DRH_10Q_Sep 7 2012

Table of Contents


 

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

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 7, 2012
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.)
 
 
 
3 Bethesda Metro Center, Suite 1500, Bethesda, Maryland
 
20814
(Address of Principal Executive Offices)
 
(Zip Code)
(240) 744-1150
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
The registrant had 195,145,707 shares of its $0.01 par value common stock outstanding as of October 15, 2012.
 



Table of Contents
INDEX
 
 
 
Page No.
 
 
 
 
 
 
 
Condensed Consolidated Statements of Operations for the Fiscal Quarters ended September 7, 2012 and September 9, 2011 and the Periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011
 
 
Condensed Consolidated Statements of Cash Flows for the Periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1



Table of Contents


PART I. FINANCIAL INFORMATION
Item I.
Financial Statements

DIAMONDROCK HOSPITALITY COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 7, 2012 and December 31, 2011
(in thousands, except share and per share amounts)
 
September 7, 2012
 
December 31, 2011
 
(Unaudited)
 
 
ASSETS
 
 
 
Property and equipment, at cost
$
3,089,494

 
$
2,667,682

Less: accumulated depreciation
(482,641
)
 
(433,178
)
 
2,606,853

 
2,234,504

Assets held for sale
41,819

 
263,399

Deferred financing costs, net
8,261

 
5,869

Restricted cash
60,263

 
53,871

Due from hotel managers
70,569

 
50,728

Note receivable
54,237

 
54,788

Favorable lease assets, net
40,746

 
43,285

Prepaid and other assets
68,890

 
65,900

Cash and cash equivalents
21,604

 
26,291

Total assets
$
2,973,242

 
$
2,798,635

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Mortgage debt
$
898,471

 
$
762,933

Mortgage debt of assets held for sale

 
180,000

Senior unsecured credit facility
120,000

 
100,000

Total debt
1,018,471

 
1,042,933

 
 
 
 
Deferred income related to key money, net
24,414

 
24,593

Unfavorable contract liabilities, net
80,619

 
81,914

Due to hotel managers
49,115

 
41,676

Liabilities of assets held for sale
1,735

 
3,805

Dividends declared and unpaid
15,871

 
13,594

Accounts payable and accrued expenses
81,615

 
87,963

Total other liabilities
253,369

 
253,545

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

 

Common stock, $0.01 par value; 400,000,000 shares authorized; 195,141,934 and 167,502,359 shares issued and outstanding at September 7, 2012 and December 31, 2011, respectively
1,951

 
1,675

Additional paid-in capital
1,983,404

 
1,708,427

Accumulated deficit
(283,953
)
 
(207,945
)
Total stockholders’ equity
1,701,402

 
1,502,157

Total liabilities and stockholders’ equity
$
2,973,242

 
$
2,798,635

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

-1-


Table of Contents


DIAMONDROCK HOSPITALITY COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Fiscal Quarters Ended September 7, 2012 and September 9, 2011 and
the Periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011
(in thousands, except per share amounts)
 
Fiscal Quarter Ended
 
Period From
 
 
 
 
 
January 1, 2012 to September 7, 2012
 
January 1, 2011 to September 9, 2011
 
September 7, 2012
 
September 9, 2011
 
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
Revenues:
 
 
 
 
 
 
 
Rooms
$
132,578

 
$
111,984

 
$
338,043

 
$
278,215

Food and beverage
40,791

 
36,676

 
117,415

 
105,379

Other
10,504

 
8,177

 
27,787

 
20,442

Total revenues
183,873

 
156,837

 
483,245

 
404,036

Operating Expenses:
 
 
 
 
 
 
 
Rooms
35,428

 
30,141

 
92,386

 
75,043

Food and beverage
30,008

 
26,170

 
85,731

 
76,177

Management fees
5,744

 
4,551

 
15,313

 
13,488

Other hotel expenses
64,098

 
55,772

 
171,131

 
145,887

Depreciation and amortization
22,612

 
20,577

 
62,802

 
57,170

Impairment losses
30,376

 

 
30,844

 

Hotel acquisition costs
8,314

 
445

 
10,345

 
2,604

Corporate expenses
6,227

 
6,453

 
15,711

 
14,900

Total operating expenses
202,807

 
144,109

 
484,263

 
385,269

Operating (loss) profit
(18,934
)
 
12,728

 
(1,018
)
 
18,767

Other Expenses (Income):
 
 
 
 
 
 
 
Interest income
(60
)
 
(24
)
 
(278
)
 
(579
)
Interest expense
12,732

 
11,281

 
36,710

 
30,114

Gain on early extinguishment of debt

 

 
(144
)
 

Total other expenses
12,672

 
11,257

 
36,288

 
29,535

(Loss) income from continuing operations before income taxes
(31,606
)
 
1,471

 
(37,306
)
 
(10,768
)
Income tax benefit (expense)
916

 
(2,239
)
 
4,992

 
(1,646
)
Loss from continuing operations
(30,690
)
 
(768
)
 
(32,314
)
 
(12,414
)
Loss from discontinued operations, net of income taxes
(14,089
)
 
(247
)
 
(905
)
 
(199
)
Net loss
$
(44,779
)
 
$
(1,015
)
 
$
(33,219
)
 
$
(12,613
)
Loss per share:
 
 
 
 
 
 
 
Continuing operations
$
(0.16
)
 
$
(0.01
)
 
$
(0.19
)
 
$
(0.08
)
Discontinued operations
(0.08
)
 
(0.00
)
 
(0.00
)
 
(0.00
)
Basic and diluted loss per share
$
(0.24
)
 
$
(0.01
)
 
$
(0.19
)
 
$
(0.08
)

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

-2-


Table of Contents


DIAMONDROCK HOSPITALITY COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011
(in thousands)
 
Period From
 
January 1, 2012 to September 7, 2012
 
January 1, 2011 to September 9, 2011
 
 
 
(Unaudited)
 
(Unaudited)
Cash flows from operating activities:
 
 
 
Net loss
$
(33,219
)
 
$
(12,613
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Real estate depreciation
64,149

 
66,835

Corporate asset depreciation as corporate expenses
66

 
59

Gain on sale of hotel properties
(9,541
)
 

Gain on early extinguishment of debt
(144
)
 

Non-cash ground rent
4,621

 
4,878

Non-cash financing costs, debt premium and interest rate cap as interest
2,529

 
1,068

Impairment losses
45,534

 

Amortization of unfavorable contract liabilities
(1,296
)
 
(1,284
)
Amortization of deferred income
(658
)
 
(414
)
Stock-based compensation
3,230

 
3,339

Payment of Los Angeles Airport Marriott litigation settlement
(1,709
)
 

Changes in assets and liabilities:
 
 
 
Prepaid expenses and other assets
(1,261
)
 
(1,371
)
Restricted cash
(1,532
)
 
(5,225
)
Due to/from hotel managers
(15,281
)
 
(7,438
)
Accounts payable and accrued expenses
(10,822
)
 
(4,564
)
Net cash provided by operating activities
44,666

 
43,270

Cash flows from investing activities:
 
 
 
Hotel capital expenditures
(26,354
)
 
(35,403
)
Hotel acquisitions
(415,188
)
 
(385,472
)
Net proceeds from sale of properties
92,120

 

Cash received from mortgage loan
551

 
1,704

Change in restricted cash
(6,193
)
 
(3,164
)
Purchase deposits
(1,898
)
 
(20,000
)
Receipt of deferred key money
479

 
3,430

Net cash used in investing activities
(356,483
)
 
(438,905
)
Cash flows from financing activities:
 
 
 
Scheduled mortgage debt principal payments
(7,441
)
 
(6,217
)
Repurchase of common stock
(2,946
)
 
(3,849
)
Proceeds from sale of common stock, net
199,831

 
149,674

Proceeds from mortgage debt
170,368

 
100,000

Prepayment of mortgage debt
(26,963
)
 

Draws on senior unsecured credit facility
175,000

 
130,000

Repayments of senior unsecured credit facility
(155,000
)
 

Payment of financing costs
(4,412
)
 
(2,457
)
Purchase of interest rate cap
(934
)
 

Payment of cash dividends
(40,373
)
 
(26,940
)
Net cash provided by financing activities
307,130

 
340,211

Net decrease in cash and cash equivalents
(4,687
)
 
(55,424
)
Cash and cash equivalents, beginning of period
26,291

 
84,201

Cash and cash equivalents, end of period
$
21,604

 
$
28,777


-3-


Table of Contents


 
 
 
 
Supplemental Disclosure of Cash Flow Information:
 
 
 
Cash paid for interest
$
38,236

 
$
39,436

Cash paid for income taxes
$
1,192

 
$
629

Capitalized interest
$
802

 
$
1,036

Non-cash Financing Activities:
 
 
 
Assumption of mortgage debt
$

 
$
71,421

Unpaid dividends
$
15,871

 
$
13,569

Buyer assumption of mortgage debt on sale of hotels
$
180,000

 
$

Issuance of common stock in connection with acquisition of hotel portfolio
$
75,000

 
$

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


-4-


Table of Contents


DIAMONDROCK HOSPITALITY COMPANY

Notes to the Condensed Consolidated Financial Statements
(Unaudited)

1.
Organization

DiamondRock Hospitality Company (the “Company” or “we”) is a lodging-focused real estate company that currently owns a portfolio of 26 premium hotels and resorts. We also hold the senior note on a mortgage loan secured by an additional hotel and have the right to acquire, upon completion, a hotel under development. Our hotels are concentrated in key gateway cities and in destination resort locations and most are operated under a brand owned by one of the leading global lodging brand companies (Marriott International, Inc. (“Marriott”), Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”), or Hilton Worldwide (“Hilton”)). We are an owner, as opposed to an operator, of the hotels in our portfolio. As an owner, we receive all of the operating profits or losses generated by our hotels after we pay fees to the hotel managers, which are based on the revenues and profitability of the hotels.

As of September 7, 2012, we owned 27 hotels with 11,868 guest rooms, located in the following markets: Atlanta, Georgia (2); Boston, Massachusetts (2); Burlington, Vermont; Charleston, South Carolina; Chicago, Illinois (2); Denver, Colorado (2); Fort Worth, Texas; Los Angeles, California (2); Minneapolis, Minnesota; New York, New York (4); Oak Brook, Illinois; Orlando, Florida; Salt Lake City, Utah; San Diego, California; Sonoma, California; Washington D.C. (2); St. Thomas, U.S. Virgin Islands; and Vail, Colorado. We also own a senior mortgage loan secured by a 443-room hotel located in Chicago, Illinois. On October 3, 2012, we sold the 372-room Atlanta Westin North at Perimeter.

