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Edited Transcript of DRH earnings conference call or presentation 4-May-18 1:00pm GMT

Q1 2018 DiamondRock Hospitality Co Earnings Call

BETHESDA Sep 10, 2018 (Thomson StreetEvents) -- Edited Transcript of DiamondRock Hospitality Co earnings conference call or presentation Friday, May 4, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jay Lecoryelle Johnson

DiamondRock Hospitality Company - Executive VP & CFO

* Mark W. Brugger

DiamondRock Hospitality Company - President, CEO & Director

* Sean Kensil

* Thomas G. Healy

DiamondRock Hospitality Company - Executive VP of Asset Management & COO

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Conference Call Participants

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* Anthony Franklin Powell

Barclays Bank PLC, Research Division - Research Analyst

* Austin Todd Wurschmidt

KeyBanc Capital Markets Inc., Research Division - VP

* Bennett Smedes Rose

Citigroup Inc, Research Division - Director and Analyst

* Gregory Poole Miller

SunTrust Robinson Humphrey, Inc., Research Division - US Communications and Internet Infrastructure Analyst

* Jeffrey John Donnelly

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Lukas Michael Hartwich

Green Street Advisors, LLC, Research Division - Senior Analyst

* Michael Joseph Bellisario

Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst

* Richard Allen Hightower

Evercore ISI Institutional Equities, Research Division - MD & Research Analyst

* Shaun Clisby Kelley

BofA Merrill Lynch, Research Division - MD

* William H. Ketelhut

Goldman Sachs Group Inc., Research Division - Associate

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the First Quarter 2018 DiamondRock Hospitality Company Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to introduce our host for today's conference, Sean Kensil, Director of Finance. Mr. Kensil, you may begin.

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Sean Kensil, [2]

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Thank you, Sarah. Good morning, everyone, and welcome to DiamondRock's First Quarter 2018 Earnings Call and Webcast.

Before we begin, I would like to remind participants that many of our comments today are considered forward-looking statements under federal securities laws and may not be historical fact. These statements are subject to risks and uncertainties as described in the company's SEC filings.

In addition, as management discusses certain non-GAAP financial measures, it may be helpful to review the reconciliations to GAAP set forth in our earnings press release.

This morning, Mark Brugger, our President and Chief Executive Officer, will provide a brief overview of our first quarter results as well as discuss the company's revised outlook for 2018. Jay Johnson, our Chief Financial Officer, will provide greater detail on our first quarter performance and discuss our balance sheet.

With that, I'm pleased to turn the call over to Mark.

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [3]

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Good morning, everyone, and thank you for joining us on DiamondRock's First Quarter 2018 Earnings Call.

I am very pleased to introduce Jay Johnson as our new CFO. Jay brings with him a wealth of experience and knowledge about the hospitality and baking industries. He is a tremendous addition to the team. For those of you who have not yet met him, I'm certain that you'll appreciate his thoughtfulness and insights.

It's great that DiamondRock is able to start the year on a positive note. Lodging fundamentals performed modestly ahead of our internal expectations, with industry RevPAR growth of 3.5% for the first quarter. Resorts outperformed and had another strong quarter with 6.4% RevPAR growth. This encouraging trend for lodging demand, along with the success of our several of our asset management initiatives, has allowed us to raise DiamondRock's full year outlook for RevPAR to 1.5% to 2.5%, a 100 basis point move at the midpoint compared to prior guidance. Adjusted EBITDA was raised to $254 million to $263 million, a $3.5 million increase at the midpoint and a $5 million increase at the bottom end as compared to prior guidance.

Delving into DiamondRock's first quarter results. RevPAR and EBITDA came in ahead of our internal forecasts. Comparable RevPAR growth was 1.8% as the portfolio gained 70 basis points of market share during the quarter. In fact, 23 of our 28 open hotels outperformed their budget in the quarter, an encouraging sign. The results were bolstered by strong results at our resorts, which were up 7.4% in RevPAR and our New York City select service portfolio up 5.7% in RevPAR. Star performers in the quarter included our 2 hotels in Sedona, the Shorebreak California resort, The Lodge at Sonoma, The Gwen Chicago and the Charleston Renaissance. Top line results were held back by the inaugural comp at our D.C. hotels and the renovation impact at our Chicago Marriott. Excluding these hotels, portfolio RevPAR increased 3.6%, which is roughly in line with industry performance and well ahead of performance for upper upscale segment. Jay will discuss our first quarter results in more detail a little later on this call.

Let's spend a minute on DiamondRock's capital recycling program. In 2016, the company made the strategic decision to enhance its overall portfolio by selling 3 noncore hotels for $275 million at a 12.8x EBITDA multiple or a 6.6% NOI cap rate, including deferred capital. The strategic play was to reinvest that money into higher-quality hotels with superior NAV growth potential. The sold hotels had an average RevPAR of just $120 as compared to our current portfolio RevPAR that is about 50% higher than that. Since we executed on those dispositions, we acquired 4 hotels for approximately $220 million. These hotels have average RevPAR of $219, almost $100 higher than the sold hotels. The 4 new hotels collectively outperformed in the first quarter with RevPAR growth of 6.3%.

Our first redeployment was the off-market acquisition of the L'Auberge de Sedona and Orchards Inn Sedona. These hotels are great examples of DiamondRock's strategy of focusing on supply constraint markets late cycle to reduce risk and ride what we believe will be a sustained trend towards experiential resort out-performance. The 2 Sedona hotels, both had double-digit RevPAR increases last year. In the first quarter of 2008 (sic) [2018], they delivered some impressive results with combined RevPAR growth of 21%, EBITDA growth of 41% and 420 basis points of margin improvement. In our first year of ownership alone, our team increased profits such that the 12.6x board EBITDA multiple at acquisition is now only a 9.6x multiple on our current investment. We estimate that NAV has increased over $10 million or approximately 11% since our acquisition just over a year ago.

