Table of Contents
UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2020
OR
☐
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 ofIncorporation or Organization)
(I.R.S. EmployerIdentification Number)
200 Spectrum Center Drive, 21st FloorIrvine, California
92618
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code: (949) 330-4000
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common Stock, $0.01 par value
SHO
New York Stock Exchange
Series E Cumulative Redeemable Preferred Stock, $0.01 par value
SHO.PRE
Series F Cumulative Redeemable Preferred Stock, $0.01 par value
SHO.PRF
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 ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of November 2, 2020, there were 215,635,550 shares of Sunstone Hotel Investors, Inc.’s common stock, $0.01 par value per share, outstanding.
SUNSTONE HOTEL INVESTORS, INC.
QUARTERLY REPORT ON
For the Quarterly Period Ended September 30, 2020
TABLE OF CONTENTS
Page
PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements
2
Consolidated Balance Sheets as of September 30, 2020 (unaudited) and December 31, 2019
Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2020 and 2019
3
Unaudited Consolidated Statements of Equity for the Three Quarters and Nine Months Ended September 30, 2020 and 2019
4
Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019
6
Notes to Unaudited Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
46
Item 4.
Controls and Procedures
PART II—OTHER INFORMATION
Legal Proceedings
48
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
49
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
50
SIGNATURES
51
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
September 30,
December 31,
2020
2019
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents
$
461,288
816,857
Restricted cash
42,346
48,116
Accounts receivable, net
4,624
35,209
Prepaid expenses and other current assets
14,500
13,550
Total current assets
522,758
913,732
Investment in hotel properties, net
2,621,476
2,872,353
Finance lease right-of-use asset, net
46,549
47,652
Operating lease right-of-use assets, net
39,489
60,629
Deferred financing costs, net
3,686
2,718
Other assets, net
12,824
21,890
Total assets
3,246,782
3,918,974
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued expenses
44,162
35,614
Accrued payroll and employee benefits
15,747
25,002
Dividends and distributions payable
3,208
135,872
Other current liabilities
36,562
46,955
Current portion of notes payable, net
188,096
82,109
Total current liabilities
287,775
325,552
Notes payable, less current portion, net
743,545
888,954
Finance lease obligation, less current portion
15,569
15,570
Operating lease obligations, less current portion
45,939
49,691
Other liabilities
25,909
18,136
Total liabilities
1,118,737
1,297,903
Commitments and contingencies (Note 12)
Equity:
Stockholders’ equity:
Preferred stock, $0.01 par value, 100,000,000 shares authorized:
6.95% Series E Cumulative Redeemable Preferred Stock, 4,600,000 shares issued and outstanding at September 30, 2020 and December 31, 2019, stated at liquidation preference of $25.00 per share
115,000
6.45% Series F Cumulative Redeemable Preferred Stock, 3,000,000 shares issued and outstanding at September 30, 2020 and December 31, 2019, stated at liquidation preference of $25.00 per share
75,000
Common stock, $0.01 par value, 500,000,000 shares authorized, 215,635,550 shares issued and outstanding at September 30, 2020 and 224,855,351 shares issued and outstanding at December 31, 2019
2,156
2,249
Additional paid in capital
2,584,005
2,683,913
Retained earnings
951,765
1,318,455
Cumulative dividends and distributions
(1,640,178)
(1,619,779)
Total stockholders’ equity
2,087,748
2,574,838
Noncontrolling interest in consolidated joint venture
40,297
46,233
Total equity
2,128,045
2,621,071
Total liabilities and equity
See accompanying notes to consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended September 30,
Nine Months Ended September 30,
REVENUES
Room
16,266
200,242
147,535
580,835
Food and beverage
2,109
61,366
50,312
206,183
Other operating
10,535
20,031
32,699
55,197
Total revenues
28,910
281,639
230,546
842,215
OPERATING EXPENSES
13,715
52,514
65,037
152,606
7,748
44,928
54,533
140,149
1,295
4,162
6,283
12,494
Advertising and promotion
3,895
13,285
20,447
40,998
Repairs and maintenance
6,075
10,632
21,499
31,107
Utilities
4,170
7,458
13,238
20,656
Franchise costs
663
8,606
6,337
24,024
Property tax, ground lease and insurance
20,800
21,880
59,975
62,842
Other property-level expenses
9,528
30,913
47,109
97,768
Corporate overhead
6,582
7,395
22,414
22,989
Depreciation and amortization
33,005
37,573
104,290
110,484
Impairment losses
—
133,466
Total operating expenses
107,476
239,346
554,628
716,117
Interest and other income
139
3,762
2,751
13,497
Interest expense
(12,742)
(13,259)
(43,199)
(43,401)
Gain on sale of assets
189
Loss on extinguishment of debt
(210)
(Loss) income before income taxes
(91,190)
32,796
(364,551)
96,194
Income tax benefit (provision), net
83
749
(6,575)
1,185
NET (LOSS) INCOME
(91,107)
33,545
(371,126)
97,379
Loss (income) from consolidated joint venture attributable to noncontrolling interest
1,816
(2,508)
4,436
(6,062)
Preferred stock dividends
(3,208)
(9,622)
(LOSS) INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS
(92,499)
27,829
(376,312)
81,695
Basic and diluted per share amounts:
Basic and diluted (loss) income attributable to common stockholders per common share
(0.43)
0.12
(1.74)
0.36
Basic and diluted weighted average common shares outstanding
214,257
224,530
216,498
226,369
UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY
(In thousands, except share and per share data)
Preferred Stock
Noncontrolling
Series E
Series F
Common Stock
Cumulative
Interest in
Number of
Additional
Retained
Dividends and
Consolidated
Shares
Amount
Paid in Capital
Earnings
Distributions
Joint Venture
Total Equity
Balance at December 31, 2019 (audited)
4,600,000
3,000,000
224,855,351
Amortization of deferred stock compensation
2,324
Issuance of restricted common stock, net
456,219
(3,996)
(3,992)
Forfeiture of restricted common stock
(355)
Common stock distributions and distributions payable at $0.05 per share
(10,777)
Series E preferred stock dividends and dividends payable at $0.434375 per share
(1,998)
Series F preferred stock dividends and dividends payable at $0.403125 per share
(1,209)
Distributions to noncontrolling interest
(2,000)
Repurchases of outstanding common stock
(9,770,081)
(98)
(103,796)
(103,894)
Net loss
(162,061)
(458)
(162,519)
Balance at March 31, 2020
215,541,134
2,155
2,578,445
1,156,394
(1,633,763)
43,775
2,337,006
3,193
Issuance of restricted common stock
94,416
1
(1)
Contribution from noncontrolling interest
500
(115,338)
(2,162)
(117,500)
Balance at June 30, 2020
215,635,550
2,581,637
1,041,056
(1,636,970)
42,113
2,219,992
2,368
(1,210)
(89,291)
(1,816)
Balance at September 30, 2020
Balance at December 31, 2018 (audited)
228,246,247
2,282
2,728,684
1,182,722
(1,440,202)
47,685
2,711,171
2,221
345,132
(4,439)
(4,435)
(3,932)
(11,429)
(1,950)
Net income
16,317
1,599
17,916
Balance at March 31, 2019
228,587,447
2,286
2,726,466
1,199,039
(1,454,838)
47,334
2,710,287
3,002
51,840
(11,411)
(788)
(432,464)
(4)
(5,731)
(5,735)
43,963
1,955
45,918
Balance at June 30, 2019
228,206,823
2,723,737
1,243,002
(1,469,456)
48,501
2,738,066
(11,243)
(2,625)
(3,344,845)
(33)
(44,232)
(44,265)
31,037
2,508
Balance at September 30, 2019
224,861,978
2,681,754
1,274,039
(1,483,907)
48,384
2,712,519
5
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Bad debt expense
305
405
(189)
210
Noncash interest on derivatives and finance lease obligations, net
5,534
6,908
Depreciation
104,259
110,416
Amortization of franchise fees and other intangibles
31
68
Amortization of deferred financing costs
2,288
2,094
7,509
7,168
Deferred income taxes, net
7,415
(246)
Changes in operating assets and liabilities:
Accounts receivable
30,173
(10,700)
Prepaid expenses and other assets
75
(1,744)
Accounts payable and other liabilities
