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Edited Transcript of DRH earnings conference call or presentation 26-Feb-19 2:00pm GMT

Q4 2018 DiamondRock Hospitality Co Earnings Call

BETHESDA Mar 1, 2019 (Thomson StreetEvents) -- Edited Transcript of DiamondRock Hospitality Co earnings conference call or presentation Tuesday, February 26, 2019 at 2:00:00pm 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

DiamondRock Hospitality Company - Director of Financial Planning & Analysis

* Thomas G. Healy

DiamondRock Hospitality Company - Executive VP of Asset Management & COO

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Conference Call Participants

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* Austin Todd Wurschmidt

KeyBanc Capital Markets Inc., Research Division - VP

* Chris Jon Woronka

Deutsche Bank AG, Research Division - Research Analyst

* Felicia Rae Kantor Hendrix

Barclays Bank PLC, Research Division - MD & Senior Equity Research Analyst

* Jeffrey John Donnelly

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Richard Allen Hightower

ISI Group Inc., Research Division - Former Research Analyst

* Stephen White Grambling

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Thomas Glassbrooke Allen

Morgan Stanley, Research Division - Senior Analyst

* William Andrew Crow

Raymond James & Associates, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q4 2018 DiamondRock Hospitality Company Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

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

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Sean Kensil, DiamondRock Hospitality Company - Director of Financial Planning & Analysis [2]

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Thank you, Jimmy. Good morning, everyone, and welcome to DiamondRock's Full Year and Fourth 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 law 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 fourth quarter results, recent acquisition activity as well as discuss the company's 2019 outlook. Jay Johnson, our Chief Financial Officer, will provide greater detail on our fourth 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. Since we have previously announced preliminary 2018 results, we will focus today's call on more details related to the market trends, recent acquisitions, capital allocation and specifics within the DiamondRock portfolio. We will also offer additional details on our previously announced outlook for 2019. The overall economy and lodging fundamentals still look fine, the broader U.S. economy remains healthy, GDP growth continues to be solid and unemployment rates remain extraordinarily low. With that said, 2019 has already been affected by the government shutdown, and we anticipate positive but moderating GDP growth for this year. Lodging industry metrics also remained solid.

Fourth quarter 2018 RevPAR growth in the U.S. was 2.4%. Industry growth in the quarter would have been even better, but was challenged, with difficult year-over-year comps from the demand spike following hurricanes in 2017. It's worth noting that the top 25 markets were a little more impacted by supply and underperformed the broader U.S., with RevPAR growth of less than 1%. For the full year 2018, lodging fundamentals were generally at their historic averages, with RevPAR growth at 2.9% and supply growing at 2%. The best growth was seen in the resort and lodging segments, which significantly outperformed, with RevPAR growth of 4% and 3.7%, respectively.

Now I'll touch on DiamondRock's 2018 results. Overall, we were pleased with our fourth quarter results, which came in better than our previously announced preliminary results, with adjusted EBITDA $500,000 above the high end of the range and FFO per share beating by $0.01. Fourth quarter comparable RevPAR increased 1.9% and total revenue grew 2.4%. F&B revenue shined in the quarter, with 3.1% growth. We need to point out that one asset, in particular, did have a big impact on portfolio results. The Westin Boston had a tough quarter, as it was impacted by both a union strike and continued disruption from the Marriott/Starwood integration. The underperformance of the Westin Boston negatively impacted RevPAR growth in the quarter for the entire portfolio by 40 basis points. Excluding the Westin Boston, the company's RevPAR growth for the fourth quarter was 2.3% and hotel adjusted EBITDA margins were impressively flat. The only real upside from the Westin Boston underperformance in 2018 is that it provides an easier comp for 2019.

Jay will discuss our fourth quarter and full year results in more detail shortly. So let's spend a minute on our 2018 acquisitions. In 2018, the company completed a total of 3 acquisitions for $274 million. At the end of the fourth quarter, we completed the acquisition of Cavallo Point, the Lodge at the Golden Gate Bridge, for approximately $152 million. This is a world-class asset, and we were thrilled to be able to do this deal off market. The hotel sits at the base of the Golden Gate Bridge in scenic Sausalito, with fantastic of San Francisco across the bay. The lodge has consistently been recognized by Condé Nast Traveler and Travel & Leisure as one of the top luxury hotels in the world. The hotel is certainly additive to portfolio quality, with the second highest RevPAR in our portfolio behind only our 5-star L'Auberge de Sedona resort. Cavallo Point does have our portfolio's highest total RevPAR at over $800, which impressively also may be the highest total RevPAR of any San Francisco hotel.

The hotel does a number of positive things for us, including increased exposure to the San Francisco Bay market and to the resort segment. Importantly, Cavallo Point has a long list of value-creation opportunities, most powerfully the potential to add up to 83 incremental rooms on the 45-acre site. We expect Cavallo Point to perform well in 2019 as it benefits from the strong San Francisco market. The hotel truly is a one-of-a-kind.

The 2 other acquisitions in 2018 include the Landing Resort Lake Tahoe, in Northern California, and the Kimpton Palomar Phoenix, in the heart of the ongoing CityScape development. All 3 of our acquisitions are lifestyle hotels, ranked top 2, 5 and 6 within their respective markets on TripAdvisor and have terminable or short-term management agreements. Importantly, they're going to be great growth stories for us. Collectively, the 3 hotels are budgeted to grow RevPAR by over 5% in 2019.