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

2.
Summary of Significant Accounting Policies

Basis of Presentation

We have condensed or omitted certain information and footnote disclosures normally included in financial statements presented in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, in the accompanying unaudited condensed consolidated financial statements. We believe the disclosures made are adequate to prevent the information presented from being misleading. However, the unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2011, included in our Annual Report on Form 10-K filed on February 29, 2012.

In our opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments necessary to present fairly our financial position as of September 7, 2012, the results of our operations for our fiscal quarters ended September 7, 2012 and September 9, 2011 and the periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011, and our cash flows for the periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011. Interim results are not necessarily indicative of full-year performance because of the impact of seasonal and short-term variations.

Our financial statements include all of the accounts of the Company and its subsidiaries in accordance with U.S. GAAP. All intercompany accounts and transactions have been eliminated in consolidation. If the Company determines that it has an interest in a variable interest entity within the meaning of the FASB ASC 810, Consolidation, the Company will consolidate the entity when it is determined to be the primary beneficiary of the entity.

Reporting Periods

The results we report in our condensed consolidated statements of operations are based on results of our hotels reported to us by our hotel managers. Our hotel managers use different reporting periods. Marriott, the manager of 14 of our hotels, uses a fiscal year ending on the Friday closest to December 31 and reports 12 weeks of operations for each of the first three quarters and 16 or 17 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, Davidson Hotels & Resorts, manager of the Atlanta Westin North at Perimeter, Hilton Hotels Corporation, manager of the Conrad Chicago and Hilton Minneapolis, Westin Hotel

-5-


Table of Contents


Management, L.P., manager of the Westin Boston Waterfront Hotel, Alliance Hospitality Management, manager of the Hilton Garden Inn Chelsea/New York City, Sage Hospitality, manager of the JW Marriott Denver at Cherry Creek and the Courtyard Denver Downtown, Highgate Hotels, manager of the Lexington Hotel New York, WHM LLC, manager of the Hilton Boston Downtown, and Interstate Hotels & Resorts, manager of the Westin Washington, D.C. City Center, Westin San Diego, and Hilton Burlington report results on a monthly basis. Additionally, as a REIT, we are required by U.S. federal tax laws to report results on a calendar year basis. As a result, we have adopted the reporting periods used by Marriott for its domestic hotels, except that our fiscal year always ends on December 31 to comply with REIT rules. Our first three fiscal quarters end on the same day as Marriott’s fiscal quarters but our 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 we have 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 we adopted is more closely aligned with the reporting calendar used by the manager of 14 of our hotels, one final consequence of the calendar is that we are unable to report any results for Frenchman’s Reef, Vail Marriott, Atlanta Westin North at Perimeter, Conrad Chicago, Westin Boston Waterfront Hotel, Hilton Minneapolis, Hilton Garden Inn Chelsea/New York City, JW Marriott Denver at Cherry Creek, Courtyard Denver Downtown, Lexington Hotel New York, Hilton Boston Downtown, Westin Washington, D.C. City Center, Westin San Diego, or Hilton Burlington for the month of operations that ends after our fiscal quarter-end because none of Westin Hotel Management, L.P., Hilton Hotels Corporation, Davidson Hotels & Resorts, Alliance Hospitality Management, Vail Resorts, Sage Hospitality, Highgate Hotels, WHM LLC, Interstate Hotels & Resorts, nor Marriott (with respect to Frenchman’s Reef) make mid-month results available to us. As a result, our quarterly results of operations include results from these hotels as follows: first quarter (January and 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.

Marriott recently announced preliminary plans to change its current fiscal year to a calendar year effective January 1, 2013. Marriott expects to make the fiscal year change on a prospective basis and will not adjust the prior year operating results. The change to Marriott's fiscal year will not impact the Company's full year results, which are currently reported on a calendar year. However, the preliminary change will impact the prior year comparability of each of our 2013 fiscal quarters.

Property and Equipment

Investments in hotel properties, land, land improvements, building and furniture, fixtures and equipment and identifiable intangible assets are recorded at fair value upon acquisition. Property and equipment purchased after the hotel acquisition date is recorded at cost. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation is removed from the Company’s accounts and any resulting gain or loss is included in the statements of operations.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 15 to 40 years for buildings, land improvements, and building improvements and one to ten years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets.

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

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

-6-


Table of Contents



Note Receivable

We initially record acquired notes receivable at cost. Notes receivable are evaluated for collectability and if collectability of the original amounts due is in doubt, the value is adjusted for impairment. Our impairment analysis considers the anticipated cash receipts as well as the underlying value of the collateral. If collectability is in doubt, the note is placed in non-accrual status. No interest is recorded on such notes until the timing and amounts of cash receipts can be reasonably estimated. We record cash payments received on non-accrual notes receivable as a reduction in basis. We continually assess the current facts and circumstances to determine whether we can reasonably estimate cash flows. If we can reasonably estimate the timing and amount of cash flows to be collected, then income recognition becomes possible.

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 (Loss) Per Share

Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) 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.

Comprehensive Income (Loss)

We do not have any items of comprehensive income (loss) other than net income (loss). If we do incur any additional items of comprehensive income (loss), such that a statement of comprehensive income would be necessary, such statement will be reported as one statement with the consolidated statement of operations.

Stock-based Compensation

We account for stock-based employee compensation using the fair value based method of accounting. We record the cost of awards with service or market conditions based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render the requisite service.

Income Taxes

We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted.

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

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

We had no accruals for tax uncertainties as of September 7, 2012 and December 31, 2011.


-7-


Table of Contents


Fair Value Measurements

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

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

Intangible Assets and Liabilities

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

Straight-Line Rental Income and Expense

We record rental income and 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.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of our note receivable and cash and cash equivalents. We perform periodic evaluations of the underlying hotel property securing the note receivable. While the note receivable is currently in default, the estimated fair value of the underlying hotel exceeds our carrying value of the note. See further discussion in Note 6. We maintain cash and cash equivalents with various financial institutions. We perform periodic evaluations of the relative credit standing of these financial institutions and limit the amount of credit exposure with any one institution.

Use of Estimates

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

Risks and Uncertainties

The state of the overall economy can significantly impact hotel operational performance and thus, impact our financial position. Should any of our hotels experience a significant decline in operational performance, it may affect our ability to make distributions to our stockholders and service debt or meet other financial obligations.

3.
Property and Equipment

Property and equipment as of September 7, 2012 (unaudited) and December 31, 2011 consists of the following (in thousands):


-8-


Table of Contents


 
September 7, 2012
 
December 31, 2011
Land
$
381,002

 
$
321,892

Land improvements
7,994

 
7,994

Buildings
2,364,250

 
2,001,762

Furniture, fixtures and equipment
326,252

 
333,305

CIP and corporate office equipment
9,996

 
2,729

 
3,089,494

 
2,667,682

Less: accumulated depreciation
(482,641
)
 
(433,178
)
 
$
2,606,853

 
$
2,234,504


As of September 7, 2012, we had accrued capital expenditures of $2.7 million. As of December 31, 2011, we had accrued capital expenditures of $1.9 million.

4. Impairments

During the fiscal quarter ended September 7, 2012, we recorded an impairment loss of $30.4 million related to the Oak Brook Hills Marriott Resort. We evaluated the recoverability of the hotel's carrying value given deteriorating operating forecasts for the year ending December 31, 2012. Based on our estimated undiscounted net cash flow, we concluded that the carrying value of the hotel was not recoverable. The Company estimated the fair value of the hotel using a discounted cash flow analysis and comparable sales information. In our analysis, we estimated the future net cash flows from the hotel, the expected useful life and holding period, and capitalization and discount rates. The impairment loss includes the impairment related to the hotel's favorable ground lease asset. See Note 5 for further discussion.

We also recorded an impairment loss related to the Atlanta Westin North at Perimeter to reduce the carrying value of the hotel to the estimated net sales proceeds during the fiscal quarter ended September 7, 2012. See Note 11 for further discussion.

5. Favorable Lease Assets

In connection with the acquisition of certain hotels, we have recognized intangible assets for favorable ground leases and tenant leases. Our favorable lease assets, net of accumulated amortization, as of September 7, 2012 (unaudited) and December 31, 2011 consist of the following (in thousands):
 
September 7, 2012
 
December 31, 2011
Boston Westin Waterfront Ground Lease
$
18,792

 
$
18,941

Boston Westin Waterfront Lease Right
9,045

 
9,513

Minneapolis Hilton Ground Lease
5,933

 
5,985

Oak Brook Hills Marriott Resort Ground Lease
5,600

 
7,352

Lexington Hotel New York Tenant Leases
1,376

 
1,494

 
$
40,746

 
$
43,285


The favorable lease assets are recorded at the acquisition date and are generally amortized using the straight-line method over the remaining non-cancelable term of the lease agreement. Amortization expense for the period from January 1, 2012 to September 7, 2012 was approximately $0.7 million.

We own a favorable lease asset related to the right to acquire a leasehold interest in a parcel of land adjacent to the Westin Boston Waterfront Hotel for the development of a 320 to 350 room hotel (the “lease right”). The option expires in 2016. We do not amortize the lease right but review the asset for impairment annually or at interim periods if events or circumstances indicate that the asset may be impaired. An impairment loss of $0.5 million was recorded during the period from January 1, 2012 to September 7, 2012 due to lower comparable market rents in the City of Boston. No impairment loss was recorded during 2011.

In conjunction with our impairment analysis of the Oak Brook Hills Marriott Resort (see Note 4), we evaluated the hotel's favorable ground lease asset for recoverability of the carrying value as of September 7, 2012. We concluded that the fair value of the ground lease was $5.6 million resulting in an impairment loss of $1.4 million. The impairment of the favorable ground lease asset is included in the $30.4 million impairment loss on the condensed consolidated statements of operations. The new carrying value of the favorable ground lease asset will be amortized over the remaining non-cancelable term of the ground lease.


