UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2005
OR
For the transition period from to
Commission file number 333-117141
Sunstone Hotel Investors, Inc.
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
903 Calle Amanecer, Suite 100
San Clemente, California
Registrant’s telephone number, including area code: (949) 369-4000
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 ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 30, 2005, 34,533,321 shares, $0.01 par value per share, of the registrant’s common stock were outstanding.
SUNSTONE HOTEL INVESTORS, INC.
QUARTERLY REPORT ON
For the Quarterly Period Ended March 31, 2005
TABLE OF CONTENTS
Consolidated Balance Sheets as of March 31, 2005 (unaudited) and December 31, 2004
Unaudited Consolidated and Combined Statements of Operations for the Three Months Ended March 31, 2005 and 2004
Consolidated Statements of Stockholders’ Equity as of March 31, 2005 (unaudited) and December 31, 2004
Unaudited Consolidated and Combined Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004
Notes to Unaudited Consolidated and Combined Financial Statements
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PART I—FINANCIAL INFORMATION
SUNSTONE HOTEL INVESTORS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash
Accounts receivable, net
Due from related parties
Inventories
Prepaid expenses
Current assets of discontinued operations
Total current assets
Investment in hotel properties, net
Investment in hotel properties held for sale, net
Other real estate, net
Deferred financing costs, net
Goodwill
Other assets, net
Other assets, net, of discontinued operations
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses
Accrued payroll and employee benefits
Due to Management Company
Dividends payable
Distributions payable
Other current liabilities
Current portion of notes payable
Current liabilities of discontinued operations
Total current liabilities
Notes payable, less current portion
Other liabilities
Notes payable of discontinued operations
Total liabilities
Commitments and contingencies (Note 11)
Minority interest
Stockholders’ equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized; Series A and Series B 4,850,000 shares issued and outstanding at March 31, 2005 and none at December 31, 2004, stated at liquidation preference of $25.00 per share
Common stock, $0.01 par value, 100,000,000 shares authorized, 34,533,321 shares issued and outstanding
Additional paid in capital
Unearned and accrued stock compensation
Accumulated deficit
Cumulative dividends
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to consolidated and combined financial statements.
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SUNSTONE HOTEL INVESTORS, INC. AND SUBSIDIARIES AND
SUNSTONE PREDECESSOR COMPANIES
CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
REVENUES
Room
Food and beverage
Other operating
Management and other fees from affiliates
Total revenues
OPERATING EXPENSES
Advertising and promotion
Repairs and maintenance
Utilities
Franchise costs
Property tax, ground lease, and insurance
Property general and administrative
Corporate general and administrative
Depreciation and amortization
Impairment loss
Total operating expenses
Operating income
Interest and other income
Interest expense
Income (loss) before minority interest, income taxes and discontinued operations
Income tax provision
Income (loss) from continuing operations before discontinued operations
Income (loss) from discontinued operations
NET INCOME (LOSS)
Preferred stock dividends
INCOME AVAILABLE TO COMMON STOCKHOLDERS
Basic and diluted per share amounts:
Income from continuing operations available to common stockholders
Income from discontinued operations
Income available to common stockholders per common share
Weighted average common shares outstanding:
Basic
Diluted
Dividends paid per common share
2
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Balance at December 31, 2004, audited
Net proceeds from sale of preferred stock
Issuance of unvested restricted common stock
Vesting of restricted common stock
Common dividends declared and payable at $0.285 per share
Preferred dividends declared and payable at $0.50 per share
Net income
Balance at March 31, 2005, unaudited
See accompanying notes to consolidated and combined financial statements
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CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Bad debt recovery
Loss on sale of hotel properties
Depreciation
Amortization of deferred franchise fees
Amortization of deferred financing costs
Amortization of deferred stock compensation
Impairment loss—investment in hotel properties and discontinued operations
(Gain) loss on interest rate cap agreements
Deferred income taxes
Changes in operating assets and liabilities:
Accounts receivable
Due from affiliates
Prepaid expenses and other assets
Accounts payable and other liabilities
Discontinued operations
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to hotel properties and other real estate
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from preferred securities offering
Payment of offering costs
Proceeds from notes payable
Payments on notes payable
Payments of deferred financing costs
Dividends and distributions paid
Contributions from members
Distributions to members
Contributions from minority interest holders
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest
Income taxes paid
NONCASH FINANCING ACTIVITY
Dividends and distributions payable
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NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
1. Organization and Description of Business
Sunstone Hotel Investors, Inc. (the “Company”), through its 90.3% 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 owning, acquiring, selling, and renovating hotel properties in the United States. The Company operates as a real estate investment trust (“REIT”) for federal income tax purposes.
The Company was formed to succeed the businesses of Sunstone Hotel Investors, L.L.C. (“SHI”), WB Hotel Investors, LLC (“WB”), and Sunstone/WB Hotel Investors IV, LLC (“WB IV”) (collectively, the “Sunstone Predecessor Companies” or the “Predecessor”), which were engaged in owning, acquiring, selling, managing, and renovating hotel properties in the United States. The Company was incorporated in Maryland on June 28, 2004, in anticipation of an initial public offering of common stock (the “IPO”), which was consummated on October 26, 2004 concurrently with the consummation of various formation transactions. These transactions were designed to (i) enable the Company to raise the necessary capital to acquire properties from the Predecessor and repay certain mortgage debt relating thereto, (ii) provide a vehicle for future acquisitions, (iii) enable the Company to comply with certain requirements under the federal income tax laws and regulations relating to real estate investment trusts, (iv) facilitate potential financings and (v) preserve certain tax advantages for the Predecessor. From June 28, 2004 through October 26, 2004, the Company did not have any operations.
