DiamondRock Hospitality Company (DRH) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 DiamondRock Hospitality Co. Earnings Conference Call. My name is Jasmine, and I'll be your coordinator for today. [Operator Instructions] As a reminder, the conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, to Mr. Mark Brugger, Chief Executive Officer. You may proceed.

Thanks, Jasmine. Good morning, everyone, and welcome to DiamondRock's Second Quarter 2012 Earnings Conference Call. Today, I'm joined by John Williams, our President and Chief Operating Officer; as well as Sean Mahoney, our Chief Financial Officer. As usual, before we begin, I would like to remind everyone that many of our comments today are not historical facts and are considered forward-looking statements under Federal securities law. They may not be updated in the future. These statements are subject to risks and uncertainties as described in our SEC filings. Moreover, as we discuss certain non-GAAP financial measures, it may be helpful to review the reconciliation to GAAP set forth in our earnings press release. As you know, we have been very busy since our last earnings call. We have acquired a portfolio of 4 high-quality city center hotels for $0.5 billion, issued $200 million of stock and benefited from a $75-million strategic investment from Blackstone. These efforts are the latest examples of us -- of executing our strategy of improving portfolio quality, owning urban assets in target markets, increasing brand and operator diversity and actively recycling capital. Today, we own a terrific portfolio of 27 hotels concentrated in strong gateway markets such as New York City, Chicago and Boston. Moreover, we maintain one of the strongest balance sheets in the industry, and the company continues to be one of the most active players in the space, having completed over $750 million in deals year to date. The company is well positioned for growth, as our portfolio continues to benefit from the ongoing U.S. lodging recovery and the implementation of our best practice asset management initiatives. Furthermore, with our solid balance sheet, we are well positioned to take advantage of opportunistic acquisitions, while selectively recycling capital through the disposition of non-core assets. I'd like to now spend a couple of minutes discussing the impact of the recent Blackstone portfolio acquisition. As part of our capital recycling strategy, we created investment capacity through the disposition of 3 non-core suburban hotels earlier this year and redeployed that capital into 4 higher growth hotels in more attractive markets. Consider these 6 consolidated facts about the transaction: One, almost 90% of the entire portfolio's EBIT comes from hotels in city center locations of Boston, Washington, D.C. and San Diego; Two, these hotels increased our overall portfolio RevPAR and profit margins; Three, each of the hotels is owned in fee simple; Four, the hotels are unencumbered by brand management, thereby increasing our ability to influence operations and increase potential exit value; Five, we have uncovered numerous asset management opportunities to create outsized growth; and six, we are making capital investment as an upside opportunity to reposition each hotel in order to gain market share over the next several years. I would also note that as part of acquisition, Blackstone made a significant strategic investment in the company. We are pleased to welcome Blackstone as a shareholder and look forward to exploring opportunities for us to partner with them going forward. Now let's turn to the second quarter results. Our portfolio's operating performance were strong and consistent with our expectation. We achieved second quarter RevPAR growth of 6.5%, with the majority of our hotels gaining market share during the quarter. The company's second quarter adjusted EBITDA improved 17% from 2011. Including Frenchman's Reef, our hotel's debt-to-EBITDA margins expanded 90 basis points. Even more impressively, the year-to-date performance of our portfolio reflects RevPAR growth of 7.6%, hotel adjusted EBITDA margin expansion of 115 basis points and improved market share. Turning to the balance sheet. We funded only 25% of the Blackstone portfolio acquisition with debt, a move consistent with our strategy of maintaining a low levered balance sheet. We expect to end 2012 with a debt-to-EBITDA ratio of just 4.5x. Remarkably, 16 of our 27 hotels are unencumbered by debt. To give you an idea of how much borrowing power that provides the company, our cost basis in those 16 unencumbered hotels is $1.7 billion. We feel very good about the balance sheet and fundamentally believe that conservative leverage is crucial for a lodging REIT to create exceptional shareholder value over the cycle. This conservative leverage strategy, along with strong operating results, allows DiamondRock to pay well covered and competitive dividend yield of over 3%. I would like to add that being an income company is another core tenant in our strategy to deliver outstanding shareholder returns. Now turning to guidance. Lodging fundamentals continue to show strength and are generally meeting our high expectations. The balance of the year, group booking pace remains strong, up 7.8% compared to the same time in 2011. Moreover, we expect to end the year in a stronger position than last year and anticipate achieving success during the 2013 corporate rate negotiations, which will begin in a few months. Our updated guidance incorporates our recent portfolio acquisition, equity offering and share issuance to Blackstone, as well as the most recent hotel operating forecast for our current portfolio of 27 hotels. Based on these factors, our revised full year 2012 guidance is as follows: RevPAR growth of 5.5% to 7.5%, adjusted EBITDA of $193 million to $201 million, and adjusted FFO per share of $0.76 to $0.80. The company's third quarter guidance is as follows: RevPAR growth of 3% to 4%, adjusted EBITDA of $44.5 million to $48.5 million, and adjusted FFO per share of $0.18 to $0.19. As discussed in the press release, we expect more moderate growth in the third quarter than we experienced in the second, followed by strong growth during the fourth quarter. The company's third quarter will be impacted by a few specific items. First, the façade project at the Worthington Renaissance is expected to create $2 million of disruption during the third quarter. This disruption is expected to negatively impact the company's third quarter RevPAR growth by about 60 basis points. Second, the citywide group meeting calendar in Chicago is weighted toward the second and fourth quarters, resulting in third quarter group booking pace at the Chicago Marriott being down approximately 6%. Our Chicago hotels will negatively impact our third quarter RevPAR growth by about 70 basis points. And third, as discussed earlier this year, the Hilton Minneapolis 2012 RevPAR growth is challenged by a difficult convention calendar comp, particularly in the third quarter. The Minneapolis Hilton will negatively impact our third quarter RevPAR growth by about 50 basis points. The company expects strong RevPAR growth during the fourth quarter as a result of several catalysts. Our fourth quarter will benefit substantially from favorable timing of citywide meeting from Chicago, as evidenced by the fourth quarter group booking pace for the Chicago Conrad and Chicago Marriott up 46% and 14%, respectively. Moreover, our fourth quarter will benefit from the strong convention activity at the Boston Convention and Exhibition Center, with our Westin Boston fourth quarter group booking pace up almost 11%. We also expect the LAX Marriott to outperform during the fourth quarter. The group booking pace at this hotel is up at over 50%. Additionally, we expect strong fourth quarter performance for our well-located hotels in New York City. I'll now turn the call over to John to review our results in further detail and discuss our recent acquisitions.

