Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2011

 

OR

 

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to

 

Commission file number 001-32319

 

 

Sunstone Hotel Investors, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

---

 

Maryland		20-1296886
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)
120 Vantis, Suite 350 Aliso Viejo, California		92656
(Address of Principal Executive Offices)		(Zip Code)

 

Registrant’s telephone number, including area code: (949) 330-4000

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  x No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  o  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x		Accelerated filer  o
Non-accelerated filer  o		Smaller reporting company  o
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  o No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

118,183,239 shares of Common Stock, $0.01 par value, as of May 1, 2011

 

 

Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

QUARTERLY REPORT ON

FORM 10-Q

 

For the Quarterly Period Ended March 31, 2011

 

TABL E OF CONTENTS

 

		Page
PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010	1
	Unaudited Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010	2
	Consolidated Statement of Equity as of March 31, 2011 (unaudited) and December 31, 2010	3
	Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010	4
	Notes to Unaudited Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	35
Item 4.	Controls and Procedures	36
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3	Defaults Upon Senior Securities	37
Item 4.	Removed and Reserved	37
Item 5.	Other Information	37
Item 6.	Exhibits	38
SIGNATURES		39

 

i

Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1.                                     Financial Statements

 

SUNSTONE HOTEL INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

		March 31, 2011			December 31, 2010
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents ($1,889 and $1,365 related to VIEs)		$	153,214		$	275,881
Restricted cash ($2,469 and $3,581 related to VIEs)		61,370			55,972
Accounts receivable, net ($4,574 and $1,885 related to VIEs)		29,784			18,173
Due from affiliates		17			44
Inventories ($224 and $159 related to VIEs)		2,674			2,568
Prepaid expenses		10,006			8,004
Investment in hotel property of discontinued operations, net		115,909			116,104
Other current assets of discontinued operations, net		3,426			2,635
Total current assets		376,400			479,381
Investment in hotel properties, net		2,361,863			1,918,119
Other real estate, net		12,109			12,012
Investments in unconsolidated joint ventures		—			246
Deferred financing fees, net		8,628			8,907
Interest rate derivative agreements		348			—
Goodwill		13,088			4,673
Other assets, net ($10 and $3 related to VIEs)		37,723			12,768
Total assets		$	2,810,159		$	2,436,106
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued expenses ($887 and $713 related to VIEs)		$	29,841		$	21,187
Accrued payroll and employee benefits ($851 and $1,123 related to VIEs)		13,713			12,674
Due to Third-Party Managers		7,855			7,852
Dividends payable		5,137			5,137
Other current liabilities ($2,168 and $1,439 related to VIEs)		24,187			17,212
Current portion of notes payable		288,699			16,486
Other current liabilities of discontinued operations, net		21,338			20,700
Total current liabilities		390,770			101,248
Notes payable, less current portion		1,163,654			1,126,817
Other liabilities ($12 and $30 related to VIEs)		9,517			8,742
Total liabilities		1,563,941			1,236,807
Commitments and contingencies (Note 13)
Preferred stock, Series C Cumulative Convertible Redeemable Preferred Stock, $0.01 par value, 4,102,564 shares authorized, issued and outstanding at March 31, 2011 and December 31, 2010, liquidation preference of $24.375 per share		100,000			100,000
Equity:
Stockholders’ equity:
Preferred stock, $0.01 par value, 100,000,000 shares authorized. 8.0% Series A Cumulative Redeemable Preferred Stock, 7,050,000 shares issued and outstanding at March 31, 2011 and December 31, 2010, stated at liquidation preference of $25.00 per share		176,250			176,250
Common stock, $0.01 par value, 500,000,000 shares authorized, 117,166,822 shares issued and outstanding at March 31, 2011 and 116,950,504 shares issued and outstanding at December 31, 2010		1,172			1,170
Additional paid in capital		1,314,099			1,313,498
Retained earnings		80,928			29,593
Cumulative dividends		(423,212		)	(418,075		)
Accumulated other comprehensive loss		(3,137		)	(3,137		)
Total stockholders’ equity		1,146,100			1,099,299
Non-controlling interest		118			—
Total equity		1,146,218			1,099,299
Total liabilities and equity		$	2,810,159		$	2,436,106

 

The abbreviation VIEs above refers to “Variable Interest Entities.”

 

See accompanying notes to consolidated financial statements.

