Independent Auditors’ Report

Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010

Statements of Operations for the three months ended March 31, 2011 and 2010 (unaudited) and year ended December 31, 2010

Statements of Changes in Equity for the three months ended March 31, 2011 (unaudited) and year ended December 31, 2010

Statements of Cash Flows for the three months ended March 31, 2011 and 2010 (unaudited) and year ended December 31, 2010

Notes to Financial Statements

Unaudited Pro Forma Financial Information

Unaudited Pro Forma Consolidated Balance Sheet as of June 17, 2011

Notes to Unaudited Pro Forma Consolidated Balance Sheet as of June 17, 2011

Unaudited Pro Forma Consolidated Statement of Operations for the Period from January 1, 2011 to June 17, 2011

Notes to Unaudited Pro Forma Consolidated Statement of Operations for the Period from January 1, 2011 to June 17, 2011

Unaudited Pro Forma Consolidated Statement of Operations for the Year Ended December 31, 2010

Notes to Unaudited Pro Forma Consolidated Statement of Operations for the Year Ended December 31, 2010

 

Consent of KPMG LLP.

Investment in Hotel, net of accumulated depreciation of $40,811,987 (unaudited) and $39,355,051, respectively

Cash and cash equivalents

Restricted cash

Accounts receivable

Prepaid expenses and other assets

Deferred expenses, net of accumulated amortization of $190,371 (unaudited) and $185,130, respectively

 

Total assets

 

Debt

Accounts payable and other liabilities

Accrued interest

Accrued payroll and benefits

Accrued management and incentive fees

Deposits

 

Total liabilities

Equity

 

Total liabilities and equity

 

Revenues:

Room

Food and beverage

Other

 

Total revenues

 

Expenses:

Rooms

Food and beverage

Other property and operating

Management and incentive fees

Interest

Depreciation

 

Total expenses

 

Income (loss) before income taxes

Income tax expense

 

Net income (loss)

 

Equity at January 1, 2010

Distributions

Contributions

Net income

 

Equity at December 31, 2010

Distributions (unaudited)

Net loss (unaudited)

 

Equity at March 31, 2011 (unaudited)

 

Cash flows from operating activities:

Net income (loss)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

Amortization

Depreciation

Loss on interest rate protection agreements

Loss on sale of assets

Changes in assets and liabilities:

Restricted cash

Accounts receivable

Prepaid expenses and other assets

Accounts payable and other liabilities

Accrued interest

Accrued payroll and benefits

Accrued management and incentive fees

Deposits

 

Net cash provided by operating activities

 

Cash flows from investing activities:

Change in restricted cash

Hotel improvements

 

Net cash provided by (used in) investing activities

 

Cash flows from financing activities:

Distributions

Contributions

Payment of loan costs

Payment of interest rate protection agreements

 

Net cash used in financing activities

 

Net increase (decrease) in cash and cash equivalents

Cash and cash equivalents at beginning of period

 

Cash and cash equivalents at end of period

 

Supplemental disclosure of cash flow information:

Cash paid for interest

Cash paid for unincorporated business tax

Supplemental disclosure of noncash investing activities:

Retirement of fully depreciated furniture, fixtures and equipment

The Radisson Lexington Hotel (the Hotel) is a full service 712-room hotel located at 511 Lexington Avenue, New York, New York. The Hotel includes guest rooms, meeting facilities, conference rooms, restaurants, a fitness center and retail facilities.

These financial statements present the carve-out balance sheets, statements of operations and cash flows of the Hotel, not of an existing legal entity. The accompanying financials statements are presented in accordance with U.S. generally accepted accounting principles (U.S. GAAP).

The accompanying unaudited financial statements of the Hotel as of March 31, 2011 and for the three-month periods ended March 31, 2011 and 2010, have been prepared pursuant to the Securities and Exchange Commission (SEC) rules and regulations. All amounts included in the notes to the financial statements referring to March 31, 2011, and for the three-month periods ended March 31, 2011 and 2010 are unaudited. The accompanying financial statements reflect, in the opinion of management, all adjustments considered necessary for a fair presentation of the interim financial statements. All adjustments are of a normal and recurring nature.