Switching gears. We want to provide an update on Frenchman’s Reef and Morning Star Beach Resort. Most of you are familiar with the story. Frenchman's is a spectacularly well-located resort in the U.S. Virgin Islands. It was significantly impacted and closed by sequential hurricanes in 2017. The company has comprehensive insurance and has commenced rebuilding the resort with a projected reopening in mid-2020. Once complete, Frenchman’s Reef will be the most important resort in the Virgin Islands. It is projected to generate stabilized EBITDA in excess of $25 million. Now we remain in sensitive discussion with our insurance carriers over the claim for Frenchman's Reef. We are doing everything possible to ensure that the claim is resolved efficiently and effectively and that we receive the full amount of coverage we are entitled to.

In regards to business interruption insurance, we are entitled to all lost profits. Last year, we booked business interruption income of $16.1 million related to Frenchman's, and we believe we are entitled to at least that amount in 2019. The insurance company has agreed to $8.8 million, which covers the period from January 1 through April 2019. We hope to be able to resolve discussion with the insurance carriers and get the full $16 million plus in business interruption income that we are owed. However, our 2019 guidance only assumes the $8.8 million is recognized into income. So there is potential upside there.

With that, I'll turn it over to Jay to discuss our detail -- our results in more detail. Jay?

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

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Thanks, Mark. Before I discuss details of our fourth quarter and full year results, I would like to remind everyone that comparable RevPAR, hotel adjusted EBITDA margins and other portfolio metrics are pro forma and include Cavallo Point, the Landing, Palomar Phoenix, Orchards Inn and L'Auberge de Sedona for the entire year. Additionally, comparable results exclude Frenchman’s Reef and Havana Cabana Key West for all periods presented as well as the Hotel Emblem, formerly Hotel Rex, from September 1 through year-end, as it was closed for renovation.

Our fourth quarter results were in line with internal expectations. RevPAR grew 1.9% and was held back by -- and it was held back 40 basis points by disruption from the union strike at the Westin Boston. We are very pleased with strong performance at our Chicago and New York City hotels, which more than offset off-cycle citywide calendar impact at our Washington, D.C., and Salt Lake City hotels.

Food and beverage revenues were very strong in the quarter, up 3.1%, and had excellent flow through with F&B profits up 5.6%. Our F&B results were bolstered by strong group demand trends as well as the successful F&B repositioning at the Westin Fort Lauderdale.

In the fourth quarter, excluding the Westin Boston, GOP margins were up 37 basis points and EBITDA margins were flat. For the full year, also excluding the Westin Boston, GOP margins were up 8 basis points, while EBITDA margins contracted by 8 basis points. While the asset management team did a great job in constraining controllable costs, property taxes and insurance premiums increased meaningfully this past year. Property taxes were up 7% in 2018 with the bulk of the increase resulting from reassessments at our 2 Chicago hotels, which occur once every 3 years. We are in the process of appealing and may see an adjustment this year.

Property insurance costs were also up 35%. An increase in premiums were anticipated in light of the claims filed arising from events we experienced in 2017. While these 2 expense categories only comprise 7% of revenue, we do expect them to increase in the mid- to high-single digits in 2019. Tom and his team did an excellent job mitigating cost increases in a tough operating environment, and we expect them to add additional wins in 2019. The asset management team has more opportunities to implement an array of initiatives relating to labor management, food cost and energy, among other areas, to drive growth. We're beginning to see real results from prior implementations and expect 2019 to be even better.

Business interruption income was significant in 2018 as it replaced lost income. We recognized $3.1 million of income in the fourth quarter from business interruption insurance related to Frenchman's Reef. For the full year, we recognized $19.4 million in business interruption related to Frenchman's Reef, Havana Cabana and the Lodge at Sonoma. Frenchman's was the majority of the BI proceeds at $16.1 million. All insurance claims with respect to Havana Cabana and Sonoma have been settled with insurers. Mark will spend a little more time later discussing our outlook for business interruption this year.

Now let me spend a couple of minutes discussing quarterly results and trends in our 3 significant segments. Please note, all segmentation metrics exclude Havana Cabana Key West and Hotel Emblem.

Business transient remained our strongest segment in the fourth quarter, with 3.8% growth. The strongest performers were the Boston Hilton, Hilton Garden Inn Times Square, Courtyard Fifth Avenue and Chicago Marriott. The Westin Boston and JW Cherry Creek were challenged in the fourth quarter due to the strike in Boston and slower demand in Denver. Throughout 2018, business transient was our strongest segment as the robust economy has benefited the BT customer.

Looking to 2019. We expect this segment to continue to be one of our strongest. Leisure, contract and other revenues were up 2% in the fourth quarter. However, for the full year, leisure, contract and other was down approximately 2%. This segment was negatively affected for the full year by renovations at the leisure-centric Vail Marriott and Westin Fort Lauderdale. Group revenue was up 60 basis points for the fourth quarter. The strike at the Westin Boston impacted Q4 group by 150 basis points. The Westin D.C. also had a challenging quarter.

On the positive side, our Chicago hotels were up double digits as well as the Worthington, Renaissance Charleston and our New York City Courtyards. For the full year 2018, group was up 50 basis points over the prior year. The Marriott/Starwood integration issues and the strike at the Westin Boston impacted group revenues by 100 basis points for the full year.