Thanks, Mark, and good morning, everyone. Second quarter results showed continuation of positive demand trends, with RevPAR up 6.5%, led by ADR -- an ADR increase of 4.6%. We saw a good demand growth in the quarter, as revenue gains in group up over 10.5% and leisure up 10% accounted for 85% of the revenue gain. The balance of the revenue gain was a result of some well-priced contact business we put into the Lexington Hotel in New York. Business transient rate was up over 5% in the quarter with slightly lower room nights, as demand from other segments displaced some BT rooms. We continue to focus on revenue management strategies as a means of maximizing the total revenue potential of our hotels. We encourage our operators to take calculated risk to maximize rate. We've seen great successes at several of our hotels. We implemented the strategy this year at the Conrad in Chicago of not renewing lower-rated special corporate accounts in anticipation of rate potential from the strong convention calendar and resulting compression in the city, which contributed to the BT results. The revenue management strategy turned about to be too aggressive in Q2 because the city experienced less group pickup than expected. But we anticipate stronger rates at the Conrad for the balance of the year and believe our strategy will pay off. The Conrad's new ballroom will open August 2, and group pace at the Conrad, as Mark mentioned, is up 46% in the fourth quarter. Food and beverage revenues were up almost 11% in the quarter, with increases in banquet sales related to higher group volume. Food and beverage margins would have been even better but were held back by higher cover counts and lower average check in one large convention hotel and higher wages and benefits due to higher volumes. Group pace for the balance of the year, including the recent acquisitions, remains robust, up 7.8%. The profit flow-through for the quarter resulted in a 90 basis points of EBITDA margin expansion. Our asset management group remains very focused on getting every incremental dollar of revenue to the bottom line. We were encouraged by productivity gains. Overall, productivity for the portfolio was good with man hours per occupied room down 4.6% and sales per man hour up 13.1% for the quarter. Rooms margins were impacted by the cost of employee benefits and travel agent commissions, which were up 10.8% and 21%, respectively, this quarter. Support costs in the quarter were well controlled and were up 4.2%. Sales and marketing and G&A costs were higher, partially from increased occupancy, up 7% and 6.2%, respectively. These costs were partially offset by modest increases in R&M and utilities, which were lower by 3.6%, reflecting lower rates, the $4 million we've invested in energy-saving initiatives across the portfolio and energy contracts we've negotiated in the past year. I'd like to spend some time addressing our current significant capital projects. As we have discussed, we're in the final planning stages for a $32-million renovation at the Lexington Hotel. The renovation will reposition the hotel as an Autograph Collection by Marriott and will touch every guest experience at the hotel. Rooms, bathrooms, the hotel lobby will be completely reinvented. This project will begin in late December and be completed in mid-2013. The project will be phased to minimize disruption. The Manhattan Courtyards are also in the final design for a guestroom renovation in the first half of 2013. The lobby of the Fifth Avenue Courtyard was completed in the first quarter of this year, and the lobby of the Third Avenue Courtyard is being redesigned and will enable us to move the fitness center off of the rooms floor to the lobby and gain an additional 4 keys. In June, we began the renovation of the Worthington Renaissance façade. The project will be phased over 2 years in order to minimize disruption. We're also finalizing a lease for the restaurant, lobby lounge and room service at the hotel, which will reconfigure a portion of the lobby and dramatically improve food and beverage margins as well as guest satisfaction. Construction has begun on the 42nd Street Hilton Garden Inn, and it's scheduled for completion in mid-2014. It is 286-room hotels at 42nd and Broadway, the heart of Times Square. The Conrad ballroom addition will be opened in a week, and the booking pace is a testament to the market demand for the space. Turning to our recent acquisition of the high-quality Blackstone portfolio. We acquired 4 hotels from Blackstone for $495 million, representing a discount for replacement cost at $339,000 a key. The acquisition expanded our portfolio into 3 strategic target markets: Boston, Washington, D.C. and San Diego. It expanded our strategic relationship with Hilton and Starwood and increased our third-party management exposure. The acquired hotels will improve portfolio RevPAR by $2 and margins by 140 basis points. We see margin improvement opportunities at the hotels because revenue potential at these hotels come from rate gains, as we enhance revenue strategies and put capitals into the hotels to capture higher-rated business. Let me give you a little more background at the -- on the upside opportunities. Blackstone reacquired control of this portfolio in December of 2010 from Columbia Sussex. Columbia Sussex had acquired, renovated, rebranded and assumed management of the hotels in 2006. The Columbia Sussex brand and management strategy relied almost exclusively on the brands for marketing and focused on extremely tight and unsustainable cost controls. Let me just say that in our experience, this is not a recipe for maximizing value. When Blackstone converted the hotels to third-party management in 2011, Interstate and LXR began the process of reinstituting marketing and more appropriate staffing levels into the hotel, an effort which has just started to bear fruit and should accelerate going forward. Now that we own the hotels, we have the ability for our asset management team to implement our best practices initiative, that we either not fully implemented or not yet initiated at all at the hotels. Areas of opportunities at all 4 hotels relate to product repositioning, revenue management, marketing, parking, food and beverage profit maximization and labor forecasting. We consider this portfolio acquisition central to our strategy of using smart capital recycling to enhance DiamondRock's portfolio through the disposition of lower quality, slower growth assets and redeploying the capital into assets such as these, concentrating in high growth, gateway urban markets with numerous upside opportunities. The Hilton Boston Downtown is a AAA 4-diamond hotel with 362 keys, including 66 suites and 10,000 square feet of functional meeting space. It's Boston Financial District location is 1 block from the waterfront and Faneuil Hall and 10 minutes from Logan Airport. The hotel is a 1920s era Art Deco building, one of Boston's first high-rise office buildings. The building was converted to a hotel and fully renovated in 1999. All food and beverage operations are leased, making the operation essentially rooms only, resulting in very high GOP and EBITDA margins supplemented by the significant lease income. Lease income from existing tenants provide $1 million in stable annual NOI. We see several opportunities for asset management to significantly improve revenue and profitability at the Hilton. We intend to lease 4,000 square feet of prime street access retail space, currently vacant. We are evaluating proposals for management companies who would like to assume management of the hotel. We'll develop a revenue management strategy tailored to Boston demand patterns, drawing on our experience at the Westin Waterfront. We'll integrate the marketing efforts of Hilton's citywide marketing team and Boston Convention Center Authority into the hotel's marketing plan. We will divide some of the 66 suites to gain additional keys and longer-term, we'll investigate the feasibility of relocating Northeastern's lease space to add up to 50 rooms and/or additional meeting space. And we will design and implement a hotel renovation in order to improve RevPAR penetration. The Westin D.C. City Center has 406 rooms and 13,000 square feet of meeting space. The hotel's 14th and M Street location is central to the Washington CBD office concentration and 5 blocks from the D.C. Convention Center and The White House. Asset management initiatives here will include, as in Boston we will develop a marketing plan and revenue management strategy to improve RevPAR penetration and close the unjustified $50 RevPAR gap with the Westin West End. We'll design and implement a hotel renovation plan, including a -- including reconfiguring the lobby and food and beverage space to enhance functionality and profitability, and we'll renegotiate a higher-yielding profit parking contract and outsource laundry operations. The Hilton Burlington is the 258-room hotel with 16,000 square feet of indoor and outdoor meeting space, which benefits from its CBD location with views of Lake Champlain and the Adirondack Mountains and with convenient access to downtown shops and restaurants. The Hilton is the only full-service hotel in the Burlington CBD, which is the center of a vibrant and growing regional commercial hub. We've identified asset management opportunities at Burlington as well. We will rejuvenate the marketing team and redirect marketing strategy to penetrate local transient and group accounts, which are not currently solicited. We will develop relationships with the University of Vermont, a major local demand generator who are often paid attention to by the hotel marketing staff. We will refresh the guestroom Sofcoast package to regain lost RevPAR index and develop seasonal amenity packages to further penetrate in seasonally for demand. We will reclaim existing office space to add water view meeting rooms. And we'll renegotiate the parking agreement and significantly increase profit. Overall, this is a very profitable hotel that generates over $18,000 per key in EBITDA and has continued growth potential. Finally, the Westin San Diego is a 436-room hotel with 22,000 square feet of meeting space. This iconic mixed use building opened in 1991 and is a landmark in the San Diego skyline. Its CBD location on Broadway is approximate to downtown demand generators and within walking distance to San Diego's Convention Center and Gaslamp District. A new federal courthouse and expanded county courthouse surround the hotel. We've identified several asset management initiatives at the Westin. The hotel will also benefit from development of a rational pricing strategy and better coordination with Starwood citywide marketing team. We will improve the hotel's interaction and cooperation with the San Diego Convention Center sales force. We'll develop legal research and mock trial meeting space in the hotel to capture demand from the federal and county courthouses. This is a significant new revenue opportunity. We will activate the lobby area and reconfigure food and beverage space to drive revenue and profitability. And we'll lease the street-facing food and beverage outlet to increase profitability. And we will design and execute a rooms renovation to further improve RevPAR penetration. So the Blackstone acquisition is the execution of our strategy to redeploy capital from lower growth secondary markets to gateway urban core markets and into assets that can benefit from aggressive asset management. Now I'll turn the call back over to Mark.

