1, 2018 to June 30, 2018 is as follows:
 
Number of
Target Units
 
Weighted-
Average Grant
Date Fair
Value
Unvested balance at January 1, 2018
785,797

 
$
10.42

Granted
293,111

 
9.82

Additional units from dividends
18,260

 
11.13

Vested (1)
(218,514
)
 
11.98

Unvested balance at June 30, 2018
878,654

 
$
9.85

______________________
(1)
The number of shares of common stock earned for the PSUs vested in 2018 was equal to 51.75% of the PSU Target Award.

The remaining target units are expected to vest as follows: 301,189 units during 2019, 281,270 units during 2020 and 296,195 units during 2021. The number of shares earned upon vesting is subject to the attainment of the performance goals described above. As of June 30, 2018, the unrecognized compensation cost related to the PSUs was $4.3 million and is expected to be recognized on a straight-line basis over a weighted average period of 26 months. We recorded $0.6 million of compensation expense related to the PSUs for each of the three months ended June 30, 2018 and 2017. We recorded $1.7 million and $1.2 million, respectively, of compensation expense related to the PSUs for the six months ended June 30, 2018 and 2017. The compensation expense for the six months ended June 30, 2018 includes $0.6 million related to the accelerated vesting of awards in connection with the departure of our former Chief Financial Officer. Subsequent to June 30, 2018, we entered into a settlement agreement with our former Chief Financial Officer, in which he forfeited certain of his equity awards. As a result, the compensation expense previously recorded related to the forfeited awards will be reversed.

7. Earnings Per Share

Basic earnings per share is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding. Diluted earnings per share is calculated by dividing net income available to common stockholders that has been adjusted for dilutive securities, by the weighted-average number of common shares outstanding including dilutive securities.

The following is a reconciliation of the calculation of basic and diluted earnings per share (in thousands, except share and per share data):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Numerator:
 
 
 
 
 
 
 
Net income
$
28,009

 
$
36,595

 
$
32,347

 
$
45,482

Denominator:
 
 
 
 
 
 
 
Weighted-average number of common shares outstanding—basic
203,574,282

 
200,810,323

 
202,366,359

 
200,732,639

Effect of dilutive securities:
 
 
 
 
 
 
 
Unvested restricted common stock
148,608

 
99,677

 
207,279

 
165,483

Shares related to unvested PSUs
793,252

 
831,394

 
793,252

 
831,394

Weighted-average number of common shares outstanding—diluted
204,516,142

 
201,741,394

 
203,366,890

 
201,729,516

Earnings per share:


 
 
 


 


Basic earnings per share
$
0.14

 
$
0.18

 
$
0.16

 
$
0.23

Diluted earnings per share
$
0.14

 
$
0.18

 
$
0.16

 
$
0.23


8. Debt

The following table sets forth information regarding the Company’s debt as of June 30, 2018 and December 31, 2017 (dollars in thousands):

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Principal Balance as of
Loan
 
Interest Rate
 
Maturity Date
 
June 30, 2018
 
December 31, 2017
Salt Lake City Marriott Downtown mortgage loan
 
4.25%
 
November 2020
 
$
55,874

 
$
56,717

Westin Washington D.C. City Center mortgage loan
 
3.99%
 
January 2023
 
63,791

 
64,833

The Lodge at Sonoma, a Renaissance Resort & Spa mortgage loan
 
3.96%
 
April 2023
 
27,954

 
28,277

Westin San Diego mortgage loan
 
3.94%
 
April 2023
 
64,126

 
64,859

Courtyard Manhattan / Midtown East mortgage loan
 
4.40%
 
August 2024
 
83,346

 
84,067

Renaissance Worthington mortgage loan
 
3.66%
 
May 2025
 
83,331

 
84,116

JW Marriott Denver at Cherry Creek mortgage loan
 
4.33%
 
July 2025
 
62,967

 
63,519

Boston Westin mortgage loan
 
4.36%
 
November 2025
 
196,263

 
198,046

New Market Tax Credit loan (1)
 
5.17%
 
December 2020
 
2,943

 

Unamortized debt issuance costs
 
 
 
 
 
(4,456
)
 
(4,795
)
Total mortgage and other debt, net of unamortized debt issuance costs
 
 
 
 
 
636,139

 
639,639

 
 
 
 
 
 
 
 
 
Unsecured term loan
 
LIBOR + 1.45% (2)
 
May 2021
 
100,000

 
100,000

Unsecured term loan
 
LIBOR + 1.45% (2)
 
April 2022
 
200,000

 
200,000

Unamortized debt issuance costs
 
 
 
 
 
(1,617
)
 
(1,847
)
Unsecured term loan, net of unamortized debt issuance costs
 
 
 
 
 
298,383

 
298,153

 
 
 
 
 
 
 
 
 
Senior unsecured credit facility
 
LIBOR + 1.50%
 
May 2020 (3)
 

 

 
 
 
 
 
 
 
 
 
Total debt, net of unamortized debt issuance costs
 
 
 
 
 
$
934,522

 
$
937,792

Weighted-Average Interest Rate
 
3.99%
 
 
 
 
 
 
_______________________

(1)
Assumed in connection with the acquisition of the Hotel Palomar Phoenix in March 2018.
(2)
The interest rate at June 30, 2018 was 3.43%.
(3)
The credit facility may be extended for an additional year upon the payment of applicable fees and the satisfaction of certain customary conditions.

Mortgage and Other Debt

We have incurred limited recourse, property specific mortgage debt secured by certain of our hotels. In the event of default, the lender may only foreclose on the secured assets; however, in the event of fraud, misapplication of funds or other customary recourse provisions, the lender may seek payment from us. As of June 30, 2018, eight of our 30 hotels were secured by mortgage debt.

Our mortgage debt contains certain property specific covenants and restrictions, including minimum debt service coverage ratios that trigger “cash trap” provisions as well as restrictions on incurring additional debt without lender consent. As of June 30, 2018, we were in compliance with the financial covenants of our mortgage debt.

On March 1, 2018, in connection with our acquisition of the Hotel Palomar in Phoenix, Arizona, we assumed a $2.9 million loan originated under a qualified New Market Tax Credit program. The loan is interest-only and bears an annual fixed interest rate equal to 5.17%. The loan matures on December 6, 2020.

Senior Unsecured Credit Facility

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We are party to a senior unsecured credit facility with a capacity up to $300 million. The maturity date is May 2020 and may be extended for an additional year upon the payment of applicable fees and the satisfaction of certain customary conditions. The facility also includes an accordion feature to expand up to $600 million, subject to lender consent. The interest rate on the facility is based upon LIBOR, plus an applicable margin based upon the Company’s leverage ratio, as follows:
Leverage Ratio
 
Applicable Margin
Less than or equal to 35%
 
1.50
%
Greater than 35% but less than or equal to 45%
 
1.65
%
Greater than 45% but less than or equal to 50%
 
1.80
%
Greater than 50% but less than or equal to 55%
 
2.00
%
Greater than 55%
 
2.25
%

In addition to the interest payable on amounts outstanding under the facility, we were required to pay an amount equal to 0.20% of the unused portion of the facility if the average usage of the facility was greater than 50% or 0.30% of the unused portion of the facility if the average usage of the facility was less than or equal to 50%.

The facility also contains various corporate financial covenants. A summary of the most restrictive covenants is as follows:
 
 
 
Actual at
 
Covenant
 
June 30, 2018
Maximum leverage ratio (1)
60%
 
25.1%
Minimum fixed charge coverage ratio (2)
1.50x
 
4.12x
Minimum tangible net worth (3)
$1.98 billion
 
$2.70 billion
Secured recourse indebtedness
Less than 45% of Total Asset Value
 
20.4%
_____________________________
(1)
Leverage ratio is net indebtedness, as defined in the credit agreement, divided by total asset value, defined in the credit agreement as the value of our owned hotels based on hotel net operating income divided by a defined capitalization rate.
(2)
Fixed charge coverage ratio is Adjusted EBITDA, generally defined in the credit agreement as EBITDA less FF&E reserves, for the most recently ending 12 months, to fixed charges, which is defined in the credit agreement as interest expense, all regularly scheduled principal payments and payments on capitalized lease obligations, for the same most recently ending 12-month period.
(3)
Tangible net worth, as defined in the credit agreement, is (i) total gross book value of all assets, exclusive of depreciation and amortization, less intangible assets, total indebtedness, and all other liabilities, plus (ii) 75% of net proceeds from future equity issuances.