Continuing with our redeployment program, we recently executed on 2 acquisitions during the first quarter. The Landing Resort & Spa in Lake Tahoe, California, and the Hotel Palomar in Phoenix, Arizona. The Landing is a boutique luxury resort in one of the best locations in the Lake Tahoe market. It was recently ranked a top 20 hotel in the entire United States by TripAdvisor's Travelers' Choice awards. The Lake Tahoe market is primarily fed by the San Francisco Bay Area just a few hours drive away. The market is supply insulated and has grown at a 9% RevPAR CAGR over the last 5 years. This is one of the only resorts in the U.S. that has a beach out its front door and a ski gondola at a little short walk out its back door. Moreover, the resort has a number of value-add opportunities, including a rare and valuable rate in Lake Tahoe to increase the key count by 20%. Based on our analysis, this deal should stabilize in a few years at a 10.5x EBITDA multiple on our total investment.

The other acquisition in the first quarter was the Hotel Palomar in Phoenix, Arizona. This is the best hotel and best location in downtown Phoenix. The hotel is rated top 4 in TripAdvisor among 174 hotels in greater Phoenix. We are bullish on the Phoenix market. Phoenix is the 12th largest MSA in the U.S. and demand growth in the city has been among the fastest in America with a 7% RevPAR CAGR since 2012. Lack of new supply has been another attractive part of the Phoenix story with less than 1% supply growth over that same period.

The growth and revitalization of downtown Phoenix has been remarkable. It now has over 23 million square feet of office space and is home to a diverse group of demand generators. The Palomar is the heart of Phoenix's CityScape development, which sits blocks from the convention center, Diamondbacks baseball stadium, the Phoenix Suns basketball arena and major office tenants in downtown Phoenix. This deal is off market, and we believe we bought it at attractive pricing.

The acquisition price represents a 12.6x multiple of budgeted 2018 EBITDA. We've just begun implementing our value-add program, and we are making property-level operational changes to enhance performance. After implementing our changes and benefiting from market growth, we expect performance to stabilize in a few years at a 10.8x multiple on our total investment.

Before turning the call over to Jay, I do want to touch on the impact on our portfolio from last year's hurricanes. Two properties were closed for extended periods as a result of the hurricane impact. The Inn at Key West as well as the Frenchman’s Reef resort in the U.S. Virgin Islands. I'm pleased to let you know that the Inn at Key West reopened in April as the Havana Cabana after substantially completing its renovation. The newly deemed Cuban-inspired resort is imaginative and different, and we believe that the fresh product and concept will be able to drive $1 million in upside over pre-hurricane results once stabilized.

The Key West market continues to ramp back up from the hurricane, albeit a little slower than we would have hoped. There is positive demand for bookings later in the year, and we have strong conviction about this market long term. More consequential, the Frenchman's Reef resort sustained major hurricane damage and will remain closed through at least the end of 2019. This creates a unique opportunity for DiamondRock. We have comprehensive insurance with a $361 million cap, subject to certain limitations that covers DiamondRock from both property damage as well as lost profits from business interruption. As we previously told investors, we anticipate recognizing approximately $20 million in total business interruption insurance in 2018 for all our natural disaster claims. Any rebuild of the resort will result in a world-class practically new resort with the best location in the U.S. Virgin Islands. We have begun discussions with insurers on the property portion of the claim, important in any rebuild scenario, and hope to have a more definitive update on Frenchman's during our next earnings call. We remain confident though that any likely outcome will create value for our shareholders.

With that, I'll turn it over to Jay.

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Jay Lecoryelle Johnson, DiamondRock Hospitality Company - Executive VP & CFO [4]

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Thanks, Mark. Before we begin, I would like to say what an honor and privilege it is to join DiamondRock as CFO. I look forward to getting to know our investors and spending more time with analysts that cover the company. I was excited to join DiamondRock because of its great team, high-quality portfolio and balance sheet capacity to be opportunistic. DiamondRock has a compelling story, and I'm looking forward to hearing your feedback in the coming weeks.

Before I discuss our first quarter results, I would like to remind everyone that comparable RevPAR, hotel-adjusted EBITDA margin and other portfolio metrics include L'Auberge de Sedona, Orchards Inn, The Landing Resort & Spa and Palomar Phoenix while excluding Frenchman's Reef and Havana Cabana Key West for all periods presented.

As Mark noted, we had a good first quarter. Our hotels performed well and gained market share during the period. Comparable RevPAR grew 1.8% through a combination of increases in both occupancy and room rate. While January was difficult with RevPAR contraction due to the inauguration comparison and having our meeting space under the knife at the Chicago Marriott, RevPAR growth for the balance of the quarter was strong with February and March increasing 4.6% and 2.2%, respectively. Over 80% of our hotels beat budget in the first quarter.

We began the second quarter strong with April RevPAR growth just over 4% and expect May and June to be essentially flat year-over-year. Food and beverage revenue was approximately flat and margins were down 192 basis points during the quarter. F&B results held back primarily because of renovation of the meeting space in Chicago Marriott which displaced group business. Excluding the Chicago Marriott, food and beverage revenue was up 7.4% with margins down only 47 basis points.

Now let me spend a couple of minutes discussing the quarter's results and trends in our 3 major segments. First, business transient was our strongest segment this quarter with 5.6% growth, driven by 4.4% increase in occupancy. The Chicago Gwen significantly outperformed following a successful renovation where business transient revenue tripled year-over-year. Other top performers include the Charleston Renaissance, Westin Fort Lauderdale, Worthington Renaissance and the Chicago Marriott.

