Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 13, 2008

 

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.)

 

 

 

6903 Rockledge Drive, Suite 800, Bethesda, Maryland

 

20817

(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.       x Yes o No

 

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

 

Large accelerated filer  x

 

Accelerated filer  o

Non-accelerated filer o (Do not check if a smaller reporting company)

 

Smaller reporting company  o

 

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

 

The registrant had 92,173,815 shares of its $0.01 par value common stock outstanding as of July 22, 2008.

 

 

 



Table of Contents

 

Table of Contents

 

INDEX

 

PART I. FINANCIAL INFORMATION

 

 

 

 

Page No.

Item 1.

Financial Statements (unaudited):

 

 

 

Condensed Consolidated Balance Sheets as of June 13, 2008 and December 31, 2007

 

1

 

 

 

 

 

Condensed Consolidated Statements of Operations For the Fiscal Quarters ended June 13, 2008 and June 15, 2007 and the Periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007

 

2

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows For the Periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007

 

3

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

5

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Results of Operations and Financial Condition

 

14

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

28

 

 

 

 

Item 4.

Controls and Procedures

 

28

 

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

29

 

 

 

 

Item 1A.

Risk Factors

 

29

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

29

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

29

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

29

 

 

 

 

Item 5.

Other Information

 

30

 

 

 

 

Item 6.

Exhibits

 

30

 



Table of Contents

 

Item I. Financial Statements

 

DIAMONDROCK HOSPITALITY COMPANY

 

CONDENSED CONSOLIDATED BALANCE SHEETS

As of June 13, 2008 and December 31, 2007

(in thousands, except share amounts)

 

 

 

June 13, 2008

 

December 31, 2007

 

 

 

(Unaudited)

 

 

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Property and equipment, at cost

 

$

2,123,272

 

$

2,086,933

 

Less: accumulated depreciation

 

(182,922

)

(148,101

)

 

 

 

 

 

 

 

 

1,940,350

 

1,938,832

 

 

 

 

 

 

 

Deferred financing costs, net

 

3,652

 

4,020

 

Restricted cash

 

34,138

 

31,736

 

Due from hotel managers

 

72,460

 

68,153

 

Favorable lease assets, net

 

41,721

 

42,070

 

Prepaid and other assets

 

21,065

 

17,043

 

Cash and cash equivalents

 

24,937

 

29,773

 

 

 

 

 

 

 

Total assets

 

$

2,138,323

 

$

2,131,627

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Mortgage debt

 

$

823,117

 

$

824,526

 

Senior unsecured credit facility

 

32,000

 

 

Total debt

 

855,117

 

824,526

 

 

 

 

 

 

 

Deferred income related to key money, net

 

20,631

 

15,884

 

Unfavorable contract liabilities, net

 

85,329

 

86,123

 

Due to hotel managers

 

36,048

 

36,910

 

Dividends declared and unpaid

 

23,923

 

22,922

 

Accounts payable and accrued expenses

 

59,309

 

64,980

 

 

 

 

 

 

 

Total other liabilities

 

225,240

 

226,819

 

 

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

 

 

 

 

 

 

Preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued and outstanding

 

 

 

Common stock, $.01 par value; 200,000,000 shares authorized; 94,535,000 and 94,730,813 shares issued and outstanding at June 13, 2008 and December 31, 2007, respectively

 

945

 

947

 

Additional paid-in capital

 

1,144,108

 

1,145,511

 

Accumulated deficit

 

(87,087

)

(66,176

)

 

 

 

 

 

 

Total shareholders’ equity

 

1,057,966

 

1,080,282

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

2,138,323

 

$

2,131,627

 

 

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

 

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DIAMONDROCK HOSPITALITY COMPANY

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Fiscal Quarters Ended June 13, 2008 and June 15, 2007 and

the Periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007

(in thousands, except per share amounts)

 

 

 

Fiscal Quarter
Ended
June 13, 2008

 

Fiscal Quarter
Ended
June 15, 2007

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

 

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rooms

 

$

116,011

 

$

114,252

 

$

201,938

 

$

199,006

 

Food and beverage

 

55,532

 

54,275

 

95,614

 

95,722

 

Other

 

9,473

 

9,417

 

16,327

 

15,429

 

Total revenues

 

181,016

 

177,944

 

313,879

 

310,157

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rooms

 

26,249

 

25,146

 

47,408

 

45,259

 

Food and beverage

 

36,377

 

35,745

 

65,305

 

64,232

 

Management fees

 

8,048

 

7,882

 

13,013

 

13,063

 

Other hotel expenses

 

55,189

 

54,043

 

101,641

 

97,835

 

Depreciation and amortization

 

18,069

 

17,371

 

34,756

 

33,169

 

Corporate expenses

 

3,345

 

3,273

 

6,305

 

6,422

 

Total operating expenses

 

147,277

 

143,460

 

268,428

 

259,980

 

Operating profit

 

33,739

 

34,484

 

45,451

 

50,177

 

 

 

 

 

 

 

 

 

 

 

Other Expenses (Income):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

(332

)

(666

)

(770

)

(1,260

)

Interest expense

 

11,430

 

11,884

 

22,125

 

23,379

 

Total other expenses

 

11,098

 

11,218

 

21,355

 

22,119

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

22,641

 

23,266

 

24,096

 

28,058

 

 

 

 

 

 

 

 

 

 

 

Income tax (provision) benefit

 

(886

)

(3,160

)

2,836

 

(1,580

)

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

21,755

 

20,106

 

26,932

 

26,478

 

 

 

 

 

 

 

 

 

 

 

Income from discontinued operations, net of tax

 

 

407

 

 

825

 

Net income

 

$

21,755

 

$

20,513

 

$

26,932

 

$

27,303

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.23

 

$

0.21

 

$

0.28

 

$

0.28

 

Discontinued operations

 

 

0.00

 

 

0.01

 

Basic and diluted earnings per share

 

$

0.23

 

$

0.21

 

$

0.28

 

$

0.29

 

 

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

 

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DIAMONDROCK HOSPITALITY COMPANY

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007

(in thousands)

 

 

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

 

 

(Unaudited)

 

(Unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

26,932

 

$

27,303

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Real estate depreciation

 

34,756

 

33,704

 

Corporate asset depreciation as corporate expenses

 

75

 

79

 

Non-cash ground rent

 

3,550

 

3,594

 

Non-cash financing costs as interest

 

372

 

349

 

Amortization of debt premium and unfavorable contract liabilities

 

(794

)

(868

)

Amortization of deferred income

 

(253

)

(164

)

Stock-based compensation

 

1,567

 

2,097

 

Yield support received

 

797

 

1,741

 

Non-cash yield support recognized

 

 

(189

)

Changes in assets and liabilities:

 

 

 

 

 

Prepaid expenses and other assets

 

(4,022

)

(460

)

Restricted cash

 

(582

)

530

 

Due to/from hotel managers

 

(5,966

)

(10,650

)

Accounts payable and accrued expenses

 

(8,455

)

(3,630

)

Net cash provided by operating activities

 

47,977

 

53,436

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Hotel acquisitions

 

 

(331,325

)

Receipt of deferred key money

 

5,000

 

 

Hotel capital expenditures

 

(36,766

)

(22,549

)

Change in restricted cash

 

(1,820

)

(564

)

Net cash used in investing activities

 

(33,586

)

(354,438

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Repayments of credit facility

 

(15,000

)

(35,000

)

Draws on credit facility

 

47,000

 

61,500

 

Scheduled mortgage debt principal payments

 

(1,413

)

(1,707

)

Payment of financing costs

 

 

(1,113

)

Proceeds from sale of common stock

 

 

317,935

 

Payment of costs related to sale of common stock

 

 

(380

)

Share repurchases

 

(3,184

)

 

Payment of dividends

 

(46,630

)

(36,658

)

Net cash (used in) provided by financing activities

 

$

(19,227

)

$

304,577

 

 

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)

For the Periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007

(in thousands)

 

 

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

 

 

(Unaudited)

 

(Unaudited)

 

Net (decrease) increase in cash and cash equivalents

 