 

1

---

Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

		Three Months Ended March 31, 2011			Three Months Ended March 31, 2010
REVENUES
Room		$	107,833		$	90,378
Food and beverage		40,403			38,208
Other operating		14,339			12,313
Total revenues		162,575			140,899
OPERATING EXPENSES
Room		29,445			24,207
Food and beverage		30,614			27,688
Other operating		6,834			6,738
Advertising and promotion		8,828			7,407
Repairs and maintenance		7,415			6,463
Utilities		6,968			5,829
Franchise costs		5,250			4,515
Property tax, ground lease and insurance		14,135			10,307
Property general and administrative		20,496			17,145
Corporate overhead		7,664			4,580
Depreciation and amortization		26,482			23,558
Total operating expenses		164,131			138,437
Operating income (loss)		(1,556		)	2,462
Equity in net earnings of unconsolidated joint ventures		21			112
Interest and other income		72			171
Interest expense		(17,944		)	(20,041		)
Gain on remeasurement of equity interests		69,230			—
Income (loss) from continuing operations		49,823			(17,296		)
Income (loss) from discontinued operations		1,512			(3,795		)
NET INCOME (LOSS)		51,335			(21,091		)
Distributions to non-controlling interest		(7		)	—
Preferred stock dividends and accretion		(5,137		)	(5,187		)
Undistributed income allocated to unvested restricted stock compensation		(302		)	—
Undistributed income allocated to Series C preferred stock		(209		)	—
INCOME AVAILABLE (LOSS ATTRIBUTABLE) TO COMMON STOCKHOLDERS		$	45,680		$	(26,278	)
Basic per share amounts:
Income (loss) from continuing operations available (attributable) to common stockholders		$	0.38		$	(0.23	)
Income (loss) from discontinued operations		0.01			(0.04		)
Basic income available (loss attributable) to common stockholders per common share		$	0.39		$	(0.27	)
Diluted per share amounts:
Income (loss) from continuing operations available (attributable) to common stockholders		$	0.38		$	(0.23	)
Income (loss) from discontinued operations		0.01			(0.04		)
Diluted income available (loss attributable) to common stockholders per common share		$	0.39		$	(0.27	)
Weighted average common shares outstanding:
Basic		117,074			97,047
Diluted		117,211			97,047
Dividends declared per common share		$	—		$	—

 

See accompanying notes to consolidated financial statements.

 

2

Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

CONSOLIDATED STATEMENT OF EQUITY

(In thousands, except share data)

 

		Sunstone Hotel Investors, Inc. Stockholders’ Equity
		Preferred Stock					Common Stock					Additional									Accumulated Other			Non-
		Number of  Shares		Amount			Number of  Shares		Amount			Paid in  Capital			Retained  Earnings			Cumulative  Dividends			Comprehensive Loss			Controlling  Interest			Total
Balance at December 31, 2010		7,050,000		$	176,250		116,950,504		$	1,170		$	1,313,498		$	29,593		$	(418,075	)	$	(3,137	)	$	—		$	1,099,299
Vesting of restricted common stock (unaudited)							216,318		2			601															603
Non-controlling interest assumed at acquisition (unaudited)																								125			125
Distributions to non-controlling interest (unaudited)																								(7		)	(7		)
Series A preferred dividends and dividends payable at $0.50 per share year to date (unaudited)																		(3,525		)							(3,525		)
Series C preferred dividends and dividends payable at $0.393 per share year to date (unaudited)																		(1,612		)							(1,612		)
Net income and comprehensive income (unaudited)															51,335												51,335
Balance at March 31, 2011 (unaudited)		7,050,000		$	176,250		117,166,822		$	1,172		$	1,314,099		$	80,928		$	(423,212	)	$	(3,137	)	$	118		$	1,146,218

 

See accompanying notes to consolidated financial statements.

 

