DiamondRock Hospitality Company (DRH) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the DiamondRock Hospitality Company Third Quarter 2019 Earnings Conference Call. At this time all participants’ lines are in the listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please to be advised that today’s conference call is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker Ms. Briony Quinn, Senior Vice President and Treasurer.

Thank you, Howard, and good morning everyone. Welcome to DiamondRock's third quarter 2019 earnings call. Before we begin, I'd like to remind everyone that many of the comments made today are considered forward-looking statements under federal securities laws. As described in our filings with the SEC, these statements are subject to numerous risks and uncertainties that could cause future results to differ materially from those implied by our comments today. In addition, on today's call, we will discuss certain non-GAAP financial information. A reconciliation of this information to the most directly comparable GAAP financial measures can be found in our earnings press release. With that I am pleased to turn the call over to Mark Brugger, our President and Chief Executive Officer.

Good morning and thank you for your continued interest in DiamondRock. We are pleased to report solid operating and financial results for the third quarter. Before I get into the results, I'd like to first provide an overview of the economic and industry backdrop. After which I'll turn the call over to our new Chief Financial Officer, Jeff Donnelly, who will provide additional color on the portfolio performance as well as a balance sheet review. I’ll then conclude the prepared remarks with commentary or guidance and our outlook for the future. Current economic expansion continues to set records for duration, but the cloud of uncertainty around the political landscape and trade environment is creating a pause on business fixed investment and has tempered the near-term outlook for growth. Encouragingly, corporate profits continue to see steady gains and employment rates remain exceptionally strong and this is showing outsized disposable income and personal consumption growth. We believe these factors should continue to benefit our destination resort hotels and help support our portfolio results until the clouds of uncertainty clear and business consumption can hopefully reaccelerate. Lodging industry fundamentals were muted in the recent quarter. According to STR, RevPAR growth in the U.S., overall, for the third quarter was up 0.7%. This growth was uneven with the top 25 markets declining 0.4% and all other markets registering 1.3% growth. Importantly, demand continues to be healthy in the major markets, increasing 2.3% versus 1.6% growth in all other markets. While demand was superior in the top 25 markets, underperformance of RevPAR growth in the top markets was primarily attributable to new hotel supply as these markets are the most desirable for investors, developers and lenders. Rooms available in the top 25 markets increased by 2.6%, which is nearly 100 basis points higher than the supply growth in all other markets. We expect that these supply pressures will persist into next year for many urban markets. The many destination resort markets will have very low or no supply. DiamondRock’s third quarter profits were modestly ahead of prior guidance. This positive result was made possible by the hard work of our asset managers and operators, who delivered very solid performance in the face of a challenging operating environment. The portfolio's relative performance was very good. We gained share at over two thirds of our hotels and the portfolio reported a 1.6% increase in comparable RevPAR. This RevPAR growth exceeded our aggregate, competitive sets by over 400 basis points. Even more impressively comparable total RevPAR increased a robust 3.1%, thanks to excellent growth and outside the room spend by groups as well as the success with other revenue sources. Third quarter adjusted FFO was $55.3 million. Adjusted FFO per share was $0.27 and in line with our expectation. Third quarter adjusted EBITDA was $67.5 million, towards the high end of our guidance range. Comparable hotel adjusted EBITDA margins contracted 58 basis points in the quarter, but it is important to note that margins contracted only 15 basis points. If we exclude the disruption from Hurricane Dorian and the one-time benefit from business interruption insurance proceeds recognized for Sonoma in the comparable quarter last year. This is a testament to the tight cost controls being implemented at our hotels. We are proud of this result. And looking at how demand segments performed during the third quarter, we saw solid increases in group and business transient. Group and business transient demand increased 2% and a healthy 3.5% respectively, driving similar increases in segment revenues. Short-term pickup in the group was less than the first half of the year, but that was primarily because we had lots of groups already on the books as a result of strong group calendars in our markets, which left only the least desirable gaps to fill. We’re happy to have sold more group room nights in the quarter than the comparable period. Nevertheless, we are watching our fourth quarter pace closely as there are less citywide events in our markets in that quarter. Looking ahead, our booking pace for 2020 remains very strong and is currently up over 17%. We want to recognize the talented sales teams at our two most important group hotels, the Chicago, Marriott and Boston Westin, where our pace for next year is collectively up 30%. As expected, there was a small deceleration in our overall booking pace for 2020 from the end of the second quarter. The change primarily related to shift at smaller hotels, where frankly group is less important to their overall performance. Our resort portfolio shined in the quarter. According to STR, destination resort and spa hotels were the strongest performing segments in the third quarter with RevPAR up over 2% as compared to 0.6% decline at urban hotels. For DiamondRock, our destination resorts outperformed even this positive trend in the quarter. Collectively, our resort portfolio generated 2.2% RevPAR growth and outpaced their markets by 290 basis points. There are numerous success stories in our resort portfolio at hotels like the Vail Mountain Marriott, The Landing Lake Tahoe, and the Fort Lauderdale Beach Resort among others, but we want to highlight just two on this call: L'Auberge de Sedona and Havana Cabana in Key West. L'Auberge saw a 5.2% RevPAR increase in the quarter. Our pacing its competitive set by over 200 basis points. Hotel EBITDA increased 9% in the quarter and the property 2019 revenues and EBITDA were on track to beat our original underwriting at the time of acquisition in 2017 by over 10%. Havana Cabana, Havana Cabana continues to win awards and was named number three on the list of the top 10 best hotels in all of Florida by Travel & Leisure last quarter. The financial results were also excellent with 18% RevPAR growth. We expect both Havana Cabana and L'Auberge to outperform next year as well. Overall, we have strong conviction that our resort portfolio is at competitive advantage and over time we will increase our portfolio allocation to destination resort in order to capitalize upon what we see as a secular trend towards experiential travel. We believe that these type of properties will outperform the national average for the lodging sector for years to come. I'll now turn the call over to Jeff for additional detail on our financial results and market commentary. Jeff?