As of June 30, 2018, we had no borrowings outstanding under the facility and the Company's leverage ratio was 25.1%. Accordingly, interest on our borrowings under the facility will be based on LIBOR plus 150 basis points for the following quarter. We incurred interest and unused credit facility fees on the facility of $0.3 million and $0.2 million for the three months ended June 30, 2018 and 2017, respectively. We incurred interest and unused credit facility fees on the facility of $0.7 million and $0.5 million for the six months ended June 30, 2018 and 2017, respectively.

Unsecured Term Loans

We are party to two five-year unsecured term loans. The financial covenants of the term loans are consistent with the covenants on our senior unsecured credit facility, which are described above. The interest rate on each of the term loans is based on a pricing grid ranging from 145 to 220 basis points over LIBOR, as follows:
Leverage Ratio
 
Applicable Margin
Less than or equal to 35%
 
1.45
%
Greater than 35% but less than or equal to 45%
 
1.60
%
Greater than 45% but less than or equal to 50%
 
1.75
%
Greater than 50% but less than or equal to 55%
 
1.95
%
Greater than 55%
 
2.20
%

As of June 30, 2018, the Company's leverage ratio was 25.1%. Accordingly, interest on our borrowings under the term loans will be based on LIBOR plus 145 basis points for the following quarter. We incurred interest on the term loans of $2.6 million

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and $1.5 million for the three months ended June 30, 2018 and 2017, respectively. We incurred interest on the term loans of $5.0 million and $2.1 million for the six months ended June 30, 2018 and 2017, respectively.

9. Acquisitions

On March 1, 2018, we acquired the 77-room Landing Resort & Spa in South Lake Tahoe, California, for a total contractual purchase price of $42 million. The acquisition was funded with corporate cash. The acquisition is accounted for as an acquisition of assets; accordingly, our direct acquisition costs of $0.5 million were capitalized. Upon acquisition of the hotel, we entered into a new management agreement with Two Roads Hospitality for an initial term of five years. The management agreement provides for a base management fee of 1.5% of gross revenues through 2020 and 1.75% of gross revenues for the remainder of the term. The management agreement also provides for an incentive management fee of 15% of hotel operating profit above an owner's priority, determined in accordance with the terms of the management agreement. The incentive management fee is capped at 1% of gross revenues for each year. The management agreement also specifies a corporate marketing contribution of 1% of gross revenues.

On March 1, 2018, we acquired the 242-room Hotel Palomar in Phoenix, Arizona, for a total contractual purchase price of $80 million. The acquisition was funded with corporate cash. In connection with the acquisition, we assumed a $2.9 million loan under a qualified New Market Tax Credit program. Refer to Note 8 for additional information about the loan. The acquisition is accounted for as an acquisition of assets; accordingly, our direct acquisition costs of $0.3 million were capitalized. We assumed the existing management agreement with Kimpton Hotel and Restaurant Group. The management agreement provides for a base management fee of 3.5% of gross revenues. The management agreement also provides for an incentive management fee of 20% of hotel operating profit above an owner's priority, determined in accordance with the terms of the management agreement. The incentive management fee is capped at 1.5% of gross revenues for each year.

We lease the surface and air rights of the hotel property pursuant to a ground lease with the City of Phoenix. We own the building improvements fee simple. The ground lease expires in 2085, including all extension options. As lessee of government property, we are subject to a Government Property Lease Excise Tax ("GPLET") under Arizona state statute in lieu of ad valorem real estate taxes through the end of the term of the ground lease. We reviewed the terms of the ground lease and GPLET agreement and concluded that the terms of the ground lease are favorable to us compared with a typical market ground lease. Accordingly, we recorded a $20.0 million favorable ground lease asset that will be amortized over the remaining term of the ground lease, including all extension options.

We assumed an agreement previously made with the lessee of the subsurface parking facility under the hotel, which requires us to pay 50% of the lessee's lease payments to the landlord—the City of Phoenix. The agreement is coterminous with the underlying subsurface ground lease, which expires in 2085, including all extensions at the lessee's option. We reviewed the terms of the parking agreement and concluded that the terms are unfavorable to us compared with a typical market parking agreement. Accordingly, we recorded a $4.6 million unfavorable agreement liability that will be amortized over the remaining term of the parking agreement, including all extension options.

The following table summarizes the relative fair value of the assets acquired and liabilities assumed in our acquisitions (in thousands):
 
 
The Landing Resort & Spa
 
Hotel Palomar Phoenix
Land
 
$
14,816

 
$

Building and improvements
 
24,351

 
59,703

Furnitures, fixtures and equipment
 
3,346

 
5,207

    Total fixed assets
 
42,513

 
64,910

Favorable ground lease asset
 

 
20,012

Unfavorable contract liability
 

 
(4,644
)
New Market Tax Credit loan assumption
 

 
(2,943
)
Other assets and liabilities, net
 
(658
)
 
497

Total
 
$
41,855

 
$
77,832


10. Fair Value of Financial Instruments


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The fair value of certain financial assets and liabilities and other financial instruments as of June 30, 2018 and December 31, 2017, in thousands, is as follows:
 
June 30, 2018
 
December 31, 2017
 
Carrying
Amount (1)
 
Fair Value
 
Carrying
Amount (1)
 
Fair Value
Debt
$
934,522

 
$
919,752

 
$
937,792

 
$
942,529

_______________

(1)
The carrying amount of debt is net of unamortized debt issuance costs.

The fair value of our debt is a Level 2 measurement under the fair value hierarchy (see Note 2). We estimate the fair value of our debt by discounting the future cash flows of each instrument at estimated market rates. The carrying value of our other financial instruments approximate fair value due to the short-term nature of these financial instruments.

11. Commitments and Contingencies

Litigation

We are subject to various claims, lawsuits and legal proceedings, including routine litigation arising in the ordinary course of business, regarding the operation of our hotels and company matters. While it is not possible to ascertain the ultimate outcome of such matters, management believes that the aggregate amount of such liabilities, if any, in excess of amounts covered by insurance will not have a material adverse impact on our financial condition or results of operations. The outcome of claims, lawsuits and legal proceedings brought against the Company, however, is subject to significant uncertainties.

Other Matters

As previously reported, in February 2016, the Company was notified by the franchisor of one of its hotels that as a result of low guest satisfaction scores, the Company was in default under the franchise agreement for that hotel. The Company continues to proactively work with the franchisor and the manager of the hotel and has developed and executed a plan aimed to improve guest satisfaction scores. To date, the guest satisfaction scores have improved so that the Company is no longer in default under the franchise agreement. However, if the guest satisfaction scores were to decrease again, the franchisor may again notify the Company that it is in default under the franchise agreement and that the franchisor is reserving all of its rights under the franchise agreement, including the right to terminate the franchise agreement in the future.
While the Company continues to work diligently with the franchisor and manager to maintain the guest satisfaction scores at a level such that the Company does not fall back into default, no assurance can be given that the Company will be successful. If the Company is not successful, the franchisor may seek to terminate the franchise agreement and assert a claim it is owed a termination fee, including a payment for liquidated damages, which could result in a material adverse effect on the Company's business, financial condition or results of operation.


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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 risks discussed herein and the risk factors discussed from time to time in our periodic filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2017 as updated by our Quarterly Reports on Form 10-Q. 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.

