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RLJ > SEC Filings for RLJ > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for RLJ LODGING TRUST


9-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition.

The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report, as well as the information contained in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013 (the "Annual Report"), which is accessible on the SEC's website at www.sec.gov.

Statement Regarding Forward-Looking Information

The following information contains certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, that are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements generally are identified by the use of the words "believe," "project," "expect," "anticipate," "estimate," "plan," "may," "will," "will continue," "intend," "should," "may" or similar expressions. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, beliefs and expectations, such forward-looking statements are not predictions of future events or guarantees of future performance and our actual results could differ materially from those set forth in the forward-looking statements. Some factors that might cause such a difference include the following: the current global economic uncertainty, increased direct competition, changes in government regulations or accounting rules, changes in local, national and global real estate conditions, declines in the lodging industry, seasonality of the lodging industry, risks related to natural disasters, such as earthquakes and hurricanes, hostilities, including future terrorist attacks or fear of hostilities that affect travel, our ability to obtain lines of credit or permanent financing on satisfactory terms, changes in interest rates, access to capital through offerings of our common and preferred shares of beneficial interest, or debt, our ability to identify suitable acquisitions, our ability to close on identified acquisitions and integrate those businesses and inaccuracies of our accounting estimates. Given these uncertainties, undue reliance should not be placed on such statements.

Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. We caution investors not to place undue reliance on these forward-looking statements and urge investors to carefully review the disclosures we make concerning risks and uncertainties in the sections entitled "Risk Factors," "Forward-Looking Statements," and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report, as well as risks, uncertainties and other factors discussed in this Quarterly Report on Form 10-Q and identified in other documents filed by us with the SEC.

Overview

We are a self-advised and self-administered Maryland real estate investment trust, or REIT, that acquires primarily premium-branded, focused-service and compact full-service hotels. We are one of the largest U.S. publicly-traded lodging REITs in terms of both number of hotels and number of rooms. Our hotels are concentrated in urban and dense suburban markets that we believe exhibit multiple demand generators and high barriers to entry.

Our strategy is to acquire primarily premium-branded, focused-service and compact full-service hotels. Focused-service hotels typically generate most of their revenue from room rentals, have limited food and beverage outlets and meeting space and require fewer employees than traditional full-service hotels. We believe premium-branded, focused-service and compact full-service hotels have the potential to generate attractive returns relative to other types of hotels due to their ability to achieve RevPAR levels at or close to those achieved by traditional full-service hotels while achieving higher profit margins due to their more efficient operating model and less volatile cash flows.

We recognize the challenging geopolitical environment and the possibility that the current economic recovery might not be as robust as anticipated or that economic conditions could deteriorate. However, with growth in lodging supply expected to be below historical averages for the next few years and corporate profits rising, we currently do not anticipate any significant slowdown in lodging fundamentals. Accordingly, we remain cautiously optimistic that we are in the midst of a multiyear lodging recovery.

Furthermore, we believe that attractive acquisition opportunities that meet our investment profile remain available in the market. We believe our cash on hand and expected access to capital (including availability under our unsecured revolving


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credit facility) along with our senior management team's experience, extensive industry relationships and asset management expertise, will enable us to compete effectively for such acquisitions and enable us to generate additional internal and external growth

As of March 31, 2013, we owned 148 properties with approximately 22,000 suites/rooms, comprised of 147 hotels and one planned hotel conversion, located in 21 states and the District of Columbia, interests in land parcels located adjacent to certain hotels and an interest in two mortgage loans secured by hotels. We own, through wholly-owned subsidiaries, 100% of the interests in 146 hotels and one planned hotel conversion and a 95% interest in one hotel.

We elected to be taxed as a REIT, for U.S. federal income tax purposes, when we filed our U.S. federal tax return for the taxable year ended December 31, 2011. Substantially all of our assets are held by, and all of our operations are conducted through, our operating partnership RLJ Lodging Trust, L.P. (the "Operating Partnership"). We are the sole general partner of our operating partnership. As of March 31, 2013, we owned, through a combination of direct and indirect interests, 99.3% of the units of limited partnership interest in the Operating Partnership ("OP units").