Leisure contract and other was down 5.5%. However, this is a little misleading given leisure overall and resorts, in particular, did well in the first quarter. A significant driver to the decline in leisure was the inauguration comparison affecting our D.C. hotels and an unusually weak snow season in Vail. Finally, the group segment performed ahead of our expectations in the first quarter, growing 3.6%. This was based on a 2.6% increase in rate and 90 basis point increase in occupancy. Short-term trends were encouraging with our in-the-quarter, for-the-quarter bookings up nearly 50%. Our recent renovations were particularly effective at driving group business. The Lodge at Sonoma, Shorebreak, Charleston Renaissance and the Chicago Gwen grew at a combined rate of 68%. Group was most challenged at the Chicago Marriott as expected due to renovation of the meeting space. Excluding the Chicago Marriott, group revenues were up 6.4%.

Looking forward, we booked approximately $20 million in group business in the first quarter, and we have approximately 80% of our group business on the books for the year. Our group pace has improved modestly since our last call, although it remains approximately flat for the year. We expect the third quarter to be the most challenging for our group segment and the fourth quarter to be the strongest due to convention calendars in our major markets.

I'd like to spend some time discussing results in a handful of our key markets. Our Chicago hotels performed well this quarter, with combined RevPAR growth of 15% despite the final phase of the Chicago Marriott renovation being completed during the quarter. Group pace is up 13% combined for both hotels for the remainder of the year. We expect Chicago to significantly outperform in Q2 as well as the remainder of the year. In particular, The Gwen delivered some of the best results ever for the hotel and is truly benefiting from its conversion to the luxury collection. The future for The Gwen remains bright.

Our New York City hotels performed ahead of internal expectations this quarter, with our select service portfolio generating RevPAR growth of 5.7%. Although ahead of expectations, the Lexington's flat RevPAR growth was behind the market due primarily to loss of some nonrepeat contract business that we are in the process of replacing. We continue to expect the New York market to be approximately flat for the year, but we're encouraged by the momentum thus far. Frankly, we are positive on New York City over the next several years as supply is peaking and should decline substantially in the back half of next year. This should position the market well over the next 5 years.

The Boston market was a mixed bag for us. The Boston Hilton was a star as we implemented a sophisticated revenue strategy that led to 8% RevPAR growth. However, the Westin Boston had a challenging quarter for a few reasons: A weaker convention calendar, a modest rooms redo program at the hotel and some transitory issues relating to the Marriott-Starwood merger integration as they reorganized the cluster sales organization.

We expect the Boston market to slightly underperform the national average this year, although this still remains one of our favorite markets long term, given the demand generators and the massive development occurring in the Seaport area.

And finally, our resort markets. Resorts were bright spot with RevPAR increasing 7.4% collectively. Even more notable, excluding Vail, which was hurt by low snowfall this reason, results increase an impressive 14.3% in the quarter.

Let me turn to our asset management initiatives on expense control and capital investment. Our entire team is focused intently on cost controls. Hotel EBITDA margins contracted by 132 basis points in the first quarter, and there are a few key drivers. First, margin growth was hurt by approximately 100 basis points from property tax increases and some nonrepeating key money amortization. Second, having all the meeting space off-line at our largest group asset, the Chicago Marriott, meant that we missed all associated profits from banquets at the hotel, resulting in a 20 basis point impact on portfolio margins.

Going forward for the full year, we expect margins to be impacted negatively by approximately 75 basis points from a combination of property tax and insurance premium increases. The Asset Management team is implementing a number of creative programs around labor efficiencies, food cost and energy conservation. Assuming successful implementation of these asset management programs, our revised full year guidance assumes slightly negative margins at the midpoint of guidance.

Although it does not impact margins, I would like to point out that we recognized $6 million of income from business interruption insurance associated with lost profits at Frenchman's Reef, Havana Cabana Key West and The Lodge at Sonoma. This figure came in $1 million ahead of guidance provided last quarter, but it does not impact our original full year expectations.

DiamondRock is focused on maximizing value from its portfolio and driving value from creative ROI projects. The company plans to invest approximately $135 million in its hotels this year to enhance long-term performance. There are a number of exciting projects planned. At the Westin Fort Lauderdale beach resort, we will complete the rooms renovation in Q3 to drive market share increases and complement our recent F&B repositioning.

At the Vail Marriott, upon completion of the ski season, we commenced the renovation of the resort's guest rooms and meeting space. We'll renovate these spaces to a luxury level to help raise average daily rates and close the rate gap between our hotel and the luxury competitive set.

At the Hotel Rex San Francisco, in connection with joining the Viceroy collection, we expect to complete a comprehensive renovation of the hotel. The property will close during renovation for the final 4 months of 2018, with the newly renovated hotel and branding in place to take advantage of the strong 2019 expected in San Francisco.

At the JW Marriott Denver, we expect to renovate the hotel's guest rooms, public space and meeting rooms beginning in the fourth quarter with the majority of the work occurring in 2019. This renovation will secure the hotel's position as the top hotel -- top luxury hotel in the high-end Cherry Creek submarket.

There are a number of smaller projects planned as well, including portfolio-wide ROI initiatives, such as our energy conservation program. We remain dedicated to finding new opportunities to grow NAV at our existing hotels.

Before turning the call over to -- back over to Mark, I would like to touch on our balance sheet. The company has conservative leverage and ended the quarter with pro forma net debt to EBITDA of only 3.4x, cash of approximately $70 million and no outstandings on our $300 million revolving credit facility. In addition, we have a well-lettered debt maturity schedule, weighted average interest rate of just under 4% and 22 of our 30 hotels are unencumbered by mortgage debt. This conservative capital structure with significant embedded flexibility provides us with meaningful protection for potential downturn while also allowing us to opportunistically pursue potential value creation opportunities.

With that, I will now turn the call back over to Mark.