On October 26, 2004, the Company commenced operations after completing the IPO, which consisted of the sale of 21,294,737 shares of common stock at a price per share of $17.00, generating gross proceeds of $362.0 million. The proceeds to the Company, net of underwriters’ discount and offering costs, were $333.5 million. Concurrent with the IPO, the Company received gross proceeds of $75.0 million from a new unsecured term loan facility and $10.0 million from a draw on a new $150.0 million revolving credit facility. The Company also entered into a new mortgage loan with one of its existing lenders and repaid the existing indebtedness. The costs associated with the unsecured term loan facility, revolving credit facility and the new mortgage loan totaled $6.1 million. The proceeds from the IPO and the unsecured term loan facility were used to acquire limited partnership interests in the Operating Partnership held by the Predecessors’ members as a result of the IPO for $195.9 million, repay secured notes payable of $210.1 million, and purchase a ground lessor’s interest in a ground lease under one of the properties that was purchased for $6.3 million. On November 23, 2004, as a result of the exercise of the underwriters’ over-allotment option, the Company sold an additional 3,165,000 shares of common stock resulting in gross proceeds of $53.8 million which it used to purchase an additional 3,165,000 limited partnership interests in the Operating Partnership from the Predecessor.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements as of March 31, 2005 and December 31, 2004 and for the three months ended March 31, 2005 include the accounts of the Company, the Operating Partnership and the TRS Lessee and their subsidiaries. Property interests contributed to the Operating Partnership by the Predecessor have been accounted for as a reorganization of entities under common control in a manner similar to a pooling-of-interests. Accordingly, the contributed assets and assumed liabilities were recorded at the Predecessors’ historical cost basis. All significant intercompany balances and transactions have been eliminated.
The accompanying combined financial statements for the three months ended March 31, 2004 include the accounts of SHI, WB, and WB IV. Significant intercompany accounts and transactions have been eliminated for all periods presented.
The accompanying interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States and in conformity with the rules and regulations of the Securities and Exchange Commission. In our 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 our Form 10-K, filed with the Securities and Exchange Commission on February 22, 2005.
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Use of Estimates
The preparation of consolidated and combined financial statements in conformity with U.S. generally accepted accounting principles 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 materially differ from those estimates in the near term.
Accounts Receivable
Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize hotel services. Accounts receivable also includes receivables from customers who utilize the Company’s laundry facilities in Salt Lake City, Utah, and Rochester, Minnesota. The Company maintains an allowance for doubtful accounts sufficient to cover potential credit losses. The Company’s accounts receivable at March 31, 2005 and December 31, 2004 includes an allowance for doubtful accounts of $1.0 million and $2.2 million, respectively. At March 31, 2005 and December 31, 2004, the Company had approximately $5.0 million and $12.3 million in accounts receivable, respectively, with one customer who is operating under a contract with the United States government. The Company has specifically reserved a portion of this particular receivable in the amount of $196,000 and $1.3 million at March 31, 2005 and December 31, 2004, respectively.
Deferred Financing Costs
Interest expense related to the amortization of deferred financing costs was $1.1 million for the three months ended March 31, 2005 and 2004.
Minority Interest
Minority interests of the Company represent the limited partnership interests in the Operating Partnership. The carrying value of the minority interest has been increased by the minority interests’ share of earnings and reduced by cash distributions and the purchase of limited partnership interests. The weighted average number of limited partnership units for the three months ended March 31, 2005, was 3,699,572. The reconciliation of minority interests for the three months ended March 31, 2005, is as follows (dollars in thousands):
Balance at December 31, 2004 (audited)
Balance at March 31, 2005 (unaudited)
Minority interests of the Predecessor represent the limited partners’ interest in limited partnerships that are controlled by WB IV. The carrying value of the minority interest has been increased by the minority interests’ share of WB IV earnings and reduced by WB IV partnership cash distributions as well as return of capital distributions.
Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per common share:
Numerator:
Less preferred dividends
Numerator for basic and diluted earnings available to common stockholders
Denominator:
Weighted average basic common shares outstanding
Unvested restricted stock awards
Weighted average diluted common shares outstanding
Basic and diluted earnings available to common stockholders per common share
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Reclassifications
Certain amounts included in the combined financial statements for prior periods have been reclassified to conform with the most recent financial statement presentation.
3. Investment in Hotel Properties
Investment in hotel properties consisted of the following (in thousands):
Land
Buildings and improvements
Fixtures, furniture and equipment
Franchise fees
Construction in process
Accumulated depreciation and amortization
4. Discontinued Operations
As part of a strategic plan to dispose of non-core hotel assets, the Company and its Predecessor sold seven hotel properties during 2004 and held two hotel properties for sale at March 31, 2005. These nine hotel properties met the “held for sale” and “discontinued operations” criteria in accordance with SFAS 144.
The following sets forth the discontinued operations for the three months ended March 31, 2005 and 2004, related to hotel properties held for sale (in thousands):
Operating revenues
Operating expenses
Loss on sale of hotels
Provision for income taxes
The assets and liabilities of the discontinued operations consisted of the following at March 31, 2005 (in thousands):
Assets:
Hotel properties held for sale, net
Other assets
Total assets of discontinued operations
Liabilities:
Notes payable
Total liabilities of discontinued operations
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5. Other Real Estate
Other real estate consists of the following (in thousands):
Laundry facilities:
Accumulated depreciation
Land held for future development or sale
6. Derivative Financial Instruments
At March 31, 2005 and December 31, 2004, the Company held interest rate cap agreements to manage its exposure to the interest rate risks related to its floating rate debt. The fair values of the interest rate cap agreements are included in deferred financing costs, net on the consolidated balance sheets as of March 31, 2005 and December 31, 2004. None of the Company’s interest rate cap agreements held as of March 31, 2005 and December 31, 2004, qualify for effective hedge accounting treatment under SFAS No. 133. Accordingly, changes in the fair value of the Company’s and the Predecessors’ interest rate cap agreements for the three months ended March 31, 2005 and 2004, resulted in a net gain of $1,000 and a net loss of $437,000, respectively. The changes in fair value have been reflected as a decrease and an increase in interest expense for the three months ended March 31, 2005 and 2004, respectively.