The Hotel is stated at cost and is depreciated using the straight-line method over its estimated useful life of 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method over an estimated useful life of 5 years.

Whenever events or changes in circumstances indicate that the carrying value of the hotel may not be recoverable, management reviews the carrying value of the Hotel to determine if the carrying value cannot be recovered based on estimated future undiscounted cash flows, without interest charges. If management determines that the carrying value cannot be recovered based on estimated future undiscounted cash flows, without interest charges, over the shorter of the Hotel’s estimated useful life or the expected holding period, an impairment loss would be recorded based on the estimated fair value of the Hotel. No impairment loss with respect to the carrying value of the Hotel has been recorded in 2010 or the three-month period ended March 31, 2011.

Maintenance and repairs are charged to operations as incurred. Major renewals and betterments with a useful life greater than one year are capitalized. Upon the sale or disposition of a fixed asset, the asset and related accumulated depreciation are removed from the accounts, and the related gain or loss is included in operations.

The Hotel capitalizes interest and certain other costs, such as property taxes, property insurance and employee costs related to major renovations and redevelopments. The Hotel ceases capitalizing these costs when construction is substantially complete. No such costs were capitalized in 2010 or in the three-month period ended March 31, 2011.

All highly liquid investments with original maturities of three months or less when purchased are considered to be cash equivalents.

Restricted cash consists of escrow accounts for taxes, insurance and capital expenditures, as required by the mortgage loan agreement. Also included in this total are cash receipts funded into a lender controlled lockbox for the payment of operating costs of the Hotel as discussed in Note 6.

Accounts receivable consist of amounts due from guests or groups for rooms and services provided by the Hotel. Also included in accounts receivable is $901,707 of deferred rent receivable related to retail leases. The Hotel maintains an allowance for doubtful accounts for estimated losses on uncollectible accounts receivable, if necessary. At December 31, 2010, and March 31, 2011, there were no allowances provided as all accounts are expected to be fully collectible.

Deferred expenses consist primarily of leasing commissions. Leasing commissions are amortized over the term of the related lease. Amortization of leasing commissions is included in other property and operating expense in the accompanying consolidated financial statements.

Deposits consist of advance deposits and security deposits. Advance deposits are deposits received from guests to reserve rooms and services in advance and are recorded as revenue as the related rooms are utilized or services rendered. Security deposits are deposits received from retail tenants leasing space within the Hotel.

Room revenues and food and beverage revenues are recognized as earned when rooms are occupied and as services are performed. Rental income on retail space is recognized on a straight-line basis over the term of each respective lease. Other income is recognized as earned and consists primarily of telephone, internet, movies, cancellation fees, interest income and other miscellaneous fees and services.

The costs of advertising, promotional, sales and marketing programs are charged to operations in the year incurred and are included in other property and operating expenses in the accompanying consolidated statement of operations.

The preparation of financial statements in conformity with 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 recognized during the reporting period. Actual results could differ from those estimates.

The Hotel maintains cash and cash equivalents and restricted cash in accounts with various financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation. The Hotel’s management does not believe there is a significant credit risk associated with deposits in excess of federally insured amounts.

During all periods presented, the owner of the Hotel was a limited liability company which is taxed for federal and state income tax purposes as a partnership and, accordingly, all taxable income or loss flows through to the Members in their individual tax returns. In addition, the Hotel is subject to New York City unincorporated business tax, which is approximately 4% of taxable income.

In accordance with the authoritative guidance on accounting for and disclosure of uncertainty in tax positions, the Hotel determines whether a tax position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For tax positions meeting the more likely than not threshold, the tax amount recognized in the financial statements is reduced by the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement with the relevant taxing authority. The Hotel has determined that there was no effect on the consolidated financial statements from the adoption of the authoritative guidance and the Hotel does not expect that the total amount of unrecognized tax benefits will materially change over the next twelve months. Additionally, no interest or penalty related to uncertain taxes has been recognized in the accompanying consolidated financial statements.