2,923
2,449
(9,255)
(3,045)
Operating lease right-of-use assets and obligations
(923)
(523)
Net cash (used in) provided by operating activities
(87,305)
210,629
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of assets
76,855
Acquisition of hotel property
(1,296)
(193)
Acquisition of intangible asset
(102)
Renovations and additions to hotel properties and other assets
(44,043)
(75,277)
Payment for interest rate derivative
(111)
Net cash provided by (used in) investing activities
31,303
(75,470)
CASH FLOWS FROM FINANCING ACTIVITIES
(50,000)
Repurchases of common stock for employee tax obligations
Proceeds from credit facility
300,000
Payments on credit facility
(300,000)
Payments on notes payable
(40,190)
(5,770)
Payments of deferred financing costs
(2,698)
Dividends and distributions paid
(153,063)
(155,715)
(5,363)
Net cash used in financing activities
(305,337)
(221,283)
Net decrease in cash and cash equivalents and restricted cash
(361,339)
(86,124)
Cash and cash equivalents and restricted cash, beginning of period
864,973
862,369
Cash and cash equivalents and restricted cash, end of period
503,634
776,245
Supplemental Disclosure of Cash Flow Information
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the consolidated balance sheets to the amount shown in the consolidated statements of cash flows:
730,039
46,206
Total cash and cash equivalents and restricted cash shown on the consolidated statements of cash flows
The Company paid the following amounts for interest and income taxes, during the nine months ended September 30, 2020 and 2019:
Cash paid for interest
34,118
36,703
Cash paid for income taxes, net
18
354
Supplemental Disclosure of Noncash Investing and Financing Activities
The Company’s noncash investing and financing activities during the nine months ended September 30, 2020 and 2019 consisted of the following:
Accrued renovations and additions to hotel properties and other assets
7,195
8,149
Amortization of deferred stock compensation — construction activities
376
304
14,451
7
NOTES TO UNAUDITED 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 elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes, commencing with its taxable year ended on December 31, 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 or repositioning hotel properties, and may also selectively sell hotels that no longer fit its stated strategy.
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. 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, in transactions that are intended to generate qualifying income.
As of September 30, 2020, the Company had interests in 19 hotels (the “19 Hotels”), currently held for investment. The Company’s third-party managers included the following:
Number of Hotels
Subsidiaries of Marriott International, Inc. or Marriott Hotel Services, Inc. (collectively, “Marriott”)
Highgate Hotels L.P. and an affiliate
Crestline Hotels & Resorts
Hilton Worldwide
Interstate Hotels & Resorts, Inc.
Davidson Hotels & Resorts
Hyatt Corporation
Singh Hospitality, LLC
Total hotels owned as of September 30, 2020
19
The novel coronavirus (“COVID-19”) global pandemic, along with federal, state and local government mandates have disrupted and are expected to continue to disrupt the Company’s business. In the United States, individuals are being encouraged to practice social distancing, are restricted from gathering in groups, and in some areas, either have been or are subject to mandatory shelter-in-place orders, which have restricted or prohibited social gatherings, travel and non-essential activities outside of their homes.
In response to the COVID-19 pandemic, the Company temporarily suspended operations at the following 15 hotels during the nine months ended September 30, 2020, 12 of which have since resumed operations:
Hotel
Suspension Date
Resumption Date
Oceans Edge Resort & Marina
March 22, 2020
June 4, 2020
Embassy Suites Chicago
April 1, 2020
July 1, 2020
Marriott Boston Long Wharf
March 12, 2020
July 7, 2020
Hilton New Orleans St. Charles
March 28, 2020
July 13, 2020
Hyatt Centric Chicago Magnificent Mile
April 6, 2020
JW Marriott New Orleans
July 14, 2020
Hilton San Diego Bayfront
March 23, 2020
August 11, 2020
Renaissance Washington DC
March 26, 2020
August 24, 2020
Hyatt Regency San Francisco
October 1, 2020
Renaissance Orlando at SeaWorld®
March 20, 2020
The Bidwell Marriott Portland
March 27, 2020
October 5, 2020
Wailea Beach Resort
March 25, 2020
November 1, 2020
Hilton Garden Inn Chicago Downtown/Magnificent Mile
Hilton Times Square
June 30, 2020
Renaissance Westchester
April 4, 2020
The Company is unable to predict when any of its remaining hotels with temporarily suspended operations will resume their operations, or if those hotels that have resumed operations will be temporarily suspended again. The extent of the effects of the COVID-19 pandemic on the Company’s business and the hotel industry at large is significant and highly uncertain, and will ultimately depend on future developments, including, but not limited to, the duration and severity of the outbreak, the development, distribution, and administration of a successful vaccine or therapy, and the length of time it takes for demand and pricing to return and normal economic and operating conditions to resume.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements as of September 30, 2020 and December 31, 2019, and for the three and nine months ended September 30, 2020 and 2019, include the accounts of the Company, the Operating Partnership, the TRS Lessee and their controlled subsidiaries. All significant intercompany balances and transactions have been eliminated. If the Company determines that it has an interest in a variable interest entity, the Company will consolidate the entity when it is determined to be the primary beneficiary of the entity.
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, 2019, filed with the Securities and Exchange Commission on February 19, 2020. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.
The Company does not have any comprehensive income other than what is included in net income. If the Company has any comprehensive income in the future such that a statement of comprehensive income would be necessary, the Company will include such statement in one continuous consolidated statement of operations.
Certain prior year amounts in these financial statements have been reclassified to conform to the presentation for the three and nine months ended September 30, 2020.
The Company has evaluated subsequent events through the date of issuance of these financial statements.
9
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.
Earnings Per Share
The Company applies the two-class method when computing its earnings per share. Net income per share for each class of stock is calculated assuming all of the Company’s net income is distributed as dividends to each class of stock based on their contractual rights.
Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are considered participating securities and are included in the computation of earnings per share.
Basic earnings (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 (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 more dilutive of either the two-class method or the treasury stock method.
The following table sets forth the computation of basic and diluted (loss) earnings per common share (unaudited and in thousands, except per share data):
Numerator:
Distributions paid on unvested restricted stock compensation
(61)
(69)
(183)
Undistributed income allocated to unvested restricted stock compensation
(89)
(257)
Numerator for basic and diluted (loss) income attributable to common stockholders
27,679
(376,381)
81,255
Denominator:
Weighted average basic and diluted common shares outstanding
The Company’s unvested restricted shares associated with its long-term incentive plan have been excluded from the above calculation of earnings per share for the three and nine months ended September 30, 2020 and 2019, as their inclusion would have been anti-dilutive.