$

(4,836

)

$

3,575

 

Cash and cash equivalents, beginning of period

 

29,773

 

19,691

 

Cash and cash equivalents, end of period

 

$

24,937

 

$

23,266

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

24,176

 

$

24,716

 

Cash paid for income taxes

 

$

861

 

$

340

 

Capitalized interest

 

$

183

 

$

 

 

 

 

 

 

 

Non-Cash Financing Activities:

 

 

 

 

 

 

 

 

 

 

 

Unpaid dividends

 

$

23,923

 

$

22,947

 

 

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

 

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DIAMONDROCK HOSPITALITY COMPANY

 

Notes to the Condensed Consolidated Financial Statements

(Unaudited)

 

1.    Organization

 

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

 

The Company owns, as opposed to operates, its hotels.  As an owner, the Company receives all of the operating profits or losses generated by its hotels, after paying the hotel managers a fee based on the revenues and profitability of the hotels and reimbursing all of their direct and indirect operating costs.  As of June 13, 2008, the Company owned twenty hotels, comprising 9,586 rooms, located in the following markets: Atlanta, Georgia (3); Austin, Texas; Boston, Massachusetts; Chicago, Illinois (2); Fort Worth, Texas; Lexington, Kentucky; Los Angeles, California (2); New York, New York (2); Northern California; Oak Brook, Illinois; Orlando, Florida; Salt Lake City, Utah; Washington D.C.; St. Thomas, U.S. Virgin Islands; and Vail, Colorado.

 

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

 

2.    Summary of Significant Accounting Policies

 

Basis of Presentation

 

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

 

In the Company’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments necessary to present fairly the Company’s financial position as of June 13, 2008, and the results of the Company’s operations for the fiscal quarters ended June 13, 2008 and June 15, 2007 and for the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007 and cash flows for the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007.   Interim results are not necessarily indicative of full-year performance because of the impact of seasonal and short-term variations.

 

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

 

Reporting Periods

 

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

 

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

 

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

 

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

 

Revenue Recognition

 

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

 

Earnings Per Share

 

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

 

Stock-based Compensation

 

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

 

Key Money

 

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

 

Yield Support

 

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

 

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Intangible Assets

 

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

 

Favorable Lease Assets and Unfavorable Contract Liabilities

 

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

 

Concentration of Credit Risk

 

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

 

Straight-Line Rent

 

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

 

Use of Estimates

 

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

 

3.    Property and Equipment

 

Property and equipment as of June 13, 2008 (unaudited) and December 31, 2007 consists of the following (in thousands):

 

 

 

June 13, 2008

 

December 31, 2007

 

Land

 

$

219,590

 

$

219,590

 

Land improvements

 

7,994

 

7,994

 

Buildings

 

1,654,027

 

1,630,793

 

Furniture, fixtures and equipment

 

238,827

 

213,348

 

CIP and corporate office equipment

 

2,834

 

15,208

 

 

 

2,123,272

 

2,086,933

 

Less: accumulated depreciation

 

(182,922

)

(148,101

)

 

 

$

1,940,350

 

$

1,938,832

 

 

As of June 13, 2008 and December 31, 2007, the Company had accrued capital expenditures of $10.4 million and $10.8 million, respectively.

 

4.    Capital Stock

 

Common Shares

 

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

 

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

 

Share Repurchase Program

 

On February 27, 2008, the Company’s Board of Directors authorized a program to repurchase up to 4.8 million shares of its common stock.  The common stock may be purchased in the open market or through private transactions, dependent upon market conditions.  The plan does not obligate the Company to repurchase any specific number of shares and may be suspended at any time at its discretion.  As of July 21, 2008, the Company has purchased 2.8 million shares under this program for an average price of $10.74 per share.  The Company has retired all shares purchased under the program on the settlement date.

 

Preferred Shares

 

The Company is authorized to issue up to 10,000,000 shares of preferred stock, $.01 par value per share. The Company’s board of directors is required to set for each class or series of preferred stock the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, and terms or conditions of redemption. As of June 13, 2008 and December 31, 2007, there were no shares of preferred stock outstanding.

 

5.    Stock Incentive Plans

 

As of June 13, 2008, the Company has issued or committed to issue 1,493,491 shares of its common stock under its 2004 Stock Option and Incentive Plan, as amended, including 474,701 shares of unvested restricted common stock and a commitment to issue 445,185 units of deferred common stock.

 

Restricted Stock Awards

 

As of June 13, 2008, the Company’s officers and employees have been awarded 1,338,246 shares of restricted common stock, including those shares that have since vested.  Shares issued to the Company’s officers and employees vest over a three-year period from the date of the grant based on continued employment.  The Company measures compensation expense for the restricted stock awards based upon the fair market value of its common stock at the date of grant. Compensation expense is recognized on a straight-line basis over the vesting period and is included in corporate expenses in the accompanying condensed consolidated statements of operations.

 

A summary of the Company’s restricted stock awards from January 1, 2006 to June 13, 2008 is as follows:

 

 

 

Number of
Shares

 

Weighted-
Average
Grant Date
Fair Value

 

Unvested balance at January 1, 2006

 

747,000

 

$

10.04

 

Granted

 

197,360

 

15.91

 

Vested

 

(482,833

)

10.02

 

Unvested balance at December 31, 2006

 

461,527

 

12.57

 

Granted

 

199,885

 

17.99

 

Vested

 

(314,787

)

11.27

 

Unvested balance at December 31, 2007

 

346,625

 

16.88

 

Granted

 

194,001

 

12.59

 

Vested

 

(65,925

)

18.00

 

Unvested balance at June 13, 2008

 

474,701

 

$

14.97

 

 

The remaining share awards will vest as follows: 81,658 shares during 2008, 197,076 shares during 2009, 131,296 shares during 2010 and 64,671 during 2011.  As of June 13, 2008, the unrecognized compensation cost related to restricted stock awards was $5.4 million and the weighted-average period over which the unrecognized compensation expense will be recorded is approximately 23 months.  For the fiscal quarters ended June 13, 2008 and June 15, 2007, the Company recorded $0.7 million and $1.1 million, respectively, of compensation expense related to restricted stock awards. For the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007, the Company recorded $1.4 million and $2.1 million, respectively, of compensation expense related to restricted stock awards.

 

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Deferred Stock Awards

 

At the time of the Company’s initial public offering, the Company made a commitment to issue 382,500 shares of deferred stock units to the Company’s senior executive officers.  These deferred stock units are fully vested and represent the promise of the Company to issue a number of shares of the Company’s common stock to each senior executive officer upon the earlier of (i) a change of control or (ii) five years after the date of grant, which was the initial public offering completion date (the “Deferral Period”). However, if an executive’s service with the Company is terminated for “cause” prior to the expiration of the Deferral Period, all deferred stock unit awards will be forfeited.  The executive officers are restricted from transferring these shares until the fifth anniversary of the initial public offering completion date.  As of June 13, 2008, the Company has a commitment to issue 445,185 shares under this plan.  The share commitment increased from 382,500 to 445,185 since the Company’s initial public offering because current dividends are not paid out but instead are effectively reinvested at the dividend payment date’s closing price of the Company’s common stock.  No expense has been recognized during 2008 or 2007 for these awards.  During 2005, the Company recorded $3.7 million of stock based compensation expense related to these awards.