Looking forward, our group pace continues to improve for 2019. While the current 2019 group pace is down approximately 4%, we're very encouraged by the recent booking pace and the 240 basis point improvement in pace since our last call. While citywide calendars are off-cycle in a few of our markets in 2019, the asset management team and our operators have devised plans to replace citywide group business with in-house group, transient and other demand channels. This strategy has been effective. Q4 2018 in-the-quarter for-the-quarter bookings were up 33% compared to the prior year. And we expect this positive short-term booking momentum to continue.

I would now like to touch on some of our major markets. New York City as a market outperformed our expectations in 2018. Our hotels generated 3.7% RevPAR growth in Q4 and 3% growth for the full year. This was well ahead of our expectations at the start of the year as Manhattan demand was robust and more than offset the significant new hotel supply. Furthermore, the Lexington benefited from this demand and added $3 million in EBITDA in 2018, which was a major success for us. The large year-over-year increase was helped by the successful union restructuring and new urban facility fee. Looking forward, we expect New York City to perform in line with national averages in 2019 and even better in the coming years as the supply picture improves, especially in the Midtown East submarket.

Chicago had a very strong year with 5.1% growth in the market for the full year. Our hotels outperformed the market by 500 basis points, with 10% RevPAR growth in 2018. Q4 marked a strong finish to the year, with combined 8.3% RevPAR growth for our Chicago hotels. The Gwen and the Marriott benefited from their recent renovations ahead of a strong citywide calendar. The hotels added nearly $6 million in combined EBITDA year-over-year. 2019 in Chicago will be more challenging as the citywide pattern is slightly weaker. However, this was expected as Chicago citywides typically operate on a 3-year cycle, and we have been working hard to backfill business in anticipation of this weakness. 2020 group pace in Chicago is already pacing up a remarkable 30%.

Boston was a bit of a mixed bag for us this year. The Boston Hilton performed well, with 7.4% and 5.5% RevPAR growth in Q4 and full year 2018, respectively. This performance was particularly impressive in light of a challenging citywide calendar. However, as discussed throughout the year, the Westin Boston faced significant challenges, with the Marriott/Starwood merger integration as well as the strike in Q4. RevPAR at the Westin was down 3% in Q4 and declined 4.4% for the full year. Headwinds from the merger integration issues and strike held us back by 50 basis points for the full year and 40 basis points in the fourth quarter. That being said, the strike has now been resolved and we believe that most of the issues related to the Marriott/Starwood merger integration are behind us. The easy comp will help relative performance this year. While Boston has a challenging citywide pattern in 2019, we believe our hotels should generate slightly positive growth. Our 2020 group pace for our Boston hotels is up almost 20%.

The Washington, D.C., market was disappointing in 2018, and we saw RevPAR decline 6.2% for both the fourth quarter and full year at the Westin D.C. The federal government shutdown did not help in January as the Westin D.C.'s RevPAR was down 11% last month. We expect D.C. to be difficult this year, with lingering demand issues from the shutdown and a weaker citywide pattern ahead of an election year. Like Chicago and Boston, the citywide calendar in 2020 is much stronger in Washington and our booking pace is up double digits.

Before leaving our market discussion, I should mention that several of our resort markets performed extremely well. Our 2 hotels in Sedona saw RevPAR increase 8.9% combined in 2018 and continue to outperform our acquisition underwriting. The hotels were acquired in 2017 at a 12.6x EBITDA multiple and finished the year at 9.6x. RevPAR at our Shorebreak resort in Huntington Beach was up 8.8% for the full year. And finally, the Lodge at Sonoma and Renaissance Charleston had RevPAR growth of 7.6% and 7.1%, respectively. We are pleased with this segment of our business.

Turning to our balance sheet. We have one of the best balance sheets among lodging REITs and the strongest in the history of the company. We finished the year at 3.5x net debt-to-EBITDA, which is at the low end of our peers, and while there are a number of variables, including how much stock we repurchase, we expect to end 2019 at approximately the same level. 23 of our 31 hotels are unencumbered by mortgage debt, which is less than 20% of our total asset value creating enormous flexibility, particularly on the asset management front. Our financial policy is to continue to unencumber the balance sheet and enhance our use of unsecured debt going forward. At year-end, our total debt to total asset value was approximately 28% and our fixed charge coverage was 4.2x, both solid credit metrics.

Before handing it back over to Mark, I'd like to touch on a successful exercise in capital allocation over the last year related to our share repurchase program. We have repurchased $62 million of DiamondRock shares since early December at a weighted average price of $9.50 per share, which represents a 30-plus percent discount to our internal NAV. As you may recall, in 2018, we issued $93 million of stock under our ATM program at $12.56 per share. One way to think about it is that we locked in at $3 per share in value for our shareholders on those repurchases. We still have significant capacity under our current program to be opportunistic, and we will continue to pick our spots.

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. I'd like to spend a little more time discussing our 2019 outlook in detail. Consistent with our previously provided outlook, we expect 2019 RevPAR growth for our portfolio to be at a range between 50 basis points and 2.5%. 2019 RevPAR growth will be led by our 3 recent acquisitions, including Cavallo Point as well as our 2 completed repositionings, Havana Cabana Key West and the Emblem Viceroy. We also have high expectations for several of our resorts, including the Vail Marriott and the Westin Fort Lauderdale Beach resort. And hopefully, the above expectation performance in New York City continues in 2019 as well.