Thank you, Mark. And let me start by thanking you for placing your trust in me and thanking the entire DiamondRock family for welcoming me to the Bethesda. I feel fortunate to be a part of this team of warm, passionate, hardworking people. Let me take this opportunity to express my gratitude to everyone at DiamondRock for their patience with my questions and receptivity to new ideas. Before I walked through our third quarter income statement, I want to remind everyone that Comparable RevPAR, Hotel Adjusted EBITDA Margins, and other portfolio metrics are pro forma to include our 2018 acquisitions for all periods. Comparable results exclude Frenchman's Reef and Hotel Emblem for the month of September due to its renovation closure last year. Third quarter financial results were modestly ahead of our internal expectation owning the stronger total revenue growth. On a comparable basis RevPAR increased 1.6% in the third quarter driven by a 1% increase in average daily rate and 0.4% increase in occupancy. Hurricane Dorian negatively impacted RevPAR by 40 basis points with most of the disruption experienced in Charleston and Fort Lauderdale and to a lesser extent Key West. Third quarter room revenue was $174.1 million or $1 million behind expectations largely due to Hurricane Dorian. Non-room revenue however was $1.6 million ahead of expectations even despite an estimated $400,000 headwind from Dorian, because of strong growth in our F&B outlets and hotels in Boston, Chicago, Fort Lauderdale and Northern California, partially offset by the Western San Diego owing to softness in group at that hotel during the quarter. According to STR, over 60% of our sub-markets reported positive RevPAR growth during the quarter and over two-thirds of our hotels outperformed their sub-market in competitive set. The largest outperformers were avail Fort Lauderdale and Phoenix and the under-performers were Burlington and San Diego. For the outperformers, the Vail Marriott generated over 30% RevPAR growth compared to the prior year and outpaced its competitive set by comparable amount. Group and transient revenues were very strong owing to improved group sales initiatives and increased weekend leisure business that was limited by renovations in the prior year. Vail Mountain is set to open November 15th. We are encouraged by recent trends but remain vigilant whether recent modifications to redemption policies and Marriott Bonvoy program could impact financial results in the fourth quarter. The Western Fort Lauderdale saw 4.8% increase in RevPAR in the third quarter compared to a 10% decline for its competitive set. As we mentioned previously, financial performance was negatively impacted by Hurricane Dorian but it nevertheless outperformed because it remained open when many of its peers closed in anticipation of the storm. The Hotel Palomar Phoenix saw RevPAR increased 0.7% as compared to a 9.6% decline in the competitive set. A sharp decline in the volume and quality of events at Talking Stick Arena negatively impacted all transient channels in the quarter, but the well located Palomar was able to offset this impact with nearly 35% growth in group revenue and 20% growth in F&B sales. That's where the two underperformers RevPAR at the Hilton Burlington increased 2.6% in the quarter versus an 8.9% increase in the competitive set. The softness was the result of an inability to replace one-time group business in the third quarter of 2018 and the loss of an airline crew to a lower cost select service hotel nearby. The Western San Diego saw RevPAR dip 4.8% as compared to a 0.6% rides from the competitive set. This was the result of an inability to replace a series of in-house group events and the associated food and beverage revenue in the third quarter 2018. Our group pace for 2020 is up 6 points since the end of the second quarter and we're exploring options to enhance the awareness and appeal of the F&B outlets to attract the daytime population. From a segmentation standpoint, group revenues increased 1.2% in the quarter based upon a 2% increase in rooms and 0.8% decline in ADR, partially due to weakness at the Western San Diego. Transient revenues increased 1.6% on 0.1% increase in rooms and 1.5% increase in ADR. Drilling deeper, it was a business transient segment that was a real source of strength generating 3.3% revenue growth on a 3.5% increase in rooms. Total expenses grew 3.7% as a result of programs to reduce food costs which improved margins by 30 basis points and initiatives that increased labor efficiency by 50 basis points. Comparable hotel adjusted EBITDA was $73.4 million. In total this met our internal expectations but came as a result of slightly lower than expected rooms departmental profit that was offset by better than expected food and beverage profit as well as favorable variances in incentive management fees and property taxes. Comparable hotel adjusted EBITDA margin declined 58 basis points from 2018 but the result is really better than the headline number, because it was negatively impacted by two items. First 27, basis points from the recognition of business interruption insurance proceeds in the third quarter of 2018 for a fire-related closure in Sonoma in 2017. Second, 16 basis points from Hurricane Dorian disruption in the quarter. Adjusting for these two factors, comparable hotel adjusted EBITDA would have declined 15 basis points. Corporate EBITDA was $67.5 million slightly better than internal expectations and adjusted FFO with $55.3 million also ahead of internal expectations as a result of lower than expected interest rates. Adjusted FFO per share with $0.27 in-line with our prior expectations. The balance sheet remains in great shape. At September 30th DiamondRock had $26.7 million of unrestricted cash on hand and $1.1 billion of total debt outstanding at a weighted average interest rate of 3.9% and a weighted average maturity of 4.6 years. Net debt-to-EBITDA’s forecast to be 4.1 times at year-end assuming the midpoint of our new adjusted EBITDA guidance for 2019. It is important to point out who we received no consideration for Frenchman's Reef in this calculation. We have plenty of capacity with $325 million available on our $400 million senior unsecured credit facility. We also received a $40 million commitment for additional insurance proceeds in November from our insurers at Frenchman's Reef. A portion of those funds we expect to use to pay down the $75 million balance on the facility. We also continued our share repurchase activity in the third quarter. We repurchased 300,000 shares of common stock at an average price of $9.96 per share for a total purchase price of $2.8 million. We repurchased $7.8 million shares at an average price of $9.58 since we commenced our repurchase program in December 2018. We have $175.2 million of remaining authorized capacity under our $250 million repurchase program. We intend to be opportunistic about future share repurchases. Finally, DiamondRock announced a dividend of $0.125 per share that was paid on October 11 to shareholders of record as of September 30. I will now turn the floor back over to you.