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [5]

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Thanks, Jay. Before opening up the call for your questions, I did want to on our revised full year outlook. At the midpoint, we raised our RevPAR guidance by 100 basis points and our adjusted EBITDA guidance by $3.5 million. As I said at the outset of this call, the raise reflects our increased confidence in lodging fundamentals. Business transient is trending above our original expectations and grew 5% in the first quarter alone. Our group pickup was stronger than expected in the first quarter, although pace for the remainder of the year remains approximately flat as a few of our group-centric markets have lower convention calendars. But the leisure segment is expected to remain strong, and we like to set up resorts generally.

To wrap up the prepared remarks, DiamondRock had a solid quarter and continues to stay focused on executing its capital allocation strategy, which includes creating value through both investing in its own portfolio as well as pursuing acquisitions that meet stringent criteria. We have a terrific balance sheet and the capacity to be opportunistic going forward. Our entire team is committed to working hard to create value for you, our shareholders.

With that, we are now happy to open it up for any questions. Sarah?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Jeff Donnelly with Wells Fargo.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [2]

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Welcome to the fold, Jay. I had a question just on, I guess, Chicago. The Gwen and Chicago Marriott posted negative margins in the quarter. I know Q1 is not Chicago's best season and one hotel is facing renovations, the other one is comping against them. But with just the weak environment expected for Chicago maybe in the year ahead with some supply coming online, I'm curious how we should think about just the absolute dollars of EBITDA from these properties and maybe 2018 and '19 as you kind of move through the renovations and realize the benefit of what you've done?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [3]

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Sure, Jeff. This is Mark. So Gwen, there's a couple of things going on. We're very excited about what's going on there, I'd say, from the onset. There's some comping of nonrepeat key money amortization that's impacting the way the margins look there. But actually, if you back that out, it's pretty good story. We think that hotel would be up over $1 million in profits year-over-year in 2019 and still has $1 million over the next coming years to get back to the stabilized number with the ramp-up from the brand conversion and renovation. So it will be one of our strongest performers in Q2. And I think it'll be a good story throughout this year. Chicago, obviously having all your meeting spaces under the knife as a group hotel is painful experience. We're through that. It's 100% back. And that will also be a very strong performer, and I think you'll see good margins as we move through Q2. So I think both of those were kind of unique in Q1 and should be encouraging as we move through this. We're actually pretty positive on what's going in Chicago. They cross over the 60% occupancy threshold basically first time ever in Q1. Leisure was up big, the international inbound decreased substantially in Chicago which has been great and continues to be a positive trend when we think of driver for some of the transient that's going on there. So I think we're a little bit more constructive than others on Chicago right now.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [4]

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And just to be clear, I mean, you were saying, you think EBITDA will continue to grow in the '19 and maybe 2020. Just to put it in context, does that bring it back to like where it was prerenovation? And how should we think about that?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [5]

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I haven't done a quick comparison. So we think that from last year's numbers, there's $3 million of upside to the stabilized number at The Gwen. Chicago will have a good year this year. It'll have an easy comp for Q1 of start of January, February of 2019. Now citywides are down next year. So we'll, obviously, have to group up more internally as we go into '19. But the setup for the balance of 2018 is very constructive.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [6]

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And just one last question. Is -- I saw in your -- the slide deck that you guys have put out that presentation on DiamondRock's valuation relative to some of your peers and one in particular. I was just curious if there's something about that portfolio in specific that may just choose the comparison. And I guess, given your superior metrics, is there other reasons that you think kind of hold you guys back or things you need to change to kind of close that gap?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [7]

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Yes, so we put together the investor deck. We try to be responsive to inbound inquiries and questions that we receive from analyst and/or investors. So 1 or 2 of those points particularly were responding to kind of a repeated question we got from a couple of investors. So we're trying to lay out the facts as clearly as we could for people to make their own decisions.

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Operator [8]

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Our next question comes from Smedes Rose with Citi.

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [9]

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Welcome, Jay. I wanted to ask you just so you said something in your remarks about some issues on group bookings in Boston to do with the Marriott-Starwood integration. I was just wondering if that's something that you're seeing across, is that specific to Boston? Or could you just kind of maybe provide a little more detail around that? Just because I would have thought that integration was kind of behind us now in terms of the sales and group bookings.

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [10]

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Yes, I'd be happy to. So Boston is the only a market where we're seeing that transitory problem with integration. So the issue up there is they breed on the cluster sales organization, which they announced early in 2017. In November of '17, they basically made most of the sales force repost for their jobs and interview for any new jobs. So obviously, that's a very distracting event. They conducted interviews December, January, and employment letters to the sales force didn't go out till March. And the new structure wasn't finalized and people in their seats really till April 2 of this year. So during that period, we experienced kind of a loss of focus on booking our hotel. And so they lost a little bit of market share. Now that everyone is in place as of April 2, and it was a transitory issue, and it will be marching forward. We did not have that experience in Chicago to use another major market.

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [11]

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Okay, and then just maybe sticking with group for a moment, obviously, you know Marriott has announced reducing commissions to groups booked through third parties. What percent of your group bookings come through those intermediaries?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [12]

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Tom?

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Thomas G. Healy, DiamondRock Hospitality Company - Executive VP of Asset Management & COO [13]

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Yes, this is Tom. We receive about 30% of the business that comes through the intermediaries. I think the -- we believe that we're going to be just fine. We saw a big spike in first quarter bookings, group bookings because of that. We believe that -- we believe and assume that some of that was because people are trying to get in and book their business before the April 1 change. And we're monitoring it to see how we continue to perform. Obviously, it's top in our priority to measure that and evaluate our booking pace as we move forward.

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [14]

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So I mean, do you, as a team, see this as a positive move -- sorry, by Marriott? Or are you concerned about those folks being able to find alternatives spaces outside of the Marriott system?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [15]

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Yes, so it's -- and I think Hilton is going to follow suit. So we're very encouraged that it's the right thing to do to increase profit margins over the long term. The thing that we have to be cognizant of is that we pull some business forward in Q1 and to make sure that we double up some of the sales effort to make sure that stuff doesn't share shift for a short period of time. But when you look at the size of the Marriott system, I think, it's more than 50% of the big box hotels in the United States, obviously, most of the premier locations. They're still going to come to those hotels, right? I mean, the size of the group system and the quality of the big boxes -- really means that a lot of these groups don't really have a choice. Their clients want to be there. They need to book them in these hotels.