The following table summarizes the interest rate cap agreements (dollars in thousands):
Notional amount of variable rate debt
Fair value of interest rate caps
Interest rate cap rates
Maturity dates
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7. Notes Payable
Notes payable consist of the following (in thousands):
Notes payable requiring payments of interest and principal, with interest at rates ranging from variable of one-month LIBOR plus 2.14% to 2.95% to fixed rates ranging from 5.95% to 9.88%; maturing at dates ranging from November 2005 through June 2013. The notes are collateralized by first deeds of trust on 44 hotel properties and one laundry facility.
Unsecured term loan facility in the amount of $75.0 million requiring monthly payments of interest only subject to an interest rate equal to either, at the Company’s option, a fluctuating rate equal to Citibank, N.A.’s base rate or a periodic fixed rate equal to one-, two-, or six-month LIBOR, plus, in each case, a margin of 3.00% for base rate loans and 4.00% for LIBOR loans. The term loan facility matures in October 2008.
Secured revolving credit facility in the amount of $150.0 million requiring monthly payments of interest only on the principal amount drawn subject to an interest rate equal to either, at the Company’s option, a fluctuating rate equal to Citibank, N.A.’s base rate or a periodic fixed rate equal to one-, two-, three- or six-month LIBOR, plus, in each case, an applicable margin based on the Company’s leverage. The applicable margin is a percentage rate per annum that ranges from 0.5% to 1.0% for base rate loans and 1.5% to 2.0% for LIBOR loans. The revolving credit facility also requires a quarterly fee of 0.5% on the average unused commitment on the facility and a 0.125% fee upon the issuance of each letter of credit. The revolving credit facility is secured by first deeds of trust on seven hotel properties. Total available under the revolving credit facility was $114.4 million at March 31, 2005. The revolving credit facility matures in October 2007 and has a one year extension.
Construction loan requiring monthly payments of interest only at one-month LIBOR plus 3.25% and is collateralized by one hotel. The loan was paid off March 2005.
Notes payable requiring monthly payments of principal and interest at 8.25%. The notes mature in November 2023 and are collateralized by a leasehold mortgage, assignment of leases and rents, and security agreement and fixture filing on two hotel properties.
Less: current portion
Total interest incurred and expensed on the notes payable is as follows (in thousands):
Interest expense—continuing operations
Interest expense—discontinued operations
Prepayment penalty paid—continuing operations
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8. Income Taxes
The income tax benefit (provision) included in the consolidated and combined statements of operations is as follows (in thousands):
Current:
Federal
State
Deferred:
Valuation allowance
Income tax benefit
Benefit from (provision for) income taxes applicable to continuing operations and discontinued operations is as follows (in thousands):
Benefit from (provision for) continuing operations:
Current
Deferred
Benefit from continuing operations
Benefit from (provision for) discontinued operations:
Benefit from (provision for) discontinued operations
Benefit from income taxes
The provision for income taxes differs from the federal statutory rate due to various expenses that are not deductible for tax purposes.
The tax effects of temporary differences giving rise to the deferred tax assets (liabilities) are as follows (in thousands):
Deferred tax assets:
NOL carryover
State taxes and other
Other reserves
Current deferred tax asset before valuation allowance
Deferred tax liabilities:
Other
Net deferred tax liabilities
The deferred tax assets at March 31, 2005, were primarily due to net operating loss carryforwards and timing differences in the deductibility of various reserves for tax purposes as compared to book purposes. A valuation allowance is maintained to offset its deferred tax assets due to uncertainties surrounding their realization.
At March 31, 2005, and December 31, 2004, the Company had federal net operating loss carryforwards of $8.2 million and $4.1 million, respectively, which begin to expire in 2019.
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At March 31, 2005, and December 31, 2004, the Company had state net operating loss carryforwards of $8.2 million and $4.1 million, respectively, which begin to expire in 2011.
9. Series A and B Cumulative Redeemable Preferred Stock
In March 2005, the Company sold 4,850,000 shares of 8.0% Series A and B Cumulative Redeemable Preferred Stock with a liquidation preference of $25.00 per share for gross proceeds of $121.3 million. Underwriting and other costs of the offering totaled $3.8 million. Net proceeds of $117.5 million were contributed to the Operating Partnership in exchange for preferred units with economic terms substantially identical to the Series A and B preferred stock. The net proceeds were used to reduce borrowings under our credit facility and will be used for future acquisitions. On or after March 17, 2010, the Series A and B preferred stock will be redeemable at our option, in whole or in part at any time or from time to time, for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to and including the redemption date. Holders of Series A and B preferred stock will generally have no voting rights. However, if the Company is in arrears on dividends on the Series A and B preferred stock for six or more quarterly periods, whether or not consecutive, holders of the Series A and B preferred stock will be entitled to vote at our next annual meeting and each subsequent annual meeting of stockholders for the election of two additional directors to serve on our board of directors until all unpaid dividends and the dividend for the then-current period with respect to the Series A and B preferred stock have been paid or declared and a sum sufficient for the payment thereof set aside for payment. The Series A and B preferred stock have no maturity date and the Company is not required to redeem the Series A and B preferred stock at any time.
10. Long-Term Incentive Plan
Restricted shares granted pursuant to the Company’s Long-Term Incentive Plan vest over periods from three to five years from the date of grant. The value of shares granted has been calculated based on the share price on the date of grant and is being amortized as compensation expense over the vesting periods. For the three months ended March 31, 2005, the Company’s expense related to these restricted shares was $531,000. At March 31, 2005 and December 31, 2004, the unearned compensation related to restricted share grants was $7.1 million and $7.3 million, respectively, and has been classified as a component of shareholders’ equity in the accompanying balance sheet.
11. Commitments and Contingencies
Franchise Agreements
Total franchise costs incurred by the Company and Predecessor during the three months ended March 31, 2005 and 2004, were both $6.4 million. Of the total franchise costs, franchise royalties were $3.4 million and $3.6 million, respectively, for the three months ended March 31, 2005 and 2004. The remaining franchise costs include advertising, reservation and priority club assessments.