Restricted Cash
Restricted cash is comprised of reserve accounts for debt service, interest reserves, seasonality reserves, capital replacements, ground leases, property taxes and hotel-generated cash that is held in an account for the benefit of a lender. These restricted funds are subject to disbursement approval based on in-place agreements and policies by certain of the Company’s lenders and/or hotel managers. Restricted cash may also include earnest money received from a buyer or potential buyer of one of the Company’s hotels and held in escrow until the sale is completed.
10
Investments in Hotel Properties
Investments in hotel properties, including land, buildings, furniture, fixtures and equipment (“FF&E”) and identifiable intangible assets are recorded at fair value upon acquisition. Property and equipment purchased after the hotel acquisition date is recorded at cost. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation is removed from the Company’s accounts and any resulting gain or loss is included in the consolidated statements of operations.
Depreciation expense is based on the estimated life of the Company’s assets. The life is based on a number of assumptions, including the cost and timing of capital expenditures to maintain and refurbish the Company’s hotels, as well as specific market and economic conditions. Hotel properties are depreciated using the straight-line method over estimated useful lives primarily ranging from five to 40 years for buildings and improvements and three to 12 years for FF&E. Finance lease right-of-use assets other than land are depreciated using the straight-line method over the shorter of either their estimated useful life or the life of the related finance lease obligation. Intangible assets are amortized using the straight-line method over the shorter of their estimated useful life or over the length of the related agreement.
The Company’s investment in hotel properties, net also includes initial franchise fees which are recorded at cost and amortized using the straight-line method over the terms of the franchise agreements ranging from 14 to 27 years. All other franchise fees that are based on the Company’s results of operations are expensed as incurred.
While the Company believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income or the gain or loss on the sale of any of the Company’s hotels. The Company has not changed the useful lives of any of its assets during the periods discussed.
Impairment losses are recorded on long-lived assets to be held and used by the Company when indicators of impairment are present and the future undiscounted net cash flows, including potential sale proceeds, expected to be generated by those assets, based on the Company’s anticipated investment horizon, are less than the assets’ carrying amount. The Company evaluates its long-lived assets to determine if there are indicators of impairment on a quarterly basis. No single indicator would necessarily result in the Company preparing an estimate to determine if a hotel’s future undiscounted cash flows are less than the book value of the hotel. The Company uses judgment to determine if the severity of any single indicator, or the fact there are a number of indicators of less severity that when combined, would result in an indication that a hotel requires an estimate of the undiscounted cash flows to determine if an impairment has occurred. If a hotel is considered to be impaired, the related assets are adjusted to their estimated fair value and an impairment loss is recognized. The impairment loss recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. The Company performs a fair value assessment, using a discounted cash flow analysis to estimate the fair value of the hotel, taking into account the hotel’s expected cash flow from operations, the Company’s estimate of how long it will continue to own the hotel and the estimated proceeds from the disposition of the hotel. The factors addressed in determining estimated proceeds from disposition include anticipated operating cash flow in the year of disposition and terminal capitalization rate. The Company’s judgment is required in determining the appropriate discount rate applied to estimated cash flows, the estimated growth of revenues and expenses, net operating income and margins, the need for capital expenditures, as well as specific market and economic conditions. Based on the Company’s review, three hotels were impaired during the first nine months of 2020 (see Note 5).
Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than a forced or liquidation sale. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of current market yields as well as future events and conditions. Such future events and conditions include economic and market conditions, as well as the availability of suitable financing. The realization of the Company’s investment in hotel properties is dependent upon future uncertain events and conditions and, accordingly, the actual timing and amounts realized by the Company may be materially different from their estimated fair values.
Finance and Operating Leases
The Company determines if a contract is a lease at inception. Leases with an initial term of 12 months or less are not recorded on the balance sheet. Expense for these short-term leases is recognized on a straight-line basis over the lease term. For leases with an initial term greater than 12 months, the Company records a right-of-use (“ROU”) asset and a corresponding lease obligation. ROU assets represent the Company’s right to use an underlying asset for the lease term, and lease obligations represent the Company’s obligation to make fixed lease payments as stipulated by the lease.
Leases are accounted for using a dual approach, classifying leases as either operating or financing based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the Company. This classification determines whether
11
the lease expense is recognized on a straight-line basis over the term of the lease for operating leases or based on an effective interest method for finance leases.
Operating lease ROU assets are recognized at the lease commencement date, and include the amount of the initial operating lease obligation, any lease payments made at or before the commencement date, excluding any lease incentives received, and any initial direct costs incurred. For leases that have extension options that the Company can exercise at its discretion, management uses judgment to determine if it is reasonably certain that the Company will in fact exercise such option. If the extension option is reasonably certain to occur, the Company includes the extended term’s lease payments in the calculation of the respective lease liability. None of the Company’s leases contain any material residual value guarantees or material restrictive covenants.
Operating lease obligations are recognized at the lease commencement date based on the present value of lease payments over the lease term. As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate (“IBR”) based on information available at the commencement date in determining the present value of lease payments over the lease term. The IBR is the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. In order to estimate the Company’s IBR, the Company first looks to its own unsecured debt offerings, and adjusts the rate for both length of term and secured borrowing using available market data as well as consultations with leading national financial institutions that are active in the issuance of both secured and unsecured notes.
The Company reviews its right-of-use assets for indicators of impairment. If such assets are considered to be impaired, the related assets are adjusted to their estimated fair value and an impairment loss is recognized. The impairment loss recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Based on the Company’s review, the operating lease right-of-use asset at one hotel was impaired during the first nine months of 2020 (see Note 5).
Noncontrolling Interest
The Company’s consolidated financial statements include an entity in which the Company has a controlling financial interest. Noncontrolling interest is the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. Such noncontrolling interest is reported on the consolidated balance sheets within equity, separately from the Company’s equity. On the consolidated statements of operations, revenues, expenses and net income or loss from the less-than-wholly owned subsidiary are reported at their consolidated amounts, including both the amounts attributable to the Company and the noncontrolling interest. Income or loss is allocated to the noncontrolling interest based on its weighted average ownership percentage for the applicable period. The consolidated statements of equity include beginning balances, activity for the period and ending balances for each component of stockholders’ equity, noncontrolling interest and total equity.
At both September 30, 2020 and December 31, 2019, the noncontrolling interest reported in the Company’s consolidated financial statements consisted of a third-party’s 25.0% ownership interest in the Hilton San Diego Bayfront.
Revenue Recognition
Revenues are recognized when control of the promised goods or services is transferred to hotel guests, which is generally defined as the date upon which a guest occupies a room and/or utilizes the hotel’s services. Room revenue and other occupancy based fees are recognized over a guest’s stay at a previously agreed upon daily rate. Additionally, some of the Company’s hotel rooms are booked through independent internet travel intermediaries. If the guest pays the independent internet travel intermediary directly, revenue for the room is recognized by the Company at the price the Company sold the room to the independent internet travel intermediary, less any discount or commission paid. If the guest pays the Company directly, revenue for the room is recognized by the Company on a gross basis, with the related discount or commission recognized in room expense. A majority of the Company’s hotels participate in frequent guest programs sponsored by the hotel brand owners whereby the hotel allows guests to earn loyalty points during their hotel stay. The Company expenses charges associated with these programs as incurred, and recognizes revenue at the amount it will receive from the brand when a guest redeems their loyalty points by staying at one of the Company’s hotels. In addition, some contracts for rooms or food and beverage services require an advance deposit, which the Company records as deferred revenue (or a contract liability) and recognizes once the performance obligations are satisfied. Cancellation fees and attrition fees, which are charged to groups when they do not fulfill their contracted minimum number of room nights or minimum food and beverage spending requirements, are generally recognized as revenue in the period these fees are collected.