-9-


Table of Contents


The fair value of both the lease right and favorable ground lease asset are Level 3 measurements under the fair value hierarchy (see Note 2) and are derived from a discounted cash flow model using the favorable difference between the estimated participating rents or actual rents in accordance with the lease terms and the estimated market rents. For the lease right, the discount rate was estimated using a risk adjusted rate of return, the estimated participating rents were estimated based on a hypothetical hotel comparable to our Westin Boston Waterfront Hotel, and market rents were based on comparable long-term ground leases in the City of Boston. For the Oak Brook Hills Marriott Resort's favorable ground lease asset, the discount rate was estimated using a risk adjusted rate of return and market rents were based on comparable golf course leases across the United States.

6. Note Receivable

We own the $69.0 million senior mortgage loan secured by the 443-room Allerton Hotel in Chicago, Illinois. The Allerton loan matured in January 2010 and is currently in default. The Allerton loan accrues at an interest rate of LIBOR plus 692 basis points, which includes 5 percentage points of default interest. As of September 7, 2012, the Allerton loan had a principal balance of $69.0 million and unrecorded accrued interest (including default interest) of approximately $6.4 million. Foreclosure proceedings were initially filed in April 2010 and the borrower filed for bankruptcy in May 2011. We continue to pursue our rights in the bankruptcy proceedings, but the outcome is uncertain. See Note 14 for further discussion of the bankruptcy proceedings.

Recognition of interest income on the Allerton loan is contingent upon having a reasonable expectation about the timing and amount of cash payments expected to be collected from the borrower. Due to the uncertainty surrounding the timing and amount of cash payments expected, we placed the Allerton loan on non-accrual status. As of September 7, 2012, we have received default interest payments from the borrower of approximately $6.7 million, of which $0.6 million was received during the period from January 1, 2012 to September 7, 2012. These payments have been recorded as a reduction of our basis in the Allerton loan. We evaluate the potential impairment of the carrying value of the Allerton loan based on the underlying estimated fair value of the hotel and as of September 7, 2012, there was no impairment.

7. Capital Stock

Common Shares

On July 9, 2012, we amended our corporate charter to increase the number of shares of common stock, par value $0.01 per share, from 200 million shares to 400 million shares. Each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders. Holders of our common stock are entitled to receive dividends out of assets legally available for the payment of dividends when authorized by our board of directors.

Follow-On Public Offering. On July 11, 2012, we completed a follow-on public offering of our common stock. We sold 20,000,000 shares of our common stock for net proceeds to us, after deduction of offering costs, of approximately $199.8 million. The net proceeds from the offering were used to purchase a portfolio of four hotels (the “Portfolio Acquisition”) from affiliates of Blackstone Real Estate Partners VI (the “Sellers”). See Note 12 for further discussion.
    
Private Placement. On July 12, 2012, in connection with the closing of the Portfolio Acquisition, we issued to an affiliate of the Sellers (the “Holder”) 7,211,538 shares of our common stock which is equal to $75 million divided by the closing sale price of our common stock on the New York Stock Exchange, or NYSE, on July 9, 2012. The Holder and the Company entered into a Registration Rights and Lock-Up Agreement which, among other things, subjects these shares to a 150-day lock-up period and requires the Company to use its best efforts to file a re-sale “shelf” registration statement registering the Holder's resale of the shares after the lock-up period ends.
  
Dividends. We have paid the following dividends to holders of our common stock during 2012 as follows:
Payment Date
 
Record Date
 
Dividend
per Share
January 10, 2012
 
December 30, 2011
 

$0.08

April 4, 2012
 
March 23, 2012
 

$0.08

May 29, 2012
 
May 15, 2012
 

$0.08

September 19, 2012
 
September 7, 2012
 

$0.08


Preferred Shares


-10-


Table of Contents


We are authorized to issue up to 10,000,000 shares of preferred stock, $0.01 par value per share. Our board of directors is required to set for each class or series of preferred stock the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, and terms or conditions of redemption. As of September 7, 2012 and December 31, 2011, there were no shares of preferred stock outstanding.

Operating Partnership Units

Holders of operating partnership units have certain redemption rights, which enable them to cause our operating partnership to redeem their units in exchange for cash per unit equal to the market price of our common stock, at the time of redemption, or, at our option for shares of our common stock on a one-for-one basis. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of stock splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have the effect of diluting the ownership interests of the limited partners or our stockholders. As of September 7, 2012 and December 31, 2011, there were no operating partnership units held by unaffiliated third parties.

8. Stock Incentive Plans

We are authorized to issue up to 8,000,000 shares of our common stock under our 2004 Stock Option and Incentive Plan, as amended (the “Incentive Plan”), of which we have issued or committed to issue 3,239,577 shares as of September 7, 2012. In addition to these shares, additional shares of common stock could be issued in connection with the market stock unit awards as further described below and the stock appreciation rights issued in 2008. On May 3, 2012, we issued (i) 12,104 shares of common stock and (ii) 18,156 deferred stock units to our board of directors having an aggregate value of $325,000, based on the closing stock price for our common stock on the date of issuance.

Restricted Stock Awards

Restricted stock awards issued to our officers and employees generally vest over a 3-year period from the date of the grant based on continued employment. We measure compensation expense for the restricted stock awards based upon the fair market value of our common stock at the date of grant. Compensation expense is recognized on a straight-line basis over the vesting period and is included in corporate expenses in the accompanying condensed consolidated statements of operations. A summary of our restricted stock awards from January 1, 2012 to September 7, 2012 is as follows:
 
Number of
Shares
 
Weighted-
Average Grant
Date Fair
Value
Unvested balance at January 1, 2012
1,010,127

 
$
6.97

Granted
365,599

 
9.84

Additional shares from dividends
7,541

 
10.07

Forfeited
(1,004
)
 
10.06

Vested
(690,718
)
 
5.36

Unvested balance at September 7, 2012
691,545

 
$
10.09


The remaining share awards are expected to vest as follows: 5,841 shares during 2012, 343,154 during 2013, 220,851 during 2014, and 121,699 during 2015. As of September 7, 2012, the unrecognized compensation cost related to restricted stock awards was $5.0 million and the weighted-average period over which the unrecognized compensation expense will be recorded is approximately 24 months. We recorded $0.8 million and $0.9 million, respectively, of compensation expense related to restricted stock awards for each of the fiscal quarters ended September 7, 2012 and September 9, 2011. For the periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011, we recorded $2.3 million and $2.6 million, respectively, of compensation expense related to restricted stock awards.

Market Stock Units

We have awarded market stock units (“MSUs”) to our executive officers. MSUs are restricted stock units that are earned three years from the date of grant, subject to the achievement of certain levels of total stockholder return over the performance period (the "Performance Period"). Each executive officer is granted a target number of MSUs (the “Target Award”). The actual number of MSUs that will be earned, if any, and converted to shares of common stock at the end of the Performance Period is equal to the Target Award multiplied by a conversion ratio. The conversion ratio is calculated by dividing the 30-trading day average closing price of our common stock on the last day of the Performance Period plus dividends paid by the 30-trading day

-11-


Table of Contents


average closing price of our common stock on the date of grant. The target award is then multiplied by the conversion ratio. The maximum payout to an executive officer under an award is equal to 150% of the Target Award and no shares are earned if the conversion ratio is less than 50%. The number of shares that are earned at the end of the Performance Period also includes an additional number of shares of common stock to reflect dividends that would have been paid during the Performance Period on the number of MSUs actually earned. The fair values of the MSU awards are determined using a Monte Carlo simulation. A summary of our MSUs from January 1, 2012 to September 7, 2012 is as follows:
 
Number of
Units
 
Weighted-
Average Grant
Date Fair
Value
Unvested balance at January 1, 2012
161,575

 
$
11.45

Granted
89,990

 
11.14

Additional units from dividends
5,249

 
10.07

Unvested balance at September 7, 2012
256,814

 
$
11.32


As of September 7, 2012, the unrecognized compensation cost related to the MSUs was $1.4 million and is expected to be recognized on a straight-line basis over a weighted average period of 24 months. For the fiscal quarters ended September 7, 2012 and September 9, 2011, we recorded approximately $0.2 million and $0.1 million, respectively, of compensation expense related to the MSUs. For the periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011, we recorded $0.6 million and $0.4 million, respectively, of compensation expense related to market stock units.

9. Earnings (Loss) Per Share

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

The following is a reconciliation of the calculation of basic and diluted earnings (loss) per share (in thousands, except share and per share data):
 
Fiscal Quarter Ended
 
Period from
Numerator:
September 7, 2012
 
September 9, 2011
 
January 1, 2012 to September 7, 2012
 
January 1, 2011 to September 9, 2011
Loss from continuing operations
$
(30,690
)
 
$
(768
)
 
$
(32,314
)
 
$
(12,414
)
Loss from discontinued operations
(14,089
)
 
(247
)
 
(905
)
 
(199
)
Net loss
$
(44,779
)
 
$
(1,015
)
 
$
(33,219
)
 
$
(12,613
)
Denominator:
 
 
 
 
 
 
 
Weighted-average number of common shares outstanding—basic
187,010,360

 
167,431,622

 
174,241,316

 
166,277,915

Effect of dilutive securities:
 
 
 
 
 
 
 
Unvested restricted common stock

 

 

 

Shares related to unvested MSUs

 

 

 

Weighted-average number of common shares outstanding—diluted
187,010,360

 
167,431,622

 
174,241,316

 
166,277,915

Basic loss per share:


 
 
 


 


Continuing operations
$
(0.16
)
 
$
(0.01
)
 
$
(0.19
)
 
$
(0.08
)
Discontinued operations
(0.08
)
 
(0.00
)
 
(0.00
)
 
(0.00
)
Total
$
(0.24
)
 
$
(0.01
)
 
$
(0.19
)
 
$
(0.08
)
Diluted loss per share:
 
 
 
 
 
 
 
Continuing operations
$
(0.16
)
 
$
(0.01
)
 
$
(0.19
)
 
$
(0.08
)
Discontinued operations
(0.08
)
 
(0.00
)
 
(0.00
)
 
(0.00
)
Total
$
(0.24
)
 
$
(0.01
)
 
$
(0.19
)
 
$
(0.08
)

-12-


Table of Contents



We did not include the following shares in our calculation of diluted loss per share as they would be anti-dilutive:
 
Fiscal Quarter Ended
 
Period from
 
 
 
 
 