Renovation and Construction Commitments
At March 31, 2005 and December 31, 2004, the Company had various contracts outstanding with third parties in connection with the renovation of certain of the hotel properties. The remaining commitments under these contracts at March 31, 2005 and December 31, 2004 totaled $6.0 million and $7.8 million, respectively.
Operating Leases
Rent expense incurred pursuant to ground lease agreements for the three months ended March 31, 2005 and 2004, totaled $743,000 and $909,000, respectively, and was included in property tax, ground lease and insurance in the accompanying statements of operations.
Rent expense incurred pursuant to the lease on the corporate facility for the three months ended March 31, 2005 and 2004, totaled $96,000 and $189,000, respectively, and was included in general and administrative expenses in the accompanying statements of operations. The lease on the corporate facility expires in June 2005.
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At March 31, 2005 and December 31, 2004, the Company had $35.6 million and $34.8 million, respectively, of outstanding irrevocable letters of credit to guarantee the Company’s financial obligations related to the Management Company, workers’ compensation insurance programs and certain notes payable. The beneficiary may draw upon these letters of credit in the event of a contractual default by the Company relating to each respective obligation.
Other assets include a $5.0 million deposit made in connection with a potential acquisition that is subject to various contingencies.
12. Transactions With Affiliates
Management Fees
On March 30, 2004, the Predecessor entered into a management agreement with an affiliate to provide management services for the hotel located in Nashville, Tennessee owned by an affiliate. The agreement expires March 30, 2009 and includes successive one- year renewal options. Pursuant to the agreement, the Company was to receive from the affiliate a base management fee of 2.5% of gross operating revenues, as defined. In connection with the Company’s initial public offering, this agreement was cancelled and a new agreement was entered into with Interstate Hotels & Resorts, Inc., or the Management Company.
On January 30, 2004, the Predecessor entered into a management agreement with an affiliate to provide management services for the hotel located in Beverly Hills, California owned by the affiliate. The agreement expires January 30, 2009 and includes successive one-year renewal options. Pursuant to the agreement, the Company was to receive from the affiliate a base management fee of 2.5% of gross operating revenues, as defined. In connection with the Company’s initial public offering, this agreement was cancelled and a new agreement was entered into with the Management Company.
On May 22, 2002, the Predecessor entered into a management agreement with an affiliate to provide management services for the hotel property located in Nashville, Tennessee owned by the Westbrook related party. The agreement expires on May 22, 2007 and includes successive one-year renewal options. Pursuant to the agreement, the Predecessor is to receive from the Westbrook related party a base management fee of 4.0% of gross operating revenues, as defined. This agreement was terminated in February 2004 following the sale of the hotel.
On May 29, 2002, the Company entered into eight asset management agreements with an affiliate to provide asset management services for the hotel properties owned by the Westbrook related party. The agreements expire on May 29, 2007 and include successive one-year renewal options. Pursuant to the agreements, the Company is to receive an asset management fee of 1.0% of gross operating revenues, as defined. At December 31, 2004, none of the agreements were in effect due to the sale of all eight properties to an unaffiliated third party.
For the three months ended March 31, 2005 and 2004, aggregate management fees and asset management fees earned from related parties totaled $0 and $55,000, respectively.
Asset Management Fees
Following the Company’s initial public offering, the Company entered into asset management agreements to supervise outstanding capital expenditure projects for four hotel properties owned by related parties.
Acquisition Fees
During the three months ended March 31, 2004, in connection with successful acquisitions of hotel properties by certain affiliated companies, the Predecessor received aggregate acquisition fees in the amount of $318,000 in exchange for rendering services in connection with such acquisitions. Such acquisition fees were recognized as revenue and were included in management and other fees from affiliates. The Company did not earn any acquisition fees for the three months ended March 31, 2005.
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Other Reimbursements
From time to time, the Predecessor paid for certain expenses such as payroll, insurance and other costs on behalf of certain related parties. The related parties generally reimburse such amounts on a monthly basis. At March 31, 2005 and December 31, 2004, amounts owed to the Predecessor by its related parties amounted to $121,000 and $147,000 and are included in due from related parties.
13. Subsequent Events
In April 2005, the Company closed ten individual non cross-collateralized fixed rate mortgage loans totaling $276.0 million. The loans are each for a term of ten years with a fixed rate of 5.34%. Following the closing, more than 85% of the Company’s outstanding debt is fixed rate.
In April 2005, the Company sold the Doubletree hotel located in Carson, California and the Holiday Inn hotel located in Mesa, Arizona, to an unrelated third party. The hotels were sold for aggregate gross proceeds of $26.1 million. The operating results of the hotels were included in discontinued operations in the accompanying consolidated and combined statements of operations during the three months ended March 31, 2005 and 2004, as required by SFAS No. 144.
In April 2005, the Company announced its agreement to purchase the 444-room Sutton Place Hotel in Newport Beach, California. The hotel will be managed by Fairmont Hotels & Resorts. The Company is currently under contract to purchase the property with closing scheduled for May 2005. The Company will then commence a major renovation of the hotel’s guestrooms and public areas, anticipated to cost approximately $22.0 million. Upon completion, expected to occur in early 2006, the hotel will be re-named the Fairmont Newport Beach. The Company will use proceeds from its recently completed preferred stock offering to complete the acquisition.