Our Customers

Substantially all of our hotels consist of premium-branded focused-service and compact full-service hotels. As a result of this property profile, the majority of our customers are transient in nature. Transient business typically represents individual business or leisure travelers. The majority of our hotels are located in the business districts and suburban markets of major metropolitan areas. Accordingly, business travelers represent the majority of the transient demand at our hotels. As a result, macroeconomic factors impacting business travel have a greater effect on our business than factors impacting leisure travel.

Group business is typically defined as a minimum of 10 guestrooms booked together as part of the same piece of business. Group business may or may not use the meeting space at any given hotel. Given the limited meeting space at the majority of our hotels, group business that utilizes meeting space represents a smaller component of our customer base.

A number of our hotels are affiliated with brands marketed toward extended-stay customers. Extended-stay customers are generally defined as those staying five nights or longer. Reasons for extended-stays may include, but are not limited to, training and/or special project business, relocation, litigation and insurance claims.

Our Revenues and Expenses

Our revenue is primarily derived from hotel operations, including the sale of rooms, food and beverage revenue and other operating department revenue, which consist of telephone, parking and other guest services.

Our operating costs and expenses consist of the costs to provide hotel services, including room expense, food and beverage expense, management fees and other operating expenses. Room expense includes housekeeping wages and payroll taxes, reservation systems, room supplies, laundry services and front desk costs. Food and beverage expense primarily includes the cost of food, the cost of beverages and associated labor costs. Other hotel expenses include labor and other costs associated with the other operating department revenue, as well as labor and other costs associated with administrative departments, franchise fees, sales and marketing, repairs and maintenance and utility costs. Our hotels are managed by independent, third-party management companies under long-term agreements under which the management companies typically earn base and incentive management fees based on the levels of revenues and profitability of each individual hotel. We generally receive a cash distribution from the hotel management companies on a monthly basis, which reflects hotel-level sales less hotel-level operating expenses.

Critical Accounting Policies

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts may differ significantly from these estimates and assumptions. We have provided a summary of our significant accounting policies in the notes to the historical combined consolidated financial statements included elsewhere in this filing. We have set forth below those accounting policies that we believe require material subjective or complex judgments and have the most significant impact on our financial condition and


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results of operations. We evaluate our estimates, assumptions and judgments on an ongoing basis, based on information that is then available to us, our experience and various matters that we believe are reasonable and appropriate for consideration under the circumstances.

Investment in Hotel and Other Properties

Our acquisitions generally consist of land, land improvements, buildings, building improvements, furniture, fixtures and equipment ("FF&E"), and inventory. We may also acquire in-place leases or other intangible assets (e.g., management agreements or franchise agreements) when properties are acquired. We allocate the purchase price among the assets acquired and liabilities assumed based on their respective fair values.

Our investments in hotels and other properties are carried at cost and are depreciated using the straight-line method over estimated useful lives of 15 years for land improvements, 15 years for building improvements, 40 years for buildings and three to five years for FF&E. Intangible assets arising from favorable or unfavorable leases are amortized using the straight-line method over the non-cancelable portion of the term of the agreement. Maintenance and repairs are expensed and major renewals or improvements are capitalized. Upon the sale or disposition of a fixed asset, the asset and related accumulated depreciation are removed from the accounts and the related gain or loss is included in discontinued operations.

We consider each individual property to be an identifiable component of the business. In accordance with the guidance on impairment or disposal of long-lived assets, we do not consider a property as "held for sale" until it is probable that the sale will be completed within one year and the other requisite criteria for such classification have been met. Once a property is designated as "held for sale" the operations for that property are included in discontinued operations. We do not depreciate properties so long as they are classified as "held for sale." Upon designation of a property as being "held for sale" and quarterly thereafter, we review the realizability of the carrying value, less cost to sell, in accordance with the guidance. Any such adjustment in the carrying value of a property classified as "held for sale" is reflected in discontinued operations.