January 1, 2012 to September 7, 2012
 
January 1, 2011 to September 9, 2011
 
September 7, 2012
 
September 9, 2011
 
 
Unvested restricted common stock
149,502

 
452,492

 
162,858

 
517,872

Unexercised stock appreciation rights
262,461

 
262,461

 
262,461

 
262,461

Shares related to unvested MSUs
255,971

 
131,980

 
255,971

 
131,980

Total
667,934

 
846,933

 
681,290

 
912,313


10. Debt

The following table sets forth information regarding the Company’s debt as of September 7, 2012 (unaudited), in thousands:
Property
 
Principal
Balance
 
Interest Rate
 
 
 
 
 
Courtyard Manhattan / Midtown East
 
$
42,029

 
8.81%
Marriott Salt Lake City Downtown
 
29,173

 
5.50%
Courtyard Manhattan / Fifth Avenue
 
50,355

 
6.48%
Renaissance Worthington
 
54,985

 
5.40%
Frenchman’s Reef & Morning Star Marriott Beach Resort
 
59,014

 
5.44%
Marriott Los Angeles Airport
 
82,600

 
5.30%
Orlando Airport Marriott
 
57,838

 
5.68%
Chicago Marriott Downtown Magnificent Mile
 
212,445

 
5.975%
Hilton Minneapolis
 
97,547

 
5.464%
JW Marriott Denver at Cherry Creek
 
41,103

 
6.47%
Lexington Hotel New York
 
170,368

 
LIBOR + 3.00% (3.23% at September 7, 2012)
Debt premium
 
1,014

 
 
Total mortgage debt
 
898,471

 
 
 
 
 
 
 
Senior unsecured credit facility
 
120,000

 
LIBOR + 2.50% (2.75% at September 7, 2012)
Total debt
 
$
1,018,471

 
 
Weighted-Average Interest Rate
 
 
 
5.17%

Mortgage Debt

We have incurred limited recourse, property specific mortgage debt secured by certain of our hotels. In the event of default, the lender may only foreclose on the secured assets; however, in the event of fraud, misapplication of funds or other customary recourse provisions, the lender may seek payment from us. As of September 7, 2012, 11 of our 27 hotels were secured by mortgage debt. Our mortgage debt contains certain property specific covenants and restrictions, including minimum debt service coverage ratios that trigger “cash trap” provisions as well as restrictions on incurring additional debt without lender consent. As of September 7, 2012, we are in compliance with the financial covenants of our mortgage debt.

On February 7, 2012, we prepaid in full the $27.0 million mortgage loan secured by the Courtyard Denver Downtown without a prepayment penalty. In connection with the prepayment, we wrote off the unamortized debt premium of $0.1 million associated with the mortgage and recorded a gain on early extinguishment of debt.

On March 9, 2012, we closed on a limited recourse $170.4 million loan secured by a mortgage on the Lexington Hotel New York. The loan has a term of three years and may be extended for two additional one-year terms subject to the satisfaction of certain terms and conditions, including the payment of an extension fee. The loan bears interest at a floating rate of one-month LIBOR plus 300 basis points. The financing includes $25 million of corporate recourse, which will be eliminated when the hotel

-13-


Table of Contents


achieves a specific debt yield test, the planned capital renovation for the hotel is completed and certain other conditions are met. Subsequent to the quarter ended September 7, 2012, we were required to deposit $4.0 million into an escrow account upon termination of the Radisson franchise agreement and the escrow will be released upon completion of the renovation. In connection with the loan, we entered into a three-year interest rate cap agreement, which caps one-month LIBOR at 125 basis points. The cost of the interest rate cap was $0.9 million and is included in prepaid and other assets on the accompanying condensed consolidated balance sheet. Each reporting period the carrying value is adjusted to fair market value, with the accompanying charge or credit to interest expense. As of September 7, 2012, the fair market value of the interest rate cap was $0.2 million (see Note 13).

On March 23, 2012, in connection with the sale of a three-hotel portfolio, the buyer assumed $97 million of mortgage debt secured by the Renaissance Waverly and $83 million of mortgage debt secured by the Renaissance Austin.

Senior Unsecured Credit Facility

We are party to a $200.0 million unsecured credit facility, which expires in August 2014. The maturity date of the facility may be extended for an additional year upon the payment of applicable fees and the satisfaction of certain other customary conditions. We also have the right to increase the amount of the facility up to $400 million with lender approval. Interest is paid on the periodic advances under the facility at varying rates, based upon LIBOR, plus an agreed upon additional margin amount. The applicable margin is based upon the Company’s ratio of net indebtedness to EBITDA, as follows:

Ratio of Net Indebtedness to EBITDA
 
Applicable Margin
Less than 4.00 to 1.00
 
2.25
%
Greater than or equal to 4.00 to 1.00 but less than 5.00 to 1.00
 
2.50
%
Greater than or equal to 5.00 to 1.00 but less than 5.50 to 1.00
 
2.75
%
Greater than or equal to 5.50 to 1.00 but less than 6.00 to 1.00
 
3.00
%
Greater than or equal to 6.00 to 1.00
 
3.25
%

In addition to the interest payable on amounts outstanding under the facility, we are required to pay an amount equal to 0.40% of the unused portion of the facility if the unused portion of the facility is greater than 50% or 0.30% if the unused portion of the facility is less than or equal to 50%.

The facility contains various corporate financial covenants. A summary of the most restrictive covenants is as follows:
 
 
 
Actual at
 
Covenant
 
September 7,
2012
Maximum leverage ratio (1)
60%
 
49.6%
Minimum fixed charge coverage ratio (2)
1.50x
 
2.23x
Minimum tangible net worth (3)
$2.0 billion
 
$2.2 billion
Secured recourse indebtedness
$25 million
 
$25 million
_____________________________
(1)
Leverage ratio is total indebtedness, as defined in the credit agreement which includes our commitment on the Times Square development hotel, divided by total asset value, defined in the credit agreement as a) total cash and cash equivalents plus b) the value of our owned hotels based on hotel net operating income divided by an 8.5% capitalization rate, and (c) the book value of the Allerton loan.
(2)
Fixed charge coverage ratio is Adjusted EBITDA, defined in the credit agreement as EBITDA less FF&E reserves, for the most recently ending 12 fiscal months, to fixed charges, defined in the credit agreement as interest expense, all regularly scheduled principal payments and payments on capitalized lease obligations, for the same most recently ending 12 fiscal month period.
(3)
Tangible net worth, as defined in the credit agreement, is (i) total gross book value of all assets, exclusive of depreciation and amortization, less intangible assets, total indebtedness, and all other liabilities, plus (ii) 85% of net proceeds from future equity issuances.

The facility requires us to maintain a specific pool of unencumbered borrowing base properties. The unencumbered borrowing base assets are subject, among other restrictions, to the following limitations and covenants:

A minimum of 5 properties with an unencumbered borrowing base value, as defined in the credit agreement, of not less than $250 million.


-14-


Table of Contents


The unencumbered borrowing base must include the Westin Boston Waterfront, the Conrad Chicago and the Vail Marriott Mountain Resort and Spa. The Conrad Chicago and the Vail Marriott Mountain Resort and Spa may be released from the unencumbered borrowing base upon lender approval and satisfaction of certain other conditions.

In conjunction with the closing of the $170.4 million loan secured by the Lexington Hotel New York, we repaid the existing outstanding balance on the facility. In addition, the $100.0 million mortgage secured by the Lexington Hotel New York was released as security for the facility.

As of September 7, 2012, there was $120.0 million outstanding under the facility and the Company's ratio of net indebtedness to EBITDA was 4.98x. Accordingly, interest on any draws under the facility will continue to be based on LIBOR plus 250 basis points for the next fiscal quarter. We incurred interest and unused credit facility fees on the facility of $0.7 million and $0.8 million for our fiscal quarters ended September 7, 2012 and September 9, 2011, respectively, and $1.7 million and $1.5 million for the periods from January 1, 2012 to September 7, 2012 and January 1, 2011 to September 9, 2011, respectively. Subsequent to the end of the quarter, we repaid a net $35 million of the amount outstanding under the facility using the net proceeds from the sale of the Atlanta Westin North at Perimeter.


11. Discontinued Operations

On March 23, 2012, we completed the sale of a three-hotel portfolio for a contractual sales price of $262.5 million to an unaffiliated third party. The portfolio consisted of the Griffin Gate Marriott Resort and Spa, the Renaissance Waverly, and the Renaissance Austin. We received net cash proceeds of approximately $92 million from the sale and the buyer assumed $97 million of mortgage debt secured by the Renaissance Waverly and $83 million of mortgage debt secured by the Renaissance Austin. The proceeds included approximately $10 million for hotel working capital and cash previously held in restricted escrow accounts, net of closing costs. We recorded a gain on the sale of the portfolio of approximately $9.5 million. The gain on sale is recorded in discontinued operations on the accompanying condensed consolidated statements of operations.

During the fiscal quarter ended September 7, 2012, we entered into an agreement to sell the Atlanta Westin North at Perimeter to an unaffiliated third party for a contractual price of $39.6 million. The hotel has been reclassified as held for sale in the condensed consolidated balance sheet as of September 7, 2012 and the operating results are reported as discontinued operations for all periods presented in the condensed consolidated statements of operations. We recorded a $14.7 million impairment loss during the quarter ended September 7, 2012 to reduce the carrying value of the hotel assets to the estimated net sales proceeds. The impairment loss is included in discontinued operations on the accompanying condensed consolidated statements of operations. The sale of the hotel was completed on October 3, 2012.