Thanks, John. Overall, we remain bullish on the growth potential for our portfolio and believe that DiamondRock remains an outstanding investment for our shareholders. To that point, we'd like to leave you with 3 main takeaways today. The first takeaway is that our portfolio has tremendous growth potential. Just look at our legacy portfolio of 23 hotels. These hotels possess a great deal of upside potential and profit margins and in profit. It's important to observe that our portfolio has plenty of room to run, as it is nowhere near prior peak. In fact, the profit margin of our legacy hotel portfolio would need to expand approximately 500 basis points from last year just to hit prior peak profit margins. In terms of profit, our legacy portfolio needs to increase $80 million from last year just to reach prior peak. We regard these gaps as a big opportunity. The second takeaway is that we have purposefully maintained a conservative balance sheet and have structured our investments in such a way as to reduce risks to enterprise by creating maximum flexibility, with more than half the portfolio unencumbered with a myriad of financing options. For a lodging REIT, balance sheet management is arguably the #1 driver of value to shareholders. The final takeaway relates to our platform. Simply put, we have a great team. Our asset management team continues to employ best practices and investigate opportunities to cut costs and increase profit margins at our hotels. Our finance group has done a great job putting together a spectacular balance sheet and continually lowering our cost of capital, and our team, overall, has successfully executed more than $750 million in acquisitions and dispositions this year alone. In conclusion, our team remains committed to delivering shareholder value through a focused and well-executed strategy. With that, we would now like to open up the call for any questions.