No amounts have been accrued for uncertain positions as of December 31, 2010. However, management’s conclusions regarding uncertain tax positions may be subject to review and adjustment at a later date based on ongoing analyses of tax laws, regulations and interpretations thereof and other factors.

The owner of the Hotel files tax returns as prescribed by the tax laws of the jurisdictions in which the Hotel operates. In the normal course of business, the owner of the Hotel is subject to examination by the United States Internal Revenue Service, and the other state and local jurisdictions in which it operates. As of December 31, 2010, the tax years of the limited liability company that remain subject to examination by the major tax jurisdictions under the statute of limitations is from the year 2007 forward.

Investment in Hotel at December 31, 2010 consists of the following:

Land

Building and improvements

Furniture, fixtures and equipment

 

 

Accumulated depreciation

 

 

 

The franchise agreement requires the Hotel to pay royalty, reservation and marketing fees and terminates in January 2020. Royalty fees are 2.75% of gross room sales. Franchise fees are 1.0% of gross room sales. Reservation fees are 1.0% of gross room sales. For the year ended December 31, 2010, royalty fees and franchise fees were $1,801,579 and marketing fees were $608,513 and are included in other property and operating expenses on the statement of operations. Reservation fees were $737,436 for the year ended December 31, 2010 and are included in rooms expense on the statement of operations.

For the three-month periods ended March 31, 2011 and 2010, royalty fees and franchise fees were $303,770 and $341,317, respectively, marketing fees were $123,781 and $81,304, respectively, and are included in other property and operating expenses on the statement of operations. Reservation fees were $147,214 and $156,421, respectively, for the three-month periods ended March 31, 2011 and 2010 and are included in rooms expense on the statement of operations.

The Hotel’s debt consists of a senior loan of $100,000,000 due on October 9, 2011. The loan bears interest at LIBOR plus 0.478% and requires interest-only payments through maturity, when the entire balance is due. The senior loan is collateralized by the Hotel.

The Hotel is subject to provisions of its loan which permit the lender to receive all cash receipts generated by the Hotel and control the release of cash to the Company for the payment of expenses and custodial cash owed to taxing authorities and others. The Hotel became subject to the provisions in 2009 when the Net Cash Flows, as defined in the loan agreement, fell below the stated threshold. As of December 31, 2010, $16,713,936 of restricted cash is controlled by the lender subject to these provisions. As of March 31, 2011, $14,939,366 of restricted cash is controlled by the lender subject to these provisions.

On June 1, 2011, in connection with the sale of the Hotel, the loan was paid in full and the Hotel is no longer subject to the provisions of the loan.

The carrying values of the Hotel’s cash and cash equivalents, restricted cash, accounts receivable, prepaid expenses, accounts payable, and accrued expenses approximated fair value based on the short-term nature of the balances converting to cash. The Hotel estimated the fair value of its long-term debt by discounting the future cash flows at estimated market rates. The Hotel has estimated that the fair value of its long-term debt is approximately $96.8 million as of December 31, 2010. However, this estimate is affected by and is subject to significant variability based on market rates and availability of such debt.

The Hotel leases space to certain merchants. These leases are accounted for as operating leases and have scheduled rent increases throughout the lease terms. The terms of the leases typically range from 10 to 20 years. Rental income earned from these leases for the year ended December 31, 2010 and for the three-month periods ended March 31, 2011 and 2010 were $1,619,072, $386,524 and $411,934, respectively. At December 31, 2010, the future minimum lease payments to be received by the Hotel on the operating leases were:

2011

2012

2013

2014

2015

Thereafter

 

 

 

The Hotel is managed by an entity related to the Members of its owner. The hotel management agreement provides for a base management fee equal to 3% of gross receipts, as defined by the agreement. The base fee is payable monthly. The agreement also provides for an incentive fee of 1% of the gross receipts from the Hotel when certain returns are achieved. The agreement expires in June 2014 with one extension of five years. Management fees of $1,496,146 and incentive fees of $498,715 were incurred during the year ended December 31, 2010 of which $643,664 was accrued as of December 31, 2010. Management fees of $263,859 and incentive fees of $87,953 were incurred during the three-month period ended March 31, 2011 of which $195,235 was accrued as of March 31, 2011. Management fees of $259,788 and incentive fees of $86,596 were incurred during the three month period ended March 31, 2010.