Food and beverage revenue and other ancillary services revenue are generated when a customer chooses to purchase goods or services separately from a hotel room. These revenue streams are recognized during the time the goods or services are provided to the customer at the amount the Company expects to be entitled to in exchange for those goods or services. For those ancillary services provided by third parties, the Company assesses whether it is the principal or the agent. If the Company is the principal, revenue is recognized based upon the gross sales price. If the Company is the agent, revenue is recognized based upon the commission earned from the third party.
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Additionally, the Company collects sales, use, occupancy and other similar taxes at its hotels. These taxes are collected from customers at the time of purchase, but are not included in revenue. The Company records a liability upon collection of such taxes from the customer, and relieves the liability when payments are remitted to the applicable governmental agency.
Trade receivables and contract liabilities consisted of the following (in thousands):
Trade receivables, net (1)
4,499
21,201
Contract liabilities (2)
15,587
18,498
The Company did not recognize any revenue related to its outstanding contract liabilities during the three months ended September 30, 2020. During the nine months ended September 30, 2020, and the three and nine months ended September 30, 2019, the Company recognized approximately $10.2 million, $1.0 million and $16.3 million, respectively, in revenue related to its outstanding contract liabilities.
Segment Reporting
The Company considers each of its hotels to be an operating segment, and allocates resources and assesses the operating performance for each hotel. Because all of the Company’s hotels have similar economic characteristics, facilities and services, the hotels have been aggregated into a single reportable segment, hotel ownership.
New Accounting Standards and Accounting Changes
In June 2016, the FASB issued Accounting Standards Update No. 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU No. 2016-13”), which replaced the “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost. For trade and other receivables, held-to-maturity debt securities, loans and other instruments, entities will be required to use a new forward looking “expected loss” model that generally will result in the earlier recognition of allowances for losses. In addition, entities will have to disclose significantly more information, including information they use to track credit quality by year of origination for most financing receivables. In both November 2019 and November 2018, the FASB issued codification improvements to ASU No. 2016-13, including Accounting Standards Update No. 2019-11 (“ASU No. 2019-11”) in 2019 and Accounting Standards Update No. 2018-19 (“ASU No. 2018-19”), in 2018. ASU No. 2019-11 includes an amendment requiring entities to include certain expected recoveries of the amortized cost basis previously written off, or expected to be written off, in the allowance for credit losses for purchased credit deteriorated assets. ASU No. 2018-19 clarifies that operating lease receivables accounted for under ASC 842 are not in the scope of ASU No. 2016-13. The Company adopted all three of these ASUs on January 1, 2020, with no material impact on its consolidated financial statements.
In March 2020, the FASB issued Accounting Standards Update No. 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU No. 2020-04”), which provides temporary optional expedients and exceptions to the guidance in GAAP on contract modifications and hedge accounting to ease reporting burdens related to the expected market transition from the London Interbank Offered Rate (“LIBOR”) and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate (“SOFR”). Contracts that meet the following criteria are eligible for relief from the modification accounting requirements in GAAP: the contract references LIBOR or another rate that is expected to be discontinued due to reference rate reform; the modified terms directly replace or have the potential to replace the reference rate that is expected to be discontinued due to reference rate reform; and any contemporaneous changes to other terms that change or have the potential to change the amount and timing of contractual cash flows must be related to the replacement of the reference rate. For a contract that meets the criteria, the guidance generally allows an entity to account for and present modifications as an event that does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. That is, the modified contract is accounted for as a continuation of the existing contract. ASU No. 2020-04 is effective upon issuance, and is applied prospectively from any date beginning March 12, 2020. The relief is temporary and generally cannot be applied to contract modifications that occur after December 31, 2022. The Company intends to take advantage of the expedients offered by ASU No. 2020-04 when it modifies its variable rate debt, which includes the Company’s $220.0 million loan secured by the Hilton San Diego Bayfront and its credit facility. The adoption of ASU No. 2020-04 is not expected to have a material impact on the Company’s consolidated financial statements.
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3. Investment in Hotel Properties
Investment in hotel properties, net for the 19 Hotels consisted of the following (in thousands):
Land
581,426
601,181
Buildings and improvements
2,707,102
2,950,534
Furniture, fixtures and equipment
464,588
506,754
Intangible assets
25,111
32,610
Franchise fees
743
Construction in progress
39,026
40,639
Investment in hotel properties, gross
3,817,996
4,132,461
Accumulated depreciation and amortization
(1,196,520)
(1,260,108)
During the first quarter of 2020, the Company wrote down its investment in hotel properties and recorded impairment losses of $89.4 million on the Hilton Times Square and $5.2 million on the Renaissance Westchester (see Note 5). In addition, during the first quarter of 2020, the Company recorded an impairment loss of $2.3 million related to the abandonment of a potential project to expand one of its hotels.
4. Disposal
The Company sold the Renaissance Harborplace in July 2020, for net proceeds of $76.9 million, and recorded a net gain of $0.2 million on the sale. The sale did not represent a strategic shift that had a major impact on the Company’s business plan or its primary markets; therefore, the hotel did not qualify as a discontinued operation. During the second quarter of 2020, the Company wrote down the hotel’s assets and recorded an impairment loss of $18.1 million (see Note 5).
5. Fair Value Measurements and Interest Rate Derivatives
Fair Value Measurements
As of September 30, 2020 and December 31, 2019, 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.
A fair value measurement is based on the assumptions that market participants would use in pricing an asset or liability in an orderly transaction. The hierarchy for inputs used in measuring fair value is as follows:
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 of both September 30, 2020 and December 31, 2019, the Company measured its interest rate derivatives at fair value on a recurring basis. The Company estimated the fair value of its interest rate derivatives using Level 2 measurements based on quotes obtained from the counterparties, which are based upon the consideration that would be required to terminate the agreements.
The Company sold the Renaissance Harborplace in July 2020 (see Note 4). During the second quarter of 2020, the Company recorded an impairment loss of $18.1 million related to this hotel as the fair value less costs to sell was lower than the carrying value
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of the hotel. The impairment loss was determined using Level 2 measurements, consisting of the third-party offer price less estimated costs to sell the hotel, and is included in impairment losses on the Company’s consolidated statements of operations for the nine months ended September 30, 2020.
During the first quarter of 2020, the Company identified indicators of impairment at the Hilton Times Square and the Renaissance Westchester related to deteriorating profitability exacerbated by the effects of the COVID-19 outbreak on the Company’s expected future operating cash flows. The Company prepared estimates of the future undiscounted cash flows expected to be generated by the two hotels during their anticipated holding periods, using assumptions for forecasted revenue and operating expenses as well as the estimated market values of the hotels. Based on this analysis, the Company concluded the Hilton Times Square and the Renaissance Westchester should be impaired as the estimated future undiscounted cash flows for each was less than such hotel’s carrying value.