This strong growth will be partially offset by off-cycle convention calendars in Boston, Chicago and D.C. While we have recently had excellent short-term group pickup, we still have ground to make up, with group pace now about 4% behind same time last year. We are encouraged by the fourth quarter in-the-quarter for-the-quarter pickup of 33%. Importantly, the group's story essentially reverses itself next year. 2020 is setting up really well for DiamondRock. Our portfolio group pace is up approximately 15% for 2020, with robust increases in our most important group markets. Chicago is up 30%, Boston is up almost 20% and D.C. is up nearly 30%. We also think New York City is likely to see better RevPAR growth in 2020 as supply growth really levels off.

Turning to the full year outlook. Our guidance is for full year adjusted corporate EBITDA to range from $256 million to $268 million. And full year adjusted FFO per share to range from $1 to $1.04. Our guidance implies that our hotels are growing same-store EBITDA about 3.5% at the midpoint and over 5% at the high end.

As I mentioned earlier, it is important to understand that our guidance only incorporates the business interruption income from Frenchman’s Reef to the extent that we have total agreement with the insurer for lost profits. The agreement so far only covers us through April and totals $8.8 million in EBITDA. We are pushing our insurers aggressively to agree on the greater than $16 million in business interruption income that we believe we are entitled to. If we do collect more than the $8.8 million in 2019, that is dollar-for-dollar upside to our guidance.

Now looking at the first quarter 2019, based on budgeted renovations, group patterns and the D.C. impact, we expect the first quarter to be our lowest growth quarter of the year with modestly positive RevPAR growth. We expect significant acceleration of RevPAR growth in the second and third quarters as a result of several factors. First, our ramp from our 2018 renovations will be most pronounced in the second and third quarters. In particular, the Vail Marriott, Hotel Emblem and Fort Lauderdale Westin stand a benefit from the easy comp. Second, Havana Cabana will be included in our comparable RevPAR starting after the first quarter and is expected to generate double-digit growth this year resulting from the ramp-up following its 2018 repositioning.

Third, the Kimpton Palomar Phoenix and the Landing Lake Tahoe are expected to have particularly strong second and third quarter results stemming from the 2018 asset management initiatives starting to pay off. These 2 hotels are expected to generate combined growth in the high-single digits for both those quarters.

Finally, despite a challenging citywide calendar in Boston for 2019, the Westin Boston is expected to outperform the Boston market from the easy comparison resulting from last year's Marriott/Starwood merger integration challenges and in the fourth quarter, the Westin Boston will also benefit from the comparison to the 2018 period impacted by the labor strike.

Additionally, 2019 portfolio results will benefit from less renovation disruption. While we will continue to invest in our portfolio during 2019 on smart projects, we are expecting just $3 million to $4 million in EBITDA disruption this year, which is down several million dollars from 2018 disruption levels. Less disruption will be a tailwind for us this year.

Highlights from our 2019 capital renovation program include the 3 big repositionings that will be completed during the year, namely the Emblem, the Sheraton Key West and the Lodge at Sonoma. Let me give you a brief summary of each one. At the Emblem San Francisco, we recently completed the $10 million repositioning and in January, reopened as a Viceroy hotel. The hotel is designed by Wilson Ishihara, turned out fantastic and initial customer reaction has been terrific. We are also excited to build our relationship with Viceroy.

At the Sheraton Suites Key West, we expect to complete a major repositioning and renovation of the hotel during the seasonally slow summer. We're going to upgrade every aspect of the resort, which already boasts 100% suites. We believe that there is rate upside from the renovation and even more upside opportunity by potentially repositioning this hotel as a true lifestyle resort. At the Lodge at Sonoma, we plan to upgrade the resort to drive rate and better align the experience with the much-higher-rated hotels in the Sonoma, Napa Valley luxury comp set.

There are 4 prongs to this repositioning plan. One, we're once again utilizing one of our favorite design firms to upgrade our unique cottages and overall resort ambience. Two, we are partnering with world-renowned chef, Michael Mina, to create a halo restaurant concept. Three, we are bringing in a high-end spa operator in conjunction with the spa upgrade. And finally, we are working with Marriott on a potential brand change. This hotel really is a little gem.

In addition to those 3 repositionings, we are working to reimagine 2 of our other hotels: the JW Marriott Cherry Creek Denver and the Vail Marriott. At the JW Marriott Denver, we enjoy the best location in the high-end, in-town Cherry Creek area of Denver. We are investing $16 million to reimagine this hotel and secure its position as the #1 luxury hotel in Cherry Creek. Phase 1, which has started, is a total renovation of the guestrooms as designed by the well-regarded firm Abelico, out of L.A. In order to minimize disruption, we have timed the second and final phase for the end of the year and we have partnered with celebrity chef, Richard Sandoval, to re-concept the F&B at the hotel and create a Toro Bistro, which will provide a halo effect for that hotel.

At the Vail Marriott, we have a great opportunity to take the resort to the next level and push rate big time since there is a $175 rate gap to the luxury comp set. Last year, we completed a semi-interior-designed rooms renovation to a luxury level. This year, we will build a world-class spa and fitness center there. And over the next 2 years, we will reposition the lobby, the outside pool and all of the F&B venues. The franchise agreement expires in 28 months, so we have a lot of optionality on brands here. As you might suspect, we are really excited about this one.