The significant components of assets held for sale and liabilities of assets held for sale at September 7, 2012 (unaudited) and December 31, 2011 consist of the following (in thousands):
 
September 7, 2012
 
December 31, 2011
Property and equipment
$
53,083

 
$
311,819

Less: accumulated depreciation
(14,326
)
 
(61,994
)
 
38,757

 
249,825

Restricted cash
695

 
6,607

Due from hotel managers
2,030

 
6,661

Prepaid and other assets
337

 
48

Deferred financing costs, net

 
258

      Total assets held for sale
$
41,819

 
$
263,399

 
 
 
 
Mortgage debt of assets held for sale
$

 
$
180,000

Due to hotel managers
1,434

 
3,101

Accounts payable and accrued liabilities
301

 
704

      Total liabilities of assets held for sale
$
1,735

 
$
183,805


The following table summarizes the components of discontinued operations in the condensed consolidated statements of operations for the periods presented (unaudited; in thousands, except per share data):

-15-


Table of Contents


 
Fiscal Quarter Ended
 
Period from
 
September 7, 2012
 
September 9, 2011
 
January 1, 2012 to September 7, 2012
 
January 1, 2011 to September 9, 2011
Hotel revenues
$
4,129

 
$
22,160

 
$
31,329

 
$
66,733

Hotel operating expenses
(2,890
)
 
(17,299
)
 
(23,254
)
 
(51,155
)
Operating income
1,239

 
4,861

 
8,075

 
15,578

Depreciation and amortization
(449
)
 
(3,224
)
 
(1,346
)
 
(9,665
)
Interest income

 

 
1

 
11

Interest expense

 
(2,325
)
 
(2,297
)
 
(6,974
)
Impairment charge
(14,690
)
 

 
(14,690
)
 

(Loss) gain on sale of hotel portfolio
(336
)
 

 
9,541

 

Income tax benefit (expense)
147

 
441

 
(189
)
 
851

Loss from discontinued operations
$
(14,089
)
 
$
(247
)
 
$
(905
)
 
$
(199
)
Basic and diluted loss from discontinued operations per share
$
(0.08
)
 
$
(0.00
)
 
$
(0.00
)
 
$
(0.00
)

12. Acquisitions

On July 12, 2012, we acquired a portfolio of four hotels for a contractual purchase price of $495 million from affiliates of Blackstone Real Estate Partners VI. The portfolio consists of the Hilton Boston Downtown, Westin Washington D.C. City Center, Westin San Diego and Hilton Burlington. We funded the Portfolio Acquisition with a combination of approximately $120 million in borrowings under our senior unsecured credit facility, $100 million of corporate cash, net proceeds from our recent follow-on public offering of common stock and the issuance of 7,211,538 shares of common stock to an affiliate of the Sellers in a private placement.

Hilton Boston Downtown

The Hilton Boston Downtown is a 362-room full-service hotel located in the Financial District of downtown Boston. We believe the Hilton Boston is well located for business transient customers. In addition, the Hilton Boston’s location is proximate to the waterfront and the Boston Convention and Exhibition Center. The historic Art Deco building was converted to a hotel in 1999 after undergoing a major renovation. The hotel is currently operated by WHM LLC under a short-term management agreement.

Westin Washington D.C. City Center

The Westin Washington D.C. City Center is a 406-room full-service hotel located in downtown Washington, D.C. The hotel opened in 1982 and converted to the Westin brand in 2006 after undergoing a major renovation. The hotel is centrally located to appeal to business and leisure guests visiting the K Street business corridor, White House, Washington Convention Center, National Mall and U.S. Capitol. The hotel is operated by Interstate Hotels & Resorts.

Westin San Diego

The Westin San Diego is a 436-room full-service hotel located in downtown San Diego. The hotel opened in 1991 as part of a San Diego mixed-use facility and was converted to the Westin brand in 2007 after undergoing a major renovation. The hotel is within walking distance of several major group and leisure demand generators, including the San Diego Convention Center, Seaport Village, Little Italy, Gaslamp Quarter and is across the street from the new Federal Courthouse (expected to open in late 2012). The hotel is operated by Interstate Hotels & Resorts.

Hilton Burlington

The Hilton Burlington is a 258-room full-service hotel located in downtown Burlington, Vermont. The hotel was constructed in 1976 and converted to the Hilton brand in 2007 after undergoing a major renovation in 2007. The hotel is the only full-service hotel in downtown Burlington. The hotel, which overlooks Lake Champlain, is a summertime destination resort and attracts state and regional association groups year round. The hotel is operated by Interstate Hotels & Resorts.

The following table sets forth the management agreement terms for each of the four hotels acquired.

-16-


Table of Contents


Property
 
Expiration
 
Base
Management Fee(1)
 
Incentive
Management Fee
Hilton Boston Downtown
 
12/31/2012
(2)
 
2
%
 
 
None


Westin Washington D.C. City Center
 
12/3/2015
(3)
 
1
%
(4)
 
10
%
(5)
Westin San Diego
 
12/3/2015
(3)
 
1
%
(4)
 
10
%
(5)
Hilton Burlington
 
12/3/2015
(3)
 
1
%
(4)
 
10
%
(5)
____________________
(1)
As a percentage of gross revenues.
(2)
May be terminated at any time prior to the expiration date with 30 days written notice.
(3)
Term may be extended on a month-to-month basis following the expiration date.
(4)
The base management fee will increase to 1.5% of gross revenues beginning on July 12, 2014. Total management fees are capped at 3.5% of gross revenues.
(5)
Calculated as a percentage of operating profits in excess of 8% of our invested capital until July 12, 2014 and 10% of our invested capital thereafter.

The following table sets forth the franchise agreement terms for each of the four hotels acquired.
Property
 
Expiration
 
Franchise Fee
Hilton Boston Downtown
 
7/31/2022
 
5% of gross room sales and 3% of gross food and beverage sales; program fee of 4% of gross room sales
Westin Washington D.C. City Center
 
12/22/2030
 
7% of gross room sales and 3% of gross food and beverage sales
Westin San Diego
 
12/22/2030
 
7% of gross room sales and 3% of gross food and beverage sales
Hilton Burlington
 
7/31/2022
 
5% of gross room sales and 3% of gross food and beverage sales; program fee of 4% of gross room sales

The following table summarizes the preliminary estimated fair value of the assets acquired and liabilities assumed in our acquisitions (in thousands):
 
 
Hilton Boston Downtown
 
Westin Washington D.C. City Center
 
Westin San Diego
 
Hilton Burlington
Land
 
$
22,000

 
$
19,800

 
$
17,700

 
$
7,100

Building
 
133,975

 
132,505

 
103,721

 
46,182

Furnitures, fixtures and equipment
 
2,700

 
2,000

 
2,200

 
1,600

Total fixed assets
 
158,675

 
154,305

 
123,621

 
54,882

Net other assets and liabilities
 
(288
)
 
(725
)
 
(62
)
 
(220
)
Total
 
$
158,387

 
$
153,580

 
$
123,559

 
$
54,662


The acquired properties are included in our results of operations based on their date of acquisition. The following unaudited pro forma results of operations (in thousands, except per share data) reflect these transactions as if each had occurred on January 1, 2011. We believe all material adjustments necessary to reflect the effects of acquisitions have been made; however, the amounts recorded are based on a preliminary estimate of the fair value of the assets acquired and the liabilities assumed. We will finalize the recorded amounts upon the completion of our valuation analysis of the assets acquired, liabilities assumed and the share consideration paid. The pro forma information is not necessarily indicative of the results that actually would have occurred nor does it indicate future operating results.

-17-


Table of Contents


 
Fiscal Quarter Ended
 
Period from
 
September 7, 2012
 
September 9, 2011
 
January 1, 2012 to September 7, 2012
 
January 1, 2011 to September 9, 2011
Revenues
$
195,496

 
$
183,882

 
$
530,595

 
$
493,992

 
 
 
 
 
 
 
 
(Loss) income from continuing operations
(27,996
)
 
4,740

 
(24,806
)
 
(3,286
)
 
 
 
 
 
 
 
 
Net (loss) income
(42,086
)
 
4,492

 
(25,711
)
 
(3,485
)
 
 
 
 
 
 
 
 
Basic and diluted (loss) earnings per share:
 
 
 
 
 
 
 
Continuing operations
$
(0.14
)
 
$
0.02

 
$
(0.13
)
 
$
(0.02
)
Net (loss) income
$
(0.22
)
 
$
0.02

 
$
(0.13
)
 
$
(0.02
)

For the fiscal quarter ended September 7, 2012 and the period from January 1, 2012 to September 7, 2012, our condensed consolidated statements of operations include $14.2 million of revenues and $2.8 million of net income related to the operations of the four hotels acquired in 2012.

13. Fair Value of Financial Instruments

The fair value of certain financial assets and liabilities and other financial instruments as of September 7, 2012 (unaudited) and December 31, 2011, in thousands, are as follows:
 
September 7, 2012
 
December 31, 2011
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Note receivable
$
54,237

 
$
55,000

 
$
54,788

 
$
55,000

Debt
$
1,018,471

 
$
1,062,715

 
$
1,042,933

 
$
1,060,830

Interest rate cap
$
153

 
$
153

 
$

 
$


The fair value of our mortgage debt is a Level 2 measurement under the fair value hierarchy (see Note 2). We estimate the fair value of our mortgage debt by discounting the future cash flows of each instrument at estimated market rates. The fair value of our interest rate cap is a Level 2 measurement under the fair value hierarchy. We estimate the fair value of the interest rate cap using the LIBOR yield curve and implied market volatility as inputs and adjusted for the counterparty's credit risk. We concluded the inputs for the credit risk valuation adjustment are Level 3 inputs; however these inputs are not significant to the fair value measurement in its entirety. The fair value of our note receivable is a Level 2 measurement under the fair value hierarchy. We estimate the fair value of our note receivable by discounting the future cash flows related to the note at estimated market rates. The underlying collateral of the note receivable has a fair value greater than the carrying value of the note receivable. The carrying value of our other financial instruments approximate fair value due to the short-term nature of these financial instruments.

14. Commitments and Contingencies

Litigation

Except as described below, we are not involved in any material litigation nor, to our knowledge, is any material litigation pending or threatened against us. We are involved in routine litigation arising out of the ordinary course of business, all of which is expected to be covered by insurance and is not expected to have a material adverse impact on our financial condition or results of operations.

Allerton Loan

We hold the senior mortgage loan secured by the Allerton Hotel, located in downtown Chicago, Illinois. The loan matured in January 2010 and is in default. In May 2011, the borrower under the loan filed for bankruptcy protection in the Northern District of Illinois under chapter 11 of Title 11 of the U.S. Code, 11 U.S.C. §§ 101 et seq., as amended.  The senior mortgage loan is secured by substantially all of the assets of the borrower, including the Allerton Hotel. The filing of the bankruptcy case had the effect of, among other things, automatically staying the foreclosure proceedings that had been previously filed against the borrower.  The borrower filed a plan of reorganization with the bankruptcy court in December 2011 and a disclosure statement with the bankruptcy

-18-


Table of Contents


court in January 2012 (together, the "Plan"). In March 2012, the Plan was approved for submission to the creditors for a vote to approve the Plan. The creditors approved the Plan and the Plan is subject to a confirmation hearing, which began on July 23, 2012, but was not completed and is scheduled to resume on October 29, 2012. While we continue to vigorously pursue our rights in the bankruptcy case, the potential outcome is uncertain.