[Operator Instructions] And your first question comes from the line of Josh Attie with Citi.

Can you tell us what the implied RevPAR guidance is for the fourth quarter?

Sure, Josh. This is Sean. The implied fourth quarter is between 5% and 10%, depending on what end of the range we have for the third quarter.

And what -- when you look at the high end of that range, what gives you the confidence that you can hit the high end? When I look at the third quarter, it seems like even if you add back the 180 basis points you outlined that would the portfolio at 5% to 6%, which still seems a little bit light given that your quarter includes the end of June, which is very strong. So the 5% to 6% seems like it's below where the industry is trending. Is there anything else that's weighing on the portfolio in the third quarter that you expect to reverse that would help you go from 5% to 6% to closer to 10%?

Yes. Well, Josh, this is John. In the third quarter, one of the primary drivers is the group pace, which is about 3.4% against almost 12% in the fourth quarter. And that's driven by basically all of the major convention hotels, Boston, Chicago, Salt Lake and Minneapolis, all have soft convention calendars in the third quarter. However, they have very strong convention calendars in the fourth quarter. As an example, Boston's up almost 11%, Chicago Downtown 14%; Frenchman's Reef 34%, Salt Lake City at 6% and Minneapolis is up 2%. So that's a major driver of the revenue forecast.

How much of the business for the fourth quarter today is locked in or booked?

I can't give you that number, Josh, off the top of my head. Let us get that for you.

Roughly, is it less than 50%? Is it less than 30%?

Well, it's -- if you look at our group business in the fourth quarter, it's probably going to be about 35%, and probably 90% of that is booked. And then our transient booked, we just cross particularly in resorts that are already on the books, but I just don't know that number.

Okay. And John, you outlined qualitatively what some of the opportunities are at the assets that you just bought. Can you tell us financially what you think the upside there? Is there an EBITDA number that you think you can get in excess of market growth related to all the things that you spoke about?

Josh, it varies by hotel obviously. There are tremendous opportunities in a couple of the hotels. There are good opportunities in the others. I couldn't quantify it for you. I mean, I can tell you that the BX portfolio this year and the third and fourth quarter are going to be up in RevPAR 8% and 10% roughly. And then the profit margins, as you know, are already pretty strong, and we see some continued improvement opportunity there. In terms of quantifying the EBITDA between now and what, 2 years from now, is that what you're driving at?

Yes. Just when you underwrote this, how did you think about what the financial upside was or how the value of the assets were going to increase? Is it that you're going to get EBITDA growth? It sounds like you think you're going to get EBITDA growth in excess of the market growth based on all the things you outlined, and I just wanted to know if there was -- if you quantify what that EBITDA opportunity was.

Josh, this is Mark. On our underwriting, we get to -- on a 5-year hold, we get to about double-digit unlevered IRR. When we look at the growth rate and [ph] generalize for the portfolio, but the CAGR versus kind of the expectation for the market was about 2% better per annum in the market and that has to do with both implementation of the best practices but also the capital that we're going to put in. We think will have a lot more market penetration from that strategy.

And what did you assume for the exit valuation compared to what you bought at?

Our exit value, it was about 100 basis points above our acquisition price.

Josh, it varied by property, obviously, but 100 basis points overall.

Your next question comes from the line of Eli Hackel with Goldman Sachs.