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Operator [16]

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Our next question comes from Michael Bellisario with Baird.

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [17]

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Just wanted to go back to last question, Tom, just to clarify. 30% of all of your group business is intermediary or just that Marriott story?

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Thomas G. Healy, DiamondRock Hospitality Company - Executive VP of Asset Management & COO [18]

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I think it varies based on big box and small box, right, and independent versus brand. So it's -- but on the Marriott side, it's roughly 30% comes through the third party, a lot of that's short term. Most -- the big ones, HelmsBriscoe, [ConFrom] they will not -- their percentage is staying the same and then the one -- basically that represents 1/3 of the business and 2/3 of the business with the smaller third-party group bookers, and they are the ones that are going from 10 to 7. So we're monitoring it, and certainly, we'll report on this as we move forward if there are any changes.

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [19]

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Got it. Mark, on the union buyout that's in process at the Lexington, how do you think about your success here affecting the value of the property? And then does this change make you sharpen the pencil about maybe investing more dollars in New York City on a go-forward basis?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [20]

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Great question. Good catch. So DiamondRock -- so let me just back up for everyone's benefit. So DiamondRock, we've worked out a -- worked with our operator and the local union there. We think we've reached a win-win kind of agreement to offer early retirement to hotel employees in a way that will increase productivity at the Lexington. We booked about $2.8 million in severance costs related to this already. And overall, this is part of the story. But overall, we expect Lexington to be up $2 million to $3 million in profits in 2018 over last year. So we think it's a good move for these employees. We think it's a good move for productivity. We're one of the first hotels in New York to rollout this particular kind of arrangement. And so it still has several months to play out, and we'll be happy to report back on the success and the economics as we kind of move forward. But it definitely makes us more constructive on the labor setup and the availability to drive profits over the next several years in New York City. Well, on Lexo, I'd also mention over time the profits there kind of another negative -- good news there. We recently signed a contract at lease with Crunch Fitness to take up almost all the nonrevenue basement space at the Lexington. So that's going to get built up this year or open up early 2019. And when it does, it will generate about $800,000 a year in rent from spaces currently earning nothing. So that will help '19 as well.

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [21]

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Okay, that's helpful. And then just switching gears to the resort front, maybe big picture. How are you guys thinking about and underwriting kind of the longer-term risks related to drive 2 properties that you've been acquiring in some smaller markets and then also how you think about the higher cyclicality of these assets as well?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [22]

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So our -- I would say the data -- you got to be a little careful with some of the Star data and some of the other stuff historically because the big, I'll call the big golfing-maker resorts kind of skew some of that data historically. So our experience with the resorts has been they actually outperform that we put some of that information into our investor deck, but they actually outperformed our urban portfolio last downturn. So we actually think given the supply constraints and the supply forecast in our resort markets that they're probably less vulnerable as we go forward and that the leisure has actually proven to be more resilient in these kind of resorts. We ourselves mentioned in the prepared remarks our -- have strong conviction that resorts -- experiential resorts, in particular, think about the Sedona assets or Sonoma, that these kind of resorts and that kind of experiences are going to outperform that demand is going to continue to -- the trend line is going to continue to outperform RevPAR increases generally in the United States over the next 5 to 10 years.

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Operator [23]

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Our next question comes from Rich Hightower with Evercore ISI.

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Richard Allen Hightower, Evercore ISI Institutional Equities, Research Division - MD & Research Analyst [24]

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So we're going...

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [25]

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We remain cautiously optimistic.

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Richard Allen Hightower, Evercore ISI Institutional Equities, Research Division - MD & Research Analyst [26]

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That's exactly what I'm about to ask. So I do want to -- it's a test of semantics here. So yes, just I want to pair up the statements in the earnings release on that front with what appeared to be a lot of moving parts within DiamondRock's portfolio in the first quarter that maybe obscure the underlying momentum in trend. And so I want to get your sense of what that underlying trend really is, at least from your perspective. Because I think the picture so far this quarter from other companies has been, like, we're seeing a bit of confirmatory numbers in place relative to maybe what we were hoping for last quarter and it's really finally here, at least in some pockets. So just curious for a little more detail there, if you don't mind.

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [27]

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Sure. I mean, the things that are building into kind of our increased optimism, 23 of the 28 hotels beat budget. That's the most we've had beat budget in certainly recent memory, certainly since the -- in the last several years. So that's a really good sign. In the quarter, business transient was up over 5%. That's a very good sign. We had some revenue strategies. We talked a little about the health in Boston, where we pushed rate, and it's stuck. So that's all good. And in the quarter, group was very good. Now we had some availability. So that helped the number because there was some space available. But those are all encouraging signs and give us a little bit more conviction about where we're going. And then on the supply side, continue to see no development in the resort market. So we continue to remain very constructive on how they're going to perform for the balance of the year. So I think the overall, I'd say, we're modestly more constructive than we were last time we talked on the earnings call.