Looking forward, DiamondRock is well positioned. The company's portfolio is the best it has ever been in terms of quality, capital investment and market footprint. The asset management platform continues to find new opportunities to drive top line growth, constrain cost and execute on value-enhancing capital projects. We have identified multiple years' worth of ROI projects. In total, the $90 million in ROI projects being evaluated can potentially deliver over $250 million of increased NAV over the next several years. Moreover, the fortress balance sheet allows us to be opportunistic, as you saw with our recent share repurchase execution. Thank you for your continued support, and we look forward to updating you throughout the year on our progress towards these goals.

With that, we'd now be happy to answer any questions you might have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Rich Hightower with Evercore ISI.

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Richard Allen Hightower, ISI Group Inc., Research Division - Former Research Analyst [2]

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Mark, I wanted to ask about the BI proceeds at Frenchman's. It sounds like given the level of -- the sort of soft level of confidence regarding the remaining portion of what would be $16 million instead of the $8.8 million in 2019, it almost sounds like you're daring us to model that above and beyond guidance. So maybe walk us through what some of the gating factors are to getting the remainder to the extent you can in the discussions with the insurance company at this point.

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

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Yes. So Rich, I hope I didn't over imply something. So I would suggest that people only model the $8.8 million. We're in sensitive and, I would say, difficult conversations with insurers, so we can't provide any implied or explicit kind of guidance on the balance of that $16 million plus for the year. Frankly, it's kind of a unique circumstance the way the insurance claims of work. And it'll depend on the -- on kind of their willingness to reach a reasonable agreement and we can't make any promises or commitments related to that. Essentially, the process we will continue to engage with insurers and we have our expert;, they have their experts. We'll sit down and we'll continue to negotiate and hopefully be able to resolve it later this year. We don't anticipate it resolving in the very near future, but we're optimistic we'll get there at some point this year. But again, no assurances on timing.

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Richard Allen Hightower, ISI Group Inc., Research Division - Former Research Analyst [4]

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Okay. Got it. And then maybe just in terms of the acquisition landscape. Obviously, you guys have shifted focus to a pretty significant extent towards resort, leisure, independent branded hotels and that sort of thing. But what's the appetite conceptually for maybe another big-box-branded asset if something looked attractive? I mean, is it just sort of a deal-by-deal analysis and there's a price for anything? Or is there sort of a sticking to your guns on the strategic shift that's taken place?

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

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Yes. So I'd say our appetite for another big box given our portfolio footprint right now is relatively low. We have a couple of big group hotels. We're about 1/3 group and business across the portfolio. We like that distribution. I think we are looking for hotels that resonate with customers over the next decade. We like the more experiential-oriented totals and we're trying to make sure we have that balance in our portfolio. So you're much more likely to see us do a hotel, one, that's not huge. We're not going to make enormous bets at this stage of the cycle. Second, you're likely to see something that has more of a differentiated experience, whether that's location or lifestyle or provides something that's different for the lodging customer.

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Operator [6]

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And our next question comes from Jeff Donnelly with Wells Fargo.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [7]

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Maybe just on Frenchman’s Reef. I'm not sure if you can speak to it, but just as it pertains to the business interruption coverage, is it possible the insurers will, I guess, not provide full BI coverage until asset stabilization because they might argue that the rebuilding was extended by the desire to upgrade the property rather than just reopen it in its current form, so they don't feel like they're obligated to participate in the lengthened time line?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [8]

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It's a good question. I guess I need to be a little careful on what we say since we are in sensitive conversations. I'm sure you can understand.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [9]

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Understood.

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

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So I think it's -- they're going to have their position, we have our position. We think there's a lot of merit to our position. We think it's more of a timing issue on the number of recognizing this since we can't recognize it. But again, these things will take their own course, and we can't provide any guarantees.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [11]

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Understood. And just switching gears, I guess, over to Marriott. Obviously, I know you talked about some of the challenges you faced at -- in Westin. I continue to hear from other owners that Westin's new, I guess, revenue management system is, I guess, challenging, to be diplomatic. And it's impacted some of their yield management. I guess, what's your take on it in considering you have handful of big Westins? Do you think that's going to be a persistent headwind in 2019?

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

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So Marriott -- I mean, just to kind of roll it out, Marriott rolled out a new revenue management system which covers both Westins but also the existing Marriott's full-service Marriotts as well, as well as a lot of flex service that's called Yield 1, 2. And it has a lot of predictive technology built in. So a lot of analogs or artificial intelligence, if you were to refer to it that way. We like a lot of the attributes about it. It is still a tool that's learning. So both the hotels need to learn how to actually utilize it properly. And Marriott will continue to refine it over time. But clearly, it's -- there has been some challenges as they rolled it out, as you would expect with any kind of massive new tool. We anticipate that it'll get better and better as we move through 2019 and '20 as they kind of work the kinks out. And frankly, the hotels need to be better trained and do a good job of utilizing it, but we like the idea of utilizing technology and being smarter about revenue management.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [13]

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I guess, sticking with that, I mean, I know that Marriott has kind of a revamped some of its, I guess, classifications in their redemption program. Has that impacted redemption patterns for you guys in the portfolio in any material way? Or have you been relatively unimpacted by that?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [14]

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No. I would say, nothing has been dramatic, but, yes, there has been shifts within our portfolio. And there are some that have won a little bit and some that have lost a little bit as the programs have shifted and they changed redemption levels. We don't have any hotel that I would say we're going to say fundamentally has underperformed or overperformed just because as a result of the way they changed the program this year.