In April 2005, the Company announced an agreement to acquire a portfolio of six Renaissance Hotels containing 3,326 rooms for $419.5 million. The portfolio is part of a joint acquisition of 32 Renaissance Hotels and joint venture interests from CTF Holding LTD by Marriott International, Inc., a real estate opportunity fund and the Company. All of the hotel properties are, and will continue to be, operated by Marriott International or its subsidiaries under the Renaissance Hotels & Resorts brand name. The Company will spend an additional $35.5 million on a capital expenditure program to upgrade the properties. The Company has obtained equity and debt financing commitments to finance the entire cost of the purchase. The Company has agreed to sell approximately 3.75 million shares of common stock to an affiliate of GIC Real Estate, an investment arm of the Government of Singapore, at a purchase price of $20.65 per share. The closing of this offering is contingent upon the closing of the Renaissance hotels acquisition. The Company has also agreed to sell $100.0 million of Series C Convertible Redeemable Preferred Stock to Security Capital Preferred Growth. The convertible preferred stock will be sold at a purchase price of $24.375, will pay a base dividend of 6.45%, will be convertible on a one for one basis into common stock and will be callable after five years. The closing of this offering is contingent upon the closing of the Renaissance hotels acquisition and the closing of the sale of common stock to the affiliate of GIC Real Estate. Additionally, the Company has received a commitment, subject to customary closing conditions, for $250.0 million in mortgage debt secured by four of the hotels being acquired.
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Cautionary Statement
This report contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “forecasts,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms and other comparable terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider the risks outlined in detail in our Form S-11, filed with the Securities and Exchange Commission on March 10, 2005, under the caption “Risk Factors” and elsewhere in this Form 10-Q, including but not limited to the following factors:
These factors may cause our actual events to differ materially from the expectations expressed or implied by any forward-looking statement. We do not undertake to update any forward-looking statement.
Overview
We own primarily upper upscale and upscale hotels in the United States operated under leading brand names franchised or licensed from others, such as Marriott, Hilton, InterContinental, Hyatt, Starwood, Carlson and Wyndham.
Operations
Our financial data prior to October 26, 2004, is for our predecessor companies, who owned and operated the hotels during the periods presented. In conjunction with our initial public offering, we made substantial changes to our operations to effect the formation and structuring transactions as further discussed in our Form 10-K and to qualify and elect to be treated as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. As a result, our historical results of operations prior to October 26, 2004 are not indicative of our current results of operations.
Formation and structuring transactions and our initial public offering. The following items occurred or will affect our future results of operations as a result of our initial public offering:
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The effects of these matters are described under “Unaudited Pro Forma Financial Data.”
REIT structure. For us to qualify as a REIT, our income cannot be derived from our operation of hotels. Therefore, consistent with the provisions of the Code, Sunstone Hotel Partnership and its subsidiaries have leased our hotel properties to our taxable REIT subsidiary lessee, Sunstone Hotel TRS Lessee, Inc., or the TRS Lessee, who has in turn contracted with “eligible independent contractors” to manage our hotels. Under the Code, an “eligible independent contractor” is an independent contractor who is actively engaged in the trade or business of operating “qualified lodging facilities” for any person unrelated to us and the TRS Lessee. Sunstone Hotel Partnership and the TRS Lessee will be consolidated into our financial statements for accounting purposes. Since we control both Sunstone Hotel Partnership and our TRS Lessee, our principal source of funds on a consolidated basis will be from the performance of our hotels. The earnings of the TRS Lessee will be subject to taxation like other C corporations, which will reduce our operating results, funds from operations and the cash otherwise available for distribution to our stockholders.
Factors Affecting Our Results of Operations
Revenues. Substantially all of our revenues are derived from the operation of our hotels. Specifically, our revenues consist of the following:
The following performance indicators are commonly used in the hotel industry:
Operating costs and expenses. Our operating costs and expenses consist of the following:
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Most categories of variable operating expenses, such as utilities and certain labor costs, such as housekeeping, fluctuate with changes in occupancy. Increases in RevPAR attributable to improvements in occupancy are accompanied by increases in most categories of variable operating costs and expenses. Increases in RevPAR attributable to improvements in ADR typically only result in increases in limited categories of operating costs and expenses, primarily credit card commissions, franchise fees and franchise assessments. Thus, improvements in ADR have a more significant impact on improving our operating margins than occupancy.
We continually seek to improve our operating leverage, which generally refers to the ability to generate incremental profit based on limited variable costs. Notwithstanding our efforts to reduce variable costs, there are limits to how much we or the Management Company and our other operators can accomplish in that regard without affecting the competitiveness of our hotels and our guests’ experiences at our hotels. Furthermore, we have significant fixed costs, such as depreciation and amortization, insurance and other expenses associated with owning hotels that do not necessarily decrease when circumstances such as market factors cause a reduction in our hotel revenue. For example, we have experienced increases in wages, employee benefits (especially workers’ compensation in our California hotels and health insurance) and utility costs, which negatively affected our operating margin. Our historical performance may not be indicative of future results, and our future results may be worse than our historical performance.
Acquisition, Sale and Major Redevelopment Activity
Our results during the periods discussed have been, and our future results will be, affected by our acquisition, sale and redevelopment activity during the applicable period.
Acquisition of hotels.The following table sets forth the hotels that we have acquired or developed since the beginning of 2004 and indicates their room count and acquisition date:
Hotel
Residence Inn by Marriott, Rochester, Minnesota
JW Marriott, Cherry Creek, Colorado(2)
The aggregate cost for these 2 hotel acquisitions was approximately $49.6 million, or $180,000 per room.
Sale of hotels. The following table sets forth the hotels that have been sold since the beginning of 2004 and indicates their room count and sale date:
Doubletree, Carson, California
Holiday Inn, Mesa, Arizona
San Marcos Resort, Chandler, Arizona
Holiday Inn, Flagstaff, Arizona
Concord Hotel and Conference Center, Concord, California
Four Points—Sheraton, Silverthorne, Colorado
Holiday Inn, Anchorage, Alaska
Holiday Inn, La Mirada, California
Hawthorn Suites, Anaheim, California
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The aggregate net sale proceeds for the seven closed hotel dispositions through March 31, 2005 was $58.4 million, or $36,000 per room. The results of operations of all of the hotels identified above and the gains or losses on dispositions through March 31, 2005 are included in discontinued operations for all periods presented through the time of sale. The proceeds from the sales are included in our cash flows from investing activities for the respective periods.