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

negative changes in the economy, including, but not limited to, a reversal of current job growth trends, an increase in unemployment or a decrease in corporate earnings and investment;
increased competition in the lodging industry and from alternative lodging channels or third party internet intermediaries in the markets in which we own properties;
failure to effectively execute our long-term business strategy and successfully identify and complete acquisitions;
risks and uncertainties affecting hotel renovations and management (including, without limitation, construction delays, increased construction costs, disruption in hotel operations and the risks associated with our franchise agreements);
risks associated with the availability and terms of financing and the use of debt to fund acquisitions and renovations or refinance existing indebtedness, including the impact of higher interest rates on the cost and/or availability of financing;
risks associated with the lodging industry overall, including, without limitation, an increase in alternative lodging channels, decreases in the frequency of business travel and increases in operating costs;
risks associated with natural disasters;
estimated costs and duration of renovation or restoration projects and estimated insurance recoveries;
costs of compliance with government regulations, including, without limitation, the Americans with Disabilities Act;
potential liability for uninsured losses and environmental contamination;
risks associated with security breaches through cyber-attacks or otherwise, as well as other significant disruptions of our information technologies and systems, which support our operations and our hotel managers;
risks associated with our potential failure to qualify as a REIT under the Internal Revenue Code of 1986, as amended;
possible adverse changes in tax and environmental laws; and
risks associated with our dependence on key personnel whose continued service is not guaranteed.

Overview

DiamondRock Hospitality Company is a lodging-focused Maryland corporation operating as a real estate investment trust (“REIT”). As of June 30, 2018, we owned a portfolio of 30 premium hotels and resorts that contain 9,949 guest rooms located in 21 different markets in North America and the U.S. Virgin Islands. As of June 30, 2018, the Frenchman's Reef & Morning Star Marriott Beach Resort ("Frenchman's Reef") is closed as a result of damage incurred from Hurricanes Irma and Maria in September 2017.

As an owner, rather than an operator, of lodging properties, we receive all of the operating profits or losses generated by our hotels after the payment of fees due to hotel managers, which are calculated based on the revenues and profitability of each hotel.

Our vision is to be a highly professional public lodging REIT that delivers long-term returns for our stockholders which exceed long-term returns generated by our peers. Our goal is to deliver long-term stockholder returns through a combination of dividends and enduring capital appreciation. Our strategy is to utilize disciplined capital allocation, focus on high quality lodging properties in North American markets with superior growth prospects and high barriers-to-entry, aggressively asset manage those hotels, and employ conservative amounts of leverage.


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Our primary business is to acquire, own, asset manage and renovate premium hotel properties in the United States. Our portfolio is concentrated in key gateway cities and destination resort locations. Each of our hotels is managed by a third party—either an independent operator or a brand operator, such as Marriott International, Inc.

We critically evaluate each of our hotels to ensure that we own a portfolio of hotels that conforms to our vision, supports our mission and corresponds with our strategy. On a regular basis, we analyze our portfolio to identify opportunities to invest capital in certain projects or market non-core assets for sale in order to increase our portfolio quality. We are committed to a conservative capital structure with prudent leverage. We regularly assess the availability and affordability of capital in order to maximize stockholder value and minimize enterprise risk. In addition, we are committed to following sound corporate governance practices and to being open and transparent in our communications with our stockholders.

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 U.S. Generally Accepted Accounting Principles ("U.S. GAAP"), as well as other financial information that is not prepared in accordance with U.S. 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), Earnings Before Interest, Income Taxes, Depreciation and Amortization for real estate (or EBITDAre), and Adjusted EBITDA; and

Funds From Operations (or FFO) and Adjusted 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 and regional basis. ADR and RevPAR include only room revenue. Room revenue comprised approximately 72% of our total revenues for the six months ended June 30, 2018 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 U.S. economic conditions generally, regional and local employment growth, personal income and corporate earnings, office vacancy rates and business relocation decisions, airport and other business and leisure travel, increased use of lodging alternatives, new hotel construction and the pricing strategies of our competitors. In addition, our ADR, occupancy percentage and RevPAR performance is dependent on the continued success of our hotels' global brands.

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

Our Hotels

The following table sets forth certain operating information for the six months ended June 30, 2018 for each of our hotels.

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Property
 
Location
 
Number of
Rooms
 
Occupancy (%)
 
ADR($)
 
RevPAR($)
 
% Change
from 2017 RevPAR (1)
Chicago Marriott Downtown
 
Chicago, Illinois
 
1,200

 
66.8
%
 
$
221.55

 
$
148.04

 
5.2
 %
Westin Boston Waterfront Hotel
 
Boston, Massachusetts
 
793

 
73.2
%
 
245.26

 
179.41

 
(7.9
)%
Lexington Hotel New York
 
New York, New York
 
725

 
88.4
%
 
228.83

 
202.21

 
1.7
 %
Salt Lake City Marriott Downtown
 
Salt Lake City, Utah
 
510

 
74.0
%
 
176.86

 
130.91

 
0.5
 %
Renaissance Worthington
 
Fort Worth, Texas
 
504

 
77.1
%
 
193.79

 
149.49

 
4.0
 %
Frenchman’s Reef (2)
 
St. Thomas, U.S. Virgin Islands
 
502

 
%
 

 

 
(100.0
)%
Westin San Diego
 
San Diego, California
 
436

 
83.8
%
 
187.70

 
157.21

 
(6.3
)%
Westin Fort Lauderdale Beach Resort
 
Fort Lauderdale, Florida
 
432

 
90.0
%
 
222.11

 
199.80

 
3.6
 %
Westin Washington, D.C. City Center
 
Washington, D.C.
 
410

 
89.0
%
 
223.47

 
198.80

 
(4.7
)%
Hilton Boston Downtown
 
Boston, Massachusetts
 
403

 
85.1
%
 
276.24

 
234.96

 
3.4
 %
Vail Marriott Mountain Resort & Spa
 
Vail, Colorado
 
344

 
61.2
%
 
346.71

 
212.29

 
(11.3
)%
Marriott Atlanta Alpharetta
 
Atlanta, Georgia
 
318

 
67.8
%
 
179.89

 
121.95

 
(6.8
)%
Courtyard Manhattan/Midtown East
 
New York, New York
 
321

 
91.9
%
 
238.69

 
219.38

 
6.1
 %
The Gwen Chicago
 
Chicago, Illinois
 
311

 
80.5
%
 
241.96

 
194.83

 
39.0
 %
Hilton Garden Inn Times Square Central
 
New York, New York
 
282

 
97.4
%
 
230.27

 
224.28

 
7.3
 %
Bethesda Marriott Suites
 
Bethesda, Maryland
 
272

 
66.9
%
 
185.37

 
124.10

 
(9.4
)%
Hilton Burlington
 
Burlington, Vermont
 
258

 
77.6
%
 
163.37

 
126.75

 
9.7
 %
Hotel Palomar Phoenix (3)
 
Phoenix, Arizona
 
242

 
77.3
%
 
206.78

 
159.88

 
(1.9
)%
JW Marriott Denver at Cherry Creek
 
Denver, Colorado
 
196

 
80.2
%
 
248.75

 
199.60

 
(1.7
)%
Courtyard Manhattan/Fifth Avenue
 
New York, New York
 
189

 
88.0
%
 
253.92

 
223.49

 
6.9
 %
Sheraton Suites Key West
 
Key West, Florida
 
184

 
91.5
%
 
271.14

 
248.22

 
(1.2
)%
The Lodge at Sonoma, a Renaissance Resort & Spa
 
Sonoma, California
 
182

 
68.1
%
 
282.28

 
192.29

 
13.3
 %
Courtyard Denver Downtown
 
Denver, Colorado
 
177

 
81.3
%
 
190.51

 
154.96

 
(1.2
)%
Renaissance Charleston
 
Charleston, South Carolina
 
166

 
87.3
%
 
265.52

 
231.83

 
20.9
 %
Shorebreak Hotel
 
Huntington Beach, California
 
157

 
75.8
%
 
244.99

 
185.82

 
15.4
 %
Havana Cabana Key West (4)
 
Key West, Florida
 
106

 
73.1
%
 
192.94

 
141.08

 
(16.1
)%
Hotel Rex
 
San Francisco, California
 
94

 
81.4
%
 
199.58

 
162.55

 
(8.9
)%
L'Auberge de Sedona
 
Sedona, Arizona
 
88

 
77.0
%
 
620.79

 
478.06

 
13.9
 %
The Landing Resort & Spa (3)
 
South Lake Tahoe, California
 
77

 
48.9
%
 
289.79

 
141.72

 
(6.3
)%
Orchards Inn Sedona
 
Sedona, Arizona
 
70

 
77.8
%
 
265.70

 
206.73

 
11.1
 %
TOTAL/WEIGHTED AVERAGE
 
 
 
9,949

 
78.5
%
 
$
230.74

 
$
181.13

 
(0.6
)%
____________________
(1) The percentage change from 2017 RevPAR reflects the comparable period in 2017 to our 2018 ownership period for our 2018 and 2017 acquisitions.
(2) The hotel closed on September 6, 2017 due to Hurricane Irma and remains closed. Accordingly, there is no operating information for the six months ended June 30, 2018.
(3) The hotel was acquired on March 1, 2018. The operating statistics reflect the period from March 1, 2018 to June 30, 2018.
(4) The hotel closed on September 6, 2017 due to Hurricane Irma and remained closed through the end of the first quarter of 2018. Accordingly,the operating information reported for the six months ended June 30, 2018 only includes operations beginning in April 2018.