To determine the impairment loss for the Hilton Times Square, the Company applied Level 3 measurements to estimate the fair value of the hotel, using a discounted cash flow analysis, taking into account the hotel’s expected cash flow and its estimated market value based upon a market participant’s holding period. The valuation approach included significant unobservable inputs, including revenue growth projections and prevailing market multiples. To determine the impairment loss for the Renaissance Westchester, the Company used Level 2 measurements to estimate the fair value of the hotel, using appraisal techniques to estimate its market value. The Company concluded that the estimated fair value of each hotel was less than its carrying value, resulting in the Company recording impairment charges of $107.9 million on the Hilton Times Square and $5.2 million on the Renaissance Westchester, which are included in impairment losses on the Company’s consolidated statements of operations for the nine months ended September 30, 2020. The $107.9 million impairment on the Hilton Times Square is comprised of an $89.4 million write down of the Company’s investment in hotel properties, net (see Note 3), and an $18.5 million write down of the Company’s operating lease right-of-use assets, net (see Note 9). The $5.2 million impairment on the Renaissance Westchester consisted solely of a $5.2 million write down of the Company’s investment in hotel properties, net (see Note 3). Following these first quarter 2020 impairments, as of March 31, 2020, the fair market values of the Hilton Times Square and the Renaissance Westchester were $61.3 million and $29.5 million, respectively.
The following table presents the Company’s assets measured at fair value on a recurring and nonrecurring basis at September 30, 2020 and December 31, 2019 (in thousands):
Fair Value Measurements at Reporting Date
Total
September 30, 2020 (unaudited):
Interest rate cap derivatives
Total assets measured at fair value at September 30, 2020
December 31, 2019:
Renaissance Harborplace (1)
96,725
Total assets measured at fair value at December 31, 2019
The following table presents the Company’s liabilities measured at fair value on a recurring and nonrecurring basis at September 30, 2020 and December 31, 2019 (in thousands):
Interest rate swap derivatives
6,505
Total liabilities measured at fair value at September 30, 2020
1,081
Total liabilities measured at fair value at December 31, 2019
15
Interest Rate Derivatives
The Company’s interest rate derivatives, which are not designated as effective cash flow hedges, consisted of the following at September 30, 2020 (unaudited) and December 31, 2019 (in thousands):
Estimated Fair Value of Assets (Liabilities) (1)
Strike / Capped
Effective
Maturity
Notional
Hedged Debt
Type
Rate
Index
Date
Cap
6.000
%
1-Month LIBOR
November 10, 2017
December 9, 2020
220,000
Cap (2)
December 15, 2021
$85.0 million term loan
Swap
1.591
October 29, 2015
September 2, 2022
85,000
(2,429)
(132)
$100.0 million term loan
1.853
January 29, 2016
January 31, 2023
100,000
(4,076)
(949)
(6,504)
(1,081)
Noncash changes in the fair values of the Company’s interest rate derivatives resulted in (decreases) increases to interest expense for the three and nine months ended September 30, 2020 and 2019 as follows (unaudited and in thousands):
Noncash interest on derivatives
(762)
1,098
6,740
Fair Value of Debt
As of September 30, 2020 and December 31, 2019, 76.5% and 77.4%, respectively, of the Company’s outstanding debt had fixed interest rates, including the effects of interest rate swap agreements. The Company uses Level 3 measurements to estimate the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates.
The Company’s principal balances and fair market values of its consolidated debt as of September 30, 2020 (unaudited) and December 31, 2019 were as follows (in thousands):
September 30, 2020
December 31, 2019
Carrying Amount (1)
Fair Value (2)
Fair Value
Debt
934,673
899,548
974,863
976,012
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6. Other Assets
Other assets, net consisted of the following (in thousands):
Property and equipment, net
7,014
7,642
Deferred rent on straight-lined third-party tenant leases
2,879
3,542
Deferred income tax assets, net (1)
Other receivables
2,623
2,984
Other
307
Total other assets, net
7. Notes Payable
Notes payable consisted of the following (in thousands):
Notes payable requiring payments of interest and principal, with fixed rates ranging from 4.12% to 5.95%; maturing at dates ranging from November 1, 2020 through January 6, 2025. The notes are collateralized by first deeds of trust on four hotel properties at both September 30, 2020 and December 31, 2019.
324,673
329,863
Note payable requiring payments of interest only, bearing a blended rate of one-month LIBOR plus 105 basis points; initial maturity on December 9, 2020 with notice provided to the lender of intent to exercise the first available one-year extension; two additional one-year options to extend remain, which the Company also intends to exercise. The note is collateralized by a first deed of trust on one hotel property.
Unsecured term loan requiring payments of interest only, with a blended interest rate based on a pricing grid with a range of 135 to 220 basis points, depending on the Company's leverage ratios, plus the greater of one-month LIBOR or 25 basis points. LIBOR has been swapped to a fixed rate of 1.591%, resulting in an effective interest rate of 3.791%. Matures on September 3, 2022. (1)
Unsecured term loan requiring payments of interest only, with a blended interest rate based on a pricing grid with a range of 135 to 220 basis points, depending on the Company's leverage ratios, plus the greater of one-month LIBOR or 25 basis points. LIBOR has been swapped to a fixed rate of 1.853%, resulting in an effective interest rate of 4.053%. Matures on January 31, 2023. (1)
Unsecured Series A Senior Notes requiring semi-annual payments of interest only, bearing interest at 5.69%. Matures on January 10, 2026. (2)
90,000
120,000
Unsecured Series B Senior Notes requiring semi-annual payments of interest only, bearing interest at 5.79%. Matures on January 10, 2028. (2)
Total notes payable
Current portion of notes payable
189,189
83,975
Less: current portion of deferred financing costs
(1,093)
(1,866)
Carrying value of current portion of notes payable
Notes payable, less current portion
745,484
890,888
Less: long-term portion of deferred financing costs
(1,939)
(1,934)
Carrying value of notes payable, less current portion
17
The Company has not made its debt payments for the $77.2 million loan secured by the Hilton Times Square since April 2020; although the Company continues to accrue interest expense on the debt, including $1.7 million in default interest and penalties accrued as of September 30, 2020. While the Company is required to record such default interest and penalties, recovery by the lender of these expenses is non-recourse to the Company, and the Company does not intend to pay the default interest and penalties as part of the ultimate resolution with the lender. The loan matures on November 1, 2020, and is included in current portion of notes payable on the Company’s consolidated balance sheets as of September 30, 2020 and December 31, 2019. In addition, the hotel’s ground leases require monthly payments be paid to the respective landlords, which the Company has not made since March 2020 (see Notes 8 and 9). As such, the Company has received default notices from its lender and landlords, and is working with the lender to explore various options in advance of the November 2020 debt maturity, which could include a negotiated transfer of the hotel to the lender or its landlords or a discounted payoff of the loan.
In March 2020, the Company drew $300.0 million under the revolving portion of its credit facility as a precautionary measure to increase the Company’s cash position and preserve financial flexibility. In June 2020 and August 2020, the Company repaid $250.0 million and $11.2 million, respectively, of the outstanding credit facility balance after determining that it had sufficient cash on hand in addition to access to its credit facility. Also in August 2020, the Company used a portion of the proceeds it received from the sale of the Renaissance Harborplace to repay $38.8 million of the outstanding credit facility balance as stipulated in the amended agreements to its unsecured debt described below. As of September 30, 2020, the Company has no amount outstanding under the credit facility.
In July 2020, the Company completed amendments to its unsecured debt, consisting of its revolving credit facility, term loans and senior notes (the “Unsecured Debt Amendments”). The Unsecured Debt Amendments were deemed to be debt modifications and accounted for accordingly. Key terms of the Unsecured Debt Amendments include:
At September 30, 2020, the Company has $500.0 million of capacity available for additional borrowing under the revolving portion of its credit facility. The revolving portion of the amended credit facility matures in April 14, 2023, but may be extended for two six-month periods to April 14, 2024, upon the payment of applicable fees and satisfaction of certain customary conditions.