Thanks Jeff. Turning to guidance. We are making the following revisions to our full-year 2019 guidance. RevPAR growth is now expected to be flat to up 75 basis points from prior guidance of flat to up 1.5%. Total RevPAR growth is raised to 1% to 2.5% from flat 2.5%. Adjusted EBITDA is now expected to be in the range of $256 million to $260 million from the prior range of $256 million to $265 million. And adjusted FFO per share is being raised to a new range of $1.03 to $1.05, $0.01 per share increase at the midpoint from the prior guidance range of $1.01 to $1.05. The primary reason that is driving our more conservative outlook for the top-end of RevPAR growth is that while moderating trends are playing out as we expected at the time of the prior earnings call, the more optimistic scenario for the high-end of prior guidance is now less likely given the lack of acceleration and business transient demand generally. Accordingly, we are maintaining the bottom end of prior RevPAR guidance, while adjusting down the top-end. Adjusted EBITDA was revised to take into account the new RevPAR range as well as the approximately $1 million of impact from Hurricane Dorian and about another $1 million of impact from PG&E’s unscheduled power outages in California, which affected our Sonoma and Sausalito hotels in October. All of our California hotels are currently open and operating at full capacity. And our new guidance assumes stable power delivery for the balance of the year. Despite these impacts, we are able to maintain the bottom end of the prior adjusted EBITDA guidance range of $256 million, while appropriately adjusting down the midpoint of the range by $2 million. On a positive note, total RepPAR remains a good story, and we were able to raise the bottom end of our total Revpar growth outlook despite the reduction in the top-end of guidance for rooms for RevPAR growth. This is a testament to the great efforts of our asset management team and operators working side-by-side to implement numerous programs to drive other revenue streams. Our adjusted FFO per share guidance was also raised at the bottom-end because the interest expense savings stemming from both the unforecasted receipt of additional insurance proceeds related to Frenchman's Reef that will be used to pay down borrowing on the revolver as well as lower overall borrowing costs. We at DiamondRock continue to seek out ways to drive shareholder value for you regardless of the economic environment with a focus on five areas. One, resorts. As I said earlier, our research shows that there is a strong secular demand for experience with travel that should drive outperformance for years to come. We believe destination resorts particularly in geographically constrained areas face lower supply growth and lower expense pressures than in the Top 25 urban markets and the overall industry. Two, ROI projects. We have identified $90 million of significant ROI projects that we believe will generate an incremental $17 million to $19 million of EBITDA. In total that's about $0.79 per share of incremental value over the next few years. Additionally, we are optimistic that we can grow this pipeline of ROI projects in the future as we continue to uncover new opportunities. Three, relaunching Frenchman’s. We will re-launch Frenchman's Reef as two distinct resorts, Frenchman's Reef Marriott Resort & Spa and the Noni Beach Autograph Collection Resort. Reconstruction is well underway with a grand opening currently expected in the fall 2020. Reopening the Frenchman's resort complex will be a strong and differentiating driver to our earnings growth in 2021. We believe these connected resorts can generate $25 million in EBITDA at stabilization, which translates into a great driver of portfolio profit growth over the next several years. Four, opportunistic recycling. We are exploring the opportunistic sale of one or two assets to lock in attractive private market pricing. Proceeds would be recycled for debt reduction, share repurchases or re-investment depending upon market conditions at the time. A broker has been engaged and any sale is unlikely to be completed this calendar year. It is our policy to not discuss sales until they are close given the uncertain nature inherent in these processes. Accordingly, we will not comment further at this time regarding dispositions. And five asset repositioning. To improve profit and build shareholder value we are pursuing several opportunities to change managers and continue our strategic transformation of the portfolio to be comprised of a majority of short-term agreements. We believe our proactive changes will provide source to both outside NAV and outside profit growth for DiamondRock, either in an challenging environment. It is premature to announce specifics, but we do expect to have continued success on this front in 2020. We believe these five focus areas will continue to distinguish DiamondRock going forward. And we are our especially by our 17% plus group pace for 2020. On that note, we'll now open up the call and take your questions.