Highlights

Hotel Acquisitions. In March 2018, we acquired the 77-room Landing Resort & Spa in South Lake Tahoe, California, for a total contractual purchase price of $42 million. We also acquired the 242-room Hotel Palomar in Phoenix, Arizona, for a total contractual purchase price of $80 million in March 2018.

Public Equity Offering. We have a $200 million “at-the-market” equity offering program (the “ATM program”). During the six months ended June 30, 2018, we sold 7,472,946 shares of our common stock at an average price of $12.56 for net proceeds of $92.9 million under the ATM program.

Update on Insurance Claims


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As previously disclosed, we have ongoing insurance claims resulting from hurricanes that impacted Frenchman's Reef and Havana Cabana Key West in 2017, as well as from the 2017 wildfires in Northern California that impacted the Lodge at Sonoma. The Company is insured for up to $361 million for each covered event, subject to certain deductibles and other conditions. During the second quarter of 2018, we recognized $2.0 million of business interruption income related to Frenchman's Reef.

Frenchman's Reef. The hotel was significantly damaged by last year's hurricanes and is expected to remain closed through 2019. We submitted our insurance claim during the first quarter of 2018 and are continuing to work diligently with our insurance carriers and the U.S. Virgin Islands government to evaluate all alternatives to ensure the best outcome for our shareholders.

Havana Cabana Key West. We completed a comprehensive renovation and re-positioning of the hotel in connection with the remediation of substantial wind and water-related damage from Hurricane Irma. The hotel reopened as the Havana Cabana Key West in April 2018. In July 2018, we settled our insurance claim for the property damage and business interruption.

The Lodge at Sonoma. In July 2018, we settled our insurance claim for the smoke damage and business interruption.
 
Results of Operations

Comparison of the Three Months Ended June 30, 2018 to the Three Months Ended June 30, 2017

Revenue. Revenue consists primarily of the room, food and beverage and other operating revenues from our hotels, as follows (dollars in millions):
 
Three Months Ended June 30,
 
 
 
2018
 
2017
 
% Change
Rooms
$
175.1

 
$
177.5

 
(1.4
)%
Food and beverage
51.6

 
52.8

 
(2.3
)%
Other
11.3

 
13.0

 
(13.1
)%
Total revenues
$
238.0

 
$
243.3

 
(2.2
)%

Our total revenues decreased $5.3 million from $243.3 million for the three months ended June 30, 2017 to $238.0 million for the three months ended June 30, 2018. This decrease includes amounts that are not comparable quarter-over-quarter as follows:

$17.1 million decrease from Frenchman's Reef, which was closed on September 6, 2017 due to Hurricane Irma and remained closed through the end of the second quarter of 2018.
$0.5 million decrease from the Havana Cabana Key West, which was closed on September 6, 2017 due to Hurricane Irma and re-opened in April 2018.
$2.0 million increase from The Landing Resort & Spa, which was acquired on March 1, 2018.
$5.2 million increase from the Hotel Palomar Phoenix, which was acquired on March 1, 2018.

Excluding these non-comparable amounts our total revenues increased $5.1 million, or 2.3%.

The following are key hotel operating statistics for the three months ended June 30, 2018 and 2017. The 2017 amounts reflect the period in 2017 comparable to our ownership period in 2018 for the Hotel Palomar Phoenix and The Landing Resort & Spa and exclude the results from Frenchman's Reef and the Havana Cabana Key West as the hotels were not open during all of the comparable period of 2018.
 
Three Months Ended June 30,
 
 
 
2018
 
2017
 
% Change
Occupancy %
83.0
%
 
84.6
%
 
(1.6
)%
ADR
$
246.67

 
$
237.36

 
3.9
 %
RevPAR
$
204.79

 
$
200.85

 
2.0
 %


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Food and beverage revenues decreased $1.2 million from the three months ended June 30, 2017, which includes amounts that are not comparable quarter-over-quarter as follows:

$5.1 million decrease from Frenchman's Reef, which was closed on September 6, 2017 due to Hurricane Irma and remained closed through the end of the second quarter of 2018.
$0.7 million increase from The Landing Resort & Spa, which was acquired on March 1, 2018.
$2.1 million increase from the Hotel Palomar Phoenix, which was acquired on March 1, 2018.

Excluding these non-comparable amounts, food and beverage revenues increased $1.1 million, or 2.4%, primarily due to an increase in restaurant and room service revenues.

Excluding non-comparable amounts, other revenues, which primarily represent spa, parking, resort fees and attrition and cancellation fees, increased by $0.5 million, primarily due to an increase in resort fees and parking revenue, partially offset by a decrease in attrition and cancellation revenue.

Hotel operating expenses. The operating expenses consisted of the following (dollars in millions):
 
Three Months Ended June 30,
 
 
 
2018
 
2017
 
% Change (B)/W
Rooms departmental expenses
$
40.6

 
$
41.6

 
(2.4
)%
Food and beverage departmental expenses
31.7

 
33.1

 
(4.2
)
Other departmental expenses
2.5

 
3.1

 
(19.4
)
General and administrative
19.3

 
19.5

 
(1.0
)
Utilities
5.0

 
6.1

 
(18.0
)
Repairs and maintenance
8.1

 
8.9

 
(9.0
)
Sales and marketing
16.2

 
15.6

 
3.8

Franchise fees
6.9

 
6.0

 
15.0

Base management fees
5.1

 
5.8

 
(12.1
)
Incentive management fees
1.5

 
1.1

 
36.4

Property taxes
14.1

 
13.9

 
1.4

Other fixed charges
5.8

 
2.8

 
107.1

Severance costs
8.1

 

 
100.0

Ground rent—Contractual
1.3

 
1.1

 
18.2

Ground rent—Non-cash
1.9

 
1.6

 
18.8

Total hotel operating expenses
$
168.1

 
$
160.2

 
4.9
 %

Our hotel operating expenses increased $7.9 million from $160.2 million for the three months ended June 30, 2017 to $168.1 million for the three months ended June 30, 2018. The increase in hotel operating expenses includes amounts that are not comparable quarter-over-quarter as follows:

$11.6 million decrease from Frenchman's Reef, which was closed on September 6, 2017 due to Hurricane Irma and remained closed throughout the second quarter of 2018.
$0.4 million increase from the Havana Cabana Key West, which was closed on September 6, 2017 due to Hurricane Irma and re-opened in April 2018.
$2.0 million increase from The Landing Resort & Spa, which was acquired on March 1, 2018.
$3.9 million increase from the Hotel Palomar Phoenix, which was acquired on March 1, 2018.

During the three months ended June 30, 2018, we incurred $8.1 million of severance costs related to payments made to unionized employees under a voluntary buyout program that commenced during the first quarter of 2018 at the Lexington Hotel New York. Excluding these severance costs and the non-comparable amounts detailed above, hotel operating expenses increased $5.1 million, or 3.5%, from the three months ended June 30, 2017.