In September 2020, the Company repaid $35.0 million of its senior notes, comprising $30.0 million to the Series A note holders and $5.0 million to the Series B note holders, using a portion of the proceeds the Company received from the sale of the Renaissance Harborplace as stipulated in the Unsecured Debt Amendments. In conjunction with the repayments, the Company recorded a $0.2 million loss on extinguishment of debt related to the write-off of deferred financing fees.
The Company is subject to various financial covenants on its secured and unsecured debt. Due to COVID-19’s negative impact on the Company’s operations throughout 2020 and its expected impact into 2021, it is possible that the Company may not meet the terms of its unsecured debt financial covenants once such covenants are effective again in 2021. As of November 1, 2020, operations at three of the 19 Hotels remain suspended due to COVID-19, with the remainder operating at reduced capacities. The Company’s future liquidity will depend on the gradual return of guests, particularly group business, to its hotels and the stabilization of demand throughout its portfolio. The Company is currently working with its lenders to extend the Covenant Relief Period, however, there is no assurance that the Company will be able to obtain an extension in a timely manner, or on acceptable terms. If the Company is unable to obtain an extension of the Covenant Relief Period and is not able to satisfy the financial covenants following the end of the existing waiver period, the lenders of its unsecured debt may require the Company to repay the loans, which could raise doubt about the Company’s ability to continue as a going concern.
Interest Expense
Total interest incurred and expensed on the notes payable was as follows (unaudited and in thousands):
Interest expense on debt and finance lease obligations (1)
12,612
11,406
35,377
34,399
1,155
892
698
Total interest expense
12,742
13,259
43,199
43,401
8. Other Current Liabilities and Other Liabilities
Other Current Liabilities
Other current liabilities consisted of the following (in thousands):
Property, sales and use taxes payable
13,971
16,074
Accrued interest
7,462
6,735
Advance deposits
12,845
18,001
Management fees payable
92
1,527
2,192
4,618
Total other current liabilities
Other Liabilities
Other liabilities consisted of the following (in thousands):
Deferred revenue
7,252
5,225
Deferred property taxes payable (1)
8,830
8,887
3,322
2,943
Total other liabilities
9. Leases
The Company has both finance and operating leases for ground, building, office and air leases, maturing in dates ranging from 2028 through 2097, including expected renewal options. Including all renewal options available to the Company, the lease maturity date extends to 2147.
Leases were included on the Company’s consolidated balance sheet as follows (in thousands):
Finance Lease:
Right-of-use asset, gross (buildings and improvements)
58,799
Accumulated amortization
(12,250)
(11,147)
Right-of-use asset, net
Lease obligation, less current portion
Total lease obligation
15,571
Remaining lease term
77 years
Discount rate
9.0
Operating Leases:
Right-of-use assets, net (1)
4,972
4,743
Lease obligations, less current portion
Total lease obligations
50,911
54,434
Weighted average remaining lease term
25 years
Weighted average discount rate
5.4
20
The components of lease expense were as follows (unaudited and in thousands):
Finance lease cost:
Amortization of right-of-use asset
368
367
1,103
Interest on lease obligations
351
647
1,053
1,936
Operating lease cost (1)
2,681
1,729
6,751
5,187
Variable lease cost
1,958
39
4,878
Total lease cost
3,415
4,701
8,946
13,104
Supplemental cash flow information related to leases was as follows (unaudited and in thousands):
Operating cash flows used for operating leases
4,923
5,365
Changes in operating lease right-of-use assets
2,606
2,564
Changes in operating lease obligations
(3,529)
(3,087)
Changes in operating lease right-of-use assets and lease obligations, net
Operating right-of-use assets obtained in exchange for operating lease obligations
45,677
10. Stockholders’ Equity
Series E Cumulative Redeemable Preferred Stock
In March 2016, the Company issued 4,600,000 shares of its 6.95% Series E Cumulative Redeemable Preferred Stock (“Series E preferred stock”) with a liquidation preference of $25.00 per share. On or after March 11, 2021, the Series E preferred stock will be redeemable at the Company’s 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, but not including, the redemption date. Upon the occurrence of a change of control, as defined by the Articles Supplementary for Series E preferred stock, holders of the Series E preferred stock may, under certain circumstances, convert their preferred shares into shares of the Company’s common stock.
Series F Cumulative Redeemable Preferred Stock
In May 2016, the Company issued 3,000,000 shares of its 6.45% Series F Cumulative Redeemable Preferred Stock (“Series F preferred stock”) with a liquidation preference of $25.00. On or after May 17, 2021, the Series F preferred stock will be redeemable at the Company’s 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, but not including, the redemption date. Upon the occurrence of a change of control, as defined by the Articles Supplementary for Series F preferred stock, holders of the Series F preferred stock may, under certain circumstances, convert their preferred shares into shares of the Company’s common stock.
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In February 2017, the Company’s board of directors authorized a stock repurchase program to acquire up to an aggregate of $300.0 million of the Company’s common and preferred stock. In February 2020, the Company’s board of directors increased the Company’s stock repurchase program to acquire up to an aggregate of $500.0 million of the Company’s common and preferred stock. During the first quarter of 2020, the Company repurchased 9,770,081 shares of its common stock for $103.9 million, including fees and commissions, leaving approximately $400.0 million of remaining authorized capacity under the program. As of September 30, 2020, no shares of the Company’s preferred stock have been repurchased. Due to the negative impact of COVID-19 on the Company’s business, the Company has suspended its stock repurchase program in order to preserve additional liquidity. Future repurchases will depend on various factors, including the Company’s capital needs, compliance with its debt covenants, as well as the Company’s common and preferred stock price.
11. Long-Term Incentive Plan
Restricted shares granted pursuant to the Company’s Long-Term Incentive Plan (“LTIP”) generally vest over a period of three years from the date of grant. Should a stock grant be forfeited prior to its vesting, the shares covered by the stock grant are added back to the LTIP and remain available for future issuance. Shares of common stock tendered or withheld to satisfy the grant or exercise price or tax withholding obligations upon the vesting of a stock grant are not added back to the LTIP.
Compensation expense related to awards of restricted shares are measured at fair value on the date of grant and amortized over the relevant requisite service period or derived service period. The Company has elected to account for forfeitures as they occur.
The Company’s amortization expense and forfeitures related to restricted shares for the three and nine months ended September 30, 2020 and 2019 were as follows (unaudited and in thousands):
Amortization expense, including forfeitures
2,238
2,146
In addition, the Company capitalizes compensation costs related to restricted shares granted to certain employees whose work is directly related to the Company’s capital investment in its hotels. These capitalized costs totaled $0.1 million during both the three months ended September 30, 2020 and 2019, and $0.4 million and $0.3 million during the nine months ended September 30, 2020 and 2019, respectively.
12. Commitments and Contingencies
Management Agreements
Management agreements with the Company’s third-party hotel managers require the Company to pay between 1.75% and 3.0% of total revenue of the managed hotels to the third-party managers each month as a basic management fee. In addition to basic management fees, provided that certain operating thresholds are met, the Company may also be required to pay incentive management fees to certain of its third-party managers.