[Operator Instructions] Our first question comes from the line of Anthony Powell from Barclays. Your line is open.

Hi. Good morning everyone and welcome Jeff.

Hi, Anthony. Thank you.

No problem. Question on leisure versus corporate, you mentioned that your resorts are up over 4%, but you also said business transient was good in the quarter. What's really the strongest segment right now, if there's any kind of difference and can you continue to see resort RevPAR growth at his level, if we keeps seeing kind of softer overall trends next year?

Yes. This is Mark. So the destination resorts outperformed and it's really going to attract consumer sentiment. So the consumer is doing well, which means the resort business is doing well. So we expect that trend as soon as the consumer sentiment index is up, we would expect that our leisure at the destination resorts to continue to outperform industry averages. Business transient did look good in the third quarter, but I would say that's less about business transient being good and mix shift. We had a good group quarter. We were able to fill a fair amount of available rooms with group leaving less rooms to sell for business transients, which meant we were able to put in higher quality business treatments, so we were able to wash out the lower rate of business transient, put in some higher rated. It wasn't true that we were getting more rates from the same BT customer. We were just mixed shifting because of the group powering the third quarter.

Got it. Thanks. And a lot of your Marriott properties seem to gain shares in the urban markets, are you seeing kind of better traction on the buyout program and how's that going to impact your RevPAR you think next year?

Yes. We are encouraged overall by the changes that Marriott is making. There are some lapping effect of some things that happened last year. Some changes coming as well that we think are going to allow them to continue to gain share in the marketplace going into 2020.

Got it. And you mentioned the Vail Marriott, are you talking about the off peak, on peak redemption changes there that can impact the quarter?

We don't. It started, and we don't anticipate it to have an impact, but it's hard to know, no one really can tell on that. The shifts from off peak and peak will – how it'll affective in the fourth quarter. But for the third quarter, it was consistent to prior year.

Anthony, I would say we're excited about the concept of the high-low demand periods and having a flexible redemption rate. We think that makes a lot of sense for the points. We think would get ultimately capture more business. But we don't have a history or power to play out and understand the algorithms and making sure we get there, right. There could be a learning curve there as it gets implemented, but ultimately it should lead higher index and greater profits for the hotel.

Okay. Great, thank you.

Thank you. Our next question comes from the line of Austin Wurschmidt from KeyBanc Capital Markets. Your line is open.

Good morning everybody. Mark with respect to your comments on changing your management agreements to shorter duration. Can you give us a sense of what the remaining term is on your in place agreements and what types of termination payments that you would have to absorb in order to shorten that term?

It's the question. So if you look at what we've done in the portfolio over the last three to five years, we've transformed it from what was 10 years ago, almost a 90% encumbered by long-term management agreement to a portfolio that's rapidly becoming majority subject to short-term agreements. We've made recent changes at the two growth properties uncovering those with a fairly small termination payment. The un-encumbering of additional assets over the next couple of years we think will come in a very minimal cost to us often making other considerations in that exchange.

Okay, fair enough. So separately, I guess with the comment about wanting to continue to grow the resort exposure, I mean it seems like with these asset sales that you discussed, you'd be lightening up in your – in some of your existing urban markets. Can you give us a sense of what markets you feel like you're a little bit overexposed to today and where you still want to maintain kind of some footprint longer term?

So I don't think we're overexposed to any one market right now. So we'd like to be about 10% [indiscernible] I think at max 15% in any – in one market. So I don't think that the concentration or diversity to driver, but we would like to sell some of our urban assets and either redeploy that into share repurchases or redeploy that into resort acquisitions that will continue to be our vent on external growth for the foreseeable future as we redeploy capital.