The following table summarizes our portfolio and room data since the beginning of 2004 adjusted for the hotels acquired and sold during the respective periods.
January 1, 2004
through
December 31,
2004
January 1, 2005
March 31,
2005
Portfolio Data—Hotels
Number of hotels—beginning of period
Add: Acquisitions
Add: Developments
Less: Sales
Less: Assets not included
Number of hotels—end of period
Portfolio Data—Rooms
Number of rooms—beginning of period
Add: Room expansions
Number of rooms—end of period
Average rooms per hotel—end of period
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Operating Results
Comparison of Three Months Ended March 31, 2005 to Three Months Ended March 31, 2004
The following table presents our unaudited operating results for the three months ended March 31, 2005 and 2004, including the amount and percentage change in the results between the two periods. The operating results for 2004 have been derived by combining the predecessor companies’ results for the period of January 1, 2004 through March 31, 2004.
Three Months Ended
March 31, 2005
March 31, 2004
Other hotel
Operating Statistics
Occupancy(1)
Average daily rate(1)
RevPAR(1)
Room revenue. Room revenue increased $3.6 million net, primarily attributable to (1) organic growth in our existing portfolio base of $5.4 million due to increases in ADR and occupancy and (2) $0.5 million related to a mid-year 2004 acquisition, partially offset by $2.3 million related to properties included in our first quarter 2004 results of operations that were not contributed by the predecessor companies.
Food and beverage revenue. The food and beverage revenue increase was primarily driven by higher occupancy during 2005 and the factors that drove our room revenue increase, a mid year 2004 acquisition and new banquet and catering menus partially offset by properties included in our first quarter 2004 results of operations that were not contributed by the predecessor companies.
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Other operating revenue. Our increased occupancy led to increases in other operating revenue, such as parking, entertainment and guest services, and operating revenue also increased due to a mid-year 2004 acquisition, partially offset by properties included in our first quarter 2004 results of operations that were not contributed by the predecessor companies and the continuing trend of declining telephone revenue.
Management and other fees from affiliates. Management and other fees from affiliates in 2004 relate to the Doubletree, Nashville, Tennessee and Residence Inn by Marriott, Beverly Hills, California, which are properties owned by related parties. As a result of our initial public offering, we no longer receive any management or other fees from these hotels.
Other hotel expenses. Increase in other hotel expenses was primarily driven by higher occupancy and a mid-year 2004 acquisition, partially offset by properties included in our first quarter 2004 results of operations that were not contributed by the predecessor companies and ground lease expense related to the ground lease purchased as a part of our formation and structuring transactions.
Property general and administrative expense. Property general and administrative expense increased as a result of the $2.1 million in management and accounting fees payable to the Management Company as well as other hotel specific expenses, such as increased credit card commissions and franchise fees associated with the overall increase in revenue, and a mid-year 2004 acquisition, partially offset by properties included in our first quarter 2004 results of operations that were not contributed by the predecessor companies.
Corporate general and administrative expense. Corporate general and administrative expense decreased as a result of the expected decrease in salaries and wages attributable to the transfer of certain employees to the management company, partially offset by the increased costs of being a public company.
Depreciation and amortization expense. Depreciation and amortization increased as a result of the increase in our depreciable asset base and a mid year 2004 acquisition, partially offset by properties included in our first quarter 2004 results of operations that were not contributed by the predecessor companies.
Interest expense. Interest expense decreased primarily as a result of lower average borrowings resulting from the repayment of a portion of our debt at our initial public offering.
Our total notes payable, including the current portion, was $667.7 million at March 31, 2005 and $712.5 million at December 31, 2004, with a weighted average interest rate per annum of approximately 6.5% at March 31, 2005 and 6.1% at December 31, 2004. At March 31, 2005, 51.6% of the amount outstanding under our notes payable was fixed and 48.4% of the amount outstanding under our notes payable was floating.
Impairment loss. Impairment loss in 2004 consists of hotel impairment losses of $7.4 million at three hotels and does not include any goodwill impairment loss. The hotel impairment loss in 2004 related to our determination that the current carrying values of the hotels were no longer recoverable based on estimated future cash flows to be generated by the hotels. This determination resulted from certain depressed hotel markets. The fair values of the hotels were determined using factors such as net operating cash flows, terminal capitalization rates and replacement costs as described under “—Critical Accounting Policies—Impairment of Long-lived Assets.”
Provision for income taxes. As limited liability companies, the predecessor companies were pass-through entities and not liable for Federal and certain state income taxes, which were the responsibility of their respective members. However, some of our predecessor companies were corporations that were liable for taxes on their earnings. We maintain a taxable REIT subsidiary which is liable for taxes on its earnings. The change in the tax provision is attributable to the historical tax benefit for our predecessor companies being eliminated.
Income (loss) from discontinued operations. As described under “—Acquisition, Sale and Major Redevelopment Activity—Sale of Hotels,” we sold seven hotels in 2004 and have two hotels held for sale at March 31, 2005 (which were subsequently sold). Consistent with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we have reclassified the results of operations for these hotels as discontinued operations. The decrease in loss from discontinued operations between the periods was primarily due to impairment losses on disposals of $17.0 million in 2004.
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UNAUDITED PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial data gives effect to (1) hotels not contributed to us by the predecessor companies, (2) our formation and structuring transactions, (3) our initial public offering, including the sale of shares to Robert A. Alter, and the application of the net proceeds and (4) the incurrence of debt under our new term loan facility and the application of the net proceeds.
The historical financial information for the three months ended March 31, 2004 has been derived from the unaudited combined financial statements of the Sunstone Predecessor Companies, which are included elsewhere in this Form 10-Q. The unaudited pro forma combined statement of operations data for the three months ended March 31, 2004 is presented as if the transactions had occurred as of the beginning of the periods indicated.