Just 2 questions. One on the portfolio and just general acquisitions in general. As you get further into the cycle, how do you change your assumptions? Obviously, 5 years from now, is different from 5 years, 1, 2 or 3 years ago, so just how do you change your underwriting assumptions as you go through a cycle? And then second question just on expense growth. Just looking on the pro forma expense growth, it's a little bit higher than I saw, some from incentive management fees, 8% or so in the quarter just overall. What are you expecting just expense growth as we go throughout the rest of the year? And maybe just a more general comment there would be great.

Okay. I'll take the first question on underwriting. Basically, we use third-party market estimates for growth, and then we apply either a discount or a premium based on work that we're going to do at the hotel or outsized potential or issues that we see at each hotel individually. And then on a flow-through basis, we use sort of standard flow-through measures, and that results in the NOI that we use to underwrite the hotels. That changes as the -- obviously, as the cycle progresses. It changes both third party's perspective of market potential growth and our own perspective of hotel -- individual hotel growth potential against the market. So hopefully, we're smart enough to spot within the cycle coming supply or a slowdown in growth. On the expense question, I guess, I would say that we expect labor costs to go up at -- in the 4% range, 4% to 5% range this year, although they were a little higher in the second quarter because of some comparability issues. And we expect the various other costs to go up at inflation or with volume depending on the category. But generally, we are still shooting for roughly 55% flow-through from increased revenue mix between rooms and food and beverage.

And Eli, this is Sean. There's a couple expense items that are probably worth talking about specifically. You mentioned IMF for the quarter up 8%. That's really driven by Chicago, which makes up 90%, 95% of our total incentive management fees, both for the quarter as well as for the year. Our Chicago Marriott had a very strong quarter, so the incentive management fees are up accordingly for that hotel. The other item that should be worth mentioning is property taxes for our portfolio are up about $5 million year-over-year, and that's really driven by Chicago as well as Boston and to a lesser extent, Worthington. Chicago has their triannual reassessment for 2012, which we're assuming roughly a 40% increase in the assessment. The reason why we think it's going to be so significant is because the last reassessment was 2009, which was a very difficult year -- was a very difficult year for the industry. So we're assuming that there's going to be significant increases in Chicago that are going to hit this year. Boston is coming off a PILOT program, which is going to be about $1 million of increased property taxes that hit this year. And then Worthington had a favorable property tax appeal win last year, which had a positive impact of about $1 million on our property taxes.

And your next question comes from the line of Ian Weissman with ISI Group.

Maybe just a couple of or specifics on your New York City portfolio, which came in below our expectations. Are you seeing any fallout yet from, I guess, troubles in Europe given your exposure in New York?

Yes. This is John. I'll take that. The New York market, in general, in the second quarter portfolio went up about 3.6% in RevPAR, and it lost about 90 basis points in margin for the second quarter. And there's a degree of that at the Lexington and certainly, from European travel, but I don't think it's been so measurable that it's been highlighted but inevitably that both the Olympics and the issues with the European economies are inevitably going to impact the visitation. Overall, though, I think there were portions of the second quarter that were a little bit weaker than anticipated, but then there are also portions of the second quarter that were pretty strong. And when it comes to transient business, it's very difficult to pinpoint and forecast those levels. So we still feel good about the city. We feel good about our location. We're in locations within the city, and we think the supply continues to be absorbed, but we do anticipate that there could be some hiccups as we go through the year.

So are you modeling a deceleration from the 3, 6 or so that you did in New York in the second quarter in the balance of the year?

No, we're not.

You're not. Okay. And just a housekeeping issue, your closing cost, I guess, associated with the Blackstone deal, you modeled for the third quarter of about $8 million. That's considerably higher than what we expected. What's in that $8 million number?

A lot of that is driven by transfer taxes, particularly Washington D.C. has a very expensive transfer tax when you buy an asset there. And then there's also -- there's legal costs that are per portfolio transaction. It's just more expensive to get done than a single-asset acquisition.

Your next question comes from the line of Jeff Donnelly with Wells Fargo.

John, I was curious how do you think about the EBITDA growth of those 4 assets versus your own core portfolio rather than just the market. And I guess, would that mirror your outlook or the asset value growth of that portfolio as well?

Yes, Jeff, it definitely would. We see outsized growth in certainly 3 of the 4 hotels in terms of RevPAR. We also see margin improvement opportunities because, frankly, the hotels have added the cost back since Blackstone took them over in 2011, and they're just beginning to reap the rewards of enhanced marketing. We have some more marketing staff to put into the hotel, and we have significant renovations to put into it, to put in 2, particularly 2 of the hotels. But we see outsized RevPAR growth potential, food and beverage margin potential. We see a lot of potential both in revenue and profit growth outsized to our portfolio.

That's fair. I guess my question and maybe these are apples and oranges to deduce this, but if the core portfolio -- of the portfolio you just bought, you think is going to outstrip the market and you think it's going to outstrip your own core portfolio, does that sort of imply that a good number of the assets you already own in your existing portfolio are going to have sort of market-average-type performance? Does going to be -- lead you guys to thinking you might be selling more assets in the future? Or am I sort of stretching too far on that?