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Jeffrey John Donnelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [15]

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Okay. And just one last question, it was just on the 2018 acquisitions. You were talking about it driving your growth. The Landing, last year, I think did $1.5 million of EBITDA. I think when you bought it, you guys had it $3 million in the trailing 12. And the Palomar came in at, I think, like $4.7 million. And I think when you bought it, you thought it would do $6.3 million. So collectively that's kind of well below underwriting, but I wasn't sure, is that a function of the work that you guys were doing to lay the ground work for where you kind of see that asset going in '19? Or is there something about underwriting or asset management that didn't hit the numbers you guys thought in the first year?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [16]

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So let's take it one by one. I mean, so those 3 acquisitions they'll play out in 2019. Obviously, the Sedona ones, which we kind of talk about every quarter, have been a home run for us, our '17 acquisitions. Cavallo Point, we expect to be a strong performer this year. We benefit certainly from the -- what's going on in San Francisco Bay market. So that one's pretty obvious to see. The Palomar -- if we take into account the Palomar Phoenix, we did hit with some asset management initiatives or some initial expenses putting the labor systems in, putting the food consultants in the food procurement programs. Those expenses hit and we did move out the underperformers of the operating team, and that forced some of that severance in 2018. So 2019, right on track for underwriting. I think you'll be really pleased with what you see in the results from the Palomar. The very small Landing is very sensitive to expenses because it's just a -- it's a small asset. It got hit with some of those expenses as well. That one, we're not going to know. I mean, it's going to take couple of years for that deal to play out. It really all hinges on this expansion and the ability to add over 20 additional keys to the 77-room base. And so that one, we're going to have judge after that gets completed. And so we're just ramping up for that -- hopefully that expansion in 2020.

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Operator [17]

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And our next question comes from Felicia Hendrix with Barclays.

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Felicia Rae Kantor Hendrix, Barclays Bank PLC, Research Division - MD & Senior Equity Research Analyst [18]

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So this is a question for either one of you. Just with -- you talked about some of your balance sheet actions and your buybacks since December. With your stock having recovered a bit, just wondering if share repurchases remain the top priority? Are you back to prioritizing new hotel acquisitions? How should we think about capital allocation in '19?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [19]

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It's a great question. So I would say, share repurchases remain a consideration, and we're going to be opportunistic as we go. Where we are looking at some acquisitions, but I'll tell you, we're still trading at a meaningful discount to NAV, so we're still being pretty conservative on our underwriting on deals that we're looking at. So our expectation is that the stocks are going to be fairly volatile in 2019, and we're going to have to pick our stocks on kind of both ends of the capital allocation spectrum.

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Felicia Rae Kantor Hendrix, Barclays Bank PLC, Research Division - MD & Senior Equity Research Analyst [20]

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Good. That's helpful. And then just my follow-up is just regarding what's happening in private equity with C&P firms. Even some REIT starts are buying in New York again. You've talked about how you've seen New York recovering. So just wondering can you update on your ideal mix in New York City and how you see each of your assets positioned there in the long term?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [21]

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Sure. So we have 4 hotels in New York City, represents about 11% or 12% of our total EBITDA. We like to be no more than about 10%-ish in any one market. So we're kind of at that allocation in New York City now. 3 of our 4 hotels are on the East side. We're particularly excited about Midtown East, since it's the best supply picture within Manhattan, especially what's going on with JPMorgan's new headquarters and the hike at Grand Central coming out, creating kind of native supply near our hotel. So we like those dynamics a lot. We're happy to have the allocation. We're unlikely to add additional New Yorks since we're already kind of at our target allocation. But we really like the setup over the next 5 years for New York City.

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Operator [22]

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And our next question comes from Stephen Grambling with Goldman Sachs.

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Stephen White Grambling, Goldman Sachs Group Inc., Research Division - Equity Analyst [23]

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Maybe a longer-term question. As you look at the all-in cost of branding versus being independent or even so-called soft branding, how have the costs evolved from your standpoint over the past 5 years? And where do you see those moving over the next 5? And how that might dictate your decision whether to stick with brand versus look for alternatives?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [24]

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This is Mark. I think every hotel is its own business case. So expenses have generally been stable, right, the franchise fees or the management fees have generally been the same percentage of revenues. They have other program costs, but they've -- I would say, are in the same neighborhood, it ticked up a little bit. I think, really it has to be consideration of what is the market demand? Is it group-centric and you need the brand to drive the group? And is the particular market so constrained that the brand's cost versus the incremental demand it puts into your hotel isn't the right ROI? I'd say, certainly the big group boxes, it's kind of a no-brainer that you need the brands, so the less group you do, probably the -- more careful you need to be about the proposition of putting a long-time encumbrance. But there's no doubt a number of our hotels run much higher rates and much -- are much more profitable having the brands. There are some -- we have to say, we have some independents like Cavallo Point that we don't think would make as much money with a brand even if it is was a Four Seasons or a Ritz-Carlton. So we -- again, we -- I think you've got to look at each one as an individual business case.