Depreciation and amortization. Depreciation and amortization is recorded on our hotel buildings over 40 years for the periods subsequent to acquisition. Depreciable lives of hotel furniture, fixtures and equipment are estimated as the time period between the acquisition date and the date that the hotel furniture, fixtures and equipment will be replaced. Our depreciation and amortization expense increased $0.4 million, or 1.8%, from the three months ended June 30, 2017.

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Corporate expenses. Corporate expenses principally consist of employee-related costs, including base payroll, bonus, restricted stock and severance. Corporate expenses also include corporate operating costs, professional fees and directors’ fees. Our corporate expenses increased $1.0 million, or 14.7%, from $6.8 million for the three months ended June 30, 2017 to $7.8 million for the three months ended June 30, 2018 due to various drivers, including professional fees, consulting fees, and employee compensation.

Gain on business interruption insurance. In September 2017, Hurricanes Irma and Maria caused significant damage to Frenchman's Reef and the Havana Cabana Key West, which resulted in lost revenue and additional expenses covered under our insurance policy. For the three months ended June 30, 2018, we recognized a $2.0 million gain on business interruption insurance, which is in addition to $1.0 million of expense reimbursements from insurance recorded within other hotel expenses on our accompanying condensed consolidated statement of operations.

Interest expense. Our interest expense was $10.3 million and $9.6 million for the three months ended June 30, 2018 and 2017, respectively, and comprises the following (in millions):
 
Three Months Ended June 30,
 
2018
 
2017
Mortgage debt interest
$
6.9

 
$
7.4

Term loan interest
2.6

 
1.5

Credit facility interest and unused fees
0.3

 
0.2

Amortization of deferred financing costs and debt premium
0.5

 
0.5

 
$
10.3

 
$
9.6


The increase in interest expense is primarily related to the $200 million unsecured term loan entered into in April 2017. This increase is partially offset by a decrease in mortgage debt interest expense, primarily related to the repayment of the mortgage loan secured by the Lexington Hotel New York repaid on April 26, 2017.

Income taxes. We recorded income tax benefit of $0.1 million for the three months ended June 30, 2018 and an income tax expense of $4.4 million for the three months ended June 30, 2017. The income tax benefit for the three months ended June 30, 2018 is due to $0.1 million of income tax benefit on the $0.6 million pre-tax loss of our taxable REIT subsidiaries ("TRS"). The income tax expense for the three months ended June 30, 2017 includes $4.2 million of income tax expense incurred on the $10.3 million pre-tax income of our TRS, $0.1 million of state franchise taxes and $0.1 million of income tax expense incurred on the $2.0 million pre-tax income of the TRS that owns Frenchman's Reef.

Comparison of the Six Months Ended June 30, 2018 to the Six Months Ended June 30, 2017

Revenue. Revenue consists primarily of the room, food and beverage and other operating revenues from our hotels, as follows (dollars in millions):
 
Six Months Ended June 30,
 
 
 
2018
 
2017
 
% Change
Rooms
$
304.0

 
$
315.4

 
(3.6
)%
Food and beverage
92.4

 
97.5

 
(5.2
)%
Other
23.1

 
26.6

 
(13.2
)%
Total revenues
$
419.5

 
$
439.5

 
(4.6
)%

Our total revenues decreased $20.0 million from $439.5 million for the six months ended June 30, 2017 to $419.5 million for the six months ended June 30, 2018. This decrease includes amounts that are not comparable period-over-period as follows:

$39.0 million decrease from Frenchman's Reef, which was closed on September 6, 2017 due to Hurricane Irma and remained closed through the end of the second quarter of 2018.
$2.8 million decrease from the Havana Cabana Key West, which was closed on September 6, 2017 due to Hurricane Irma and re-opened in April 2018.
$2.6 million increase from The Landing Resort & Spa, which was acquired on March 1, 2018.
$8.0 million increase from the Hotel Palomar Phoenix, which was acquired on March 1, 2018.

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$3.2 million increase from the L'Auberge de Sedona, which was acquired on February 28, 2017.
$1.0 million increase from the Orchards Inn Sedona, which was acquired on February 28, 2017.

Excluding these non-comparable amounts our total revenues increased $7.0 million, or 1.8%.

The following are key hotel operating statistics for the six months ended June 30, 2018 and 2017. The 2017 amounts reflect the period in 2017 comparable to our ownership period in 2018 for the Hotel Palomar Phoenix and The Landing Resort & Spa, the full six months of the first half of 2017 for the L'Auberge de Sedona and Orchards Inn Sedona and exclude the results from Frenchman's Reef and the Havana Cabana Key West as the hotels were not open during all of the comparable period of 2018.
 
Six Months Ended June 30,
 
 
 
2018
 
2017
 
% Change
Occupancy %
78.5
%
 
79.0
%
 
(0.5
)%
ADR
$
230.88

 
$
225.11

 
2.6
 %
RevPAR
$
181.29

 
$
177.82

 
2.0
 %

Food and beverage revenues decreased $5.1 million from the six months ended June 30, 2017, which includes amounts that are not comparable period-over-period as follows:

$10.8 million decrease from Frenchman's Reef, which was closed on September 6, 2017 due to Hurricane Irma and remained closed through the end of the second quarter of 2018.
$0.2 million decrease from the Havana Cabana Key West, which was closed on September 6, 2017 due to Hurricane Irma and re-opened in April 2018.
$0.9 million increase from The Landing Resort & Spa, which was acquired on March 1, 2018.
$3.1 million increase from the Hotel Palomar Phoenix, which was acquired on March 1, 2018.
$0.8 million increase from the L'Auberge de Sedona, which was acquired on February 28, 2017.
$0.5 million increase from the Orchards Inn Sedona, which was acquired on February 28, 2017.

Excluding these non-comparable amounts, food and beverage revenues increased $0.6 million, or 0.7%, primarily due to an increase in restaurant and room service revenues.

Excluding non-comparable amounts, other revenues, which primarily represent spa, parking, resort fees and attrition and cancellation fees, increased by $0.9 million, primarily due to an increase in resort fees, partially offset by a decrease in attrition and cancellation fees.

Hotel operating expenses. The operating expenses consisted of the following (dollars in millions):
 
Six Months Ended June 30,
 
 
 
2018
 
2017
 
% Change (B)/W
Rooms departmental expenses
$
76.2

 
$
78.5

 
(2.9
)%
Food and beverage departmental expenses
59.2

 
62.5

 
(5.3
)
Other departmental expenses
5.0

 
6.1

 
(18.0
)
General and administrative
36.3

 
37.5

 
(3.2
)
Utilities
10.0

 
12.1

 
(17.4
)
Repairs and maintenance
15.9

 
17.6

 
(9.7
)
Sales and marketing
30.2

 
29.4

 
2.7

Franchise fees
12.8

 
11.0

 
16.4

Base management fees
6.7

 
10.4

 
(35.6
)
Incentive management fees
2.7

 
2.6

 
3.8

Property taxes
27.8

 
26.1

 
6.5

Other fixed charges
8.1

 
5.3

 
52.8

Severance costs
10.9

 

 
100.0

Ground rent—Contractual
2.3

 
2.0

 
15.0

Ground rent—Non-cash
3.4

 
3.1

 
9.7

Total hotel operating expenses
$
307.5

 
$
304.2

 
1.1
 %

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Our hotel operating expenses increased $3.3 million from $304.2 million for the six months ended June 30, 2017 to $307.5 million for the six months ended June 30, 2018. The decrease in hotel operating expenses includes amounts that are not comparable period-over-period as follows:

$28.0 million decrease from Frenchman's Reef, which was closed on September 6, 2017 due to Hurricane Irma and remained closed through the end of the second quarter of 2018.
$0.4 million decrease from the Havana Cabana Key West, which was closed on September 6, 2017 due to Hurricane Irma and re-opened in April 2018.
$2.6 million increase from The Landing Resort & Spa, which was acquired on March 1, 2018.
$5.4 million increase from the Hotel Palomar Phoenix, which was acquired on March 1, 2018.
$2.8 million increase from the L'Auberge de Sedona, which was acquired on February 28, 2017.
$0.8 million increase from the Orchards Inn Sedona, which was acquired on February 28, 2017.