We assess the carrying values of each property whenever events or changes in circumstances indicate that the carrying amounts of these properties may not be fully recoverable. Recoverability of the property is measured by comparison of the carrying amount of the property to the estimated future undiscounted cash flows which take into account current market conditions and our intent with respect to holding or disposing of the property. If our analysis indicates that the carrying value of the property is not recoverable on an undiscounted cash flow basis, it recognizes an impairment charge for the amount by which the carrying value exceeds the fair value of the property. Fair value is determined through various valuation techniques, including internally developed discounted cash flow models, comparable market transactions and third party appraisals, where considered necessary.

The use of projected future cash flows is based on assumptions that are consistent with a market participant's future expectations for the travel industry and economy in general and our plans to manage the underlying properties. However, assumptions and estimates about future cash flows and capitalization rates are complex and subjective. Changes in economic and operating conditions and our ultimate investment intent that occur subsequent to a current impairment analysis could impact these assumptions and result in future impairment charges of the properties.


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Results of Operations

At March 31, 2013 and 2012, we owned 148 and 141 properties, respectively. All properties owned during these periods have been included in our results of operations during the respective periods or since their date of acquisition. Based on when a property is acquired or closed for renovation, operating results for certain properties are not comparable for the three month periods ended March 31, 2013 and 2012. The properties listed in the table below are hereafter referred to as non-comparable properties:

                                                                         Non-comparable property for
                                                                           the three months ended
Property                              Location       Acquisition Date      March 31, 2013 and 2012
Hotel Indigo New Orleans Garden    New Orleans, LA   October 26, 2010                 x
District (1)
Residence Inn Bethesda Hotel       Bethesda, MD        May 29, 2012                   x
Downtown
Courtyard New York / Manhattan     New York, NY        May 30, 2012                   x
Upper East Side
Hilton Garden Inn San Francisco
/ Oakland Bay Bridge               Emeryville, CA      June 11, 2012                  x
Embassy Suites Boston/Waltham      Waltham, MA       November 13, 2012                x
Courtyard Houston Downtown         Houston, TX        March 19, 2013                  x
Residence Inn Houston Downtown     Houston, TX        March 19, 2013                  x
Humble Tower Apartments (2)        Houston, TX        March 19, 2013                  x



(1) Property was closed for renovation until December 27, 2012.

(2) Conversion to a 166-room SpringHill Suites expected to be complete by mid-2015.

Comparison of the three months ended March 31, 2013 to the three months ended March 31, 2012

Net income for the three months ended March 31, 2013 was $8.6 million compared to net loss of $6.9 million for the three months ended March 31, 2012, representing an increase of $15.5 million. This improved performance was primarily due to a $32.7 million, or 17.8%, increase in total revenue (including $14.6 million arising from hotel acquisitions), partially offset by the net impact of a $20.6 million, or 12.1%, increase in total operating expenses and a decrease in interest expense of $3.1 million, or 15.6%. The increase in total operating expenses was primarily attributable to $9.9 million from property acquisitions.


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                                      For the three months ended
                                              March 31,
                                        2013              2012          $ change      % change
                                               (amounts in thousands)
Revenue
Operating revenue
Room revenue                       $      186,427    $      158,579    $    27,848         17.6 %
Food and beverage revenue                  23,232            19,505          3,727         19.1 %
Other operating department
revenue                                     6,228             5,109          1,119         21.9 %
Total revenue                             215,887           183,193         32,694         17.8 %