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Richard Allen Hightower, Evercore ISI Institutional Equities, Research Division - MD & Research Analyst [28]

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Okay. That's helpful, Mark. And then my next question here is on Frenchman's. I know you said that we'd probably get a more detailed update around a quarter from now. Just give us a little more detail, if you don't mind, in where we are in the process, how you're thinking about the insurance proceeds, the cost to rebuild, the value of the asset pro forma. And then if you were to try to sell that asset today or sometime this year, who would be a logical buyer? And how does that factor into the calculation?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [29]

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Okay. A lot there. So I'll start the response by just saying we're in very sensitive discussions right now with the insurers. So we're a little limited on what we can comment on the call. So we submitted. So we spent a lot of time. We've stabilized the site. We've spent a several million dollars with architects, engineers, designers coming up with the cost to rebuild and the design and the plan. We've submitted that in the first quarter to the insurers. It took a while to get all that together. It's very complicated with codes and a lot of ADA and a lot of other moving pieces. So that's been submitted. We've had several face-to-face meetings with the insurance syndicate and the representatives. They're currently taking that claim. They have their own set of expertise -- experts and resources. They're going through that. They're spending time with the -- at the site, coming up with their own cost estimates. And then we'll sit down probably in the next 30 days with kind of where we are, where they are and talk about the path forward that makes sense for both of us. On the rebuild scenario, we spent a lot of time on what the concept brands would be. We anticipate that we can get financial -- considerable financial support from both whatever brand it turns out to be as well as from the USVI government, which obviously has a vested interest in seeing it rebuild. So we have one -- I would say, we have one avenue of rebuild that we're spending our resources and time doing, and we think it would do light years better than it's ever done before. It was a profitable hotel before, but it is in the A+ location in the U.S. Virgin Islands. There are -- to kind of segue a little bit to one of your other questions, there is a pretty active market for an asset like this, right? The -- from PE firms, I could probably name 20 that might have an interest in doing something like this because of its location, and they can take advantage of -- this is what a PE firm does, right? They come into a situation that can -- has a lot of upside. They take advantage of a situation and it's a good story for them, bring their expertise. They're okay with the disruption, if you will, of getting it ramped up. So I think there'd be an active market of people that would be interested in something like this.

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Operator [30]

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Our next question comes from Austin Wurschmidt with KeyBanc Capital Markets.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [31]

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Just want to touch on guidance a little bit. Curious how much of the 100 basis points increase in RevPAR guidance was driven by first quarter results versus what you're forecasting now for the back half of the year?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [32]

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Yes, so this is Mark. It's really a combination of the both. I mean, the first quarter came in probably 30 basis points ahead of our budgets, and so the balance of it's really coming in rest of the year.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [33]

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And was that due to any particular markets as you look out? I mean, you said 23 of 28 outperformed your expectations, so fairly broad base. But what about as you look forward? What markets are driving, I guess, that 70 basis points?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [34]

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Yes, the resorts look like they're strengthening. Chicago, second quarter, and it's group pace looks very strong. And then New York is probably going to be a little better than we originally budgeted for. And that's offset by some of the renovation disruption, which we had anticipated before, which hasn't changed. So we're feel a little bit more confident about the renovation disruption downside risk, if you will, of getting through the first quarter, which I assume is a little bit more confident of raising the EBITDA portion of the guidance.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [35]

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So on New York City, it sounded like you were still assuming flattish RevPAR growth for the full year, which is what I thought was assumed in your original guidance. So does that imply there's potentially some additional upside from this point based on what you're seeing in New York?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [36]

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Yes, so when I look at the forecast, they're about flat for Q2 through 4. I've to say the first quarter is the least mathematically significant quarter in New York, but we'll see. I mean, as you know, that market goes by a lot of short-term transient trends. And so trying to predict fourth quarter in New York is always a difficult task, and that's obviously the meatiest quarter for us. One encouraging sign, we were just, actually, yesterday going through some of the supply numbers and the supply on the east side where concentration of our portfolio, is basically 0. So it looks really positive from that side too. So that's encouraging.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [37]

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And then maybe sticking with New York. One, I'm curious, what segments are you seeing the most strength in, in the market? And then also you mentioned you lost some nonrepeat business at the Lex and curious what the time frame is that you'd expect to backfill that business?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [38]

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Tom, you want to take that one?

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Thomas G. Healy, DiamondRock Hospitality Company - Executive VP of Asset Management & COO [39]

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Sure. This is Tom. We expect to backfill that -- the contracted business in the next 3 months. And we are far along in the contract negotiations, and we hope to have final news here in the next few weeks. So that will be the backfill. But from a transient standpoint, New York City is first -- obviously, for the first quarter in transient, the leisure demand on the weekends was stronger and then up certainly the last 10 days of the month, thanks to the Easter holiday. So we believe that the BT has been very, very strong. We've seen very positive results with regards to business transient when we look at our portfolio. Q2 of last year was up 5%, Q3 was up 8%, Q4 was up 11%, and then the first quarter in this year was up 5.6%. So business transient continues to be very active in New York. And then we start -- we're still seeing positive -- very positive trends from international travel because the value's gotten better to come here. The international travel, for example, in New York City. Passenger lift in February was up 6.3%, about 330,000 new passengers were domestic and about 220,000 were international. So we're seeing more active international travel, which is very positive for New York City.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [40]

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Great, that's helpful. And then just last one for me. Your cash balances have kind of dwindled down, still $70 million roughly on the balance sheet at quarter-end, but curious what the appetite is for additional acquisitions and how we should think about funding to the extent that you did find some attractive opportunities?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [41]

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Sure. So let me back up and just on acquisitions a little bit. So we're sensitive to cost of capital and our cash balance, and we've been very disciplined on what we're going to buy. As you know, we're going to focus more on smaller assets as small as $42 million. So those are -- those can be funded from cash. Yes, I'd say, our pipeline now, we're focused on off-market deals, I would say, small-to-midsize resorts makes up the bulk of it. And if we could find more deals like Sedona, which are wildly accretive, we would definitely pursue those. But we're likely to do a deal that's not that big in size, maybe we'll do a couple. Cash would be obviously be the first source. We still have $300 million available on our line of credit. And then we could, obviously, do more term loans or individual property loans, if needed, but I think the cash is clearly the first line of use.

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Operator [42]

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Our next question comes from Anthony Powell with Barclays.