In August 2011, we filed a claim in New York State court under a so-called “bad boy guarantee” against an affiliate of the borrower for certain damages incurred as a result of the bankruptcy filing. In January 2012, the New York State court granted summary judgment in our favor, finding the guarantor liable for legal fees incurred by the Company arising out of the bankruptcy filing and we are preparing for a hearing on the reasonableness of the amount of fees. No assurance can be given, however, that we will be successful in collecting the amounts due to us upon a determination of the amount of damages due to us.

Los Angeles Airport Marriott Litigation

During 2011, we accrued $1.7 million for our contribution to the settlement of litigation involving the Los Angeles Airport Marriott. The settlement was recorded as a corporate expense during the year ended December 31, 2011. The Company and certain other defendants reached a tentative settlement of the matter, which involved claims by certain employees at the Los Angeles Airport Marriott.  During the fiscal quarter ended June 15, 2012, we paid our contribution to the settlement into escrow, and the settlement is pending final approval by the Superior Court of California, Los Angeles County.

Performance Termination Provisions Under Management Agreements

Our management agreements provide us with termination rights upon a manager's failure to meet certain financial performance criteria. Our termination rights may, in certain cases, be waived in exchange for consideration from the manager, such as a cure payment. Based on our forecast and the hotel's budget, the Oak Brook Hills Marriott Resort is at risk of failing its performance test at the end of 2012.

The Orlando Airport Marriott failed the performance test under the management agreement at the end of 2011. In July 2012, we amended the management agreement, which reduces the annual base management fee paid to the manager for each of fiscal years 2012 and 2013 from 3% to 2% of gross revenues should the hotel's annual debt service amount exceed hotel operating profit with respect to each such fiscal year. Should we exercise our termination rights based on the hotel failing the performance test in 2012 and 2013, we would be required to repay the manager the 1% unpaid base management fees, if any, resulting from such fiscal years.

   

-19-


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 risks discussed herein and the risk factors discussed from time to time in our periodic filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2011 as updated by our Quarterly Reports on Form 10-Q. Accordingly, there is no assurance that the Company’s expectations will be realized. Except as otherwise required by the federal securities laws, the Company disclaims any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained in this report to reflect events, circumstances or changes in expectations after the date of this report.

Overview

DiamondRock Hospitality Company is a lodging-focused Maryland corporation operating as a real estate investment trust (REIT). As of September 7, 2012, we owned a portfolio of 27 premium hotels and resorts that contain 11,868 guest rooms. We also hold the senior note on a mortgage loan secured by an additional hotel and have the right to acquire, upon completion, a hotel under development. On October 3, 2012, we sold the Atlanta Westin North at Perimeter. As an owner, rather than an operator, of lodging properties, we receive all of the operating profits or losses generated by the hotels after the payment of fees due to hotel managers, which are calculated based on the revenues and profitability of each hotel.

Our vision is to be the premier allocator of capital in the lodging industry. Our mission is to deliver long-term stockholder returns through a combination of dividends and enduring capital appreciation. Our strategy is to utilize disciplined capital allocation and focus on the acquisition, ownership and asset management of high quality, branded lodging properties with superior growth prospects in North American markets with high barriers to entry.

We differentiate ourselves from our competitors by adhering to three basic principles in executing our strategy:

high-quality urban- and destination resort-focused branded hotel real estate;

innovative asset management; and

conservative capital structure.

In addition, we are committed to enhancing the value of the Company's platform by being open and transparent in our communications with stockholders, scrutinizing our corporate overhead and adopting and following sound corporate governance practices.

Consistent with our strategy, we continue to direct our energies toward opportunistic investments in premium full-service hotels and premium urban limited-service hotels located throughout North America. Each of our hotels is managed by a third party and most are operated under a brand owned by one of the leading global lodging brand companies (Marriott International, Inc. (“Marriott”), Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”) or Hilton Worldwide (“Hilton”)).

High Quality Urban- and Destination Resort-Focused Branded Hotel Real Estate

We currently own 26 premium hotels and resorts throughout North America. Our 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 major gateway cities and in destination resort locations. We consider lodging properties located in key gateway cities and resort destinations to be most capable of creating dynamic cash flow growth and achieving superior long-term capital appreciation. We also believe that these locations are better insulated from new supply due to relatively high barriers-to-entry, including expensive construction costs and limited development sites.


-20-


Table of Contents


We critically evaluate each potential acquisition to ensure that the prospective asset is aligned with the vision we have set forth, supports our mission and corresponds with our strategy. Furthermore, we regularly analyze our portfolio to identify weaknesses therein and to strategize for the disposition of non-key assets in order to recycle capital for additional acquisitions.

A core tenet of our strategy is to leverage the top global hotel brands. We strongly believe that the largest global hotel brands create significant value as a result of each brand's ability to produce incremental revenue and that, as a result, branded hotels are able to generate greater profits than similar unbranded hotels. The dominant global hotel brands typically have very strong reservation and reward systems and sales organizations, and most of our hotels are operated under a brand owned by one of the leading global lodging brand companies (Marriott, Starwood or Hilton). Generally, we are interested in owning hotels that are currently operated under, or can be converted to, a globally recognized brand. However, we would own or acquire non-branded hotels in certain top-tier or unique markets if we believe that the returns on these hotels would be higher than if the hotels were operated under a globally recognized brand.

Innovative Asset Management

We believe that we create significant value in our portfolio by utilizing our management team's extensive experience and encouraging 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 of hotel industry contacts and relationships to maximize the value of our hotels. Under the federal income tax rules governing REITs, we are required to engage a hotel manager that is an eligible independent contractor to manage each of our hotels pursuant to a management agreement with one of our subsidiaries. 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 (all, to the extent permitted under the REIT rules), and then to use those rights to continually monitor and improve the performance of our properties. We cooperatively partner with our hotel managers 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 continue to explore strategic options to maximize the growth of revenue and profitability. We persist in impressing upon our hotel managers the importance of limiting increases in property-level operating expenses. We maintain our practice of working closely with managers to optimize business at our hotels in order to maximize revenue and we remain committed to the objective of maintaining conservative corporate expenses.

We believe we can create significant value in our portfolio through innovative asset management strategies such as rebranding, renovating and repositioning and we engage in a process of regular evaluations of our portfolio in order to determine if there are opportunities to employ these value-add strategies.

Conservative Capital Structure

Since our formation in 2004, we have been committed to a conservative capital structure with prudent leverage. Our current outstanding debt consists of fixed interest rate mortgage debt with no maturities until late 2014, the variable interest rate loan secured by the Lexington Hotel New York, and borrowings on our senior unsecured credit facility. We also maintain low financial leverage by often funding a portion of our acquisitions with proceeds from the issuance of equity. We prefer that a significant portion of our portfolio remain unencumbered by debt in order to provide maximum balance sheet flexibility. In addition, to the extent that we incur additional debt, our preference is limited recourse secured mortgage debt. We expect that our strategy will enable us to maintain a balance sheet with an appropriate amount of debt throughout all phases of the lodging cycle. We believe that it is not prudent to increase the inherent risk of highly cyclical lodging fundamentals through use of a highly leveraged capital structure.

We prefer a relatively simple but efficient capital structure. We have not invested in joint ventures and have not issued any operating partnership units or preferred stock. We 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.

At all times, we actively review and manage the sources and uses of our funds in order to mitigate our exposure to economic risks and to maximize returns for our investors. In response to volatility in the financial markets during the last several years, we have undertaken additional measures in order to navigate the challenges created thereby and we are continuously evaluating and

-21-


Table of Contents


updating these measures in order to effectively address evolving economic, social and political climates. Our ultimate goal in this regard is to create and maintain long-term stockholder value.

Key Indicators of Financial Condition and Operating Performance

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

Occupancy percentage;

Average Daily Rate (or ADR);

Revenue per Available Room (or RevPAR);

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

Funds From Operations (or FFO) and Adjusted FFO.

Occupancy, ADR and RevPAR are commonly used measures within the hotel industry to evaluate operating performance. RevPAR, which is calculated as the product of ADR and occupancy percentage, is an important statistic for monitoring operating performance at the individual hotel level and across our business as a whole. We evaluate individual hotel RevPAR performance on an absolute basis with comparisons to budget and prior periods, as well as on a company-wide and regional basis. ADR and RevPAR include only room revenue. Room revenue comprised approximately 72% of total revenues for the quarter ended September 7, 2012 and approximately 70% of total revenues for the period from January 1, 2012 to September 7, 2012, and is dictated by demand, as measured by occupancy percentage, pricing, as measured by ADR, and our available supply of hotel rooms.

Our ADR, occupancy percentage and RevPAR performance may be impacted by macroeconomic factors such as U.S. economic conditions generally, regional and local employment growth, personal income and corporate earnings, office vacancy rates and business relocation decisions, airport and other business and leisure travel, 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 our hotels' global brands.

We also use EBITDA, Adjusted EBITDA, FFO and Adjusted 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 the period from January 1, 2012 to September 7, 2012 for each of our hotels owned as of September 7, 2012. The operating information presented below assumes we owned our hotels acquired in 2012 and 2011 since January 1, 2011.