And should we expect that you would still want to maintain your current exposure to group or that some of the larger group houses could be a source of proceeds in order to redeploy into the resort strategy?

Yes. We're not going to get into specifics of which assets we're thinking about monetizing, but I'll just say we're looking at one where we think that there's an arbitrage between what we think the NAV is of asset and what we think the private market may be willing to pay for it. We think that it's a good time to test the market and to see if we can essentially exploit the public/private gap in valuation for a lot of these assets.

Understood. Thank you.

Thank you. Our next question comes from the line of Smedes Rose from Citi. Your line is open.

Hi there. I wanted just to ask on the expense side, it looks like you are today in a same-store basis, hotel expenses are almost 4% trending up and went up a little bit higher than that in that third quarter specifically. Just as we think about 2020, I mean, is there any reason to think that 3% to 4% range of cost increases would change at all either higher or lower?

Yes, Smedes, this is Mark. So the total expenses this quarter were 3.7 that's elevated because our, as you know, our total revenues were up over 3% with great F&B contribution, primarily from banquets. Banquets, we pay more people – banquet servers are higher on the wage scale, so that drives up the expenses commensurate with the additional revenue, so not surprising that it's a little bit elevated this quarter. Our current forecast for the full-year has total expenses coming in at 3% almost on the nose. Next year we're just rolling-up the budget on the expenses, but there will be wage pressure as we move into next year on both wages and benefits. So we anticipate that at all. It'll be at least 30% as we move into 2020.

Okay. And then I just – I think on your last call, so putting aside any proceeds from asset sales you talked about – I think about $300 million of investment capacity. So maybe going from here, I mean, you put a pause on repurchase activity, it wasn't – you didn't do more from the, when you did your second quarter call and you announced this repurchases in August, what sort of your updated thoughts I guess around in near-term uses of capital?

Well, I think acquisitions are highly unlikely at this point. We still believe that we're trading at a enormous discount to NAV. So share repurchasers remain very attractive way to capture that value for our shareholders and to continue in dialogue in the board room about when and how much to do, but we're going to be opportunistic in that to address that.

Okay. I mean, was there a reason why you wouldn't continue to purchase shares over the course of the third quarter then?

Well, we had authorization for a certain amount and then we had a board meeting that just occurred in the last two weeks. So we regrouped at the board meeting to discuss the next action from share repurchases.

Okay, thank you.

Thank you. Our next question comes from the line of Patrick Scholes from SunTrust. Your line is open.

Hi, good morning, Mark and Jeff.

Good morning, Patrick.

A couple of questions for you here. One thing I found very interesting in your earnings release and guidance was your total margin guide going up and you touched briefly on your asset managers and property managers helping with that. Any more specifics that you can give on that you know? Surely that's not something we've – that margin increase we've seen with other names, I’m curious what the – shed some light on the secret sauce that DiamondRock is using?

Tom, do you want to take that one?

Sure. We would continue to implement and focus on driving compliance on our food program. We look at energy holistically. We’re working on some addition of water savings programs and biodigester, small nickel and dime savings on waste. Energy continues to come in. Our energy was down 20 basis points, I believe for the quarter on more rooms sold. The labor piece is something we continue to focus on and measure on a weekly basis. And then the goal is obviously to try to drive more revenue, which helps reduce your – as a percentage of cost. And so we have a host of revenue initiatives, smaller ones that we continue to push through.

Yes, Patrick I would just add, it's just so – it's just dramatic [indiscernible] it’s so systematic across the portfolio and expense reduction on a couple programs. Labors are most – is our largest costs category. That's our number one focus in terms of our cost category. So we've implemented new systems and technologies and a number of properties which have allowed us to increase productivity to better schedule the employees and to be more efficient, pay less over time with new efficiencies and there's new technologies that have been implemented at some of the properties, particularly the non-brand operated properties that have allowed us to reduce some of the labor inefficiencies and increase the profitability there. Food costs, similarly we have a program that we've been rolling out over the entire portfolio. It's a program that Tom had brought with him from Strategic when he came over. And as you saw in our third quarter, we lowered our food cost and increase margin there by implementing that. And then energy probably would be the next category. And here there is a lot of nickels, dimes and quarters, whether its thermostats or biodegradable machines that take care of the waste from the kitchen. It's a lot of smaller items on the energy front. But we're always thinking about being better, better members of the community on the green front. But also about how we can reduce our energy footprint and reduce costs on energy front and then there's a whole host of very, very small things. I will ask that with Tom and his team of asset managers who are communicating what they're doing at the properties, the discussions on some of the small cost items sometimes get lost when you talk about what we are doing. You know hundreds of millions dollars revenue and they're focused on things that save us $6,000, but it's a $6,000 item and I think the general culture and attitude about expenses that permeate into the better cost controls generally.

Great. I appreciate the color there. And then just one additional question here. I saw that you picked Aimbridge or Frenchman's Reef, I suppose to save Marriott. What are your thought around that? Thank you.