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Anthony Franklin Powell, Barclays Bank PLC, Research Division - Research Analyst [43]

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I guess, follow-up on the last question. Given you've deployed some capital in the deals, does it make sense to go back into the market and sell more hotels right now?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [44]

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It's a great question. It's a little bit of a seller's market right now. So we are evaluating where there's opportunities. I think the stronger and more conviction we have of finding good deals that create value for our shareholders, we may look to do dispositions. As you know, earlier, we were sitting on a couple of hundred million dollars of cash, and it seems just dilutive given that set up. But as we find more acquisitions that meet our criteria and we think add value for our shareholders, that is one source we've had the internal discussions with the board about tapping to fund future acquisitions.

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Anthony Franklin Powell, Barclays Bank PLC, Research Division - Research Analyst [45]

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Got it. And looking at the portfolio, you now have a broad mix of assets, a lot of a big group boxes, little bit boutiques, resorts, some select service. When you look at those types of hotels, do you want to maybe exit or increase just kind of any of those segments? Or long term, what kind of mix do you see having?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [46]

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Right. Great question. So we really like our portfolio. I mean one of the things we strive for over the years is to make sure we have a diversified portfolio because we think that reduces risk for our shareholders over extended period of time. The area we want to -- I mean, as you heard, we're bullish on resorts, particularly midsize experiential resorts. That's an area we'd like to increase. We're about 30% that segment right now. If we could increase that to 40%, I think we would all be very happy internally.

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Anthony Franklin Powell, Barclays Bank PLC, Research Division - Research Analyst [47]

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All right. So 40% resorts. What would kind of go down? Would it be select service? Would it be kind of the standard upper upscale in the cities? What would you reduce?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [48]

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I think we're reluctant to buy more big boxes just because it's a lot -- until we get to a certain size, it's just a lot of concentration on one asset. So we would rather diversify with more small, midsize assets, than to put too many eggs in one basket with a big -- another big convention center hotel.

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Operator [49]

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Our next question comes from Stephen Grambling from Goldman Sachs.

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William H. Ketelhut, Goldman Sachs Group Inc., Research Division - Associate [50]

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This is Bill filling in for Stephen. I was just wondering if you could discuss more of the 2 new properties and maybe some of the challenges around the growth and development to get to that targeted 10.8x multiple.

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [51]

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Sure. So let me start, and then I'll let Tom here jump in. So recently, Sedona, as you know, which we bought last year, is about $650,000 above underwriting. That one's really kind of hit every metric, and there's still a lot of meat on that bone. So that one's going to continue to outperform, and we're super excited about it. The 2 first quarter acquisitions, let me start with the Landing, it's a fantastic hotel. We just got the new manager in place. I'll let Tom kind of jump in and talk about some of the value-add opportunities there and how we're going to drive margins going forward. But a little bit the same story on Palomar, but we didn't switch the manager. We are focused. We have an action plan that focuses on making operational changes there and implementing a lot of our best practices. There is a difficult comp in Q1 and 2 with the final 4, which was the end of Q1 and beginning of Q2, but the Phoenix market is very healthy. The convention calendar looks very good for this year, and the location really is A+ for that hotel. So with that, Tom, I'll turn it over to you.

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Thomas G. Healy, DiamondRock Hospitality Company - Executive VP of Asset Management & COO [52]

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Yes, on the Palomar, we're really excited. We -- it's the best location in downtown. We're 30 days into the hotel. So we're still putting together our action plans critical path. But as we get started, we actually brought our new GM. He's been there about a week, and we're evaluating all the management team to get in line with our goals. We're looking at facility fees, and then bring in all the food cost, labor cost initiatives, energy initiatives that we've been -- that we'll be using throughout the portfolio. And there are opportunities in other revenues as well. We look at parking, fitness, food and beverage program, and we think there are opportunities there. So Q1 and Q2 obviously the RevPAR were impacted, obviously, as Mark mentioned through the tough comps in the final 4 that kind of hit at the beginning of -- the end of March and beginning of April. But I think after we get through the difficult comps in the first half of year and we get our team in place and our plan in place, we expect much stronger results at the back half of '18, particularly in Q4. And Landing, this one is a gem, I just have to say. I think, Mark coined to phrase the other day, which is, "where else can you walk out the front door and be on the lake and then go out the back door and have a small ski resort?" It's spectacular. This -- these rooms are probably my favorite rooms in our portfolio. They're -- it's a great comfortable room. And the fact that we can expand this and it is exciting. We have, obviously, 2 Roads is in place here. We have used -- we, obviously, have 2 Roads in Sedona, and they're doing a very good job for us. We have a new GM in place, who is heavy, very strong in sales and marketing with -- the sales and marketing background. And we think the transition is going -- is very solid. We're implementing our value-add programs, resort fee increases, we have additional 5 keys that we can add into the facilities shortly, and we're working on fire pits and experiential programming around the space. We also have an opportunity to move the fitness center and add oceanfront suite. So there are a lot of little tricks that where we have opportunities here. We're evaluating food and beverage opportunities as well. And like I said, this is a very special place if -- when you look at this deal, we look at the success we had at Sedona, we are $650,000 over -- underwriting and that we expect about Sedona as a unique asset and just a wonderful location. We think that Landing has a lot of these similar attributes, so really excited.

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Operator [53]

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Our next question comes from Lukas Hartwich with Green Street Advisors.

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Lukas Michael Hartwich, Green Street Advisors, LLC, Research Division - Senior Analyst [54]

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Can you talk a little bit more about the $15 million increase in severance guidance? Is that all related to the Lex?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [55]

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$50 million or $15 million? Yes, it is all related to the Lex. So the number is difficult to predict because basically we offer the program to a wide variety of hotel employees. Frankly, the more they take it, the better it is. But we'll know in the next 60 days what the ultimate number is, but there is a decent return on that number.

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Operator [56]

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Our next question comes from Gregory Miller with SunTrust Robinson and Humphrey.