3

Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

		Three Months Ended March 31, 2011			Three Months Ended March 31, 2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	51,335		$	(21,091	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Bad debt expense (recovery)		3			(40		)
Gain on remeasurement of equity interests		(69,230		)	—
Loss on derivatives, net		44			—
Depreciation		27,239			25,189
Amortization of franchise fees and other intangibles		1,613			186
Amortization and write-off of deferred financing fees		616			2,089
Amortization of loan discounts		261			246
Amortization of deferred stock compensation		544			962
Equity in net earnings of unconsolidated joint ventures		(21		)	(112		)
Changes in operating assets and liabilities:
Restricted cash		11,938			(7,353		)
Accounts receivable		(5,892		)	(4,674		)
Due from affiliates		27			1
Inventories		(4		)	51
Prepaid expenses and other assets		1,408			129
Accounts payable and other liabilities		6,310			11,446
Accrued payroll and employee benefits		(2,153		)	(1,517		)
Due to Third-Party Managers		3			(108		)
Discontinued operations		(688		)	(6,920		)
Net cash provided by (used in) operating activities		23,353			(1,516		)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of hotel properties and other assets		42			—
Restricted cash — replacement reserve		(2,422		)	2,291
Acquisitions of hotel properties and other assets		(102,159		)	(4,000		)
Renovations and additions to hotel properties and other real estate		(32,606		)	(8,625		)
Net cash used in investing activities		(137,145		)	(10,334		)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable		(3,394		)	(2,745		)
Payments of deferred financing costs		(337		)	(4		)
Dividends paid		(5,137		)	(5,137		)
Distributions to non-controlling interest		(7		)	—
Net cash used in financing activities		(8,875		)	(7,886		)
Net decrease in cash and cash equivalents		(122,667		)	(19,736		)
Cash and cash equivalents, beginning of period		275,881			353,255
Cash and cash equivalents, end of period		$	153,214		$	333,519
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest		$	16,469		$	16,902
NONCASH INVESTING ACTIVITY
Deconsolidation of assets of hotel placed into receivership		$	—		$	18,393
Deconsolidation of liabilities of hotel placed into receivership		$	—		$	26,876
Amortization of deferred stock compensation — construction activities		$	57		$	42
Amortization of deferred stock compensation — unconsolidated joint venture		$	2		$	10
NONCASH FINANCING ACTIVITY
Assumption of debt in connection with acquisitions of hotel properties		$	312,183		$	—
Dividends payable		$	5,137		$	5,137

 

See accompanying notes to consolidated financial statements.

 

4

Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Organization and Description of Business

 

Sunstone Hotel Investors, Inc. (the “Company”) was incorporated in Maryland on June 28, 2004 in anticipation of an initial public offering of common stock, which was consummated on October 26, 2004.  The Company, through its 100% controlling interest in Sunstone Hotel Partnership, LLC (the “Operating Partnership”), of which the Company is the sole managing member, and the subsidiaries of the Operating Partnership, including Sunstone Hotel TRS Lessee, Inc. (the “TRS Lessee”) and its subsidiaries, is currently engaged in acquiring, owning, asset managing and renovating hotel properties. The Company may also sell certain hotel properties from time to time. The Company operates as a real estate investment trust (“REIT”) for federal income tax purposes.

 

As a REIT, certain tax laws limit the amount of “non-qualifying” income the Company can earn, including income derived directly from the operation of hotels. As a result, the Company leases all of its hotels to its TRS Lessee, which in turn enters into long-term management agreements with third parties to manage the operations of the Company’s hotels. As of March 31, 2011, the Company owned 33 hotels, including the Royal Palm Miami Beach, which was classified as held for sale as of March 31, 2011 and included in discontinued operations due to its sale in April 2011, leaving 32 hotels (the “32 hotels”) held for investment. The Company’s third-party managers included a subsidiary of Interstate Hotels & Resorts, Inc., manager of 13 of the Company’s 32 hotels; subsidiaries of Marriott International, Inc. or Marriott Hotel Services, Inc. (collectively, “Marriott”), managers of 13 of the Company’s 32 hotels; and Davidson Hotel Company, Fairmont Hotels & Resorts (U.S.), Highgate Hotels, Hilton Worldwide, Hyatt Corporation and Sage Hospitality Resources, each managers of one of the Company’s 32 hotels.  In addition, as of January 2011, the Company owns 100% of BuyEfficient, LLC (“BuyEfficient”), an electronic purchasing platform that allows members to procure food, operating supplies, furniture, fixtures and equipment.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements as of March 31, 2011 and December 31, 2010, and for the three months ended March 31, 2011 and 2010, include the accounts of the Company, the Operating Partnership, the TRS Lessee and their subsidiaries. All significant intercompany balances and transactions have been eliminated.

 

The accompanying interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and in conformity with the rules and regulations of the Securities and Exchange Commission. In the Company’s opinion, the interim financial statements presented herein reflect all adjustments, consisting solely of normal and recurring adjustments, which are necessary to fairly present the interim financial statements. These financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, filed with the Securities and Exchange Commission on February 17, 2011.

 

Certain prior year amounts have been reclassified in the consolidated financial statements in order to conform to the current year presentation.