I think that's a little bit of a stretch, Jeff. I think what we're saying to you is that there are unusual opportunities in the Blackstone portfolio just because of the way they were run in the past, and capital that we see can be very profitably put into the hotels. I think from our existing portfolio standpoint, we're consciously repositioning the portfolio as you know, and as we've said several times, into the higher growth core urban market. And that's part of what this strategy -- this acquisition did. But that's an overall strategy for the company. So yes, there are some other hotels that we'll move within the next couple of years. Then, we'll follow that same strategy, and hopefully, the acquisitions will be available in the core markets and target markets we're looking for. And all that strategy is 100% geared towards increasing overall growth and profitability of the entire portfolio.

And specific to Westin San Diego, can you talk about I guess, how RevPAR index compares there maybe versus the Westin Gaslamp and perhaps, the W because they're both a few blocks away? I wasn't sure if you might share that with us .

Yes, they -- it has historically trailed, both of those hotels, and as you know, the Gaslamp just had a significant renovation, so until we do our renovation, it will be a little bit of a product disadvantage. I would say that the potential for the -- for our hotel has a lot to do with the completion of the federal courthouse. The more effective marketing to the legal concentration, it's already there and will grow dramatically, which I think we outlined as some plans that we have for that. And then increasing penetration with the San Diego Convention Center Authority and sales force is a major effort. And finally, this hotel has been virtually left out of the citywide marketing efforts of Starwood because they haven't marketed themselves to the team, which is a gross error in our opinion. So we think we'll gain share. I think that relative to the W and the Gaslamp, we haven't looked specifically with those because we don't know their shares, but relative to the comp set, we believe we'll gain significant share.

And it's more of a sort of, call it, late 2013 event, if you will, not nearer than that, I would presume.

Yes, that's certainly fair.

And just the last question is just more on the acquisition market. It's been hearing that there's more deals in the marketplace in the second half of the year than there had been in the first. I don't know if you agree with that, but everyone asks about cap rates. I was curious if you have a sense of what the trend has been in the -- like the unlevered IRRs that you guys underwrite on deals over the last few quarters, have you seen them coming down? How do you think about that?

Yes, jeff, this is Mark. We've -- I would say on the general volume of deals we're seeing, it's slightly up from what it was the first half of the year, one of the reasons we're so excited to do the off market transaction with Blackstone. But I'd tell you we missed out on a deal very recently because the pricing was well inside of what we were willing to pay. So there is still a lot of appetite for product -- for this core market product that comes out there, and the bidding's fairly intense and -- so we've seen -- well, at least on this one recent deal, we saw cap rates come lower than they were earlier in the year.

Your next question comes from the line of Neil Malkin with RBC.

This is Wes Golladay with Neil. Quick question on the travel commissions. I was under the impression they we're beginning to moderate in the first quarter. Looks like they're ticking higher. Was this due to mix? Or is this going to be higher going forward?

This is John. It was considerably higher than the first quarter. It came as a little bit of a surprise, and it was very concentrated in group and very concentrated in 5 top producing group hotels. So we're looking into each one of those situations as to whether or not there's an opportunity to kind of refocus the way these groups are being booked. But in general, the trend is negative because a lot of these companies and associations have taken the meeting planner out of their organization, so they contract it out, and the hotel has to pay the fee for it.

Okay. So probably a little bit less impactful third quarter and maybe another uptick in commissions in the fourth. Would that be a fair way to look at it?

That's probably fair because the third quarter group volume is lower and the fourth quarter is much higher.

Okay. And your recent deal, you guys put a lot of equity, 75%. Would that be how you look at it going forward just to get to the lower leverage that you guys cited earlier? Or is it target capital structure, I guess, for new deals?

I'll take that one. This is Mark. Wes, our strategy is to stay low leveraged overall. So right now we'll end the year about 4.5x debt-to-EBITDA with very low corporate debt. That feels pretty comfortable. That's on its way to going sub-4 during the cycle, and so it will depend on each deal and the size of the deals. These individual hotels can range from a small deal of $45 million to $350 million. So often, the size of the individual deal will influence how we finance it and what we want to do. But certainly, we remain firm in our conviction that low leverage is the way to go, so we will continue to run our company with that strategy.

The other point worth noting -- this is Sean -- on the funding of the Blackstone acquisition is that we had about $100 million of capacity on our balance sheet that was created by the disposition of 3 hotels to Inland. So part of the 75% of the equity fund with equity was the $100 million of that low grade [ph] of cash from the Inland disposition.

Your next question comes from the line of Will Marks with JPMC Securities (sic) [JMP Securities].

I just wanted to ask about next year's convention calendars. In some key markets, you had some good dialogue on third and fourth quarter this year.

Yes. Will, this is John. I can take you through a few of them. I mean in San Diego, they have a number of conventions are up like 10%. Room nights are roughly flat. Chicago, they're up -- or excuse me, they're down in total number of conventions by about 8%. About half of that in rooms. Minneapolis is up 4% in conventions, down a little bit in rooms; and Boston is down in 2013. And so as a result -- and Salt Lake City, excuse me, is up in 2013. Denver is also up in 2013. So I guess from our perspective, where we see a softer citywide, we have to work that much harder at in-house groups. And that's why at the Boston Westin, for example, we added that meeting space a couple of years ago because when you have this kind of situation where the citywides are down, you have to be able to defend yourself with in-house groups, and that's the focus at each of the hotels where the citywide base was not as good. The good news is we can see it coming.