 

Stock Appreciation Rights and Dividend Equivalent Rights

 

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

 

On March 4, 2008, the Company issued 300,225 SARs/DERs to its executive officers with an aggregate fair value of approximately $2.0 million.  The strike price of the SARs is $12.59.  For the period from January 1, 2008 to June 13, 2008, the Company has recorded approximately $0.2 million of compensation expense related to the SARs/DERs.  A summary of the Company’s unvested SARs/DERs as of June 13, 2008 is as follows:

 

 

 

Number of
SARs/DERs

 

Weighted-
Average
Grant Date
Fair Value

 

Balance at January 1, 2008

 

 

$

 

Granted

 

300,225

 

6.62

 

Vested

 

 

 

 

 

 

 

 

 

Balance at June 13, 2008

 

300,225

 

$

6.62

 

 

6.     Earnings Per Share

 

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

 

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

 

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Table of Contents

 

 

 

Fiscal Quarter
Ended
June 13, 2008

 

Fiscal Quarter
Ended
June 15, 2007

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Basic Earnings per Share Calculation:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

21,755

 

$

20,513

 

$

26,932

 

$

27,303

 

Less: dividends on unvested restricted common stock

 

(119

)

(158

)

(237

)

(241

)

 

 

 

 

 

 

 

 

 

 

Net income after dividends on unvested restricted common stock

 

21,636

 

20,355

 

26,695

 

27,062

 

Less: discontinued operations

 

 

(407

)

 

(825

)

 

 

 

 

 

 

 

 

 

 

Net income from continuing operations after dividends on unvested restricted common stock

 

$

21,636

 

$

19,948

 

$

26,695

 

$

26,237

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding—basic

 

95,212,142

 

94,946,628

 

95,195,961

 

93,089,822

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.23

 

$

0.21

 

$

0.28

 

$

0.28

 

Discontinued operations

 

 

0.00

 

 

0.01

 

Total

 

$

0.23

 

$

0.21

 

$

0.28

 

$

0.29

 

 

 

 

 

 

 

 

 

 

 

Diluted Earnings per Share Calculation:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

21,755

 

$

20,513

 

$

26,932

 

$

27,303

 

Less: dividends on unvested restricted common stock

 

(119

)

(158

)

(237

)

(241

)

 

 

 

 

 

 

 

 

 

 

Net income after dividends on unvested restricted common stock

 

21,636

 

20,355

 

26,695

 

27,062

 

Less: discontinued operations

 

 

(407

)

 

(825

)

 

 

 

 

 

 

 

 

 

 

Net income from continuing operations after dividends on unvested restricted common stock

 

$

21,636

 

$

19,948

 

$

26,695

 

$

26,237

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding—basic

 

95,212,142

 

94,946,628

 

95,195,961

 

93,089,822

 

Unvested restricted common stock

 

46,406

 

345,214

 

80,061

 

372,846

 

Unvested SARs

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding—diluted

 

95,258,548

 

95,291,842

 

95,276,022

 

93,462,668

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.23

 

$

0.21

 

$

0.28

 

$

0.28

 

Discontinued operations

 

 

0.00

 

 

0.01

 

Total

 

$

0.23

 

$

0.21

 

$

0.28

 

$

0.29

 

 

7.    Debt

 

The Company has incurred limited recourse, property specific mortgage debt in conjunction with certain of its hotels. In the event of default, the lender may only foreclose on the pledged assets; however, in the event of fraud, misapplication of funds and other customary recourse provisions, the lender may seek payment from the Company.   As of June 13, 2008, twelve of the Company’s twenty hotel properties were secured by mortgage debt. The Company’s mortgage debt contains certain property specific covenants and restrictions, including minimum debt service coverage ratios that trigger cash management provisions as well as restrictions on incurring additional debt without lender consent.  As of June 13, 2008, the Company was in compliance with the financial covenants of its mortgage debt.

 

The following table sets forth information regarding the Company’s debt as of June 13, 2008 (unaudited), in thousands:

 

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Property

 

Principal
Balance

 

Interest Rate

 

 

 

 

 

 

 

Courtyard Manhattan / Midtown East

 

$

41,751

 

5.195

%

Marriott Salt Lake City Downtown

 

35,077

 

5.50

%

Courtyard Manhattan / Fifth Avenue

 

51,000

 

6.48

%

Marriott Griffin Gate Resort

 

28,789

 

5.11

%

Renaissance Worthington

 

57,400

 

5.40

%

Frenchman’s Reef & Morning Star Marriott Beach Resort

 

62,500

 

5.44

%

Marriott Los Angeles Airport

 

82,600

 

5.30

%

Orlando Airport Marriott

 

59,000

 

5.68

%

Chicago Marriott Downtown Magnificent Mile

 

220,000

 

5.975

%

Renaissance Austin

 

83,000

 

5.507

%

Renaissance Waverly

 

97,000

 

5.503

%

Bethesda Marriott Suites

 

5,000

 

LIBOR + 0.95 (3.33% as of June 13, 2008)

 

 

 

 

 

 

 

Total mortgage debt

 

823,117

 

 

 

Senior unsecured credit facility

 

32,000

 

LIBOR + 0.95 (3.40% as of June 13, 2008)

 

 

 

 

 

 

 

Total debt

 

$

855,117

 

 

 

 

 

 

 

 

 

Weighted-Average Interest Rate

 

 

 

5.5

%

 

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

 

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

 

 

 

Leverage Ratio

 

 

 

60% or greater

 

55% to 60%

 

50% to 55%

 

Less than 50%

 

Alternate base rate margin

 

0.65

%

0.45

%

0.25

%

0.00

%

LIBOR margin

 

1.55

%

1.45

%

1.25

%

0.95

%

 

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

 

 

 

 

 

Actual at

 

 

 

Covenant

 

June 13, 2008

 

 

 

 

 

 

 

Maximum leverage ratio

 

65%

 

35.6%

 

Minimum fixed charge coverage ratio

 

1.6x

 

3.9x

 

Minimum tangible net worth

 

$738.4 million

 

$1.2 billion

 

Unhedged floating rate debt as a percentage of total indebtedness

 

35%

 

4.3%

 

 

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

 

 

 

 

 

Actual at

 

 

 

Covenant

 

June 13, 2008

 

 

 

 

 

 

 

Minimum implied debt service ratio

 

1.5x

 

24.9x

 

Maximum unencumbered leverage ratio

 

65%

 

3.7%

 

Minimum number of unencumbered borrowing base properties

 

4

 

8

 

Minimum unencumbered borrowing base value

 

$150 million

 

$869.0 million

 

Percentage of total asset value owned by borrowers or guarantors

 

90%

 

100%

 

 

In addition to the interest payable on amounts outstanding under the Facility, the Company is required to pay an amount equal to 0.20% of the unused portion of the Facility if the unused portion of the Facility is greater than 50% and

 

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0.125% if the unused portion of the Facility is less than 50%.  The Company incurred interest and unused credit facility fees on the Facility of $0.4 million and $0.6 million for the fiscal quarters ended June 13, 2008 and June 15, 2007, respectively and $0.6 million and $1.0 million for the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007, respectively.  As of June 13, 2008, the Company had $32.0 million outstanding under the Facility.  Subsequent to June 13, 2008, the Company drew an additional $34 million, net, under the Facility.

 

8.    Discontinued Operations

 

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

 

 

 

Fiscal Quarter
Ended
June 15, 2007

 

Period from
January 1, 2007
to June 15, 2007

 

 

 

 

 

 

 

Revenues

 

$

1,600

 

$

3,122

 

 

 

 

 

 

 

Pre-tax income from operations

 

342

 

685

 

Income tax benefit

 

65

 

140

 

Income from discontinued operations

 

$

407

 

$

825

 

 

9.      Dividends

 

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

 

Payment Date

 

Record Date

 

Dividend per
Share

 

January 10, 2008

 

December 31, 2007

 

$

0.24

 

April 1, 2008

 

March 21, 2008

 

$

0.25

 

June 24, 2008

 

June 13, 2008

 

$

0.25

 

 

10.    Transactions with Hotel Managers

 

Key Money

 

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

 

On September 27, 2007, the Company and Hilton Hotels Corporation, the manager of the Conrad Chicago, amended the management agreement of the hotel to allow an exception to the territorial restriction and permit a new Chicago suburban airport Conrad hotel.  In connection with this amendment, the Company will receive up to $1.8 million over the new hotel development period.  These payments will be accounted for as key money when received and amortized over the remaining term of the management agreement.

 

11.    Commitments and Contingencies

 

Litigation

 

The Company is not involved in any material litigation nor, to its knowledge, is any material litigation threatened against the Company.  The Company is involved in routine litigation arising out of the ordinary course of business, all of

 

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which is expected to be covered by insurance and none of which is expected to have a material impact on its financial condition or results of operations.