 

The Company has evaluated subsequent events through the date of issuance of these financial statements.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

 

Reporting Periods

 

The results the Company reports in its consolidated statements of operations are based on results reported to the Company by its hotel managers.  These hotel managers use different reporting periods.  Marriott uses a fiscal year ending on the Friday closest to December 31 and reports twelve weeks of operations each for the first three quarters of the year, and sixteen or seventeen weeks of operations for the fourth quarter of the year. The Company’s other hotel managers report operations on a standard monthly calendar.  The Company has elected to adopt quarterly close periods of March 31, June 30 and September 30, and an annual year end of December 31. As a result, the Company’s 2011 results of operations for the

 

5

---

Table of Contents

 

Marriott-managed hotels include results from January 1 through March 25 for the first quarter, March 26 through June 17 for the second quarter, June 18 through September 9 for the third quarter, and September 10 through December 30 for the fourth quarter. The Company’s 2010 results of operations for the Marriott-managed hotels include results from January 2 through March 26 for the first quarter, March 27 through June 18 for the second quarter, June 19 through September 10 for the third quarter, and September 11 through December 31 for the fourth quarter.

 

Fair Value of Financial Instruments

 

As of March 31, 2011 and December 31, 2010, the carrying amount of certain financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses were representative of their fair values due to the short-term maturity of these instruments.

 

The Company follows the requirements of the Fair Value Measurements and Disclosure Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), which establishes a framework for measuring fair value and disclosing fair value measurements by establishing a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

 

Level 1		Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2		Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3		Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

 

As discussed in Note 9, the Company entered into interest rate protection agreements to manage, or hedge, interest rate risks in conjunction with its acquisitions of the outside 62% equity interests in the Doubletree Guest Suites Times Square and the JW Marriott New Orleans during the first quarter of 2011. The Company records interest rate protection agreements on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in the consolidated statements of operations as they are not designated as hedges. In accordance with the Fair Value Measurements and Disclosure Topic of the FASB ASC, the Company estimates the fair value of its interest rate protection agreements based on quotes obtained from the counterparties, which are based upon the consideration that would be required to terminate the agreements. The Company has valued these derivative contracts using Level 2 measurements at $0.3 million as of March 31, 2011.

 

The Company currently pays the premiums for a $5,000,000 split life insurance policy for its former Chief Executive Officer and current Executive Chairman, Robert A. Alter. The Company has valued this policy using Level 2 measurements at $1.9 million as of both March 31, 2011 and December 31, 2010. These amounts are included in other assets, net in the accompanying consolidated balance sheets.

 

The Company also has a Retirement Benefit Agreement with Mr. Alter. The Company has valued this agreement using Level 2 measurements at $1.9 million as of both March 31, 2011 and December 31, 2010. These amounts are included in accrued payroll and employee benefits in the accompanying consolidated balance sheets.

 

On an annual basis and periodically when indicators of impairment exist, the Company has analyzed the carrying values of its hotel properties using Level 3 measurements, including a discounted cash flow analysis to estimate the fair value of its hotel properties taking into account each property’s expected cash flow from operations, holding period and estimated proceeds from the disposition of the property. The factors addressed in determining estimated proceeds from disposition included anticipated operating cash flow in the year of disposition and terminal capitalization rate. For the three months ended March 31, 2011 and 2010, the Company did not identify any properties with indicators of impairment.

 

The Company also analyzes the carrying value of its goodwill using Level 3 measurements including a discounted cash flow analysis to estimate the fair value of its reporting units. For the three months ended March 31, 2011 and 2010, the Company did not identify any goodwill with indicators of impairment.

 

As of March 31, 2011 and December 31, 2010, 81.4% and 100%, respectively, of the Company’s outstanding debt had fixed interest rates, including the effect of an interest rate swap agreement. The Company’s carrying value of its debt totaled $1.5 billion and $1.1 billion as of March 31, 2011 and December 31, 2010, respectively. Using Level 3 measurements, including the Company’s weighted average cost of capital ranging between 6.0% and 9.6%, the Company estimates that the fair market value of its debt as of March 31, 2011 and December 31, 2010 totaled $1.4 billion and $1.1 billion, respectively.