Okay. And with the Blackstone deal, what is now -- it probably hasn't changed, but is group as a percentage of total?

Blackstone group as a percentage of total is lower than our portfolio, so it'll bring it down just a little bit. It's about 25% group. Our portfolio is closer to 33%. So it'll reduce a little bit.

And your next question comes from the line of Ryan Meliker with MLV & Company. Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division: Just a few questions here. First, with regards to your full year outlook, you mentioned that the Blackstone portfolio is going to be up 8% in 3Q and 10% in 4Q. Can you just give us some color on what your guidance really implies for your legacy portfolio and what trends you've seen from last quarter to this quarter that, I guess, it would seem like this has caused you to pull back on your legacy portfolio guidance ad whether that's more onetime in nature or more trending in general?

I think the main issue in terms of the full year guidance is the third quarter. We tried very hard in the first half of the year to fill some of the holes in the third quarter, and were not successful in some cases. So the third quarter is a little bit of a slowdown from what we had originally anticipated. The fourth quarter, however, is stronger than we had anticipated. So it's on balance, it's a fairly minor adjustment. Does that answer your question?

Right. If we look at year-to-date where we came in Q2, it's met our expectations and that our forecasts, quite frankly, in the middle of the range for the second quarter. We updated the full year guidance to reflect coming in the middle there. So if we didn't update the guidance, I think that the implied balance of the year would have been unrealistic, so we want to build the Q2 actuals, the middle of our guidance into the full year range, so if you just do the math, that requires some adjustments and where we've set full year numbers. Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division: Okay. And then as I think about EBITDA, maybe you'd give us some color on the seasonality of the Blackstone portfolio I guess. But when you issued you press release about the acquisition, you indicated around where you were anticipating full year EBITDA, that portfolio to come out -- are we assuming that, that $20 million of your full year guidance now incorporates Blackstone? Does that sound about accurate?

Yes, Ryan, this is Sean. The roll forward or EBITDA guidance as well as FFO guidance incorporates about $16 million of back half for the year EBITDA and FFO for the Blackstone portfolio, which is essentially the change in our guidance. Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division: Right. I think that's what I was getting at. Wonderful. That's helpful. The second thing I wanted to talk was can you give us some color, maybe additional color, I guess, on property margins. Looks like, excluding Frenchman's Reef, your legacy portfolio, basically, had flat margins on 6% RevPAR growth. Is that kind of what we have to see going forward in the current environment and we need 5%, 6% RevPAR growth just to keep margins flat? Or were there anomalous good points that we should factor in going forward?

I think the answer to your question is no, I don't think you need to factor in we need 6% RevPAR to achieve flat margins. I think this quarter, there were some unique things like -- one of them which was labor and benefits, and part of that problem was some of the positions that were filled in the second half of last year are showing up in terms of a comp issue in the second quarter. Then, labor and benefits were up just over 6 -- I'm sorry, wages and -- salaries and wages was up just over 6% in the second quarter. Benefits were up 10%. So that is much higher than we anticipate for the year, which is 4% to 5% total for wages and benefits. So I think we had some comparability issues in this quarter. We've gone back and looked at headcount, and that seems to be under control from 1 quarter to the next, but compared to last year, it's slightly higher. And then finally, if you look at the productivity numbers, we gave you man hours per occupied room and sales per man hour. Those are still positive, so those are FTEs at the hotels. So the focus for us is on salaries.

And then Ryan, the last point is on the property taxes, I mentioned earlier, impact our margin growth by 30 basis points. Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division: Right. But unfortunately -- I guess, we can all be hopeful that property tax increases will moderate at some point, but given the state of a lot of the municipalities, it doesn't seem like we're seeing an end in sight. That's why I was getting to that 6% growth number. But all that information was very helpful. And then a couple last quick questions. You mentioned earlier and maybe I missed it, but on group pace is up 7.8%. Is that inclusive of Frenchman Reef or exclusive of Frenchman's Reef?

That includes Frenchman's Reef. Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division: What is outside -- excluding Frenchman's Reef? I know its a number you've given in the past.

It's a little over -- it's over 6%. Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division: Okay. And how much of that is occupancies versus rate?

Rooms is about 2%, and ADR Is about 4.5%. Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division: Great. And then one last quick housekeeping question. Marriott next year, obviously, is going to a calendar quarter as they've announced. Should we expect you guys will follow suit as a result?

Yes. Ryan, we're -- we will follow suit next year. It's really -- it's not going to affect our fiscal year, which is already on a calendar year, but it will impact the comparability of the quarters next year, and we'll be able to provide -- we will restate prior quarters and we'll provide the operating statistics on an apples-to-apples basis when we report next year.

Your next question comes from the line of William Crow with Raymond James. William A. Crow - Raymond James & Associates, Inc., Research Division: Three very quick topics here for you. First of all, the group commission increase that you referenced that hurt second quarter, is that any set of indictment to Marriott's Sales Force One or whatever you call it, the realignment they did last year?