 

Income Taxes

 

The Company had no accruals for tax uncertainties as of June 13, 2008 and December 31, 2007.  As of June 13, 2008, all of the Company’s federal income tax returns and state tax returns for the jurisdictions in which the Company’s hotels are located remain subject to examination by the respective jurisdiction tax authorities.

 

12.    Fair Value Measurements

 

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

 

13.   Subsequent Event

 

On July 7, 2008, the Company announced that Mark W. Brugger had been named Chief Executive Officer, effective September 1, 2008.  After that date, William W. McCarten, the Company’s current Chief Executive Officer and Chairman of the Board of Directors, will continue in his role as Executive Chairman.  In addition, the Board of Directors has announced that, effective September 1, 2008, it will expand the Board of Directors from 6 members to 7 members in connection with the appointment of Mr. Brugger as a member of the Board of Directors.

 

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Table of Contents

 

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

 

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

 

Overview

 

We are a lodging focused real estate company that owns, as of July 22, 2008, twenty premium hotels and resorts which contain approximately 9,600 guestrooms.  We are committed to maximizing shareholder value through investing in premium full service hotels and, to a lesser extent, premium urban limited service hotels located throughout the United States.  Our hotels are concentrated in key gateway cities and in destination resort locations and are all operated under a brand owned by one of the top three national brand companies (Marriott, Starwood or Hilton).

 

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

 

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

 

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

 

·                  high quality urban and resort focused real estate;

·                  conservative capital structure; and

·                  thoughtful asset management.

 

High Quality Urban and Resort Focused Real Estate

 

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

 

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

 

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

 

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Table of Contents

 

Conservative Capital Structure

 

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

 

As of June 13, 2008, 95.7% of our debt carried fixed interest rates, with a weighted-average interest rate of 5.5%, and a weighted-average maturity of 6.9 years.  As of June 13, 2008, we had $855.1 million of debt outstanding, representing a net debt-to-enterprise value ratio of 42.1%, which is calculated as our net debt (debt less unrestricted cash) divided by our enterprise value, which is our market capitalization plus net debt.

 

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

 

Thoughtful Asset Management

 

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

 

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

 

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

 

We believe we can create significant value in our portfolio through innovative asset management strategies such as rebranding, renovating and repositioning. We are committed to regularly evaluating our portfolio to determine if we can employ these value-added strategies at our hotels.  During 2006, 2007 and the period from January 1, 2008 to June 13, 2008, we completed a significant amount of capital reinvestment in our hotels – completing projects that ranged from room renovations (Courtyard Manhattan/Midtown East, Los Angeles Airport Marriott, Bethesda Marriott Suites, Orlando Airport Marriott, Frenchman’s Reef & Morning Star Marriott Beach Resort and Westin Atlanta North at Perimeter) to a total renovation and repositioning of the hotel (Torrance Marriott South Bay and the Oak Brook Hills Marriott Resort) to the addition of new meeting space, spa or restaurant repositioning (Westin Boston Waterfront, Chicago Marriott and Marriott Griffin Gate Resort).  By the end of 2008, we expect to have fully renovated nearly all of the hotels in our portfolio.  In connection with our planned renovations and repositionings, our senior management team and our asset managers are individually committed to completing these renovations on time, on budget and with minimum disruption at our hotels.

 

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

 

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Table of Contents

 

Key Indicators of Financial Condition and Operating Performance

 

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

 

· Occupancy percentage;

· Average Daily Rate (or ADR);

· Revenue per Available Room (or RevPAR);

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

· Funds From Operations (or FFO).

 

Occupancy, ADR and RevPAR are commonly used measures within the hotel industry to evaluate operating performance. RevPAR, which is calculated as the product of ADR and occupancy percentage, is an important statistic for monitoring operating performance at the individual hotel level and across our business as a whole. We evaluate individual hotel RevPAR performance on an absolute basis with comparisons to budget and prior periods, as well as on a company-wide and regional basis. ADR and RevPAR include only room revenue. Room revenue comprised approximately 64% of our total revenues for the fiscal quarter ended June 13, 2008, and is dictated by demand, as measured by occupancy percentage, pricing, as measured by ADR, and our available supply of hotel rooms.

 

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

 

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

 

Our Hotels

 

The following table sets forth certain operating information for each of our hotels for the period from January 1, 2008 to June 13, 2008.  The percent change from 2007 RevPAR for the period from January 1, 2007 to June 15, 2007 includes the results of the Westin Boston Waterfront Hotel for the period prior to our acquisition of the hotel.

 

Property

 

Location

 

Number of
Rooms

 

Occupancy
(%)

 

ADR($)

 

RevPAR($)

 

% Change
from 2007
RevPAR

 

Chicago Marriott

 

Chicago, Illinois

 

1,198

 

66.3

%

$

211.34

 

$

140.11

 

(8.2

)%

Los Angeles Airport Marriott

 

Los Angeles, California

 

1,004

 

86.1

 

116.78

 

100.57

 

5.9

 

Westin Boston Waterfront Hotel (1)

 

Boston, Massachusetts

 

793

 

62.9

 

196.66

 

123.76

 

5.1

 

Renaissance Waverly Hotel

 

Atlanta, Georgia

 

521

 

71.1

 

146.55

 

104.26

 

0.3

 

Salt Lake City Marriott Downtown

 

Salt Lake City, Utah

 

510

 

70.6

 

136.27

 

96.20

 

(0.2

)

Renaissance Worthington

 

Fort Worth, Texas

 

504

 

78.0

 

183.37

 

143.00

 

3.1

 

Frenchman’s Reef & Morning Star Marriott Beach Resort (1)

 

St. Thomas, U.S. Virgin Islands

 

502

 

84.3

 

282.31

 

238.12

 

(1.3

)

Renaissance Austin Hotel

 

Austin, Texas

 

492

 

72.6

 

161.53

 

117.26

 

(9.2

)

Torrance Marriott South Bay

 

Los Angeles County, California

 

487

 

79.5

 

127.42

 

101.28

 

11.0

 

Orlando Airport Marriott

 

Orlando, Florida

 

486

 

79.9

 

129.02

 

103.12

 

(1.3

)

Marriott Griffin Gate Resort

 

Lexington, Kentucky

 

408

 

61.8

 

139.65

 

86.28

 

2.5

 

Oak Brook Hills Marriott Resort

 

Oak Brook, Illinois

 

386

 

49.2

 

131.72

 

64.84

 

(7.7

)

Westin Atlanta North at Perimeter (1)

 

Atlanta, Georgia

 

369

 

64.1

 

147.24

 

94.33

 

(4.7

)

Vail Marriott Mountain Resort & Spa (1)

 

Vail, Colorado

 

346

 

71.7

 

306.63

 

219.79

 

7.0

 

Marriott Atlanta Alpharetta

 

Atlanta, Georgia

 

318

 

62.8

 

153.12

 

96.10

 

(1.0

)

Courtyard Manhattan/Midtown East

 

New York, New York

 

312

 

89.0

 

286.94

 

255.38

 

8.5

 

Conrad Chicago (1)

 

Chicago, Illinois

 

311

 

68.5

 

228.80

 

156.80

 

8.9

 

Bethesda Marriott Suites

 

Bethesda, Maryland

 

272

 

72.1

 

198.56

 

143.20

 

3.9

 

Courtyard Manhattan/Fifth Avenue

 

New York, New York

 

185

 

87.5

 

288.86

 

252.71

 

8.8

 

The Lodge at Sonoma, a Renaissance Resort & Spa

 

Sonoma, California

 

182

 

64.9

 

209.34

 

135.96

 

3.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TOTAL/WEIGHTED AVERAGE

 

 

 

9,586

 

72.3

%

$

180.48

 

$

130.53

 

1.0

%

 

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(1)   The Frenchman’s Reef & Morning Star Marriott Beach Resort, Vail Marriott Mountain Resort & Spa, Westin Atlanta North at Perimeter, Conrad Chicago and the Westin Boston Waterfront Hotel report operations on a calendar month and year basis.  The period from January 1, 2008 to June 13, 2008 includes the operations for the period from January 1, 2008 to May 31, 2008 for these five hotels.