 

6

Table of Contents

 

The following tables present our assets and liabilities measured at fair value on a recurring and non-recurring basis at March 31, 2011 and December 31, 2010 (in thousands):

 

		Total			Fair Value Measurements at Reporting Date
		March 31, 2011			Level 1			Level 2			Level 3
		(unaudited)			(unaudited)			(unaudited)			(unaudited)
Assets:
Interest rate derivative agreements		$	348		$	—		$	348		$	—
Life insurance policy		1,934			—			1,934			—
Goodwill		13,088			—			—			13,088
Total assets		$	15,370		$	—		$	2,282		$	13,088
Liabilities:
Retirement benefit agreement		$	1,934		$	—		$	1,934		$	—
Total liabilities		$	1,934		$	—		$	1,934		$	—

 

		Total			Fair Value Measurements at Reporting Date
		December 31, 2010			Level 1			Level 2			Level 3
Assets:
Other real estate, net (1)		$	2,506		$	—		$	—		$	2,506
Life insurance policy		1,868			—			1,868			—
Goodwill		4,673			—			—			4,673
Total assets		$	9,047		$	—		$	1,868		$	7,179
Liabilities:
Retirement benefit agreement		$	1,868		$	—		$	1,868		$	—
Total liabilities		$	1,868		$	—		$	1,868		$	—

 

(1)       Includes the office building and land adjacent to one of the Company’s hotels that was impaired and recorded at fair value in June 2010.

 

The following table presents the goodwill account balance rollforward from the prior period, as well as the activity recorded for assets measured at fair value on a non-recurring basis using Level 3 inputs during the reporting period (in thousands):

 

		Goodwill
Balance at December 31, 2010		$	4,673
Purchase of outside 50% equity interest in BuyEfficient (unaudited)		8,415
Balance at March 31, 2011 (unaudited)		$	13,088

 

The following table presents the gains included in earnings as a result of applying Level 3 measurements for the three months ended March 31, 2011 and 2010 (in thousands):

 

		Three Months Ended March 31, 2011			Three Months Ended March 31, 2010
		(unaudited)			(unaudited)
Investment in unconsolidated joint ventures (1)		$	69,230		$	—
Total Level 3 measurement gains included in earnings		$	69,230		$	—

 

(1)                         Includes the gains recorded by the Company on the remeasurements of the Company’s equity interests in its Doubletree Guest Suites Times Square and BuyEfficient joint ventures.

 

7

Table of Contents

 

Accounts Receivable

 

Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize hotel services. Accounts receivable also includes, among other things, receivables from customers who utilize the Company’s commercial laundry facilities in Salt Lake City, Utah, and Rochester, Minnesota, receivables from venders who offer purchase volume rebates to BuyEfficient, as well as tenants who lease space in the Company’s hotels. The Company maintains an allowance for doubtful accounts sufficient to cover potential credit losses. The Company’s accounts receivable at both March 31, 2011 and December 31, 2010 includes an allowance for doubtful accounts of $0.1 million.

 

Goodwill

 

The Company follows the requirements of the Intangibles — Goodwill and Other Topic of the FASB ASC, which states that goodwill and intangible assets deemed to have indefinite lives are subject to annual impairment tests. As a result, the carrying value of goodwill allocated to the hotel properties and other assets is reviewed at least annually for impairment. In addition, when facts and circumstances suggest that the Company’s goodwill may be impaired, an interim evaluation of goodwill is prepared. Such review entails comparing the carrying value of the individual hotel property or other asset (the reporting unit) including the allocated goodwill to the fair value determined for that reporting unit (see Fair Value of Financial Instruments for detail on the Company’s valuation methodology). If the aggregate carrying value of the reporting unit exceeds the fair value, the goodwill of the reporting unit is impaired to the extent of the difference between the fair value and the aggregate carrying value, not to exceed the carrying amount of the allocated goodwill. The Company’s annual impairment evaluation is performed each year as of December 31.

 

During the first quarter ended March 31, 2011, the Company recorded additional goodwill of $8.4 million related to its purchase of the outside 50% equity interest in its BuyEfficient joint venture.

 

Deferred Financing Fees

 

Deferred financing fees consist of loan fees and other financing costs related to the Company’s outstanding indebtedness and are amortized to interest expense over the terms of the related debt. Upon repayment or refinancing of the underlying debt, any related unamortized deferred financing fee is charged to interest expense. Upon any loan modification, any related unamortized deferred financing fee is amortized over the remaining terms of the modified loan.

 

During the three months ended March 31, 2011 and 2010, approximately $0.3 million and $4,000, respectively were incurred and paid related to new debt and debt refinancings.