This is John. No, not in any way, I don't think. It's really a function of in the downturn, which was obviously so severe. A lot of companies and associations just eliminated their in-house meeting planning function, outsourced it. And unfortunately hotels are the -- suffered the fees associated with that. And it's interesting as you go the travel agent commissions, they're actually lower for individual travel but so much higher for group travel, which is 100%, well, almost 100% focused on the big group hotels within our portfolio. So unfortunately that's a phenomenon that we probably have to live with going forward. William A. Crow - Raymond James & Associates, Inc., Research Division: Okay. Second topic is Washington D.C. labor union negotiations, if you can give us any update and I don't know whether the Westin that you just acquired from Blackstone is a union hotel or not.

Yes. We're nonunion at the Westin, so we're not involved in the citywide negotiation. William A. Crow - Raymond James & Associates, Inc., Research Division: Okay. What are you -- are you hearing anything about that?

I haven't heard anything specific about it. William A. Crow - Raymond James & Associates, Inc., Research Division: Okay. And then final topic is the government per diem topic, and obviously, that's been a hot topic the last few weeks. Any thoughts there? Have you built anything into your assumptions for Washington, D.C. or San Diego, a couple of markets that could be particularly hard to hit as you think about the growth opportunities?

Right. We've built anything in because no one knows what it's going to -- what the outcomes going to be. We're pretty sure it's going to be lower, but I think in some of the key markets, I think they're trying to find ways to keep their travelers and their contractors in decent hotels as opposed to having go out to the suburbs and stay in Best Western. So we anticipate that some of the negotiations are going to take a little different format. We don't know what the overall format is going to be, but the rumor is they're going to drop up their upscale from the calculation. That doesn't really make sense. The rumor is in Washington, they're going to segregate CBD hotels and suburban hotels. That's going to be awful tough on suburban hotels. Overall, the business is only about 2.5% of our overall rooms revenue. And in Washington, D.C., it's about 4.5%. So it's not critical. What we're nervous about is kind of the spillover effect, and we're going to have to be pretty discreet about what business we take. And if a customer by contract has to get government rate, that's probably somebody we have to move out if it's a Draconian change. If people historically have gotten government rate even though it's not part of their contract, we're going to have to charge more money. So there's a lot of moving parts, and I'm not sure where it all lines up. William A. Crow - Raymond James & Associates, Inc., Research Division: What are you -- I agree the spillover effects could be important. What do you think the total demand is in somewhere like Washington, D.C. from government-related rates? It's only 4.5% from you. What is it for the market?

I don't know what it is for the market.

Your next question comes from the line of Enrique Torres with Green Street Advisors.

The Boston Westin, you got some pretty strong RevPAR growth there, but the margins actually shrank. Can you comment on kind of what are the cost issues of that hotel?

Yes, a couple of things to look at. This is John. There was a union audit there, which resulted in about -- we had to accrue about $200,000 for potential liabilities. There was -- that was the hotel I referred to in my prepared remarks that had a higher cover count and a lower average check. So that hurt food and beverage margins. I think sales and marketing was also an issue there. They -- Boston -- I'm sorry, Starwood has recently instituted a citywide marketing effort. They had some positions that were empty last year, that were unfilled last year that are now staffed, which is, I suppose, good for coverage but not so good for comps. So I would say those 3 areas in general on the course of the union wage increase that went into effect. At 8% this year, it is back-loaded.

Enrique, there's a couple of other factors below house profit. The property taxes year-over-year are up about $350,000. Plus, there's the ground rent, which is now cash ground rent, which historically we have not had to pay cash ground rent of another $100,000. So at the total impact, call it, $0.5 million, which is purely an increase to the cost.

Okay. Then, some of it in the house bottom line and some of it's is like below the line as well.

Correct. That's right.

It's going to be more onetime issues. Well, then at least then those won't be onetime.

Well, the property taxes and the ground rent are not onetime issues.

On comparable basis, it will be less impactful. And Enrique, just to point out, the RevPAR growth for the back half of this year at the hotel looks to be very strong, and we expect the margins will get better.

And then you guys gave some color on the group pace. You had mentioned that it's -- well, it's still strong at 8%. It did come down from 13% last quarter though, the forward pace for the rest of the year. How should I interpret that change?

I think there are 2 ways. I think over the last year, we have seen booking windows lengthen, and so I think we have more on the books as a percent of the ultimate forecast than we had in the past. So I think the availability is an issue. As overall occupancy increases and the other segments of the business gets stronger, there's less need for group. And I think other than that, it's sort of related to kind of the convention calendars in the city and where they sit particularly for the third quarter.

How was production in the second quarter?

Second quarter was -- in the quarter, for the quarter and in the quarter for the year were both down fairly significantly in the quarter for the quarter. But that was a huge impact from the State Farm group in Chicago, a million dollar group that canceled, which obviously nets out of the net bookings in the quarter for the quarter. So we were up a little bit in the quarter for the quarter x State Farm and we were up for the year x State Farm. But it's clearly moderated. Again, part of that is because of the -- simply the availability of inventory.

This concludes our question-and-answer session for today's conference. I would now like to turn the call back to Mr. Mark Brugger for closing remarks.

Thank you, Jasmine. To everyone on this call, we'd like to express our continued appreciation for your interest in DiamondRock. I look forward to updating you next quarter.

Thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a wonderful day.