A development management fee is to be paid monthly at a rate of 4% of capital improvements made to the Hotel, as defined by the agreement. There were no development management fees incurred and capitalized during the year ended December 31, 2010 or the three-month periods ended March 31, 2011 and 2010.

The Hotel is subject to environmental regulations related to the ownership, management, development and acquisition of real estate. The cost of complying with the environmental regulations was not material to the Hotel’s operations for the year ended December 31, 2010 or the three-month periods ended March 31, 2011 and 2010. The Hotel is not aware of any environmental condition which is likely to have a material adverse effect on the Hotel’s financial position.

From time to time, the Hotel has been and may in the future be involved as a party in various legal proceedings, both as plaintiff and defendant. Management regularly analyzes current information and, as necessary, provides accruals for claims for which an unfavorable outcome is probable and the amount can be estimated. As of the date of the financial statements, there were no threatened or pending legal matters of which management was aware which in the event of an unfavorable outcome would, in the opinion of management and legal counsel, have a material impact on the Hotel’s results of operations, financial position or cash flows.

In June 2008, the Internal Revenue Service (IRS) notified the owner of the Hotel that they were examining the tax return of the entity (the Seller) that originally sold the Hotel property to the owner. The IRS further informed the owner of the Hotel that it may seek to assess the owner of the Hotel transferee liability for part or all of the Seller’s potential tax liability pursuant to Section 6901 of the Internal Revenue Code of 1986, as amended. The IRS has subsequently communicated to the owner of the Hotel that it was no longer pursuing the Hotel for transferee liability. The IRS is now considering whether the owner of the Hotel has a Foreign Investment in Real Property Tax Act (FIRPTA) withholding liability as it relates to their original purchase of the property.

Management believes that any IRS assertion of FIRPTA withholding liability is unlikely to succeed and would be subject to significant defenses and management intends to vigorously defend its position. A successful claim by the IRS would likely have a material impact to the owner of the Hotel. Management believes that the potential liability is estimated at $20 million to $30 million. The audit on this issue continues to be in its initial stage, no claim for adjustment has been proposed by the IRS, and the IRS has not provided the owner of the Hotel with the legal or factual basis of any potential claim.

The Company has performed an evaluation of subsequent events through August 4, 2011 (which is the date the financial statements were available to be issued), and the results of this evaluation are appropriately reflected in these consolidated financial statements.

On June 1, 2011, the Hotel was acquired by DiamondRock Hospitality Company for a contractual purchase price of $335 million.

The Company’s acquisitions of the Hilton Minneapolis, Renaissance Charleston Historic District Hotel, Hilton Garden Inn Chelsea/New York City, JW Marriott Denver at Cherry Creek, Radisson Lexington Hotel New York, and Courtyard Denver Downtown;

The assumption of $42.4 million of mortgage debt in conjunction with the acquisition of the JW Marriott Denver at Cherry Creek and $27.2 million of mortgage debt in conjunction with the acquisition of the Courtyard Denver Downtown;

The Company’s borrowings under the $100 million mortgage secured by the Hilton Minneapolis;

The amendment to the Company’s $200 million corporate credit facility, as well as the $115 million draw in conjunction with the acquisition of the Radisson Lexington Hotel New York and the $15 million draw in conjunction with the acquisition of the Courtyard Denver Downtown; and

The Company’s follow-on public offering of 12,418,662 shares of common stock at $12.07 per share, with approximately $149.7 million of net proceeds to the Company.