In connection with the termination of the hotel manager of Frenchman's Reef, we recognized $2.2 million of accelerated amortization of key money during the six months ended June 30, 2018. This amortization reduced base management fees during the six months ended June 30, 2018 and is included within the non-comparable decrease of hotel operating expenses.

For the six months ended June 30, 2018, we incurred $10.9 million of severance costs related to payments made to unionized employees under a voluntary buyout program that commenced during the first quarter of 2018 at the Lexington Hotel New York. Excluding these severance costs and the non-comparable amounts detailed above, hotel operating expenses increased $9.1 million, or 3.3%, from the six months ended June 30, 2017.

Depreciation and amortization. Depreciation and amortization is recorded on our hotel buildings over 40 years for the periods subsequent to acquisition. Depreciable lives of hotel furniture, fixtures and equipment are estimated as the time period between the acquisition date and the date that the hotel furniture, fixtures and equipment will be replaced. Our depreciation and amortization expense increased $1.0 million, or 2.0%, from the six months ended June 30, 2017.

Hotel acquisitions costs. The acquisitions of The Landing Resort & Spa in South Lake Tahoe and the Hotel Palomar Phoenix are accounted for as an acquisition of assets. All direct acquisition related costs are capitalized as a component of acquired assets. Refer to Note 2 for additional information on the adoption of ASU No. 2017-01. We incurred $2.3 million of hotel acquisition costs during the six months ended June 30, 2017 associated with the acquisitions of L'Auberge de Sedona and Orchards Inn Sedona.

Corporate expenses. Corporate expenses principally consist of employee-related costs, including base payroll, bonus, restricted stock and severance. Corporate expenses also include corporate operating costs, professional fees and directors’ fees. Our corporate expenses increased $4.5 million, or 34.6%, from $13.1 million for the six months ended June 30, 2017 to $17.6 million for the six months ended June 30, 2018. The increase is primarily due to the recognition of $3.0 million of severance costs related to the departure of our former Chief Financial Officer in March 2018. The remaining increase is due to various drivers, including an increase in professional fees, consulting fees, and employee compensation.

Gain on business interruption insurance. In September 2017, Hurricanes Irma and Maria caused significant damage to Frenchman's Reef and the Havana Cabana Key West, which resulted in lost revenue and additional expenses covered under our insurance policy. For the six months ended June 30, 2018, we recognized a $8.0 million gain on business interruption insurance, which is in addition to $2.9 million of expense reimbursements from insurance recorded within other hotel expenses on our accompanying condensed consolidated statement of operations.

Interest expense. Our interest expense was $20.2 million and $19.1 million for the six months ended June 30, 2018 and 2017, respectively, and comprises the following (in millions):
 
Six Months Ended June 30,
 
2018
 
2017
Mortgage debt interest
$
13.6

 
$
15.5

Term loan interest
5.0

 
2.1

Credit facility interest and unused fees
0.7

 
0.5

Amortization of deferred financing costs and debt premium
0.9

 
1.0

 
$
20.2

 
$
19.1



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The increase in interest expense is primarily related to the $200 million unsecured term loan entered into in April 2017. This increase is partially offset by a decrease in mortgage debt interest expense, primarily related to the repayment of the mortgage loan secured by the Lexington Hotel New York repaid on April 26, 2017.

Income taxes. We recorded income tax benefit of $0.2 million for the six months ended June 30, 2018 and an income tax expense of $5.6 million for the six months ended June 30, 2017. The income tax benefit for the six months ended June 30, 2018 includes $1.3 million of income tax benefit on the $4.8 million pre-tax loss of our taxable REIT subsidiaries ("TRS"), offset by $1.1 million of income tax expense incurred on the $8.4 million pre-tax income of the TRS that owns Frenchman's Reef. The income tax expense for the six months ended June 30, 2017 includes $4.9 million of income tax expense incurred on the $12.2 million pre-tax income of our TRS, $0.1 million of state franchise taxes and $0.6 million of income tax expense incurred on the $7.9 million pre-tax income of the TRS that owns Frenchman's Reef.

Liquidity and Capital Resources

Our short-term liquidity requirements consist primarily of funds necessary to fund distributions to our stockholders to maintain our REIT status as well as to pay for operating expenses and capital expenditures directly associated with our hotels, funding of share repurchases under our share repurchase program, hotel acquisitions, costs to repair property damaged by natural disasters and scheduled debt payments of interest and principal. We currently expect that our available cash flows, which are generally provided through net cash from hotel operations, existing cash balances, equity issuances, proceeds from new financings and refinancings of maturing debt, insurance proceeds, proceeds from potential property dispositions, and, if necessary, short-term borrowings under our senior unsecured credit facility, will be sufficient to meet our short-term liquidity requirements.

Some of our mortgage debt agreements contain “cash trap” provisions that are triggered when the hotel’s operating results
fall below a certain debt service coverage ratio. When these provisions are triggered, all of the excess cash flow generated by the hotel is deposited directly into cash management accounts for the benefit of our lenders until a specified debt service coverage ratio is reached and maintained for a certain period of time. Such provisions do not allow the lender the right to accelerate repayment of the underlying debt.

Our long-term liquidity requirements consist primarily of funds necessary to pay for the costs of acquiring additional hotels, renovations, and other capital expenditures that need to be made periodically to our hotels, scheduled debt payments, debt maturities and making distributions to our stockholders. We expect to meet our long-term liquidity requirements through various sources of capital, including cash provided by operations, borrowings, issuances of additional equity and/or debt securities and proceeds from property dispositions. Our ability to incur additional debt is dependent upon a number of factors, including the state of the credit markets, our degree of leverage, the value of our unencumbered assets and borrowing restrictions imposed by existing lenders. Our ability to raise capital through the issuance of additional equity and/or debt securities is also dependent on a number of factors including the current state of the capital markets, investor sentiment and intended use of proceeds. We may need to raise additional capital if we identify acquisition opportunities that meet our investment objectives and require liquidity in excess of existing cash balances. Our ability to raise funds through the issuance of equity securities depends on, among other things, general market conditions for hotel companies and REITs and market perceptions about us.

Our Financing Strategy

Since our formation in 2004, we have been committed to a conservative capital structure with prudent leverage. The majority of our outstanding debt is fixed interest rate mortgage debt. We have a preference to maintain a significant portion of our portfolio as unencumbered assets in order to provide balance sheet flexibility. We expect that our strategy will enable us to maintain a balance sheet with an appropriate amount of debt throughout all phases of the lodging cycle. We believe that it is not prudent to increase the inherent risk of highly cyclical lodging fundamentals through the use of a highly leveraged capital structure.

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 structure our hotel acquisitions to be straightforward and to fit within 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.

We believe that we maintain a reasonable amount of debt. As of June 30, 2018, we had $934.5 million of debt outstanding with a weighted average interest rate of 3.99% and a weighted average maturity date of approximately 5.2 years. We maintain one of the most durable and lowest levered balance sheets among our lodging REIT peers. We maintain balance sheet flexibility with no near-term debt maturities, no borrowings outstanding under our senior unsecured credit facility and 22 of our 30 hotels unencumbered by mortgage debt. We remain committed to our core strategy of maintaining a simple capital structure with conservative leverage.

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Information about our financing activities is available in Note 8 to the accompanying condensed consolidated financial statements.

ATM Program

We have equity distribution agreements, as amended, with a number of sales agents (the “ATM Program”) to issue and sell, from time to time, shares of our common stock, par value $0.01 per share, having an aggregate offering price of up to $200 million (the “ATM Shares”). Sales of the ATM Shares can be made in privately negotiated transactions and/or any other method permitted by law, including sales deemed to be an “at the market” offering, which includes sales made directly on the New York Stock Exchange or sales made to or through a market maker other than on an exchange.
During the six months ended June 30, 2018, we sold 7,472,946 shares of common stock at an average price of $12.56 for net proceeds of $92.9 million under the ATM Program. As of June 30, 2018, $34.4 million of the ATM Shares were available to be sold under the ATM Program. Actual future sales of the ATM Shares depend upon a variety of factors, including but not limited to market conditions, the trading price of the Company's common stock and the Company's capital needs. We have no obligation to sell the ATM Shares under the ATM Program.