 

Recent Development

 

On July 7, 2008, we announced that Mark W. Brugger had been named Chief Executive Officer, effective September 1, 2008.  After that date, William W. McCarten, our current Chief Executive Officer and Chairman of the Board of Directors, will continue in his role as Executive Chairman.  In addition, the Board of Directors has announced that, effective September 1, 2008, it will expand the Board of Directors from 6 members to 7 members in connection with the appointment of Mr. Brugger as a member of the Board of Directors.

 

Outlook

 

After several years of above-average growth in the lodging industry, the operating environment has become challenging.  The economic drivers that impact underlying lodging demand, such as GDP growth, corporate earnings, consumer confidence and employment, have deteriorated during the first half of 2008.  We believe that such economic drivers may remain weak or further weaken in the second half of the year and into 2009.  The decline in these lodging demand drivers has resulted in a significantly lower revenue growth rate for our hotels, and thus we currently project that our total revenue from continuing operations will contract during the second half of 2008 compared to the same period in 2007.  We have a strong balance sheet and have maintained one of the lowest levels of leverage in the industry.

 

Furthermore, we believe that slowing economy and its impact on demand drivers has resulted in lower transient demand in the lodging industry, primarily from the customers in the corporate and leisure segments that comprise approximately 60% of our room sales.   In an uncertain economy where consumers and corporations have a negative outlook, it is very difficult to accurately forecast the behavior of these individual travelers, but it is clear that lodging demand has declined compared to the prior year.  We believe that a number of these individual travelers will continue to postpone or eliminate travel, or travel on a reduced budget, until consumer and business sentiment improves.   As a result, we currently expect full year RevPAR to contract by 1 to 3 percent.

 

Moreover, while we are taking cost containment measures at our hotels certain of our cost categories are increasing at a rate greater than the current rate of inflation, including wages, benefits, utilities and real estate taxes.  The combination of declining revenues and increasing operating costs will impact our operating results over the next several fiscal quarters and into 2009.  In addition, certain of our markets will experience new hotel supply in 2009, the most significant of which is in Fort Worth, Texas, where we have one hotel.

 

Although negative operating trends are likely to extend for some period of time, we expect operating results to improve when the general economy improves.

 

Results of Operations

 

As of June 13, 2008, we owned twenty hotels. Our total assets were $2.1 billion as of June 13, 2008. Total liabilities were $1.1 billion as of June 13, 2008, including $855.1 million of debt. Shareholders’ equity was approximately $1.1 billion as of June 13, 2008. Our total assets were $2.1 billion as of December 31, 2007. Total liabilities were $1.1 billion as of December 31, 2007, including $824.5 million of debt. Shareholders’ equity was approximately $1.1 billion as of December 31, 2007.

 

Comparison of the Fiscal Quarter Ended June 13, 2008 to the Fiscal Quarter Ended June 15, 2007

 

Our net income for the fiscal quarter ended June 13, 2008 was $21.8 million compared to $20.5 million for the fiscal quarter ended June 15, 2007.

 

Revenue.    Revenue from continuing operations consists primarily of the room, food and beverage and other operating revenues from our hotels. Revenues for the fiscal quarters ended June 13, 2008 and June 15, 2007, respectively, consist of the following (in thousands):

 

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Fiscal Quarter
Ended
June 13, 2008

 

Fiscal Quarter
Ended
June 15, 2007

 

 

 

 

 

 

 

Rooms

 

$

116,011

 

$

114,252

 

Food and beverage

 

55,532

 

54,275

 

Other

 

9,473

 

9,417

 

Total revenues

 

$

181,016

 

$

177,944

 

 

Our total revenues from continuing operations increased $3.1 million, from $177.9 million for the fiscal quarter ended June 15, 2007 to $181.0 million for the fiscal quarter ended June 13, 2008.  This increase is primarily the result of a 1.5 percent RevPAR increase at our hotels driven by a 2.2 percent increase in the average daily rate and a 0.5 percent decrease in occupancy.  The performance of our hotels varied by market. For instance, our New York City and Chicago markets were stronger while certain of our other markets, including Atlanta and Boston, were softer.

 

Individual hotel revenues for the fiscal quarters ended June 13, 2008 and June 15, 2007, respectively, consist of the following (in millions):

 

 

 

Fiscal Quarter
Ended
June 13, 2008

 

Fiscal Quarter
Ended
June 15, 2007

 

Increase
(Decrease)

 

 

 

 

 

 

 

 

 

Chicago Marriott

 

$

28.3

 

$

26.9

 

$

1.4

 

Westin Boston Waterfront Hotel (1)

 

19.0

 

19.6

 

(0.6

)

Frenchman’s Reef & Morning Star Marriott Beach Resort (1)

 

16.5

 

16.3

 

0.2

 

Los Angeles Airport Marriott

 

13.5

 

12.9

 

0.6

 

Renaissance Worthington

 

10.0

 

9.5

 

0.5

 

Renaissance Waverly Hotel

 

8.6

 

8.4

 

0.2

 

Renaissance Austin Hotel

 

8.5

 

9.0

 

(0.5

)

Courtyard Manhattan/Midtown East

 

7.8

 

7.5

 

0.3

 

Marriott Griffin Gate Resort

 

7.6

 

7.5

 

0.1

 

Vail Marriott Mountain Resort & Spa (1)

 

7.3

 

6.9

 

0.4

 

Conrad Chicago (1)

 

7.3

 

6.6

 

0.7

 

Oak Brook Hills Marriott Resort

 

6.8

 

7.0

 

(0.2

)

Torrance Marriott South Bay

 

6.0

 

5.8

 

0.2

 

Salt Lake City Marriott Downtown

 

5.9

 

5.5

 

0.4

 

Orlando Airport Marriott

 

5.8

 

6.2

 

(0.4

)

Bethesda Marriott Suites

 

4.7

 

4.7

 

 

The Lodge at Sonoma, a Renaissance Resort & Spa

 

4.7

 

4.4

 

0.3

 

Westin Atlanta North at Perimeter (1)

 

4.6

 

5.3

 

(0.7

)

Courtyard Manhattan/Fifth Avenue

 

4.4

 

4.1

 

0.3

 

Marriott Atlanta Alpharetta

 

3.7

 

3.8

 

(0.1

)

Total

 

$

181.0

 

$

177.9

 

$

3.1

 

 


(1)   The Frenchman’s Reef & Morning Star Marriott Beach Resort, Vail Marriott Mountain Resort & Spa, Westin Atlanta North at Perimeter, Conrad Chicago and the Westin Boston Waterfront Hotel report operations on a calendar month and year basis.  The fiscal quarters ended June 13, 2008 and June 15, 2007 include the operations for the period from March 1, 2008 to May 31, 2008 and March 1, 2007 to May 31, 2007, respectively, for these five hotels.

 

The following are the pro forma key hotel operating statistics for our hotels for the fiscal quarters ended June 13, 2008 and June 15, 2007, respectively.

 

 

 

Fiscal Quarter
Ended
June 13, 2008

 

Fiscal Quarter
Ended
June 15, 2007

 

% Change

 

Occupancy %

 

75.7

%

76.2

%

(0.5) percentage points

 

ADR

 

$

186.53

 

$

182.60

 

2.2%

 

RevPAR

 

$

141.20

 

$

139.14

 

1.5%

 

 

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Hotel operating expenses.    Hotel operating expenses from continuing operations consist primarily of operating expenses of our hotels, including non-cash ground rent expense. The operating expenses for the fiscal quarters ended June 13, 2008 and June 15, 2007, respectively, consist of the following (in millions):

 

 

 

Fiscal Quarter
Ended
June 13, 2008

 

Fiscal Quarter
Ended
June 15, 2007

 

Rooms departmental expenses

 

$

26.2

 

$

25.1

 

Food and beverage departmental expenses

 

36.4

 

35.7

 

Other hotel expenses

 

47.5

 

46.4

 

Base management fees

 

5.0

 

4.9

 

Yield support

 

 

(0.1

)

Incentive management fees

 

3.0

 

3.1

 

Property taxes

 

5.5

 

5.4

 

Ground rent—Contractual

 

0.5

 

0.4

 

Ground rent—Non-cash

 

1.8

 

1.9

 

Total hotel operating expenses

 

$

125.9

 

$

122.8

 

 

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 $0.7 million from $17.4 million for the fiscal quarter ended June 15, 2007 to $18.1 million for the fiscal quarter ended June 13, 2008 due to increased capital expenditures in 2008, primarily consisting of the capital projects at the Chicago Marriott and the Westin Boston Waterfront Hotel.