 

Property and equipment, net

 

Deferred financing costs, net

Restricted cash

Due from hotel managers

Note receivable

Favorable lease assets, net

Prepaids and other assets

Cash and cash equivalents

 

 

 

 

 

 

Mortgage debt

Senior unsecured credit facility

 

 

Total debt

 

 

Deferred income related to key money, net

Unfavorable contract liabilities, net

Due to hotel managers

Dividends declared and unpaid

Accounts payable and accrued liabilities

 

 

 

 

Common stock

Additional paid-in capital

Accumulated deficit

 

 

 

 

 

The acquisition of the Courtyard Denver Downtown for approximately $46.3 million;

Reflects the adjustment to record the acquisition of the Courtyard Denver Downtown as follows:

Purchase of property and equipment at a fair value of $46.3 million

Assumption of mortgage debt with a principal amount of $27.2 million and a fair value of $27.5 million, resulting in a debt premium of $0.3 million

Borrowings of $15.0 million on the Company’s corporate credit facility.

Payment of loan assumption fee of $0.1 million, accounted for as deferred financing costs

Assumption of the hotel’s net working capital liability of $0.1 million.

 

Rooms

Food and beverage

Other

 

 

 

 

Rooms

Food and beverage

Management fees

Other hotel expenses

Depreciation and amortization

Hotel acquisition costs

Corporate expenses

 

 

 

 

 

 

Interest income

Interest expense

 

 

 

 

Income tax (benefit) expense

 

 

 

 

 

 

 

 

The acquisition of the JW Marriott Denver at Cherry Creek for approximately $74.2 million;

The acquisition of the Radisson Lexington Hotel New York for approximately $336.8 million;

The acquisition of the Courtyard Denver Downtown for approximately $46.3 million;

Interest on the $42.4 million of mortgage debt assumed in conjunction with the acquisition of the JW Marriott Denver at Cherry Creek and the $27.2 million of mortgage debt assumed in conjunction with the acquisition of the Courtyard Denver Downtown;

Interest on the fixed-rate $100 million mortgage secured by the Hilton Minneapolis;

Interest on the $130 million draw on the Company’s corporate credit facility in conjunction with the acquisitions of the Radisson Lexington Hotel New York and Courtyard Denver Downtown; and

The offering of 12,418,662 shares of the Company’s common stock at $12.07 per share with approximately $149.7 million of net proceeds to the Company.

Reflects the adjustment to record the historical unaudited revenues and operating expenses of the JW Marriott Denver at Cherry Creek, Radisson Lexington Hotel New York and Courtyard Denver Downtown.

Reflects the adjustment to record the depreciation and amortization resulting from the acquisitions of the JW Marriott Denver at Cherry Creek, Radisson Lexington Hotel New York and Courtyard Denver Downtown, as follows (in thousands):

JW Marriott Denver at Cherry Creek

Radisson Lexington Hotel New York

Courtyard Denver Downtown

 

 

Total

 

Reflects the adjustment to record the pro forma income tax provision of the Company’s taxable REIT subsidiary (TRS) assuming the TRS leases were in place on January 1, 2010. The pro forma income tax provision was calculated using the TRS’ estimated effective income tax rate of 40%.

Reflects the adjustment to include interest expense incurred for the mortgage debt relating to the Hilton Minneapolis, JW Marriott Denver at Cherry Creek and Courtyard Denver Downtown and the $130 million draw on the Company’s corporate credit facility. The adjustment also reflects the amendment to the Company’s corporate credit facility, which reduced the unused fee. The interest expense includes the amortization of deferred financing costs and the debt premium related to the assumption of the mortgage debt related to the JW Marriott Denver at Cherry Creek and Courtyard Denver Downtown. The adjustment to interest expense is comprised of the following (in thousands):

Interest on new mortgage debt

Interest on assumed mortgage debt

Interest on credit facility borrowings

Amortization of deferred financing costs on credit facility amendment

Interest on environmental remediation liability

 

 

Total

 

Reflects the adjustment to weighted average shares to assume the Company’s follow-on public offering of 12,418,662 shares of common stock occurred on January 1, 2010.

 

 

Rooms

Food and beverage

Other

 

 

 

 

Rooms

Food and beverage

Management fees

Other hotel expenses

Depreciation and amortization

Hotel acquisition costs

Corporate expenses

 

 

 

 

 

 

Interest income

Interest expense

 

 

 

 

Income tax expense