Total basic and incentive management fees incurred by the Company during the three and nine months ended September 30, 2020 and 2019 were included in other property-level expenses on the Company’s consolidated statements of operations as follows (unaudited and in thousands):
Basic management fees
624
7,767
6,179
23,404
Incentive management fees
511
6,041
Total basic and incentive management fees
8,278
29,445
License and Franchise Agreements
The Company has entered into license and franchise agreements related to certain of its hotels. The license and franchise agreements require the Company to, among other things, pay monthly fees that are calculated based on specified percentages of certain revenues.
22
Total license and franchise fees incurred by the Company during the three and nine months ended September 30, 2020 and 2019 were included in franchise costs on the Company’s consolidated statements of operations as follows (unaudited and in thousands):
Franchise assessments (1)
555
6,391
5,349
18,005
Franchise royalties (2)
108
2,215
988
6,019
Total franchise costs
Renovation and Construction Commitments
At September 30, 2020, the Company had various contracts outstanding with third parties in connection with the ongoing renovations of certain of its hotel properties. The remaining commitments under these contracts at September 30, 2020 totaled $17.4 million.
Concentration of Risk
The concentration of the Company’s hotels in California, Florida, Hawaii, Illinois and Massachusetts exposes the Company’s business to economic and severe weather conditions, competition and real and personal property tax rates unique to these locales.
As of September 30, 2020, 13 of the 19 Hotels were geographically concentrated as follows (unaudited):
Trailing 12-Month
Percentage of
Total Rooms
Consolidated Revenue
California
32
35
Florida
Hawaii
Illinois
Massachusetts
The Company incurred $11.3 million and $28.9 million of additional expenses as a result of the COVID-19 outbreak during the third quarter and first nine months of 2020, respectively, related to wages and benefits for furloughed or laid off hotel employees, which included severance of $6.8 million and $8.0 million accrued in the third quarter and first nine months of 2020, respectively.
The Company has provided customary unsecured indemnities to certain lenders, including in particular, environmental indemnities. The Company has performed due diligence on the potential environmental risks, including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate the Company to reimburse the indemnified parties for damages related to certain environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, the Company could have recourse against other previous owners or a claim against its environmental insurance policies.
At September 30, 2020, the Company had $0.4 million of outstanding irrevocable letters of credit to guarantee the Company’s financial obligations related to workers’ compensation insurance programs from prior policy years. The beneficiaries of these letters of credit may draw upon these letters of credit in the event of a contractual default by the Company relating to each respective obligation. No draws have been made through September 30, 2020.
The Company is subject to various claims, lawsuits and legal proceedings, including routine litigation arising in the ordinary course of business, regarding the operation of its hotels, its managers and other Company matters. While it is not possible to ascertain the ultimate outcome of such matters, the Company believes that the aggregate identifiable amount of such liabilities, if any, in excess of amounts covered by insurance will not have a material adverse impact on its financial condition or results of operations. The outcome of claims, lawsuits and legal proceedings, including any potential COVID-19-related litigation, brought against the Company, however, is subject to significant uncertainties.
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13. Subsequent Event
The debt secured by the Hilton Times Square matured on November 1, 2020. At this time the debt remains in default and the Company continues to work with its lender to come to a resolution.
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Cautionary Statement
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. The Company intends such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and includes this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe the Company’s future plans, strategies, opinions and expectations, are generally identifiable by use of the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “project,” or similar expressions. You should not rely on forward-looking statements because they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond the Company’s control, and which could materially affect actual results, performances or achievements. Accordingly, there is no assurance that the Company’s expectations will be realized. In evaluating these statements, you should specifically consider the risks outlined in detail in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 19, 2020, under the caption “Risk Factors” and elsewhere in this Quarterly Report on 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. Except as otherwise required by federal securities laws, the Company disclaims any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Sunstone Hotel Investors, Inc. (the “Company,” “we,” “our” or “us”) is a Maryland corporation. We operate as a self-managed and self-administered real estate investment trust (“REIT”). A REIT is a corporation that directly or indirectly owns real estate assets and has elected to be taxable as a real estate investment trust for federal income tax purposes. To qualify for taxation as a REIT, the REIT must meet certain requirements, including regarding the composition of its assets and the sources of its income. REITs generally are not subject to federal income taxes at the corporate level as long as they pay stockholder dividends equivalent to 100% of their taxable income. REITs are required to distribute to stockholders at least 90% of their REIT taxable income. We own, directly or indirectly, 100% of the interests of Sunstone Hotel Partnership, LLC (the “Operating Partnership”), which is the entity that directly or indirectly owns our hotel properties. We also own 100% of the interests of our taxable REIT subsidiary, Sunstone Hotel TRS Lessee, Inc. (the “TRS Lessee”), which, directly or indirectly, leases all of our hotels from the Operating Partnership, and engages independent third-parties to manage our hotels.
We own hotels that we consider to be Long-Term Relevant Real Estate® (or LTRR®) in the United States, specifically hotels in urban and resort locations that benefit from significant barriers to entry by competitors and diverse economic drivers. As part of our ongoing portfolio management strategy, on an opportunistic basis, we may also selectively sell hotel properties that we believe do not meet our criteria of LTRR®. As of September 30, 2020, we had interests in 19 hotels (the “19 Hotels”) currently held for investment, which average 526 rooms in size. All but two (the Boston Park Plaza and the Oceans Edge Resort & Marina) of the 19 Hotels are operated under nationally recognized brands such as Marriott, Hilton and Hyatt, which are among the most respected and widely recognized brands in the lodging industry. Our two unbranded hotels are located in top urban and resort markets that have enabled them to establish awareness with both group and transient customers.
COVID-19
In March 2020, the COVID-19 outbreak was declared a National Public Health Emergency, which led to material group cancellations, corporate and government travel restrictions and a significant decline in transient demand. As a result of these cancellations, restrictions, and the health concerns related to COVID-19, we determined that it was in the best interest of our hotel employees and the communities in which our hotels operate to temporarily suspend operations at the majority of our hotels. In response to the COVID-19 pandemic, we temporarily suspended operations at the following 15 hotels during the first half of 2020, 12 of which have since resumed operations as of November 1, 2020:
Four of the 19 Hotels have remained open throughout the first nine months of 2020: the Boston Park Plaza; the Embassy Suites La Jolla; the Renaissance Long Beach; and the Renaissance Los Angeles Airport. The hotels in operation during the third quarter and first nine months of 2020 experienced a significant decrease in occupancy due to the COVID-19 pandemic. As a result, we, in conjunction with our third-party managers, materially reduced operating expenses to preserve liquidity by implementing stringent operational cost containment measures, including significantly reduced staffing levels, limited food and beverage offerings, elimination of non-essential hotel services and the temporary closure of various parts of the hotels. In addition, enhanced cleaning procedures and revised operating standards were developed and implemented.
We incurred $11.3 million and $28.9 million of additional expenses as a result of the COVID-19 outbreak during the third quarter and first nine months of 2020, respectively, related to wages and benefits for furloughed or laid off hotel employees, which included severance of $6.8 million and $8.0 million accrued in the third quarter and first nine months of 2020, respectively.