Expense
Operating expense
Room expense                               43,397            36,930          6,467         17.5 %
Food and beverage expense                  16,577            14,440          2,137         14.8 %
Management fee expense                      7,419             6,304          1,115         17.7 %
Other operating expense                    66,900            58,558          8,342         14.2 %
Total property operating
expense                                   134,293           116,232         18,061         15.5 %
Depreciation and amortization              31,435            33,697         (2,262 )       (6.7 )%
Property tax, insurance and
other                                      14,786            12,634          2,152         17.0 %
General and administrative                  8,815             7,260          1,555         21.4 %
Transaction and pursuit costs               1,089                19          1,070            -
Total operating expense                   190,418           169,842         20,576         12.1 %
Operating income                           25,469            13,351         12,118         90.8 %
Other income                                   79                84             (5 )       (6.0 )%
Interest income                               296               419           (123 )      (29.4 )%
Interest expense                          (17,034 )         (20,181 )        3,147        (15.6 )%

Income (loss) before income
taxes                                       8,810            (6,327 )       15,137       (239.2 )%

Income tax expense                           (226 )            (594 )          368        (62.0 )%

Net income (loss)                           8,584            (6,921 )       15,505       (224.0 )%

Net (income) loss attributable
to non-controlling interests
Noncontrolling interest in
joint venture                                  48               370           (322 )      (87.0 )%
Noncontrolling interest in
common units of Operating
Partnership                                  (139 )              38           (177 )     (465.8 )%
Net income (loss) attributable
to common shareholders             $        8,493    $       (6,513 )  $    15,006       (230.4 )%

Revenue

Total revenue increased $32.7 million, or 17.8%, to $215.9 million for the three months ended March 31, 2013 from $183.2 million for the three months ended March 31, 2012. The increase was a result of $14.6 million in revenue attributable to non-comparable properties and a 10.6% increase in RevPAR at the comparable properties.

The following are the quarter-to-date key hotel operating statistics for hotels owned at March 31, 2013 and 2012, respectively:

                                         For the three months ended
                                                 March 31,
                                           2013              2012        % Change
Number of hotels (at end of period)              147               141        4.3 %
Occupancy %                                     70.4 %            67.8 %      3.9 %
ADR                                   $       135.59    $       125.62        7.9 %
RevPAR                                $        95.49    $        85.11       12.2 %

Portfolio RevPAR increased to $95.49 from $85.11, a 12.2% increase. RevPAR, excluding non-comparable properties, increased 10.6% and was driven by a 3.6% increase in occupancy and a 6.8% increase in ADR.


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Room Revenue

Our portfolio consists primarily of focused-service and compact full-service hotels that generate the majority of their revenues through room sales. Room revenue increased $27.8 million, or 17.6%, to $186.4 million for the three months ended March 31, 2013 from $158.6 million for the three months ended March 31, 2012. This increase was a result of $12.4 million of room revenue from non-comparable properties and a 10.6% increase in RevPAR at the comparable properties.

Food and Beverage Revenue

Food and beverage revenue increased $3.7 million, or 19.1%, to $23.2 million for the three months ended March 31, 2013 from $19.5 million for the three months ended March 31, 2012. The increase includes $1.6 million in food and beverage revenue arising from non-comparable properties. Food and beverage revenue for the remainder of the portfolio increased $2.1 million.

Other Operating Department Revenue

Other operating department revenue, which includes revenue derived from ancillary sources such as telephone charges and parking fees, increased $1.1 million, or 21.9%, to $6.2 million for the three months ended March 31, 2013 from $5.1 million for the three months ended March 31, 2012. This increase was primarily due to $0.5 million of other operating department revenue from non-comparable properties and a $0.3 million increase in parking revenue from comparable properties.

Hotel Operating Expense

Hotel operating expense increased $18.1 million, or 15.5%, to $134.3 million for the three months ended March 31, 2013 from $116.2 million for the three months ended March 31, 2012. This increase includes $9.9 million in hotel operating expense attributable to non-comparable properties. The remaining increase was primarily attributable to higher room expense, other operating department costs, and management and franchise fees. Room expense and other operating department costs were driven by higher occupancy at hotels not under renovation. Management fees and franchise fees, which are computed as a percentage of gross revenue and room revenue, respectively, increased as a result of higher revenues.