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Gregory Poole Miller, SunTrust Robinson Humphrey, Inc., Research Division - US Communications and Internet Infrastructure Analyst [57]

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Continuing along with the Palomar acquisition, it seems like there are a lot of positive attributes about the hotel and market and deal economics. However, could you provide your thoughts about what made you confident about acquiring another Kimpton in light of what some would call recent challenges with IHG's brand integration?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [58]

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Yes, so we have a very productive relationship with IHG. Our -- if you look at our Shorebreak numbers, and what we've been able to accomplish there in that Kimpton we've owned, we have pretty limited exposure, but that's the one we've owned for a while. It's pretty impressive what they're doing there. So we're not experiencing a lot of native transition as they kind of integrate that. So the Shorebreak, which we've owned, made us feel good about, and you can see the numbers for Q1, made us feel good about our ability to work with Kimpton in a very productive way to drive profits at the hotel. There's going to be small issues with any transition, and we had a couple of little hiccups, but we feel good based on our experience at Shorebreak that we'll be able to get it right and be able to drive profits with the partnership. Now there is a termination right in 2 years at Phoenix. So there's a little bit of a safety valve. But no, we like our Kimpton. We like our relationship, and we feel good about our ability to work with them going forward.

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Gregory Poole Miller, SunTrust Robinson Humphrey, Inc., Research Division - US Communications and Internet Infrastructure Analyst [59]

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Great. And one of the question moving on to Fort Worth. The Renaissance Worthington had more moderating RevPAR growth last quarter. And I'm curious if you're starting to see a little bit more of a stabilization in that property post renovation?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [60]

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Tom? So 4.7% is pretty good.

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Gregory Poole Miller, SunTrust Robinson Humphrey, Inc., Research Division - US Communications and Internet Infrastructure Analyst [61]

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It's fine. I know relative to double digits, say, if I maybe...

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [62]

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Yes, so we had renovation comps that were helping us, but both -- it continues to gain market share post our renovation. It sits on Sundance Square. It's a terrific hotel in Fort Worth market. We are going to enhance the meeting space this year, which we should --while we lose a little bit on meetings for disruptions as we anticipate, but that will help drive market share continually as we move in 2019 as well. So there's a lot of opportunities there. This is one of the assets that Tom's probably most excited about in our entire portfolio about things to do that can drive value over the coming years. So Tom, you want to add anything?

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Thomas G. Healy, DiamondRock Hospitality Company - Executive VP of Asset Management & COO [63]

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Yes, I mean, the meeting space, the bones of this hotel are fantastic. And if everyone remembers my past from Strategic, I had the InterCon Miami for my entire tenure there. And some of the things we did at the InterCon Miami were, it added value. Worthington certainly has the opportunity. This is a lot of group space. As Mark said, we're renovating the all meeting space this year. The rooms are done, and then we have some opportunities to improve the sense of arrival, restaurant offering to drive more outlet revenues to -- and then, obviously, to help close more group business. Obviously, there's a direct correlation between sense of arrival, room experience, meeting experience that helps your increase on group and also helps your closing percentage. So this hotel, there's a lot of nuggets and some opportunities to expand meeting space and that -- and have some very unique space that's not in the market, and so we're evaluating it all. But this is one of the hotel in the portfolio that I'm very excited about. Love the market. It's great -- it’s a great labor market. And when you get to the group business and the incremental spend, it flows. So...

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Operator [64]

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Our last question comes from Shaun Kelley with Bank of America.

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [65]

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Shaun?

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [66]

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Sorry about that. Welcome, Jay. So I just wanted to go back to the prepared remarks real briefly. I think I caught this, but maybe I heard it wrong. But I think as you're walking through sort of the portfolio performance statistics, did I hear that April so far was up 4%, but you expect in May and June to be flat? Was that correct?

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Jay Lecoryelle Johnson, DiamondRock Hospitality Company - Executive VP & CFO [67]

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That's correct.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [68]

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Could you give me any color around the decel you're kind of seeing? I'm sure there's booking activity or calendar timing or something in that, but just sort of walk us through the cadence a little bit.

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Jay Lecoryelle Johnson, DiamondRock Hospitality Company - Executive VP & CFO [69]

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In terms of May and June?

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [70]

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Yes, exactly.

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Jay Lecoryelle Johnson, DiamondRock Hospitality Company - Executive VP & CFO [71]

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Yes, well, May and June are really impacted by the renovations at Vail and then the weakness we're seeing in the Boston market.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [72]

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And Boston, remind me, is specifically is that citywide?

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Jay Lecoryelle Johnson, DiamondRock Hospitality Company - Executive VP & CFO [73]

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Yes, it's is a citywide group calendar as well as the transitory issues that we're seeing with the Marriott and Starwood merger. And it's really specific to the Westin Boston, in particular.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [74]

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Okay, got it. And then the only other thing I wanted to touch on was going back to the agreement you guys reached at the Lex. Was there a catalyst for that in terms of -- did you have like either a union contract expiring or sort of a like a time line that allowed you to reach kind of a creative solution there? Was that something it was sort of a one-off where you're able to come up with on your own?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [75]

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So there is nothing particular in our agreements that open this up. This is a conversation we've had for well over a year. I would say, our operator here has been very helpful in partnering with us and working with the union to craft a win-win solution. So I would think it's probably the -- it was probably our strategy, but also I have to credit our partner here, our manager really was instrumental on helping us design and to get this effectuated. And so we think it's a good template. We wouldn't be surprised if other people tried to follow behind this model. Basically, it's a good model for everyone. But there is no contract or anything other than just an open negotiation and kind of coming to a conclusion on something that worked for all sides.

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Operator [76]

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

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [77]

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Thank you, Sarah. I'll just conclude by saying thank you very much for participating in today's call and your interest in DiamondRock. We look forward to updating you on the next quarter.

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Operator [78]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.