The contribution or sale to us of hotels and interests in entities by the Sunstone Predecessor Companies in the formation and structuring transactions were accounted for at the historical cost of such assets similar to a pooling of interests as the Sunstone Predecessor Companies are all under common control.
The unaudited pro forma financial data and related notes are presented for informational purposes only and do not purport to represent what our results of operations would actually have been if the transactions had in fact occurred on the dates discussed above. They also do not project or forecast our results of operations for any future date or period.
We believe that the pro forma information is useful to better understand the ongoing operations and financial performance during the periods presented.
The unaudited pro forma financial data should be read together with our historical consolidated and combined financial statements and related notes included elsewhere in this Form 10-Q and with the information set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The pro forma adjustments are based on available information and upon assumptions that we believe are reasonable; however, we cannot assure you that actual results will not differ from the pro forma information and perhaps in material and adverse ways.
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SUMMARY PRO FORMA DATA
Three Months Ended March 31, 2005 Compared to the Pro Forma Three Months Ended March 31, 2004
The following table presents our unaudited operating results and statistics for the three months ended March 31, 2005 and pro forma three months ended March 31, 2004, including the amount and percentage change in the results between the two periods.
Three Months
Ended
Pro Forma
Revenues
Income (loss) from continuing operations before minority interest, interest, income taxes and discontinued operations
Occupancy
Average daily rate
RevPAR
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PRO FORMA INCOME STATEMENT
For the Three Months Ended March 31, 2004
(Unaudited)
Eliminations(1)
Adjustments(3)
Management and other fees from related parties
General and administrative
General and administrative—corporate
General and administrative—property operations
Management fee expense
Operating income (loss)
Income (loss) from continuing operations before minority interest and income taxes
Income (loss) from continuing operations
Income (loss) per share from continuing operations:
Common shares outstanding:
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Notes to Unaudited Pro Forma Income Statement for the Three Months Ended March 31, 2004
1a.
Represents the elimination of the following from Embassy Suites, Los Angeles, California:
Room revenue
1b.
Food and beverage revenue
1c.
Other operating revenue
1d.
Room expense
1e.
Food and beverage expense
1f.
Other hotel expenses
1h.
Depreciation and amortization expense
1i.
1g.
Represents the elimination of general and administrative:
JW Marriott, Cherry Creek, Colorado
Embassy Suites Hotel, Los Angeles, California
(2) Represents the transfer of employee-related expenses from the corporation that managed 49 of our hotels and employed the employees for those hotels as well as certain corporate personnel involved in hotel management to the Management Company:
Transfer of employee-related expenses
(3) Other adjustments represents:
3a.
3b.
Estimated continuing and additional costs of being a public company:
Continuing costs
Additional costs
3c.
Compensation expense
3d.
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(4) The effect of the application of the net proceeds of our initial public offering, the concurrent sale of shares to Robert A. Alter and the incurrence of debt under our new term loan facility and the application of the net proceeds under our new term loan facility.
4a.
4b.
Decrease in interest expense for the repayment of debt with the net proceeds of our initial public offering
Increase in interest expense for debt under the new term loan facility
4c.
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Liquidity and Capital Resources
Historical. During the periods presented, our historical sources of cash included our operating activities, working capital, long-term notes payable, bank credit facilities, contributions by the Sunstone Predecessor Companies and proceeds of our initial public offering and preferred offering. Our primary uses for cash were for acquisitions of hotels, capital expenditures for hotels, operating expenses, distributions to the Sunstone Predecessor Companies, repayment of notes payable and dividends.
Operating activities. Net cash provided by operating activities was $16.2 million for the three months ended March 31, 2005 compared to $9.3 million for the three months ended March 31, 2004. This increase was primarily due to changes in our operating assets and liabilities as well as improved profitability during the three months ended March 31, 2005.
Investing activities. Our cash used in investment activities fluctuates primarily based on acquisitions, sales and renovations of hotels. Net cash used in investing activities for renovations in our hotels was $13.7 million in the three months ended March 31, 2005 compared to $18.4 million in the three months ended March 31, 2004.
Financing activities. Net cash provided by financing activities was $61.4 million for the three months ended March 31, 2005 compared to $5.8 million for the three months ended March 31, 2004. Net cash provided by financing activities for the three months ended March 31, 2005, consisted primarily of net proceeds from our preferred securities offering of $117.5 million partially offset by $11.0 million of dividends and distributions to our shareholders and OP unit holders and $45.0 million of principal payments on notes payable. Net cash provided by financing activities for the three months ended March 31, 2004, consisted primarily of proceeds from notes payable of $1.3 million and contributions from the Sunstone Predecessor Companies of $7.5 million partially offset by $300,000 of distributions to the Sunstone Predecessor Companies and $2.7 million principal payments on notes payable.
Future. We expect our primary uses for cash to be for acquisitions of hotels, capital expenditures for hotels, operating expenses and distributions to holders of our common stock and membership units of our operating partnership. We also expect our primary sources of cash will continue to come from the operations of our hotels and our working capital. In addition, we have a $150.0 million senior secured revolving credit facility.
We believe that our capital structure, including our $150.0 million revolving credit facility and cash flow from operations, will provide us with sufficient liquidity to meet our current operating expenses and other expenses directly associated with our business and properties. We have interest rate protection agreements covering all of our variable rate debt, which accounted for 48.4% of our total outstanding indebtedness at March 31, 2005. In April 2005, the Company closed ten individual non cross-collateralized fixed rate mortgage loans totaling $276.0 million. The loans are each for a term of ten years with a fixed rate of 5.34%. Following the closing, more than 85% of the Company’s outstanding debt is fixed rate. We believe this debt capital structure is appropriate for the operating characteristics of our business and provides for significant prepayment and refinancing flexibility.