Well, we remain big fans of Marriott and they operate a number of our properties. At this particular property, we thought that Aimbridge with their experience in the Caribbean and frankly our personal relationships with the CEO of Aimbridge and their dedication of specific resources to position this hotel success were really the right solution in choosing the operator. They really have some terrific talented people that are experts on the Caribbean market. And they've made a commitment to dedicate a number of those resources almost exclusively to this property in a way that I think no one else could given their scope and their desire to develop the partnership with DiamondRock.

Okay, great, great. Thank you. And Jeff, congratulations for joining DiamondRock. I will save my detailed accounting questions on contract revenue accounts and sales allowances to your next call. Thank you.

I appreciate that, Patrick. Thank you.

Thank you. Our next question or comment comes from the line of Rich Hightower from Evercore ISI. Your line is open.

Hi. Good morning, guys.

Good morning.

Jeff, it's equally good to bury the hatchet, you’re now – that’s on the other side. So…

Well…

Yes, of course. So, we've covered a lot of ground already, but maybe just following up on Patrick's question on Frenchman's. Now with respect to the manager, but with respect to the brand, how many other brands were seriously in contention for the asset or assets as it were? And maybe walk us through some of the other deciding factors that where you went with Marriott and of course Autograph in the package there. Just sort of take us into the hood to the extent that you can in a public forum like this.

Sure, Rich. So we had essentially an RFP process where we went out to the brands, the big brands that you can imagine would do well in the Caribbean and could source a lot of business, particularly from the Northeast markets. It came down to a competition to three, and then it was, I'd say, a hot competition between the final two. There are a number of reasons ultimately that Marriott we think will be the most successful brand there and not that the others aren’t very powerful, but the established reputation of Marriott within the Island carry a lot of brand equity at this particular property. We think that there is size of their system and the success of this hotel have had within their system being proven on the redemption side carried a lot of way. And frankly, Arnie's personal commitment to ensure success of the asset, we thought made a big difference in kind of setting yourself again for success of the property.

Okay, that’s helpful. And then maybe this is a question for Tom, but just since it's been heavily in the news this week, what do you guys make of Google increasingly promoting its own travel content at the expense of the OTAs? And how does any of that impact DiamondRock’s revenue strategy? Is this a meaningful trend for the REITs? Or is it really not that impactful at the end of the day?

Tom, I'll jump in, this is Mark. So, Rich, we've actually been spending a lot of time on digital, I'll call it digital marketing and the cost of intermediaries. And listen, Google is another intermediary and another person that's trying to take a toll on our cost of procurement on the customer that something we need to be aware of. I think the great advantage we still retain is that we control what happens to the customer once they get to the front door in a way that we haven't given over to them the ability to pick the room and really customize the service when someone walks in the front door of the JW Marriott wherever the hotel may be. So we're thinking about how we continue to differentiate and customize our service, but I think we are well aware of it. I think we need to be smart about what give over to the Googles and the Amazons and the Apples and the Facebooks of the world over the next decade. Probably the person who loses isn't the hotel owner. It's really probably going to be the existing OTA's that are going to be cut out of the process. So over time we think that it's manageable, but we do think that the intermediaries will change over time.

And any follow-up from Tom on that topic, just it's a really interesting one that's kind of been at the forefront this week.

Rich, the competition is good. You can't – you're not – you can't fight Google. You just have to find out the best way to use it and leverage it. The tools – we have tools out there and how to go direct to the customer. Social media is more important than it's ever been before. How the hotels perform, how they perform, their social score. We continue to look at improving their lobbies, improving sense of arrival, improving customer experience. That TripAdvisor ranking is critical. We've moved into quarter, our Trip ranking, we took it from 63 to – 63rd percentile to 60 – almost 66 percentile, heavy focus on improving our – the reputation of the hotels. As Mark spoken of our awards, but when you think about some of the things we've been doing, we’re trying to improve the guest experience. That guest experience and sense of arrival and customer facing interaction will certainly help us in the Google channels in driving additional revenue. And then it's just our job to control it and to monitor and get the right price. But when you think about the Westin Fort Lauderdale is 9 out of 131 in TripAdvisor, the Lona concept we put in is the number one Mexican restaurant, the third best restaurant in Fort Lauderdale. Havana Cabana has won numerous awards. It was just 11th on Condé Nast Readers’ Choice, the Palomar some of the changes we’ve made there, it’s six in the southwest of Readers Choice, Sedona – 16th in the Southwest for Readers' Choice in Condé Nast. A lot of the improvements we've made in Denver at the JW, all the renovation capital that hotel is now 20th on Condé Nast Readers' Choice for the awards. And then Gwen continues to perform well in that sector. It's sixth. So you could see where we're allocating capital and how we're spending it is critical to the guest experience. And as we have improved those and have improved the recognition and the placement of those hotels, the algorithms and we'll drive that up to the top of the list for Google and we'll take advantage of it where we can. We liked the independent hotels because we can control the business and we control going directly to the customer, which gives us an advantage. When you look at how Havana Cabana has been performing against the concept, which includes the Hilton and Marriott brand. It is outstanding because it's authentically relevant. And when we can do that in our hotels and create that authentic relevance, people will buy that. And so the good news is it's another channel. The good news is I think it's going to compete against the OTAs, competition will drive down pricing. And I think in the end if we are strategic in how we handle that, I think we should do okay with it.