 

Total amortization and write-off of deferred financing fees for the three months ended March 31, 2011 and 2010 was as follows (in thousands):

 

		Three Months Ended March 31, 2011			Three Months Ended March 31, 2010
		(unaudited)			(unaudited)
Continuing operations:
Amortization of deferred financing fees		$	616		$	493
Write-off of deferred financing fees (1)		—			1,462
Total deferred financing fees — continuing operations		616			1,955
Discontinued operations:
Amortization of deferred financing fees		—			134
Total amortization and write-off of deferred financing fees		$	616		$	2,089

 

(1)                Includes unamortized deferred financing costs written off by the Company and charged to interest expense due to the termination of its credit facility during the first quarter of 2010.

 

Earnings Per Share

 

The Company applies the two-class method when computing its earnings per share as required by the Earnings Per Share Topic of the FASB ASC, which requires the net income per share for each class of stock (common stock and convertible preferred stock) to be calculated assuming 100% of the Company’s net income is distributed as dividends to each class of stock based on their contractual rights. To the extent the Company has undistributed earnings in any calendar quarter, the Company will follow the two-class method of computing earnings per share.

 

8

Table of Contents

 

The Company follows the requirements of ASC 260-10, which states that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. For the three months ended March 31, 2011 and 2010, undistributed earnings representing nonforfeitable dividends of $0.3 million and zero, respectively, were allocated to the participating securities.

 

In accordance with the Earnings Per Share Topic of the FASB ASC, basic earnings available (loss attributable) to common stockholders per common share is computed based on the weighted average number of shares of common stock outstanding during each period. Diluted earnings available (loss attributable) to common stockholders per common share is computed based on the weighted average number of shares of common stock outstanding during each period, plus potential common shares considered outstanding during the period, as long as the inclusion of such awards is not anti-dilutive. Potential common shares consist of unvested restricted stock awards (using the treasury stock method), the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s Series C Cumulative Convertible Redeemable Preferred Stock (“Series C preferred stock”).

 

The following table sets forth the computation of basic and diluted earnings (loss) per common share (in thousands, except per share data):

 

		Three Months Ended March 31, 2011			Three Months Ended March 31, 2010
		(unaudited)			(unaudited)
Numerator:
Net income (loss)		$	51,335		$	(21,091	)
Less distributions to non-controlling interest		(7		)	—
Less preferred stock dividends and accretion		(5,137		)	(5,187		)
Undistributed income allocated to unvested restricted stock compensation		(302		)	—
Undistributed income allocated to Series C preferred stock		(209		)	—
Numerator for basic and diluted earnings available (loss attributable) to common stockholders		$	45,680		$	(26,278	)
Denominator:
Weighted average basic common shares outstanding		117,074			97,047
Unvested restricted stock awards		137			—
Weighted average diluted common shares outstanding		117,211			97,047
Basic earnings available (loss attributable) to common stockholders per common share		$	0.39		$	(0.27	)
Diluted earnings available (loss attributable) to common stockholders per common share		$	0.39		$	(0.27	)

 

The Company’s shares of Series C preferred stock issuable upon conversion and shares associated with common stock options have been excluded from the above calculation of earnings (loss) per share for the three months ended March 31, 2011 and 2010, as their inclusion would have been anti-dilutive. The Company’s unvested restricted shares associated with its long-term incentive plan have been excluded from the above calculation of loss per share for the three months ended March 31, 2010 as their inclusion would have been anti-dilutive.

 

Segment Reporting

 

The Company reports its consolidated financial statements in accordance with the Segment Reporting Topic of the FASB ASC. Currently, the Company operates in one segment, operations held for investment. Previously, the Company operated in an additional segment, operations held for non-sale disposition. As a result of deed backs and title transfers, the Company has disposed of all assets and liabilities from its operations held for non-sale disposition segment. Accordingly, all assets, liabilities and the operations from its non-sale disposition segment have been reclassified to discontinued operations.

 

9

Table of Contents

 

3. Investment in Hotel Properties

 

Investment in hotel properties, net consisted of the following (in thousands):

 

		March 31, 2011			December 31, 2010
		(unaudited)
Land		$	266,914		$	239,564
Buildings and improvements		2,175,430			1,884,602
Furniture, fixtures and equipment		295,691			256,421
Intangibles		142,821			34,081
Franchise fees		1,031			983
Construction in process		42,696			38,253
		2,924,583			2,453,904
Accumulated depreciation and amortization		(562,720		)	(535,785		)
		$	2,361,863		$	1,918,119

 