-22-


Table of Contents


Property
 
Location
 
Number of
Rooms
 
Occupancy (%)
 
ADR($)
 
RevPAR($)
 
% Change
from 2011
RevPAR
Chicago Marriott
 
Chicago, Illinois
 
1,198

 
72.2
%
 
$
193.79

 
$
139.97

 
7.4
 %
Los Angeles Airport Marriott
 
Los Angeles, California
 
1,004

 
88.0
%
 
109.93

 
96.76

 
7.2
 %
Hilton Minneapolis (1)
 
Minneapolis, Minnesota
 
821

 
73.9
%
 
140.06

 
103.58

 
(2.7
)%
Westin Boston Waterfront Hotel (1)
 
Boston, Massachusetts
 
793

 
76.3
%
 
195.33

 
148.95

 
8.7
 %
Lexington Hotel New York (1) (2)
 
New York, New York
 
712

 
94.6
%
 
189.73

 
179.53

 
4.5
 %
Salt Lake City Marriott Downtown
 
Salt Lake City, Utah
 
510

 
65.9
%
 
136.23

 
89.84

 
17.8
 %
Renaissance Worthington
 
Fort Worth, Texas
 
504

 
70.0
%
 
155.91

 
109.18

 
(4.1
)%
Frenchman’s Reef & Morning Star Marriott Beach Resort (1)
 
St. Thomas, U.S. Virgin Islands
 
502

 
83.6
%
 
239.75

 
200.39

 
 %
Torrance Marriott South Bay
 
Los Angeles County, California
 
487

 
84.4
%
 
110.04

 
92.89

 
8.5
 %
Orlando Airport Marriott
 
Orlando, Florida
 
485

 
74.2
%
 
105.70

 
78.39

 
1.6
 %
Westin San Diego (1) (3)
 
San Diego, California
 
436

 
81.1
%
 
151.82

 
123.06

 
6.4
 %
Westin Washington, D.C. City Center (1) (3)
 
Washington, D.C.
 
406

 
74.7
%
 
193.69

 
144.76

 
(4.0
)%
Oak Brook Hills Marriott Resort
 
Oak Brook, Illinois
 
386

 
58.3
%
 
115.27

 
67.17

 
8.6
 %
Atlanta Westin North at Perimeter (1) (4)
 
Atlanta, Georgia
 
372

 
79.3
%
 
107.44

 
85.25

 
9.3
 %
Hilton Boston Downtown (1) (3)
 
Boston, Massachusetts
 
362

 
79.8
%
 
215.93

 
172.25

 
10.0
 %
Vail Marriott Mountain Resort & Spa (1)
 
Vail, Colorado
 
344

 
67.7
%
 
231.23

 
156.56

 
5.1
 %
Marriott Atlanta Alpharetta
 
Atlanta, Georgia
 
318

 
67.1
%
 
139.32

 
93.47

 
2.7
 %
Courtyard Manhattan/Midtown East
 
New York, New York
 
312

 
85.7
%
 
249.58

 
213.92

 
5.4
 %
Conrad Chicago (1)
 
Chicago, Illinois
 
311

 
79.1
%
 
201.55

 
159.39

 
0.5
 %
Bethesda Marriott Suites
 
Bethesda, Maryland
 
272

 
65.6
%
 
163.69

 
107.40

 
(1.0
)%
Hilton Burlington (1) (3)
 
Burlington, Vermont
 
258

 
73.8
%
 
156.74

 
115.72

 
19.9
 %
JW Marriott Denver at Cherry Creek (1) (2)
 
Denver, Colorado
 
196

 
75.0
%
 
226.01

 
169.51

 
2.0
 %
Courtyard Manhattan/Fifth Avenue
 
New York, New York
 
185

 
89.3
%
 
253.44

 
226.42

 
8.2
 %
The Lodge at Sonoma, a Renaissance Resort & Spa
 
Sonoma, California
 
182

 
70.8
%
 
232.80

 
164.72

 
9.8
 %
Courtyard Denver Downtown (1) (2)
 
Denver, Colorado
 
177

 
85.3
%
 
158.33

 
135.11

 
10.8
 %
Hilton Garden Inn Chelsea/New York City (1)
 
New York, New York
 
169

 
94.9
%
 
195.21

 
185.29

 
3.1
 %
Renaissance Charleston
 
Charleston, South Carolina
 
166

 
85.0
%
 
183.72

 
156.09

 
8.9
 %
TOTAL/WEIGHTED AVERAGE
 
 
 
11,868

 
77.5
%
 
$
168.96

 
$
130.94

 
5.9
 %
____________________
(1)
The hotel reports operations on a calendar month and year basis. The table above includes the operations for the period from January 1, 2012 to August 31, 2012 for the hotel.
(2)
The hotel was acquired during 2011.
(3)
The hotel was acquired during 2012.
(4)
The hotel was sold on October 3, 2012.

2012 Highlights

Sale of Atlanta Westin North at Perimeter. On October 3, 2012, we completed the sale of the Atlanta Westin North at Perimeter for a contractual price of $39.6 million. We recorded an impairment loss of $14.7 million upon classifying the hotel as held for sale as of September 7, 2012, which is included in discontinued operations. We used a portion of the net sales proceeds to reduce the amount outstanding on our senior unsecured credit facility.

Acquisition of Portfolio of Four Hotels. On July 12, 2012, we acquired a portfolio of four hotels (the “Acquisition Portfolio”) from affiliates of Blackstone Real Estate Partners VI (the "Sellers") for a contractual purchase price of $495 million (the “Portfolio Acquisition”). The hotels acquired are the 362-room Hilton Boston Downtown, the 406-room Westin Washington, D.C. City Center, the 436-room Westin San Diego and the 258-room Hilton Burlington.

Follow-On Public Offering. On July 11, 2012, we completed a follow-on public offering of our common stock. We sold 20,000,000 shares of our common stock for net proceeds to us, after deduction of offering costs, of approximately $199.8 million. The net proceeds from the offering were used to purchase the Acquisition Portfolio.


-23-


Table of Contents


Sale of Three-Hotel Portfolio. On March 23, 2012, we completed the sale of a three-hotel portfolio for a contractual sales price of $262.5 million. The portfolio consisted of the Griffin Gate Marriott Resort and Spa, the Renaissance Waverly, and the Renaissance Austin. We received net cash proceeds of approximately $92 million and the buyer assumed $97 million of mortgage debt secured by the Renaissance Waverly and $83 million of mortgage debt secured by the Renaissance Austin. As part of the proceeds, we received approximately $10 million for hotel working capital and cash previously held in restricted escrow accounts, net of closing costs. We recorded a gain on the sale of the portfolio of approximately $9.5 million which is reported within discontinued operations.

Rebranding of Lexington Hotel New York. On March 23, 2012, we executed a franchise agreement with Marriott to affiliate the Lexington Hotel New York with Marriott’s Autograph Collection upon the completion of a comprehensive $32 million capital improvement plan. Separately, we exercised our termination option under the hotel's existing franchise agreement with Radisson Hotels International, Inc., for which we paid a $750,000 termination fee. The Radisson franchise agreement was terminated on September 15, 2012 and the hotel is operating as an independent hotel until the capital improvement plan is completed in 2013.

Lexington Hotel New York Mortgage Loan. On March 9, 2012, we closed on a limited recourse $170.4 million loan secured by a mortgage on the Lexington Hotel New York. The loan has a term of three years and may be extended for two additional one-year terms subject to the satisfaction of certain terms and conditions and the payment of an extension fee. The loan bears interest at a floating rate of one-month LIBOR plus 300 basis points.
 
Prepayment of Courtyard Denver Downtown Mortgage. On February 7, 2012, we prepaid the $27 million mortgage debt secured by the Courtyard Denver Downtown prior to its scheduled maturity in August 2012.

Results of Operations

Comparison of our Fiscal Quarter Ended September 7, 2012 to our Fiscal Quarter Ended September 9, 2011

Net loss for the fiscal quarter ended September 7, 2012 was $44.8 million compared to a net loss of $1.0 million for our fiscal quarter ended September 9, 2011.

Revenue. Revenue consists primarily of the room, food and beverage and other operating revenues from our hotels. Our revenues from continuing operations, which exclude revenues from the Atlanta Westin North held for sale as of September 7, 2012, increased $27.1 million, from $156.8 million for our fiscal quarter ended September 9, 2011 to $183.9 million for our fiscal quarter ended September 7, 2012. This increase includes amounts that are not comparable quarter-over-quarter as follows:

$1.4 million increase from the Courtyard Denver Downtown, which was purchased on July 22, 2011.
$4.2 million increase from the Hilton Boston Downtown, which was purchased on July 12, 2012.
$3.2 million increase from the Westin Washington, D.C. City Center, which was purchased on July 12, 2012.
$4.0 million increase from the Westin San Diego, which was purchased on July 12, 2012.
$2.8 million increase from the Hilton Burlington, which was purchased on July 12, 2012.

Individual hotel revenues for our fiscal quarters ended September 7, 2012 and September 9, 2011, respectively, consist of the following (in millions):

-24-


Table of Contents


 
Fiscal Quarter Ended
 
 
 
September 7, 2012
 
September 9, 2011
 
% Change
Chicago Marriott
$
22.2

 
$
22.3

 
(0.4
)%
Westin Boston Waterfront Hotel (1)
19.3

 
18.8

 
2.7

Hilton Minneapolis (1)
14.4

 
15.4

 
(6.5
)
Lexington Hotel New York (1)
13.3

 
13.1

 
1.5

Los Angeles Airport Marriott
12.9

 
12.4

 
4.0

Frenchman’s Reef & Morning Star Marriott Beach Resort (1) (4)
12.8

 
3.7

 
245.9

Conrad Chicago (1)
8.0

 
7.7

 
3.9

Courtyard Manhattan/Midtown East
6.3

 
6.0

 
5.0

Vail Marriott Mountain Resort & Spa (1)
6.0

 
5.4

 
11.1

Oak Brook Hills Marriott Resort
6.0

 
5.8

 
3.4

JW Marriott Denver at Cherry Creek (1)
5.6

 
5.4

 
3.7

Renaissance Worthington
5.3

 
6.0

 
(11.7
)
The Lodge at Sonoma, a Renaissance Resort & Spa
5.3

 
4.8

 
10.4

Torrance Marriott South Bay
5.2

 
5.4

 
(3.7
)
Salt Lake City Marriott Downtown
4.9

 
4.7

 
4.3

Hilton Boston Downtown (3)
4.2

 

 
100.0

Westin San Diego (3)
4.0

 

 
100.0

Courtyard Manhattan/Fifth Avenue
3.9

 
3.5

 
11.4

Orlando Airport Marriott
3.7

 
3.4

 
8.8

Bethesda Marriott Suites
3.3

 
3.0

 
10.0

Westin Washington, D.C. City Center (3)
3.2

 

 
100.0

Marriott Atlanta Alpharetta
3.2

 
3.4

 
(5.9
)
Hilton Garden Inn Chelsea/New York City (1)
3.2

 
3.1

 
3.2

Hilton Burlington (3)
2.8

 

 
100.0

Courtyard Denver Downtown (2)
2.5

 
1.2

 
108.3

Renaissance Charleston
2.4

 
2.3

 
4.3

Total
$
183.9

 
$
156.8

 
17.3
 %

(1)
The hotel reports operations on a calendar month and year basis. The fiscal quarters ended September 7, 2012 and September 9, 2011 include the months of June, July, and August for the hotel.
(2)
The hotel was acquired on July 22, 2011 and the fiscal quarter ended September 9, 2011 includes operations from July 22, 2011 to August 31, 2011.
(3)
The hotel was acquired on July 12, 2012 and the fiscal quarter ended September 7, 2012 includes operations from July 12, 2012 to August 31, 2012.
(4)
The hotel was partially closed for the fiscal quarter ended September 9, 2011 due to the hotel's extensive renovation project.