Depreciation and Amortization

Depreciation and amortization expense decreased $2.3 million, or 6.7%, to $31.4 million for the three months ended March 31, 2013 from $33.7 million for the three months ended March 31, 2012. The decrease is a result of $3.1 million of accelerated depreciation of FF&E that underwent renovations during the three months ended March 31, 2012 but not in 2013 and FF&E at other hotels being fully depreciated during the periods. Partially offsetting this was a $2.4 million increase in depreciation and amortization expense arising from non-comparable properties.

Property Tax, Insurance and Other

Property tax, insurance and other expense increased $2.2 million, or 17.0%, to $14.8 million for the three months ended March 31, 2013 from $12.6 million for the three months ended March 31, 2012. The increase includes $0.9 million in property tax, insurance and other expense attributable to non-comparable properties. The remaining increase of $1.3 million is the net impact of increasing property tax assessments offset by favorable resolution of property tax appeals.

General and Administrative

General and administrative expense increased $1.6 million, or 21.4%, to $8.8 million for the three months ended March 31, 2013 from $7.3 million for the three months ended March 31, 2012. The increase in general and administrative expense is primarily attributable to an increase in amortization of restricted share awards of $1.5 million.

Transaction and Pursuit Costs

Transaction and pursuit costs increased $1.1 million to $1.1 million for the three months ended March 31, 2013 from


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less than $0.1 million for the three months ended March 31, 2012. There were three acquisitions during the three months ended March 31, 2013 resulting in transaction costs of $0.9 million compared to zero during the three months ended March 31, 2012.

Interest Expense

Interest expense decreased $3.1 million, or 15.6%, to $17.0 million for the three months ended March 31, 2013 from $20.2 million for the three months ended March 31, 2012. The decrease in interest expense was the result of a decrease of $4.4 million of interest expense due to the $331.0 million of mortgage principal balances that were paid down, the expiration of unfavorable interest rate hedges resulting in a decrease in hedge related interest expense of $0.5 million, a $0.5 million decrease in mortgage interest expense due to decreases in principal balances as the result of mortgage amortization and a decrease in amortization of deferred financing fees of $0.2 million. The offsetting increase was primarily due to interest incurred in 2013 on the Revolver, the Five-Year Term Loan and the Seven-Year Term Loan of $0.1 million, $1.4 million and $0.8 million, respectively, that was not incurred in 2012.

Income Taxes

As part of the structure, we own taxable REIT subsidiaries ("TRSs") that are subject to federal and state income taxes. The effective tax rates were 2.56% and 3.11% for the three months ended March 31, 2013 and 2012, respectively. The decrease in rate is primarily due to changes in state tax law. Our tax expense decreased $0.4 million to $0.2 million for the three months ended March 31, 2013 from $0.6 million for the three months ended March 31, 2012, primarily as a result of a reduction in state taxes paid at our Operating Partnership.

Non-GAAP Financial Measures

We consider the following non-GAAP financial measures useful to investors as key supplemental measures of our performance: (1) FFO, (2) Adjusted FFO, (3) EBITDA, and (4) Adjusted EBITDA. These non-GAAP financial measures should be considered along with, but not as alternatives to, net income or loss as a measure of our operating performance. FFO, Adjusted FFO, EBITDA and Adjusted EBITDA, as calculated by us, may not be comparable to FFO, Adjusted FFO, EBITDA and Adjusted EBITDA as reported by other companies that do not define such terms exactly as we define such terms.

Funds From Operations

We calculate FFO in accordance with standards established by the National Association of Real Estate Investment Trusts, or NAREIT, which defines FFO as net income or loss (calculated in accordance with GAAP), excluding gains or losses from sales of real estate, items classified by GAAP as extraordinary, the cumulative effect of changes in accounting principles, plus depreciation and . . .

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