In January 2011, the Company purchased the outside 62% equity interests in its Doubletree Guest Suites Times Square joint venture for $37.5 million, and, as a result, became the sole owner of the entity that owns the 460-room Doubletree Guest Suites Times Square hotel located in New York City, New York. The hotel is encumbered by $270.0 million of non-recourse senior mortgage and mezzanine debt that matures in January 2012, and bears a blended interest rate of LIBOR plus 115 basis points. The Company expects to refinance this debt in 2011, and intends to fund any refinancing shortfall with existing cash. The hotel is encumbered by an additional $30.0 million mezzanine loan that is owned by the Company, and, therefore, eliminated in consolidation on the Company’s March 31, 2011 balance sheet. The Company recorded the acquisition at fair value using an independent third-party analysis, with the purchase price allocated to investment in hotel properties, notes payable and hotel working capital assets and liabilities. The Company recognized acquisition-related costs of $2.3 million during the three months ended March 31, 2011, which are included in corporate overhead on the Company’s statement of operations. The results of operations for the Doubletree Guest Suites Times Square have been included in the Company’s statement of operations from the acquisition date of January 14, 2011 through the first quarter ended March 31, 2011. Preferred dividends earned by investors from an entity that owns the Doubletree Guest Suites Times Square, less administrative fees, totaled $7,000 during the quarter ended March 31, 2011, and are included in distributions to non-controlling interest on the Company’s statement of operations.

 

In February 2011, the Company purchased the 494-room JW Marriott New Orleans located in New Orleans, Louisiana for approximately $51.6 million in cash and the assumption of a $42.2 million floating-rate, non-recourse senior mortgage. The mortgage, which matures in September 2015, has been swapped to a fixed rate of 5.45%, and is subject to a 25-year amortization schedule. The Company recorded the acquisition at fair value using an independent third-party analysis, with the purchase price allocated to investment in hotel properties, notes payable and hotel working capital assets. The Company recognized acquisition-related costs of $0.4 million during the three months ended March 31, 2011, which are included in corporate overhead on the Company’s statement of operations. The results of operations for the JW Marriott New Orleans have been included in the Company’s statement of operations from the acquisition date of February 15, 2011 through the end of Marriott’s first quarter March 25, 2011.

 

The fair values of the assets acquired and liabilities assumed at the dates of acquisition for the Doubletree Guest Suites Times Square and the JW Marriott New Orleans were consistent with the purchase prices of these two hotels and were allocated based on independent third-party analyses. The following table summarizes the fair values of assets acquired and liabilities assumed in these two acquisitions (in thousands):

 

Assets:
Investment in hotel properties (1)		$	434,990
Cash		12,958
Restricted cash		14,914
Accounts receivable		4,957
Other assets		5,367
Total assets acquired		473,186
Liabilities:
Notes payable		312,183
Accounts payable and other current liabilities		11,310
Total liabilities acquired		323,493
Non-controlling interest		125
Gain on remeasurement of equity interests (2)		60,501
Total cash paid for acquisitions		$	89,067

 

(1)  Investment in hotel properties was allocated to land ($27.4 million), buildings and improvements ($275.1 million), furniture, fixtures and equipment ($23.8 million) and intangibles ($108.7 million).

 

(2)  Gain on remeasurement of equity interests includes a gain of $30.1 million recognized on the remeasurement of the Company’s equity interest in its Doubletree Guest Suites Times Square joint venture to its fair market value, and a gain of $30.4 million recognized on the remeasurement of the Company’s investment in a $30.0 million, 8.5% mezzanine loan secured by the Doubletree Guest Suites Times Square to its fair market value in connection with the Company’s purchase of the outside 62% equity interests in the Doubletree Guest Suites Times Square joint venture.

 

10

Table of Contents

 

Acquired properties are included in the Company’s results of operations from the date of acquisition. The following unaudited pro forma results of operations reflect the Company’s results as if the acquisitions of the Doubletree Guest Suites Times Square in January 2011 and the JW Marriott New Orleans in February 2011 both occurred on January 1, 2010. In the Company’s opinion, all significant adjustments necessary to reflect the effects of the acquisitions have been made (in thousands, except per share data):

 

		Three Months Ended March 31, 2011			Three Months Ended March 31, 2010
		(unaudited)			(unaudited)
Revenues		$	167,412		$	158,223
Income available (loss attributable) to common stockholders from continuing operations		$	49,545		$	(18,950	)
Income (loss) per diluted share available (attributable) to common stockholders from continuing operations		$	0.42		$	(0.25	)

 

4. Discontinued Operations

 

The Company has classified the Royal Palm Miami Beach as held for sale as of March 31, 2011, reclassifying the hotel’s assets and liabilities on its March 31, 2011 and December 31, 2010 balance sheets as held for sale, and the hotel’s results of operations for the three months ended March 31, 2011, to discontinued operations. As the hotel was purchased by the Company in August 2010, no results of operations for the Royal Palm Miami Beach are included in the Company’s statement of operations for the three months ended March 31, 2010. The Royal Palm Miami Beach was sold in April 2011 for $130.0 million, subject to $90.0 million of seller financing.