The following pro forma key hotel operating statistics for our hotels reported in continuing operations for the fiscal quarters ended September 7, 2012 and September 9, 2011, respectively, include the prior year operating statistics for the prior year period comparable to our 2012 ownership period.
 
Fiscal Quarter Ended
 
 
 
September 7, 2012
 
September 9, 2011
 
% Change
Occupancy %
81.8
%
 
82.6
%
 
(0.8) percentage points
ADR
$
171.06

 
$
163.64

 
4.5
%
RevPAR
$
139.94

 
$
135.21

 
3.5
%

The increase in RevPAR is attributable to a 4.5% growth in ADR, slightly offset by a 0.8 percentage point decrease in occupancy. Occupancy decreased for group and business transient segments, offset by increases in leisure and contract segments. ADR increased in all customer segments, including 4.5% for group, 3.1% for business transient, and 6.6% for leisure.

Food and beverage revenues increased $4.1 million from the comparable period in 2011, which includes a $1.5 million increase in revenues from our 2012 acquisitions. The remaining increase of $2.6 million at our comparable hotels is driven primarily by higher outlet revenue. Other revenues, which primarily represent spa, golf, parking and attrition and cancellation fees, increased

-25-


Table of Contents


$2.3 million, which includes a $1.0 million increase in revenues from our 2012 acquisitions and 2011 acquisition of the Courtyard Denver. The remaining increase of $1.3 million is due to our comparable hotels.

Hotel operating expenses. The operating expenses for our fiscal quarters ended September 7, 2012 and September 9, 2011 consists of the following (in millions):
 
Fiscal Quarter Ended
 
 
 
September 7,
2012
 
September 9,
2011
 
%
Change
Rooms departmental expenses
$
35.4

 
$
30.1

 
17.6
 %
Food and beverage departmental expenses
30.0

 
26.2

 
14.5

Other departmental expenses
5.1

 
4.3

 
18.6

General and administrative
14.7

 
13.0

 
13.1

Utilities
6.9

 
6.1

 
13.1

Repairs and maintenance
8.2

 
7.1

 
15.5

Sales and marketing
15.3

 
12.2

 
25.4

Base management fees
4.6

 
3.3

 
39.4

Incentive management fees
1.1

 
1.3

 
(15.4
)
Property taxes
7.8

 
7.3

 
6.8

Other fixed charges
2.7

 
2.3

 
17.4

Ground rent—Contractual
2.0

 
1.8

 
11.1

Ground rent—Non-cash
1.5

 
1.6

 
(6.3
)
Total hotel operating expenses
$
135.3

 
$
116.6

 
16.0
 %

Our hotel operating expenses increased $18.7 million, or 16.0 percent, from $116.6 million for our fiscal quarter ended September 9, 2011 to $135.3 million for our fiscal quarter ended September 7, 2012. The increase in hotel operating expenses includes amounts that are not comparable quarter-over-quarter as follows:

$0.7 million increase from the Courtyard Denver Downtown, which was purchased on July 22, 2011.
$2.5 million increase from the Hilton Boston Downtown, which was purchased on July 12, 2012.
$2.2 million increase from the Westin Washington, D.C. City Center, which was purchased on July 12, 2012.
$2.7 million increase from the Westin San Diego, which was purchased on July 12, 2012.
$1.5 million increase from the Hilton Burlington, which was purchased on July 12, 2012.

The remaining increase in operating expenses of $9.1 million at our comparable hotels is primarily due to higher rooms and other departmental costs, especially food and beverage costs.

Base management fees are calculated as a percentage of total revenues and incentive management fees are based on the level of operating profit at certain hotels. The increase in base management fees is due primarily to the impact of our 2012 acquisitions and higher revenues at our comparable hotels.

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 $2.0 million from the third fiscal quarter in 2011 to the third fiscal quarter in 2012 due primarily to the extensive renovation at Frenchman's Reef during 2011 and the impact of our 2012 acquisitions.

Impairment losses. During our fiscal quarter ended September 7, 2012, we recorded impairment losses of $30.4 million related to the Oak Brook Hills Marriott Resort. No impairment loss was recorded during our fiscal quarter ended September 9, 2011.

Corporate expenses. 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. Our corporate expenses decreased $0.3 million, from $6.5 million for our fiscal quarter ended September 9, 2011 to $6.2 million for our fiscal quarter ended September 7, 2012. The decrease in corporate expenses is due primarily to the $1.7 million litigation settlement which was accrued in the third quarter of 2011, which is partially offset by higher legal expenses related to the bankruptcy

-26-


Table of Contents


proceedings of the Allerton Hotel, a $0.6 million write-off of costs related to a ballroom construction project at the Chicago Marriott Downtown, which we determined would not be completed, and higher employee-related costs.

Hotel acquisition costs. Hotel acquisition costs incurred during the quarter ended September 7, 2012 were primarily related to the Portfolio Acquisition, which was completed on July 12, 2012.

Interest expense. Our interest expense was $12.7 million and $11.3 million for our fiscal quarters ended September 7, 2012 and September 9, 2011, respectively. The increase in interest expense is primarily attributable to the mortgage financing at the Lexington Hotel New York and the fair value adjustment to our interest rate cap.

Our interest expense for the fiscal quarters ended September 7, 2012 and September 9, 2011 is comprised of the following (in millions):
 
Fiscal Quarter Ended
 
September 7, 2012
 
September 9, 2011
Mortgage debt interest
$
11.3

 
$
10.7

Credit facility interest and unused fees
0.7

 
0.8

Amortization of deferred financing costs and debt premium
0.7

 
0.3

Capitalized interest
(0.2
)
 
(0.5
)
Interest rate cap fair value adjustment
0.2

 

 
$
12.7

 
$
11.3


As of September 7, 2012, we had property-specific mortgage debt outstanding on eleven of our hotels. Most of our mortgage debt is fixed-rate secured debt bearing interest at rates ranging from 5.30 percent to 8.81 percent per year. The mortgage loan secured by the Lexington Hotel New York bears interest at a floating rate based on one-month LIBOR plus 300 basis points. As of September 7, 2012, we had $120 million of outstanding borrowings under our credit facility. Our weighted-average interest rate on all debt as of September 7, 2012 was 5.17 percent.

Interest income. Interest income increased less than $0.1 million from our fiscal quarter ended September 9, 2011 to our fiscal quarter ended September 7, 2012, respectively. The increase is primarily due to higher average cash balances during our third fiscal quarter of 2012.

Discontinued operations. Income from discontinued operations for the quarter ended September 7, 2012 represents the results of operations of the Atlanta Westin North at Perimeter, which was classified as held for sale as of September 7, 2012. We recorded an impairment charge of $14.7 million as a result of classifying the Atlanta Westin North as held for sale. The hotel was sold on October 3, 2012.

Income taxes. We recorded an income tax benefit on continuing operations of $0.9 million for our fiscal quarter ended September 7, 2012 and an income tax expense on continuing operations of $2.2 million for our fiscal quarter ended September 9, 2011. The third fiscal quarter 2012 income tax benefit includes $0.9 million of income tax benefit incurred on the $2.2 million pre-tax loss from continuing operations of our taxable REIT subsidiary, or TRS, and $0.1 million of foreign income tax benefit incurred on the $0.5 million pre-tax loss of the TRS that owns Frenchman's Reef, offset by $0.1 million of state franchise taxes. The third fiscal quarter 2011 income tax expense includes $2.4 million of income tax expense incurred on the $6.1 million pre-tax income from continuing operations of our TRS for our fiscal quarter ended September 9, 2011 and $0.1 million of state franchise taxes, offset by $0.3 million of foreign income tax benefit incurred on the $3.5 million pre-tax loss of the TRS that owns Frenchman's Reef.

Comparison of the Period from January 1, 2012 to September 7, 2012 to the Period from January 1, 2011 to September 9, 2011

Net loss for the period from January 1, 2012 to September 7, 2012 was $33.2 million compared to a net loss of $12.6 million for the period from January 1, 2011 to September 9, 2011.

Revenue. Revenue consists primarily of the room, food and beverage and other operating revenues from our hotels. Our revenues from continuing operations increased $79.2 million, from $404.0 million for the period from January 1, 2011 to September 9, 2011 to $483.2 million for the period from January 1, 2012 to September 7, 2012. This increase includes amounts that are not comparable period-over-period as follows:


-27-


Table of Contents


$6.7 million increase from the JW Marriott Denver at Cherry Creek, which was purchased on May 19, 2011.
$19.9 million increase from the Lexington Hotel New York, which was purchased on June 1, 2011.
$5.1 million increase from the Courtyard Denver Downtown, which was purchased on July 22, 2011.
$4.2 million increase from the Hilton Boston Downtown, which was purchased on July 12, 2012.
$3.2 million increase from the Westin Washington D.C. City Center, which was purchased on July 12, 2012.
$4.0 million increase from the Westin San Diego, which was purchased on July 12, 2012.
$2.8 million increase from the Hilton Burlington, which was purchased on July 12, 2012.

Individual hotel revenues for the period from January 1, 2012 to September 7, 2012 and the period from January 1, 2011 to September 9, 2011, respectively, consist of the following (in millions):
 
Period from
 
 
 
January 1, 2012 to September 7, 2012
 
January 1, 2011 to September 9, 2011
 
% Change
Chicago Marriott
$
61.8

 
$
58.4

 
5.8
 %
Westin Boston Waterfront Hotel (1)
48.0

 
43.7

 
9.8

Frenchman’s Reef & Morning Star Marriott Beach Resort (1)
40.2

 
24.0

 
67.5

Los Angeles Airport Marriott
39.8

 
37.0

 
7.6

Lexington Hotel New York (1) (3)
33.1

 
13.1

 
152.7