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Stephen White Grambling, Goldman Sachs Group Inc., Research Division - Equity Analyst [25]

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And I guess, looking at the small-resort strategy, are you seeing any change in the transaction environment for these types of properties either from a seller standpoint more coming on the market or a bidder standpoint more people looking at these?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [26]

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Yes. So I guess, one of the things on the seller front that we really like about resorts is that they're less institutionally owned traditionally so there is more ability, like Cavallo Point, to do off-market deals and hopefully we're getting better pricing by doing those off-market deals. So that's one of the things that we're very attracted to the what I'll call the small midsize resort kind of generally that acquisition strategy. But we're not alone in recognizing that resorts are hot. I mean, if you look at Smith Travel, whether it's last year or this year, resorts continue to stand out. People are looking at similar data. When we talk to our friends in PE particularly, resorts are at the top of their acquisition wish list as well. So we're going to have to continue to hustle a little faster and try to find a couple unique deals here and there, but there is clearly much more interest in resorts than there was a couple of years ago, at least I think a lot of people are focused on the same data that's driving our acquisition strategy.

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Operator [27]

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Our next question comes from Bill Crow with Raymond James.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [28]

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A question for you on capital allocation and sources and uses, you haven't sold an asset since 2016 and, certainly, your peers have been active on the sales front. And as I look through your portfolio, I think there's 3 or 4 hotels that just don't seem to fit with where you're trying to get to. Can you talk about the prospects for maybe raising capital from asset sales?

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

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Sure. So we were a very active seller of assets early in this cycle, as you know. We do have like any portfolio that, by definition, there is about 10% of things that are not as fast to grow or something doesn't quite fit the box of what our ideal asset is. And we are looking at potentially amortizing an asset or 2 this year, but I think we need to be very, very cautious about our cost of capital on that relative trade. So I would say, yes, there are 1 or 2 assets which we would consider for disposition, but we need to get the right pricing to transact.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [30]

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But depending on how your stock is trading, buying your stock below NAV could be a pretty good trade, right?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [31]

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Absolutely. The lower our stock price, the easier it is to sell the assets because the [bid] is there, no doubt.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [32]

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All right. Let me just over the Cavallo Point asset, and I think I get it, but you're talking about -- it's pretty obvious how it's going to have a great year given the San Francisco backdrop. But when I think of San Francisco, I think of really the CBD market benefiting from this amazing convention demand and I'm just curious. I know there's going to be compression throughout the city, but you are on the other side of the bridge or primarily targeting resort or leisure travelers, I should say, and at a pretty high price point that maybe convention dollars wouldn't pay. So is it that obvious that -- and I don't know how long the booking window is, but just kind of draw that bridge on why it's obvious that it's going to have a terrific year this year?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [33]

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Sure. So as you imagine, every weekend is overwhelmed with demand in Sausalito and what really drives kind of terrific year-over-year RevPAR growth is the ability to put in high-end small groups midweek, and so as San Francisco is superhot, we're able to put in more high-tech groups, more incentive travel, more of everything that's getting kind of pushed into the San Francisco area and there is less other places for them to go. And we provide a very unique experience. So that incremental demand on Tuesday, Wednesday, Thursday, with that -- particularly that small group is really what's going to drive the year-over-year RevPAR growth.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [34]

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So is there a concern --- and then I'll get off the phone. But is there a concern that the pricing in the New York -- excuse me, of the San Francisco market may shift demand away this year from leisure would-be guests and maybe inbound international travelers as well might be a little bit weaker this year, so you're kind of battling that a little bit, or no?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [35]

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Tom, you want to answer that?

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Thomas G. Healy, DiamondRock Hospitality Company - Executive VP of Asset Management & COO [36]

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Bill, I don't resell, but I think there's a significant demand as Mark said. The leisure demand on the weekends is incredible, one, for rooms and two, for just foot traffic into the resort as people come off the bridge, but there is a fair amount of activity in and around resort in the restaurants. So I think the weekend takes care of itself and as Mark said, the demand, the compression in San Francisco and Palo Alto, the midweek group, we're seeing a tremendous amount of demand into the hotel with Monday through Thursday for group business and then the incremental spend on a group room night that's pretty significant. So we feel pretty good that the demand on all pieces are -- is appropriate and we feel pretty confident that the resort will perform.

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Operator [37]

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Our next question comes from Thomas Allen with Morgan Stanley.

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Thomas Glassbrooke Allen, Morgan Stanley, Research Division - Senior Analyst [38]

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What do you see in terms of international inbound in general and what are kind of your expectations there?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [39]

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Yes. Thomas, I would say, the market that we're in that is most attuned to international inbound traveler is New York City. And New York City had record inbound international last year. So we continue to be actually a little surprised of how strong international has been for us throughout the portfolio. Our expectation, what's built into our budget, is flat expectation for international inbound guests at our hotels in 2019.

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Thomas Glassbrooke Allen, Morgan Stanley, Research Division - Senior Analyst [40]

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Perfect. And then a little bit granular, but you gave incremental color on how you're thinking about first quarter, second quarter and third quarter next year. There are just a lot of moving parts on fourth quarter in terms of the comps. Any commentary there?

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

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Yes, so we think, as we said, first quarter is going to be modest to positive RevPAR growth and then the second really through the fourth. Second and third quarter have a lot of unique things that are going to be positive as well as groups that are in the second and third. Fourth quarter has a little -- is a little softer on the group side, but a little easier on some of the renovation comp. So we expect fourth quarter to be decent, but not quite as robust as we're going to expect in the middle of the year.

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Operator [42]

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Our next question comes from Chris Woronka with Deutsche Bank.