 

Corporate expenses.    Our corporate expenses were $3.3 million for the fiscal quarters ended June 15, 2007 and June 13, 2008.  Corporate expenses principally consist of employee-related costs, including base payroll, bonus and restricted stock. Corporate expenses also include corporate operating costs, professional fees and directors’ fees.

 

Interest expense.    Our interest expense decreased $0.5 million from $11.9 million for the fiscal quarter ended June 15, 2007 to $11.4 million for the fiscal quarter ended June 13, 2008.  The decrease in interest expense is primarily attributable to the refinancing of our mortgage on the Bethesda Marriott in 2007, which resulted in reduced borrowings at a lower interest rate, and a lower interest rate on the outstanding borrowings under our credit facility during the second fiscal quarter of 2008.   The 2008 interest expense is comprised of mortgage debt ($10.8 million), amortization of deferred financing costs ($0.2 million) and interest and unused facility fees on our credit facility ($0.4 million). The 2007 interest expense is comprised of mortgage debt ($11.2 million), amortization of deferred financing costs ($0.1 million) and interest and unused facility fees on our credit facility ($0.6 million).

 

As of June 13, 2008, we had property-specific mortgage debt outstanding on twelve of our hotels. On all but one of the hotels, we have fixed-rate secured debt, which bears interest at rates ranging from 5.11% to 6.48% per year. Amounts drawn under the credit facility bear interest at a variable rate that fluctuates based on the level of outstanding indebtedness in relation to the value of our assets from time to time. The weighted-average interest rate as of June 13, 2008 on the outstanding balance under our credit facility was 3.40% as compared to 6.27% as of June 15, 2007.  We had $32.0 million drawn on the credit facility as of June 13, 2008.  Subsequent to June 13, 2008, we drew an additional $34.0 million, net, under the credit facility.  Our weighted-average interest rate on all debt as of June 13, 2008 was 5.5%.

 

Interest income.  Interest income decreased $0.4 million from $0.7 million for the fiscal quarter ended June 15, 2007 to $0.3 million for the fiscal quarter ended June 13, 2008 primarily due to lower interest rates earned on our corporate cash in 2008.

 

Discontinued operations.  Income from discontinued operations for the fiscal quarter ended June 15, 2007 was the result of the sale of the SpringHill Suites Atlanta Buckhead on December 21, 2007.

 

Income taxes.    We recorded an income tax expense for income from continuing operations of $0.9 million and $3.2 million for the fiscal quarters ended June 13, 2008 and June 15, 2007, respectively.   The second quarter 2008 income tax expense was incurred on the $0.6 million pre-tax income of our taxable REIT subsidiary, or TRS, for the fiscal quarter ended June 13, 2008, together with foreign income tax expense of $0.5 million related to the taxable REIT subsidiary that owns the Frenchman’s Reef & Morning Star Marriott Beach Resort.  The second quarter 2007 income tax expense was incurred on the $7.4 million pre-tax income of our TRS for the fiscal quarter ended June 15, 2007, together with foreign income tax expense

 

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Table of Contents

 

of $0.2 million related to the taxable REIT subsidiary that owns the Frenchman’s Reef & Morning Star Marriott Beach Resort.

 

Comparison of the Period from January 1, 2008 to June 13, 2008 to the Period from January 1, 2007 to June 15, 2007

 

Our net income for the period from January 1, 2008 to June 13, 2008 was $26.9 million compared to $27.3 million for the period from January 1, 2007 to June 15, 2007.

 

Revenue.    Revenue from continuing operations consists primarily of the room, food and beverage and other operating revenues from our hotels. Revenues for the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007, respectively, consist of the following (in thousands):

 

 

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

 

 

 

 

 

 

Rooms

 

$

201,938

 

$

199,006

 

Food and beverage

 

95,614

 

95,722

 

Other

 

16,327

 

15,429

 

Total revenues

 

$

313,879

 

$

310,157

 

 

Our total revenues from continuing operations increased $3.7 million, from $310.2 million for the period from January 1, 2007 to June 15, 2007 to $313.9 million for the period from January 1, 2008 to June 13, 2008.   The increase is primarily due to a 1.0 percent increase in RevPAR, driven by a 2.7 percent increase in average daily rate and a 1.2 percent decrease in occupancy.  Throughout the first half of 2008 our hotels experienced a wide range in operating performance, varying by market.  The results for the period from January 1, 2008 to June 13, 2008 were significantly impacted by the performance of the Chicago Marriott Downtown, which experienced both disruption from a substantial renovation as well as a weak convention calendar during the first quarter of 2008, partially offset by a stronger market during the second quarter of 2008.

 

Individual hotel revenues for the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007, respectively, consist of the following (in millions):

 

 

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

Increase
(Decrease)

 

 

 

 

 

 

 

 

 

Chicago Marriott

 

$

39.2

 

$

44.3

 

$

(5.1

)

Los Angeles Airport Marriott

 

27.9

 

27.2

 

0.7

 

Westin Boston Waterfront Hotel (1)(2)

 

27.9

 

23.6

 

4.3

 

Frenchman’s Reef & Morning Star Marriott Beach Resort (1)

 

27.7

 

27.1

 

0.6

 

Renaissance Worthington

 

19.5

 

19.2

 

0.3

 

Renaissance Waverly Hotel

 

17.3

 

17.5

 

(0.2

)

Renaissance Austin Hotel

 

16.7

 

17.7

 

(1.0

)

Vail Marriott Mountain Resort & Spa (1)

 

15.6

 

14.6

 

1.0

 

Courtyard Manhattan/Midtown East

 

13.8

 

12.7

 

1.1

 

Orlando Airport Marriott

 

13.4

 

13.3

 

0.1

 

Salt Lake City Marriott Downtown

 

12.3

 

12.3

 

 

Torrance Marriott South Bay

 

11.7

 

10.8

 

0.9

 

Marriott Griffin Gate Resort

 

11.6

 

11.5

 

0.1

 

Oak Brook Hills Marriott Resort

 

10.1

 

10.5

 

(0.4

)

Conrad Chicago (1)

 

9.8

 

9.0

 

0.8

 

Westin Atlanta North at Perimeter (1)

 

8.3

 

8.7

 

(0.4

)

Bethesda Marriott Suites

 

8.3

 

8.2

 

0.1

 

Courtyard Manhattan/Fifth Avenue

 

7.8

 

7.2

 

0.6

 

The Lodge at Sonoma, a Renaissance Resort & Spa

 

7.7

 

7.4

 

0.3

 

Marriott Atlanta Alpharetta

 

7.3

 

7.4

 

(0.1

)

Total

 

$

313.9

 

$

310.2

 

$

3.7

 

 

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Table of Contents

 


(1)   The Frenchman’s Reef & Morning Star Marriott Beach Resort, Vail Marriott Mountain Resort & Spa, Westin Atlanta North at Perimeter, Conrad Chicago and the Westin Boston Waterfront Hotel report operations on a calendar month and year basis.  The periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007 include the operations for the period from January 1, 2008 to May 31, 2008 and January 1, 2007 to May 31, 2007, respectively, for these five hotels.

(2)   The Westin Boston Waterfront Hotel was acquired on January 31, 2007.  The period from January 1, 2007 to June 15, 2007, includes the operations for the period from January 31, 2007 (date of acquisition) to May 31, 2007.

 

The following are the pro forma key hotel operating statistics for our hotels for the period from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007, respectively.  The pro forma hotel operating statistics presented below include the results of operations of the Westin Boston Waterfront Hotel under previous ownership for the period from January 2, 2007 to January 30, 2007.