Share Repurchase Program

We have a $150 million share repurchase program authorizing us to repurchase shares of our common stock. Information about our share repurchase program is found in Note 5 to the accompanying condensed consolidated financial statements. During the six months ended June 30, 2018, we did not repurchase any shares of our common stock. As of August 6, 2018, we have $150 million of authorized capacity remaining under our share repurchase program.

Short-Term Borrowings

Other than borrowings under our senior unsecured credit facility, discussed below, we do not utilize short-term borrowings to meet liquidity requirements.

Senior Unsecured Credit Facility

We are party to a $300 million senior unsecured credit facility expiring in May 2020. Information about our senior unsecured credit facility is found in Note 8 to the accompanying condensed consolidated financial statements. As of June 30, 2018, we had no borrowings outstanding under our senior unsecured credit facility.

Unsecured Term Loans

We are party to a $100 million unsecured term loan expiring in May 2021 and a $200 million unsecured term loan expiring in April 2022. Information about our unsecured term loans is found in Note 8 to the accompanying condensed consolidated financial statements.

Sources and Uses of Cash

Our principal sources of cash are net cash flow from hotel operations and borrowings under mortgage debt, term loans, and our senior unsecured credit facility, proceeds from potential hotel dispositions, and proceeds from insurance claims. Our principal uses of cash are acquisitions of hotel properties, debt service, debt maturities, capital expenditures, operating costs, corporate expenses, natural disaster remediation and repair costs, and dividends. As of June 30, 2018, we had $134.6 million of unrestricted corporate cash and $41.6 million of restricted cash, as well as full borrowing capacity under our senior unsecured credit facility.

Our net cash provided by operations was $68.1 million for the six months ended June 30, 2018. Our cash from operations generally consists of the net cash flow from hotel operations and insurance proceeds related to our hotels impacted by Hurricanes Irma and Maria, offset by cash paid for corporate expenses and other working capital changes.

Our net cash used in investing activities was $151.2 million for the six months ended June 30, 2018, which consisted of $119.5 million paid for the acquisitions of The Landing Resort & Spa and the Hotel Palomar Phoenix, capital expenditures at our hotels of $62.4 million, offset by $30.7 million of insurance proceeds related to property casualty losses at our hotels impacted by Hurricanes Irma and Maria.

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Our net cash provided by financing activities was $35.4 million for the six months ended June 30, 2018, which consisted of $92.9 million of proceeds from the issuance of ATM Shares, offset by $50.6 million of dividend payments, $6.8 million of scheduled mortgage debt principal payments, and $0.1 million paid to repurchase shares upon the vesting of restricted stock for the payment of tax withholding obligations.

We currently anticipate our significant sources of cash for the remainder of the year ending December 31, 2018 will be the net cash flow from hotel operations and proceeds from potential mortgage debt. We expect our uses of cash for the remainder of the year ending December 31, 2018 will be regularly scheduled debt service payments, capital expenditures, dividends, corporate expenses, and potential hotel acquisitions.

Dividend Policy

We intend to distribute to our stockholders dividends at least equal to our REIT taxable income to avoid paying corporate income tax and excise tax on our earnings (other than the earnings of our TRS, which are all subject to tax at regular corporate rates) and to qualify for the tax benefits afforded to REITs under the Code. In order to qualify as a REIT under the Code, we generally must make distributions to our stockholders each year in an amount equal to at least:

90% of our REIT taxable income determined without regard to the dividends paid deduction and excluding net capital gains, plus

90% of the excess of our net income from foreclosure property over the tax imposed on such income by the Code, minus

any excess non-cash income.

The timing and frequency of distributions will be authorized by our board of directors and declared by us based upon a variety of factors, including our financial performance, restrictions under applicable law and our current and future loan agreements, our debt service requirements, our capital expenditure requirements, the requirements for qualification as a REIT under the Code and other factors that our board of directors may deem relevant from time to time.

We have paid the following dividends to holders of our common stock during 2018:
Payment Date
 
Record Date
 
Dividend
per Share
January 12, 2018
 
December 29, 2017
 
$
0.125

April 12, 2018
 
March 29, 2018
 
$
0.125

July 12, 2018
 
June 29, 2018
 
$
0.125


Capital Expenditures

The management and franchise agreements for each of our hotels provide for the establishment of separate property improvement funds to cover, among other things, the cost of replacing and repairing furniture, fixtures and equipment at our hotels and other routine capital expenditures. Contributions to the property improvement fund are calculated as a percentage of hotel revenues. In addition, we may be required to pay for the cost of certain additional improvements that are not permitted to be funded from the property improvement fund under the applicable management or franchise agreement. As of June 30, 2018, we have set aside $35.1 million for capital projects in property improvement funds, which are included in restricted cash.

We expect to spend approximately $135 million on capital improvements at our hotels in 2018. We spent approximately $62.4 million on capital improvements at our hotels during the six months ended June 30, 2018, primarily related to the completion of the renovations at the Chicago Marriott Downtown, Havana Cabana Key West, Bethesda Marriott Suites and Westin Boston Waterfront Hotel, and the commencement of the Vail Marriott Moutain Resort & Spa renovation. Significant projects planned for the remainder of 2018 include:

Vail Marriott Mountain Resort & Spa: We commenced a renovation of the hotel's guest rooms and meeting space during the second quarter. The renovation will bring the guest rooms to a luxury level to help raise the average daily rate and narrow the rate gap with the hotel's luxury competitive set.
Westin Fort Lauderdale Beach Resort: We expect to renovate and upgrade the hotel's guest rooms in the third quarter of 2018 to drive market share.

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Hotel Rex: In connection with its addition to the Viceroy Collection, we expect to complete a comprehensive renovation and re-positioning of the hotel beginning in September 2018. The hotel will close for approximately four months during renovation. The renovation is expected to be completed in time to take advantage of an expected strong 2019 lodging market in San Francisco.
JW Marriott Denver: We expect to begin renovating the hotel's guest rooms, public space and meeting rooms in the fourth quarter of 2018, with the majority of the work occurring in 2019. The renovation is expected to secure the hotel's position as one of the top luxury hotels in the high-end Cherry Creek submarket of Denver.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Non-GAAP Financial Measures

We use the following non-GAAP financial measures that we believe are useful to investors as key measures of our operating performance: EBITDA, EBITDAre, Adjusted EBITDA, FFO and Adjusted FFO. These measures should not be considered in isolation or as a substitute for measures of performance in accordance with U.S. GAAP. EBITDA, EBITDAre, Adjusted EBITDA, FFO and Adjusted FFO, as calculated by us, may not be comparable to other companies that do not define such terms exactly as the Company.

Use and Limitations of Non-GAAP Financial Measures

Our management and Board of Directors use EBITDA, EBITDAre, Adjusted EBITDA, FFO and Adjusted FFO to evaluate the performance of our hotels and to facilitate comparisons between us and other lodging REITs, hotel owners who are not REITs and other capital intensive companies. The use of these non-GAAP financial measures has certain limitations. These non-GAAP financial measures as presented by us, may not be comparable to non-GAAP financial measures as calculated by other real estate companies. These measures do not reflect certain expenses or expenditures that we incurred and will incur, such as depreciation, interest and capital expenditures. We compensate for these limitations by separately considering the impact of these excluded items to the extent they are material to operating decisions or assessments of our operating performance. Our reconciliations to the most comparable U.S. GAAP financial measures, and our consolidated statements of operations and cash flows, include interest expense, capital expenditures, and other excluded items, all of which should be considered when evaluating our performance, as well as the usefulness of our non-GAAP financial measures.

These non-GAAP financial measures are used in addition to and in conjunction with results presented in accordance with U.S. GAAP. They should not be considered as alternatives to operating profit, cash flow from operations, or any other operating performance measure prescribed by U.S. GAAP. These non-GAAP financial measures reflect additional ways of viewing our operations that we believe, when viewed with our U.S. GAAP results and the reconciliations to the corresponding U.S. GAAP financial measures, provide a more complete understanding of factors and trends affecting our business than could be obtained absent this disclosure. We strongly encourage investors to review our financial information in its entirety and not to rely on a single financial measure.