In the future, we may also explore other financing alternatives, including our sale of equity and debt securities. Our ability to incur additional debt depends on a number of factors, including our degree of leverage, the value of our unencumbered assets and borrowing restrictions imposed by existing lenders under our existing notes payable, including our revolving credit facility. Our ability to raise funds through the issuance of equity securities depends on, among other things, general market conditions for hotel companies and REITs and market perceptions about us. We will continue to analyze which source of capital is most advantageous to us at any particular point in time. However, the capital markets may not be available to us when needed on favorable terms or at all.
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Contractual Obligations
The following table summarizes our payment obligations and commitments as of March 31, 2005 (in thousands):
Contractual obligations
Operating lease obligations
Construction commitments
Franchise obligations
Employment obligations
Total
Capital Expenditures and Reserve Funds
We believe we maintain each of our hotels in good repair and condition and in conformity with applicable franchise agreements, ground leases, laws and regulations. Our capital expenditures primarily relate to the ongoing maintenance of our hotels and are budgeted in the reserve accounts described in the following paragraph. We also incur capital expenditures following the acquisition of hotels for renovation and development. Our capital expenditures for 2005 are expected to be approximately $65.0 million to $75.0 million. This renovation budget includes our $6.0 million of contractual construction commitments. All of these amounts are expected to be funded out of our cash and reserve accounts. Our capital expenditures could increase if we determine to acquire, renovate or develop additional hotels in the future. Our capital expenditures also fluctuate from year to year, since we are not required to spend the entire amount in the reserve accounts each year.
With respect to our hotels that are operated under franchise agreements with major national hotel brands and for all of our hotels subject to a first mortgage lien, we are obligated to maintain a furniture, fixture and equipment, or FF&E, reserve account for future planned and emergency-related capital expenditures at these hotels. The amount funded into each of these reserve accounts is determined pursuant to the management, franchise and loan agreements for each of the respective hotels, ranging between 4.0% and 5.0% of the respective hotel’s total annual revenue. For example, in the case of the Residence Inn by Marriott, Rochester, Minnesota, opened in June 2004, the loan agreement requires an increase in the reserve percentage from 0.0% to 4.0% of the gross revenue between the first operating year and the beginning of the third operating year, respectively. As of March 31, 2005, $8.7 million was available in restricted cash reserves for future capital expenditures at our hotels. According to the respective loan agreements, the reserve funds are to be held by the respective lenders in a restricted cash account.
Derivative Financial Instruments
We use derivative financial instruments, primarily interest rate caps, to manage our exposure to the interest rate risks related to the following variable rate debt. Following the repayment of some of our floating rate debt with the proceeds from our initial public offering, we own interest rate caps having aggregate notional amounts well in excess of our floating rate debt. At March 31, 2005, our interest rate caps consisted of the following:
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The net settlements, if any, paid or received under these interest rate cap agreements are accrued consistent with the terms of the agreements and are recognized in interest expense over the term of the related debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. We generally use outside consultants to determine the fair values of our derivative instruments. Such methods generally incorporate market conventions and techniques such as discounted cash flow analysis and option pricing models to determine fair value. We believe these methods of estimating fair value result in general approximation of value, and such value may or may not actually be realized. For the three months ended March 31, 2005, our mark to market adjustments of these contracts resulted in a net gain of $1,000.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements during the periods presented and did not have any upon the completion of our offering.
Seasonality
The lodging business is seasonal in nature, and we experience some seasonality in our business as indicated in the table below. Revenue for hotels in tourist areas generally are substantially greater during tourist season than other times of the year. Quarterly revenue also may be adversely affected by events beyond our control, such as extreme weather conditions, terrorist attacks or alerts, SARS, airline strikes, economic factors and other considerations affecting travel. Our revenues by quarter during 2004 and 2005 were as follows (dollars in thousands):
Inflation
Inflation may affect our expenses, including, without limitation, by increasing such costs as taxes, property and casualty insurance and utilities.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated and combined financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities.
We evaluate our estimates on an ongoing basis. We base our estimates on historical experience, information that is currently available to us and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the most significant judgments and estimates used in the preparation of our combined financial statements.
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New Accounting Standards and Accounting Changes
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment. SFAS 123(R) requires all share-based payments to employees, including grants of common stock, to be recognized in the financial statements based on their fair values. We have adopted the provisions of SFAS 123(R).
Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Some of our outstanding debt has a variable interest rate. As described in “—Derivative Financial Instruments” above, we use some derivative financial instruments, primarily interest rate caps, to manage our exposure to interest rate risks related to our floating rate debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. As of March 31, 2005, our total outstanding debt was approximately $667.7 million, of which approximately $323.2 million, or 48.4%, was variable rate debt. If market rates of interest on our variable rate debt decrease by 1.0% or approximately 100 basis points, the decrease in interest expense on our variable rate debt would increase future earnings and cash flows by approximately $3.2 million annually. On the other hand, if market rates of interest on our variable debt increase by 1.0% or approximately 100 basis points, the increase in interest expense on our variable debt would decrease future earnings and cash flows by approximately $3.2 million annually.
Interest risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of a reduced level of overall economic activity. If overall economic activity is significantly reduced, we may take actions to further mitigate our exposure. However, because we cannot determine the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.
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Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this quarterly report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of such date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in applicable SEC’s rules and forms. No system of controls, no matter how well designed and operated, can provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
There have been no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II—OTHER INFORMATION
In August 2003, a suit against the Predecessor was filed in United States District Court, Phoenix, Arizona Division, by a hotel guest who became ill and alleged the illness resulted from exposure to a Legionella bacteria during a stay at one of our hotels. We have liability insurance to cover this claim subject to certain insurance deductibles. The litigation has commenced and we and our insurance company’s lawyers have not been able to assess the exposure, if any, to us associated with this litigation.
Additionally, we are involved from time to time in various claims and other legal actions in the ordinary course of business. We do not believe that the resolution of such additional matters will have a material adverse effect on our financial position or results of operations when resolved.
None.
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(a) Exhibits. The following Exhibits are filed as a part of this report:
Description
(b) Reports on Form 8-K.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 10, 2005
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EXHIBIT INDEX
33