 

 

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

% Change

 

Occupancy %

 

72.3

%

73.5

%

(1.2) percentage points

 

ADR

 

$

180.48

 

$

175.76

 

2.7%

 

RevPAR

 

$

130.53

 

$

129.19

 

1.0%

 

 

Hotel operating expenses.    Hotel operating expenses from continuing operations consist primarily of operating expenses of our hotels, including non-cash ground rent expense. The operating expenses for the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007, respectively, consist of the following (in millions):

 

 

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

Rooms departmental expenses

 

$

47.4

 

$

45.3

 

Food and beverage departmental expenses

 

65.3

 

64.2

 

Other hotel expenses

 

86.6

 

83.1

 

Base management fees

 

8.6

 

8.5

 

Yield support

 

 

(0.1

)

Incentive management fees

 

4.4

 

4.7

 

Property taxes

 

10.6

 

10.3

 

Ground rent—Contractual

 

1.0

 

0.8

 

Ground rent—Non-cash

 

3.5

 

3.6

 

Total hotel operating expenses

 

$

227.4

 

$

220.4

 

 

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 $1.6 million from $33.2 million for the period from January 1, 2007 to June 15, 2007 to $34.8 million for the period from January 1, 2008 to June 13, 2008 due to increased capital expenditures in 2008 primarily consisting of the capital projects at the Chicago Marriott and the Boston Westin.

 

Corporate expenses.    Our corporate expenses decreased from $6.4 million for the period from January 1, 2007 to June 15, 2007 to $6.3 million for the period from January 1, 2008 to June 13, 2008 primarily due to lower stock compensation expense in 2008 partially offset by higher legal and payroll costs.  Corporate expenses principally consist of employee-related costs, including base payroll, bonus and restricted stock. Corporate expenses also include corporate operating costs, professional fees and directors’ fees.

 

Interest expense.    Our interest expense decreased $1.3 million from $23.4 million for the period from January 1, 2007 to June 15, 2007 to $22.1 million for the period from January 1, 2008 to June 13, 2008.  The decrease in interest expense is primarily attributable to the refinancing of our mortgage on the Bethesda Marriott in 2007, which resulted in reduced borrowings at a lower interest rate and a lower interest rate on outstanding borrowings under our credit facility during the period from January 1, 2008 to June 13, 2008.   The 2008 interest expense is comprised of mortgage debt ($21.1 million), amortization of deferred financing costs ($0.4 million) and interest and unused facility fees on our credit facility ($0.6 million). The 2007 interest expense is comprised of mortgage debt ($22.1 million), amortization of deferred financing costs ($0.3 million) and interest and unused facility fees on our credit facility ($1.0 million).

 

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As of June 13, 2008, we had property-specific mortgage debt outstanding on twelve of our hotels. On all but one of the hotels, we have fixed-rate secured debt, which bears interest at rates ranging from 5.11% to 6.48% per year. Amounts drawn under the credit facility bear interest at a variable rate that fluctuates based on the level of outstanding indebtedness in relation to the value of our assets from time to time. The weighted-average interest rate as of June 13, 2008 on our outstanding balance under our credit facility was 3.40% as compared to 6.27% as of June 15, 2007.  We had $32.0 million drawn on the credit facility as of June 13, 2008.  Subsequent to June 13, 2008, we drew an additional $34 million, net, under the credit facility.  Our weighted-average interest rate on all debt as of June 13, 2008 was 5.5%.

 

Interest income.  Interest income decreased $0.5 million from $1.3 million for the period from January 1, 2007 to June 15, 2007 to $0.8 million for the period from January 1, 2008 to June 13, 2008 primarily due to lower interest rates earned on our corporate cash in 2008.

 

Discontinued operations.  Income from discontinued operations for the period from January 1, 2007 to June 15, 2007 was the result of the sale of the SpringHill Suites Atlanta Buckhead on December 21, 2007.

 

Income taxes.    We recorded an income tax benefit of $2.8 million for the period from January 1, 2008 to June 13, 2008 and an income tax expense of $1.6 million for the period January 1, 2007 to June 15, 2007, respectively.   The 2008 income tax benefit was incurred on the $9.9 million pre-tax loss of our taxable REIT subsidiary, or TRS, for the period from January 1, 2008 to June 13, 2008, together with foreign income tax expense of $0.9 million related to the taxable REIT subsidiary that owns the Frenchman’s Reef & Morning Star Marriott Beach Resort.  The 2007 income tax expense was incurred on the $3.1 million pre-tax income of our TRS for the period from January 1, 2007 to June 15, 2007, together with foreign income tax expense of $0.4 million related to the taxable REIT subsidiary that owns the Frenchman’s Reef & Morning Star Marriott Beach Resort.

 

Liquidity and Capital Resources

 

Our short-term liquidity requirements consist primarily of funds necessary to fund future distributions to our stockholders to maintain our REIT status, funds required to purchase shares under our share repurchase program and funds required for corporate expenses as well as to pay for operating expenses and other expenditures directly associated with our hotels, including maintenance and recurring capital expenditures as well as payments of interest and principal. We expect to meet our short-term liquidity requirements generally through net cash provided by operations, existing cash balances and short-term borrowings under our credit facility.

 

Our long-term liquidity requirements consist primarily of funds necessary to pay for the costs of acquiring additional hotels, renovations, expansions and other capital expenditures that need to be made periodically to our hotels, scheduled debt payments and making distributions to our stockholders. We expect to meet our long-term liquidity requirements through various sources of capital, cash provided by operations, existing cash balances, and borrowings as well as through the issuances of additional equity or debt securities. Our ability to incur additional debt is dependent upon a number of factors, including our degree of leverage, the value of our unencumbered assets and borrowing restrictions imposed by existing lenders. Our ability to raise funds through the issuance of debt and equity securities is dependent upon, among other things, general market conditions for REITs and market perceptions about us.

 

Our Financing Strategy

 

We are committed to maintaining a conservative capital structure with aggregate leverage weighted towards long-term fixed-rate debt. However, we maintain the flexibility to modify these strategies if we believe fundamental changes have occurred in the capital or lodging markets.

 

As of June 13, 2008, 95.7% of our debt carries fixed interest rates, with a weighted-average interest rate of 5.5%, and a weighted-average maturity of 6.9 years. As of June 13, 2008, we had $855.1 million of debt outstanding.

 

We have a strong preference towards fixed-rate, long-term, limited recourse, single property specific debt. When possible and desirable, we will seek to replace short-term sources of capital with long-term financing. In addition to property-specific debt and our credit facility, we intend to use other financing methods as necessary, including obtaining funds from banks, institutional investors or other lenders, bridge loans, letters of credit and other arrangements, any of which may be unsecured or may be secured by mortgages or other interests in our investments. In addition, we may issue publicly or privately placed debt instruments.

 

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Share Repurchase Program

 

On February 27, 2008, our Board of Directors authorized a program to repurchase up to 4.8 million shares of our common stock.  The common stock may be purchased in the open market or through private transactions, dependent upon market conditions.  The plan does not obligate us to repurchase any specific number of shares and may be suspended at any time at our discretion.  As of July 21, 2008, we have purchased 2.8 million shares under this program at an average price of $10.74 per share.  We have retired all shares purchased under the program on the settlement date.