EBITDA, EBITDAre and FFO

EBITDA represents net income (calculated in accordance with U.S. GAAP) excluding: (1) interest expense; (2) provision for income taxes, including income taxes applicable to sale of assets; and (3) depreciation and amortization. The Company computes EBITDAre in accordance with the National Association of Real Estate Investment Trusts ("Nareit") guidelines, as defined in its September 2017 white paper "Earnings Before Interest, Taxes, Depreciation and Amortization for Real Estate." EBITDAre represents net income (calculated in accordance with U.S. GAAP) adjusted for: (1) interest expense; (2) provision for income taxes, including income taxes applicable to sale of assets; (3) depreciation and amortization; (4) gains or losses on the disposition of depreciated property, including gains or losses on change of control; (5) impairment write-downs of depreciated property and of investments in unconsolidated affiliates caused by a decrease in value of depreciated property in the affiliate; and (6) adjustments to reflect the entity's share of EBITDAre of unconsolidated affiliates.

We believe EBITDA and EBITDAre are useful to an investor in evaluating our operating performance because they help investors evaluate and compare the results of our operations from period to period by removing the impact of our capital structure (primarily interest expense) and our asset base (primarily depreciation and amortization, and in the case of EBITDAre, impairment and gains or losses on dispositions of depreciated property) from our operating results. In addition, covenants included in our

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debt agreements use EBITDA as a measure of financial compliance. We also use EBITDA and EBITDAre as one measure in determining the value of hotel acquisitions and dispositions.

The Company computes FFO in accordance with standards established by the Nareit, which defines FFO as net income determined in accordance with U.S. GAAP, excluding gains or losses from sales of properties and impairment losses, plus depreciation and amortization. The Company believes that the presentation of FFO provides useful information to investors regarding its operating performance because it is a measure of the Company's operations without regard to specified non-cash items, such as real estate depreciation and amortization and gains or losses on the sale of assets. The Company also uses FFO as one measure in assessing its operating results.

Adjustments to EBITDA and FFO

We adjust EBITDA and FFO when evaluating our performance because we believe that the exclusion of certain additional items described below provides useful supplemental information to investors regarding our ongoing operating performance and that the presentation of Adjusted EBITDA and Adjusted FFO, when combined with U.S. GAAP net income, EBITDA and FFO, is beneficial to an investor's complete understanding of our consolidated operating performance. We adjust EBITDA and FFO for the following items:

Non-Cash Ground Rent: We exclude the non-cash expense incurred from the straight line recognition of rent from our ground lease obligations and the non-cash amortization of our favorable lease assets. We exclude these non-cash items because they do not reflect the actual rent amounts due to the respective lessors in the current period and they are of lesser significance in evaluating our actual performance for that period.
Non-Cash Amortization of Favorable and Unfavorable Contracts: We exclude the non-cash amortization of the favorable and unfavorable contracts recorded in conjunction with certain acquisitions because the non-cash amortization is based on historical cost accounting and is of lesser significance in evaluating our actual performance for that period.
Cumulative Effect of a Change in Accounting Principle: Infrequently, the Financial Accounting Standards Board (FASB) promulgates new accounting standards that require the consolidated statement of operations to reflect the cumulative effect of a change in accounting principle. We exclude the effect of these adjustments, which include the accounting impact from prior periods, because they do not reflect the Company's actual underlying performance for the current period.
Gains or Losses from Early Extinguishment of Debt: We exclude the effect of gains or losses recorded on the early extinguishment of debt because these gains or losses result from transaction activity related to the Company's capital structure that we believe are not indicative of the ongoing operating performance of the Company or our hotels.
Hotel Acquisition Costs:  We exclude hotel acquisition costs expensed during the period because we believe these transaction costs are not reflective of the ongoing performance of the Company or our hotels.
Severance Costs:  We exclude corporate severance costs incurred with the termination of corporate-level employees and severance costs incurred at our hotels related to lease terminations or structured severance programs because we believe these costs do not reflect the ongoing performance of the Company or our hotels.
Hotel Manager Transition Items:  We exclude the transition items associated with a change in hotel manager because we believe these items do not reflect the ongoing performance of the Company or our hotels.
Other Items:  From time to time we incur costs or realize gains that we consider outside the ordinary course of business and that we do not believe reflect the ongoing performance of the Company or our hotels. Such items may include, but are not limited to, the following: pre-opening costs incurred with newly developed hotels; lease preparation costs incurred to prepare vacant space for marketing; management or franchise contract termination fees; gains or losses from legal settlements; costs incurred related to natural disasters; and gains from insurance proceeds, other than income related to business interruption insurance.

In addition, to derive Adjusted FFO we exclude any fair value adjustments to debt instruments. We exclude these non-cash amounts because they do not reflect the underlying performance of the Company.

The following table is a reconciliation of our U.S. GAAP net income to EBITDA, EBITDAre and Adjusted EBITDA (in thousands):

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Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
Net income
$
28,009

 
$
36,595

 
$
32,347

 
$
45,482

Interest expense
10,274

 
9,585

 
20,151

 
19,098

Income tax (benefit) expense
(50
)
 
4,389

 
(235
)
 
5,644

Real estate related depreciation and amortization
26,033

 
25,585

 
50,935

 
49,948

EBITDA
64,266

 
76,154

 
103,198

 
120,172

Impairment losses

 

 

 

Gain on sale of hotel properties

 

 

 

EBITDAre
64,266

 
76,154

 
103,198

 
120,172

Non-cash ground rent
1,943

 
1,614

 
3,478

 
3,164

Non-cash amortization of favorable and unfavorable contracts, net
(501
)
 
(478
)
 
(979
)
 
(956
)
Hotel acquisition costs

 
22

 

 
2,273

Hurricane-related costs (1)
1,529

 

 
1,315

 

Hotel manager transition/pre-opening items (2)
384

 

 
(1,799
)
 

Loss on early extinguishment of debt

 
274




274

Severance costs (3)
8,195

 

 
14,042

 

Adjusted EBITDA
$
75,816

 
$
77,586

 
$
119,255

 
$
124,927

____________________

 
(1)
Represents stabilization, cleanup, and other costs (such as professional fees and hotel labor) incurred at our hotels impacted by Hurricanes Irma or Maria that have not been or are not expected to be recovered by insurance.
 
(2)
For the three months ended June 30, 2018, consists of (a) transition costs of $0.1 million related to L'Auberge de Sedona and Orchards Inn Sedona, and (b) pre-opening costs of $0.3 million related to the reopening of the Havana Cabana Key West. For the six months ended June 30, 2018, consists of (a) transition costs of $0.1 million related to L'Auberge de Sedona and Orchards Inn Sedona, and (b) pre-opening costs of $0.3 million related to the reopening of the Havana Cabana Key West, offset by (c) $2.2 million of accelerated amortization of key money received from Marriott for Frenchman's Reef in connection with the termination of the hotel's management agreement.
 
(3)
For the three months ended June 30, 2018, consists of (a) $8.1 million related to payments made to unionized employees under a voluntary buyout program at the Lexington Hotel New York, which are classified within other hotel expenses on the condensed consolidated statement of operations, and (b) $0.1 million of expenses related to the departure of our former Chief Financial Officer, which is classified within corporate expenses on the condensed consolidated statements of operations. For the six months ended June 30, 2018, consists of (a) $10.9 million related to payments made to unionized employees under a voluntary buyout program at the Lexington Hotel New York, which are classified within other hotel expenses on the condensed consolidated statement of operations, and (b) $3.1 million related to the departure of our former Chief Financial Officer, which is classified within corporate expenses on the condensed consolidated statement of operations.

The following table is a reconciliation of our U.S. GAAP net income to FFO and Adjusted FFO (in thousands):

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Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
Net income
$
28,009

 
$
36,595

 
$
32,347

 
$
45,482

Real estate related depreciation and amortization
26,033

 
25,585

 
50,935

 
49,948

FFO
54,042

 
62,180

 
83,282

 
95,430

Non-cash ground rent