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Chris Jon Woronka, Deutsche Bank AG, Research Division - Research Analyst [43]

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Wanted to ask you on the 2 potential rebrands, Sonoma and Vail, and I know you're still working in both places, but could you get something done before all of the renovations and capital spend are complete and what -- is this just kind of still going through the bake off process in terms of brands and key money and things like that?

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

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All right. So let's kind of take them one at a time. So Vail, we still have 2 years. We wouldn't want to rebrand it unless we were done with the complete renovation because you kind of get one shot of reintroducing you're property to the world. So we would complete everything ahead of that brand change. So no, we wouldn't rebrand it before close property 2 years from now. And we want to stage the capital so it's not very disruptive. The good thing about Vail is you have very short-shoulder seasons that you can do a lot of work in. And so we want to stage it over the next 2 years to minimize disruption and then relaunch it as the fully renovated, fantastic whatever it's going to be. The Renaissance, The Lodge at Sonoma, is different. We have a long-term agreement with Marriott there. So our only option is to rebrand what's in that brand family and our discussion with them now is could we rebrand to a lifestyle brand within their portfolio and what would the capital be there? So we're repositioning, as I mentioned, the Michael Mina restaurant is getting built this year. We're redoing the spa brand, bringing in the luxury-spa operator that will get done this year and then what else would we need to do to satisfy their brand requirements to switch the brand there probably next year. So that's the ongoing dialogue with Marriott.

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Chris Jon Woronka, Deutsche Bank AG, Research Division - Research Analyst [45]

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Okay. That's helpful. And then I just want to ask Mark, I know it's been said you guys have gone a little bit deeper into the resorts and a little bit more boutique-y in different markets, which I think is differentiated. Do you think there is something secular in the industry? Everything you've sold has been kind of a 4-star generally, don't want to say, commodity hotel, but commodity-like hotels. Is there something you're seeing and do you think there is lasting customer shifts in where the growth is going to be in terms of going into these smaller resorts?

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

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I think the shift is -- I think we are more sensitized as we kind of think about holding our assets for the next 10 years when we go into our assets. And sometimes we do; sometimes we don't, things change. But what we're trying to think what is it that resonates with the customer. Clearly the big group boxes that are -- can't be duplicated, big groups need that kind of experience. So we're happy with that. I think the one that the customer is less distinguished, especially as these brands get very big and have multiple options within the same market is kind of your standard hotel without any special features. So we're more and more sensitive to those kind of properties and even in with our existing portfolio, we are doing a number of capital projects and a lot of the upsides on figuring out how we can reposition those assets to capture that unique customer experience. So yes, the assets we would be -- we have been more likely to sell have been the ones that are less distinguished. They are good hotels in good markets, but there is nothing that's unique or special about them that would necessarily outperform over the next several years.

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Operator [47]

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And 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 [48]

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Just curious on the Vail Marriott, you've talked about the $3 million or $4 million of upside and I'm just curious what base level of hotel EBITDA that that's off of? And how upside are you expecting to capture in 2019 or is that fully post the rebranding?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [49]

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So we expect this to be a big year for Vail, partially due to the easy comp from doing the rooms renovation last year, though. So looking here, we anticipate doing well north of $11 million of EBITDA that -- at that hotel this year. And so it's off of that level. Really the whole push is going to be how much of that $175 rate gap to the luxury comp set can we close. And even if we can only close $50 or $70 of it, it would be enormously profitable to us.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [50]

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So what -- how much of that rate gap is assumed in the $3 million to $4 million of upside?

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

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None. I mean, basically the numbers this year are mostly just recapturing what we lost last year and then we would anticipate outperformance in 2020 as people see the room -- the renovated rooms and the renovated new space.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [52]

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Got it. I appreciate the thoughts there. And then I know we've talked a little bit about Frenchman's and ongoing negotiations with BI, but as we think about 2020 and sort of the combination of the ramping EBITDAs as that hotel comes back online as well as any potential BI, what's sort of the thought process next year in terms of contribution from the hotel in terms of your underwriting?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [53]

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So the way our insurance policy works is that we're entitled for our all lost profits until it reopens, plus for a period of up to 18 months after it reopens between what the stabilized number would be and what it actually does. Unfortunately, for the modeling, the way the accounting rules work is we can't take it in the income until we have agreement with the insurance company. So it's going to be a little lumpy next year.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [54]

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And how much, I guess, contribution are you expecting just from reopening the hotel aside from, I guess, the 18-month window of lost profits that you said that you can still recapture in BI insurance?

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

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Yes. So it's not going to reopen till the middle of next year, which means it's going to reopen into the softest period of the year still. So the EBITDA contribution's going to really be about how much business interruption insurance we can get into 2020.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [56]

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Got it. Understood. And then just last one for me, you've talked about New York City, the optimism in that market based off of better-than-expected results in 2018. What are you assuming for RevPAR growth for New York City in 2019?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [57]

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Our markets -- our budgets are between 1.5% and 2%.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [58]

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I'm sorry, can you repeat that?

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [59]

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Between 1.5% and 2% RevPAR growth.

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Operator [60]

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Thank you. And I'm showing no further questions at this time. I'd like to turn the call back over to Mark Brugger, CEO, for any closing remarks.

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Mark W. Brugger, DiamondRock Hospitality Company - President, CEO & Director [61]

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Thank you. We appreciate everyone joining us today, and we look forward to updating you on our next quarterly call. Take care.

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Operator [62]

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