 

Credit Facility

 

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

 

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

 

 

 

Leverage Ratio

 

 

 

60% or greater

 

55% to 60%

 

50% to 55%

 

less than 50%

 

Alternate base rate margin

 

0.65

%

0.45

%

0.25

%

0.00

%

LIBOR margin

 

1.55

%

1.45

%

1.25

%

0.95

%

 

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

 

 

 

 

 

Actual at

 

 

 

Covenant

 

June 13, 2008

 

 

 

 

 

 

 

Maximum leverage ratio

 

65%

 

35.6%

 

Minimum fixed charge coverage ratio

 

1.6x

 

3.9x

 

Minimum tangible net worth

 

$738.4 million

 

$1.2 billion

 

Unhedged floating rate debt as a percentage of total indebtedness

 

35%

 

4.3%

 

 

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

 

 

 

 

 

Actual at

 

 

 

Covenant

 

June 13, 2008

 

 

 

 

 

 

 

Minimum implied debt service ratio

 

1.5x

 

24.9x

 

Maximum unencumbered leverage ratio

 

65%

 

3.7%

 

Minimum number of unencumbered borrowing base properties

 

4

 

8

 

Minimum unencumbered borrowing base value

 

$150 million

 

$869.0 million

 

Percentage of total asset value owned by borrowers or guarantors

 

90%

 

100%

 

 

In addition to the interest payable on amounts outstanding under the Facility, we are required to pay an amount equal to 0.20% of the unused portion of the Facility if the unused portion of the Facility is greater than 50% and 0.125% if the unused portion of the Facility is less than 50%.  We incurred interest and unused credit facility fees on the Facility of $0.4 million and $0.6 million for the fiscal quarters ended June 13, 2008 and June 15, 2007, respectively and we incurred interest and unused credit facility fees on the Facility of $0.6 million and $1.0 million for the periods from January 1, 2008 to June 13, 2008 and January 1, 2007 to June 15, 2007, respectively.  As of June 13, 2008, we had $32.0 million outstanding on the Facility.  Subsequent to June 13, 2008, we drew an additional $34.0 million, net, under the Facility.

 

Sources and Uses of Cash

 

Our principal sources of cash are revenues from operations, borrowing under mortgage financings, draws on the Facility and the proceeds from our equity offerings. Our principal uses of cash are debt service, share repurchases, capital expenditures, operating costs, corporate expenses and dividends.

 

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Cash Provided by Operating Activities.    Our cash provided by operating activities was $48.0 million for the period from January 1, 2008 to June 13, 2008, which is the result of our $26.9 million net income adjusted for the impact of several non-cash charges, including $34.8 million of depreciation, $3.6 million of non-cash ground rent, $0.4 million of amortization of deferred financing costs, $0.8 million of yield support received and $1.6 million of stock compensation, offset by $0.8 million of amortization of unfavorable agreements, $0.3 million of amortization of deferred income and unfavorable working capital changes of $19.0 million.

 

Our cash provided by operating activities was $53.4 million for the period from January 1, 2007 to June 15, 2007, which is the result of our $27.3 million net income, adjusted for the impact of several non-cash charges, including $33.7 million of depreciation, $3.6 million of non-cash straight line ground rent, $1.7 of yield support received,  $0.3 million of amortization of deferred financing costs, $2.1 million of stock compensation, offset by $0.9 million of amortization of debt premium and unfavorable agreements, and unfavorable working capital changes of $14.2 million.

 

Cash Used In Investing Activities.    Our cash used in investing activities was $33.6 million for the period from January 1, 2008 to June 13, 2008.  During the period from January 1, 2008 to June 13, 2008, we incurred capital expenditures at our hotels of $36.8 million and a decrease in restricted cash of $1.8 million, which was offset by the receipt of $5.0 million of key money related to the Chicago Marriott Downtown.

 

Our cash used in investing activities was $354.4 million for the period from January 1, 2007 to June 15, 2007.  During the period from January 1, 2007 to June 15, 2007, we utilized $331.3 million of cash for the acquisition of the Westin Boston Waterfront Hotel and incurred capital expenditures at our hotels of $22.5 million.

 

Cash Used In Financing Activities.    Our cash used in financing activities was $19.2 million for the period from January 1, 2008 to June 13, 2008 consisted of $1.4 million of scheduled debt principal payments, $3.2 million of share repurchases and $46.6 million of dividend payments offset by $32.0 million of net draws under our credit facility.

 

Our cash provided by financing activities for the period from January 1, 2007 to June 15, 2007, primarily consists of $317.6 million of net proceeds from sale of our common stock and $61.5 million in draws under our credit facility.  The cash provided by financing activities for the period from January 1, 2007 to June 15, 2007 was offset by the $35.0 million in repayments of the credit facility, $1.7 million of scheduled debt principal payments, $1.1 million payment of financing costs and $36.7 million of dividend payments.

 

The following table summarizes our significant financing activities through July 22, 2008:

 

Transaction Date

 

Description of Transaction

 

Amount

 

Debt:

 

 

 

 

 

January

 

Draw under credit facility

 

$

8.0 million

 

February

 

Draw under credit facility

 

3.0 million

 

March

 

Draws under credit facility

 

23.0 million

 

April

 

Draws under credit facility

 

5.0 million

 

May

 

Repayments of credit facility

 

(15.0 million

)

June

 

Draws under credit facility

 

32.0 million

 

July

 

Draw under credit facility

 

18.0 million

 

July

 

Repayment of credit facility

 

(8.0 million

)

 

 

 

 

 

 

Equity:

 

 

 

 

 

January

 

Payment of fourth quarter 2007 dividends

 

(22.8 million

)

April

 

Payment of first quarter 2008 dividends

 

(23.8 million

)

June

 

Payment of second quarter 2008 dividends

 

(23.8 million

)

June

 

Share repurchases

 

(14.1 million

)

July

 

Share repurchases

 

(16.3 million

)

 

Dividend Policy

 

Generally, we intend to continue to distribute to our stockholders each year on a regular quarterly basis sufficient amounts of our REIT taxable income so as to avoid paying corporate income tax and excise tax on our earnings (other than the earnings of our TRS and TRS lessees, which are all subject to tax at regular corporate rates) and to qualify for the tax benefits afforded to REITs under the Internal Revenue Code of 1986, as amended (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, plus

 

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·                     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.

 

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

 

Payment Date

 

Record Date

 

Dividend per
Share

 

January 10, 2008

 

December 31, 2007

 

$

0.24

 

April 1, 2008

 

March 21, 2008

 

$

0.25

 

June 24, 2008

 

June 13, 2008

 

$

0.25

 

 

Capital Expenditures

 

The management 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 and fixtures at our hotels. Contributions to the property improvement fund are calculated as a percentage of hotel sales. 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 agreement. As of June 13, 2008, we have set aside $32.2 million for capital projects in property improvement funds. Funds held in property improvement funds for one hotel are typically not permitted to be applied to any other property.

 

We have and continue to make significant capital investments in our hotels.  In 2008, we expect to incur approximately $70 to $80 million of capital improvements at our hotels.  We incurred $36.8 million of capital projects in the period from January 1, 2008 to June 13, 2008.  The most significant projects are as follows:

 

·                     Chicago Marriott Downtown:  We completed a $35 million renovation of the hotel in April 2008.  The renovation, which began in the third quarter of 2007, included a complete redo of all the meeting and ballrooms, adding 17,000 square feet of new meeting space, reconcepting and relocating the restaurant, expanding the lobby bar and creating a Marriott “great room” in the lobby.

 

·                     Westin Boston Waterfront: We have completed the construction of additional meeting rooms in the building attached to the hotel in March 2008.  The $19 million project, which began in the third quarter of 2007, included the creation of over 37,000 square feet to meeting/exhibit space.

 

·                     Conrad Chicago:  We completed a renovation of the guestrooms and corridors during the first quarter and plans to upgrade the arrival experience with a front entrance repositioning to be completed in the fourth quarter of 2008.

 

·                     Salt Lake City:  We plan to significantly renovate the guestrooms at the hotel in late 2008.

 

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 two non-GAAP financial measures that we believe are useful to investors as key measures of our operating performance: (1) EBITDA and (2) FFO. These measures should not be considered in isolation or as a substitute for measures of performance in accordance with GAAP.

 

EBITDA represents net income excluding: (1) interest expense; (2) provision for income taxes, including income taxes applicable to sale of assets; and (3) depreciation and amortization. We believe EBITDA is useful to an investor in evaluating our operating performance because it helps 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) from our operating results. In addition, covenants included in our indebtedness use EBITDA

 

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

 

 

 

Fiscal Quarter
Ended
June 13, 2008

 

Fiscal Quarter
Ended
June 15, 2007

 

Period from
January 1, 2008
to June 13, 2008

 

Period from
January 1, 2007
to June 15, 2007

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$