Awesome, thanks for the color guys.

Thank you. Our next question or comment comes from the line of Thomas Allen from Morgan Stanley. Your line is open.

Hey, good morning. So when I do a simple average of the quarters and it implies 4Q RevPAR guidance is about down 2 to up 1. Is that right? And then can you just talk about results in October and kind of how you're thinking about the things that get in place November and December? Thank you.

Hey, Thomas. This is Jeff. You're correct in your math on fourth quarter. That's effectively in the vicinity of what the RevPAR would be for the fourth quarter implied by our guidance. As far as October, we actually don't have a good estimate at this time of our RevPAR for October, mainly because of some of the disruption that was caused in the quarter from the voluntary power outages out in California, but, of course, we don't have anything else we can add at this time.

Okay. And then just one thing I noticed on your balance sheet was that you only had $27 million of cash at the quarter end. Is that a new strategy? Is that a one-off thing? And did that influence your buyback decisions? Can you just help us to think about that going forward? Thank you.

Hey, Tom. This is Mark. Now, we tried to keep about $25 million as the minimum cash. We tried to use our revolver very efficiently to keep our interest expense down. We still think we have very conservatively $300 million of investment capacity at our current level of leverage. So that wouldn't take the cash balance of signaling anything one way or another other than we're trying to be efficient on our interest expense.

Helpful, thank you.

Thank you. Our next question or comment comes from the line of Chris Woronka from Deutsche Bank. Your line is open.

Hey, good morning guys and Jeff, welcome on board. So I want to ask about New York for a minute. And kind of your – I think your four hotels, I think you have mixed results kind of year-to-date, but overall I think in the aggregate you're down a little bit. Do you still have a really long-term positive view in that market? Or do you think there are some secular impairments from a margin perspective? And maybe you might delineate your answer based on kind of your select service assets versus the Lex?

Sure, I'll take this. Chris, I think, the long term for New York structurally looks pretty good. So supply after we get through the next year starts getting a lot better. And we know that there's a number of hotels that they're talking about taking out and covering that those hotels turn them down and building office towers. So particularly on Midtown East, the set up over the next five years we think looks favorable. We don't think next year is going to exceed the industry average, but we do feel fairly confident in New York low rebound over the next few years and we'll be a good mark to be located. And there is no doubt that we have expense issues. It's a union - it's that we have union hotels. I would say in this particular market, it's constructive in that. The current contract goes through 2026 and a CAGR of wage growth is below 3%, but real estate taxes have been going up. We just have gone up more than inflation over the last forever really. So there are similar pressures – similar pressures that you get in a market like San Francisco. But we do think once the supply starts to subside, which we think occurs after next year, we do think that the New York market will once again return to healthier levels. It doesn't mean it will return to prior peak, but we do think that it'll start exceeding national average growth rates as soon as we can get the supply under control, which is probably the next 18 to 24 months.

Okay, great. And then want to stick on the cost topic, but to the portfolio more broadly you guys had a lot of success in this kind of low RevPAR growth environment. But at some point we hit a downturn. I mean has what you’ve done to date? Does that impair at all your ability to take a step down in further cost reductions if you need to do something more, more severe later?

Chris, this is Tom. We have – as part of the process of budgeting process this year, we're really focused on – we're very focused on cost and contingency plans in case – certainly in case there is a downturn and we have opportunities to try to reduce costs, fixed costs and certainly variable cost will go down. So does it get more challenging? Certainly it gets in an extended period of low RevPAR growth with low unemployment. It certainly creates the challenge for the asset management team, but we have a roadmap and we have a plan. And so, what we will do is implement that plan and to whatever level that's required to try to maintain margins. It’s certainly – it's well documented. It’s a tricky time to do business with wage pressure, low unemployment and then low RevPAR. And the focus will continue to be cost, but we also have to find other ways to get other revenues and we have to find ways to drive incremental revenue and rate out of our properties. And that's what we'll do, but we do have plans. We have contingency plans in place for revenue RevPAR, total RevPAR declines and we have it at different levels and we have a plan to pull the trigger on the different levels.

Okay. Very good. And then just on Frenchman's, it's an impressive stabilized EBITDA target you guys put out there. Is there any – and I know that there is clearly going to be some revenue upside, but is there anything that's changed with the structure of how the property is operated? Or any of the – is there more flexibility in some of the ways that you staff or things like that?