 

In 2009, pursuant to a secured debt restructuring program, the Company elected to cease the subsidization of debt service on four loans secured by 11 of its hotels:  W San Diego, Renaissance Westchester, Marriott Ontario Airport, and the “Mass Mutual eight” (Renaissance Atlanta Concourse, Hilton Huntington, Residence Inn by Marriott Manhattan Beach, Marriott Provo, Courtyard by Marriott San Diego (Old Town), Holiday Inn Downtown San Diego, Holiday Inn Express San Diego (Old Town), and Marriott Salt Lake City (University Park)). In December 2009, the Company transferred possession and control of the Renaissance Westchester to a court-appointed receiver. In June 2010, the Company reacquired the Renaissance Westchester, and the $29.2 million non-recourse mortgage secured by the hotel was cancelled. The Company recorded a gain on extinguishment of debt of $6.7 million to discontinued operations in June 2010. In July 2010, the Company completed the deed back of the W San Diego, and title to the hotel was transferred to the lender. The Company recorded a gain on extinguishment of debt of $35.4 million to discontinued operations in July 2010, and removed the hotel’s net assets and liabilities from its 2010 balance sheet. In August 2010, the Marriott Ontario Airport was sold by the receiver, and title to the hotel was transferred to the new owner. In connection with this sale, the Company recorded a $5.1 million gain on extinguishment of debt to discontinued operations in August 2010, and removed the net assets and liabilities from its 2010 balance sheet. In November 2010, the Company completed the deed back of the Mass Mutual eight hotels, and titles to the hotels were transferred to the lender. In connection with such transfer, Mass Mutual delivered to the Company a covenant and agreement pursuant to which Mass Mutual agreed to not sue the Company for any matter or claim which Mass Mutual may ever have relating to the hotels, the loan or the loan documents. There are certain customary carveouts from this covenant not to sue, including fraud, a breach of the deed in lieu agreement itself and the environmental indemnity agreement delivered at the time the loan was originated. Additionally, the Company made certain customary representations and warranties, all of which survive the closing for a period of six months. Five of the Mass Mutual eight hotels remain subject to franchise agreements which contain corporate guaranties. If the franchise agreements on these five hotels were to be terminated, the Company may be liable for up to $19.6 million in termination fees. The Company recorded a gain on extinguishment of debt of $39.0 million to discontinued operations in the fourth quarter of 2010, and the net assets and liabilities were removed from its 2010 balance sheet. Additional gain of $19.6 million will be deferred until all significant contingencies are resolved. The Company expects the franchise agreements on these five hotels to be finalized during the second quarter of 2011, and to record any necessary adjustments to its liability for the termination fees in its statement of operations for the three months ended June 30, 2011, however, resolution may not be achieved until the second half of 2011.

 

The following sets forth the discontinued operations for the three months ended March 31, 2011 and 2010, related to the Royal Palm Miami Beach and to the 11 hotel properties deeded back to lenders or sold by the receiver during 2010 (in thousands):

 

		Three Months Ended March 31, 2011			Three Months Ended March 31, 2010
		(unaudited)			(unaudited)
Operating revenues		$	6,918		$	21,676
Operating expenses		(3,973		)	(17,968		)
Interest expense		—			(5,686		)
Depreciation and amortization expense		(1,433		)	(1,817		)
Income (loss) from discontinued operations		$	1,512		$	(3,795	)

 

5. Other Real Estate

 

Other real estate, net consisted of the following (in thousands):

 

		March 31, 2011			December 31, 2010
		(unaudited)
Land		$	2,768		$	2,768
Buildings and improvements		9,297			9,297
Furniture, fixtures and equipment		6,796			6,687
Construction in process		310			116
		19,171			18,868
Accumulated depreciation		(7,250		)	(7,044		)
		11,921			11,824
Land held for investment		188			188
		$	12,109		$	12,012

 

As of March 31, 2011, other real estate, net included the Company’s two commercial laundry facilities, an office building and one vacant parcel of land.

 

11