Yeah, this is Mark and Tom can jump in here too. So we're going to open with new F&B outlets that we didn't have before. Everything will be – everything essentially that got replaced from the hurricane will be new on the stuff that was damaged previously. So it gives us a very nice product for the consumer. So we think that there's – a lot of savings that come from having the new infrastructure projects. So there will be not only a better revenue, but we expect to have better profitability because we'll have a new energy plan, new water plant, and other efficiencies that we didn't have before.

And instructionally we think that we have a better opportunity, creating two resorts to set separate pricing. So you won't get the upgrade from up top down to the beach front. We will have two separate pricing plants. Noni Beach will have its own market strategy and sales deployment. The Noni Beach we believe will be able to play in some luxury channels, which will drive incremental rooms that didn't exist before and we'll drive incremental rate. And then we have some additional revenue streams that we will – retail, leisure services and activities that we believe will drive significant revenue increases outside the room.

Chris, as you know, above the claim, we've talked about before, above the claim money of – DiamondRock is going to invest over $50 million to enhance the property. So we expect a very strong return on our enhanced dollars.

Okay. Very good. Thanks guys.

Thank you. Our next question or comment comes from the line of Michael Bellisario from Baird.

Good morning everyone. Just on the same topic of Frenchman's. Can you maybe give us your estimate of how much more capital that you need to spend or that you do expect to spend? And then maybe explain why you did get that $40 million the commitment from the insurance companies because I think I heard you say was it unexpected? And then how might that impact any potential settlement payment you'll get down the road?

So let me take the last one first. So we're in litigation over the insurance claim with the trial date in January. So as you can imagine, we need to be a sense of our discussion around Frenchman's Reef, the payment is a small piece of what we think were owed. They have an obligation to continue to adjust the claim all the way up to the trial date. We didn't expect and didn't want to build in any expectations to receive any cash before that trial date because it really depends on their judgment. We're not going to get anything forced until we get to court. But that's kind of the story on the cash. I don't know that it has an influence on whether we settle or not before we get to the trial, but we appreciate the cash certainly. Michael, remind me your other parts of your questions.

And just how much more cash out the door that you think you'll have to spend?

So from above the claim, we're well over $50 million of enhancements. So the majority of those are things like the Noni Beach Autograph Collection, we think that there is a significant rate premium by extensively renovating those rooms and taking them up quite a notch that there's well over $100 of rate potential by making that kind of investment for our bias. There is some F&B enhancements that we're doing on our dime that we think will be a great customer experience, but also help the ultimate performance of the hotel as well. There is a number of those, but I think the number to think about is a number north of $50 million from the company going into this above the claim.

Got it. I sense you probably don't want to go down this path, but I was going for more so that kind of gross cash out the door for you guys. I am just trying to figure out potential balance sheet leverage impact between now and when a settlement is ultimately received, but we can discuss that offline further. Just switching gears, one more, maybe for time on the group side, it seems like everyone is pursuing the group up strategy. I know you guys have talked about it for a few quarters now. I guess my question is do you sense it's getting more competitive to capture incremental group because everyone else is trying to go after that same group. How much more room is out there to actually get? And then how are you guys changing your approach here if at all?

So we still think it makes sense to group up in a defensive posture given the moderation in business transient demand. A lot of your success or failure in group and your ability to execute on that strategy depends on the strength of your particular market. So in Boston and Chicago, we have good city-wides, it's going into 2020. So it's easier to execute on that strategy and we think actually, Tom's group with – along with Marriott those two properties has done a tremendous job in capturing a lot of in-house group and really more than their fair share as we move into next year. So it looks like based on our pace and our ability to execute on it, we're having success and continue to have success on that front. The group pace at the Boston Westin is up something like 40% for next year and I think we're up almost 25% in Chicago Marriott. So I think the – a lot of people will pursue the strategy because it makes sense in light of the weakness in business transient. But so far we continue to have success despite competition for those groups.

Thank you.

Thank you. Our next question or comment comes from the line of Dori Kesten from Wells Fargo. Your line is open.

Thanks. Good afternoon guys and welcome, Jeff.

Thanks, Dori.

Given the strong group pace for 2020, how should we be thinking about total RevPAR growth versus RevPAR growth for next year?

You know Dori, I think this year we've actually had good success. Obviously in our total RevPAR growth I think has exceeded our rooms RevPAR growth by about 150 basis point to 200 basis points. And I think next year as we think about that revenue mix, I think we're optimistic that we can maintain that pace for next year. Yes, I think that's the way we are thinking about it.

Okay. The $90 million of ROI projects that you talked about, how long do you expect it to take to generate the incremental $17 million to $19 million in EBITDA?

Those projects that's going to be capital that's expended, it's actually already been occurring 2019-2020 and we think most of those projects will probably have about a two-year ramp after that. So I think you’re going to see this come folding into our numbers in 2020, 2021 and 2022.

Okay, thank you.

Thanks.

Thank you. I'm showing no additional questions in the queue at this time, I'd like to turn the conference back over to Mr. Mark for any closing remarks.

We just like to thank everyone for participating in today's call and we want to thank you for your continued to interest in DiamondRock. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.