Our asset management team has worked closely with each hotel’s third-party manager to create a detailed path to reopening, which includes the following protocols:
In addition to approving the above COVID-19 protocols, before we authorize a hotel to resume operations, we first determine whether enough demand exists in the hotel’s market to financially support resuming operations. As hotels begin to resume operations, we are experiencing more competition for hotel guests. After reaching a trough in April, we are experiencing slow but steady improvements in hotel demand, most significantly in leisure travel, which benefited our hotels in drive-to leisure markets such as the Embassy Suites La Jolla, the Renaissance Long Beach and the Oceans Edge Resort & Marina. We also experienced a modest demand increase at our hotels in certain urban markets after resuming operations in Boston, Chicago, New Orleans and San Diego. At this point, the majority of our group business for 2020 has cancelled. Of the group business that has cancelled to date, approximately 23% has rebooked into future periods. While a recovery timeline is highly uncertain, we expect to resume operations at our three remaining suspended hotels as soon as there is sufficient market demand, which we anticipate may not occur until the first half of 2021. The extent of the effects of the pandemic on our business and the hotel industry at large, however, will ultimately depend on future developments, including, but not limited to, the duration and severity of the pandemic, the development, distribution, and administration of a successful vaccine or therapy, the length of time it takes for demand and pricing to return and normal economic and operating conditions to resume.
In response to this challenging economic environment, we are focused on maximizing our liquidity. To increase liquidity, we deferred a portion of our planned 2020 non-essential capital improvements to our portfolio. However, we did accelerate specific capital investment projects in order to take advantage of the suspended operations and the low demand environment to perform otherwise extremely disruptive capital projects. During the first nine months of 2020, these projects took place at the Renaissance Orlando at SeaWorld®, the Renaissance Washington DC, and The Bidwell Marriott Portland, all while adhering to the relevant government regulations and social distancing mandates aimed at both protecting those involved in the construction work and stemming the spread of COVID-19. At the Renaissance Orlando at SeaWorld®, the hotel’s closure allowed us to completely upgrade the hotel’s atrium and lobby. At the Renaissance Washington DC, we remodeled the porte-cochere, which improved traffic flow and the guest’s arrival experience. Additionally, at the Renaissance Washington DC, we replaced the escalators that connect all levels of the hotel’s meeting space with the lobby, a project that would not be possible with group business in the hotel. At The Bidwell Marriott Portland, we took advantage of the hotel’s closure by completely remodeling the guest rooms, gym, meeting rooms, public space and the M Club. We also converted a majority of the guestroom baths to showers, and added seven new guest rooms.
In March 2020, we drew $300.0 million under the revolving portion of our credit facility as a precautionary measure to increase our cash position and preserve financial flexibility. In June 2020 and August 2020, we repaid $250.0 million and $50.0 million, respectively, of the outstanding credit facility balance. At September 30, 2020, we have no amount outstanding under the credit facility, with $500.0 million of capacity available for additional borrowing under the agreement. The revolving portion of the credit facility matures in April 2023, but may be extended for two six-month periods to April 2024, upon the payment of applicable fees and satisfaction of certain customary conditions.
In July 2020, we completed amendments to the agreements governing our unsecured debt, consisting of the revolving credit facility, term loans, and senior notes, providing financial covenant relief through the first quarter of 2021, with the first quarterly covenant test as of the period ended June 30, 2021. Due to COVID-19’s negative impact on our operations throughout 2020 and its expected impact into 2021, it is possible that we may not meet the terms of our unsecured debt financial covenants once such covenants are effective again. See “Liquidity and Capital Resources” below for additional details.
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To preserve additional liquidity, we have temporarily suspended both our stock repurchase program and our common stock quarterly dividend. During the first quarter of 2020, we repurchased 9,770,081 shares of our common stock under our stock repurchase program at an average purchase price of $10.61 per share. Approximately $400.0 million of authorized capacity remains under our stock repurchase program. Future repurchases will depend on the effects of COVID-19 and various other factors, including our obligations under our various financing agreements and capital needs, as well as the price of our common and preferred stock. On April 15, 2020, we paid our previously announced first quarter dividends and distributions which totaled $14.0 million, including $10.8 million paid to our common stockholders. At this time, we do not expect to pay a quarterly dividend on our common stock for the remainder of the year. The resumption in quarterly common dividends will be determined by our Board of Directors after considering our obligations under our various financing agreements, projected taxable income, compliance with our debt covenants, long-term operating projections, expected capital requirements and risks affecting our business.
We believe that the steps we have taken to increase our cash position and preserve our financial flexibility, combined with the amendments to our unsecured debt, our already strong balance sheet, and our low leverage, will be sufficient to allow us to navigate through this crisis. In addition, we are currently working with our lenders to further extend our unsecured debt’s financial covenant relief period; however, there is no assurance that we will be able to obtain an extension in a timely manner, or on acceptable terms. Given the unprecedented impact of COVID-19 on the global market and our hotel operations, we cannot assure you that our forecast or the assumptions we used to estimate our liquidity requirements will be correct. The magnitude and duration of the COVID-19 pandemic is uncertain, and we cannot accurately estimate its impact on our business, financial condition or operational results with reasonable certainty; however, we anticipate a net loss on our operations for the year ending December 31, 2020.
Operating Activities
Revenues. Substantially all of our revenues are derived from the operation of our hotels. Specifically, our revenues consist of the following:
Expenses. Our expenses consist of the following:
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Other Revenue and Expense. Other revenue and expense consists of the following:
Operating Performance Indicators. The following performance indicators are commonly used in the hotel industry:
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Factors Affecting Our Operating Results. The primary factors affecting our operating results include overall demand for hotel rooms, the pace of new hotel development, or supply, and the relative performance of our operators in increasing revenue and controlling hotel operating expenses.
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Operating Results. The following table presents our unaudited operating results for our total portfolio for the three months ended September 30, 2020 and 2019, including the amount and percentage change in the results between the two periods.
Change $
Change %
(in thousands, except statistical data)
(183,976)
(91.9)
(59,257)
(96.6)
(9,496)
(47.4)
(252,729)
(89.7)
Hotel operating
58,361
163,465
(105,104)
(64.3)
(21,385)
(69.2)
(813)
(11.0)
(4,568)
(12.2)
(131,870)
(55.1)
(3,623)
(96.3)
517
3.9
100.0
(100.0)
(123,986)
(378.1)
Income tax benefit, net
(666)
(88.9)
(124,652)
(371.6)
4,324
172.4
(120,328)
(432.4)
The following table presents our unaudited operating results for our total portfolio for the nine months ended September 30, 2020 and 2019, including the amount and percentage change in the results between the two periods.
(433,300)
(74.6)
(155,871)
(75.6)
(22,498)
(40.8)
(611,669)
(72.6)
247,349
484,876
(237,527)
(49.0)
(50,659)
(51.8)
(575)
(2.5)
(6,194)
(5.6)
(161,489)
(22.6)
(10,746)
(79.6)
202
0.5
(460,745)
(479.0)
Income tax (provision) benefit, net
(7,760)
(654.9)
(468,505)
(481.1)
10,498
173.2
(458,007)
(560.6)
Operating Statistics. The following table includes comparisons of the key operating metrics for the six hotels open during the entire third quarter of 2020 (defined below), the six hotels open during a portion of the third quarter of 2020 (defined below), and the 19 Hotels.
Change
Occ%
ADR
RevPAR
Six Hotels Open During the Entire Third Quarter of 2020 (1)
27.0
138.40
37.37
91.9
208.13
191.27
(6,490)
bps
(33.5)
(80.5)
Six Hotels Open During a Portion of the Third Quarter of 2020 (2)
12.5
156.32
19.54
84.5
239.35
202.25
(7,200)
(34.7)
(90.3)
19 Hotels
12.1
145.33
17.58
86.7
239.03
207.24
(7,460)
(39.2)
(91.5)
34.2
154.09
52.70
89.5
199.17
178.26
(5,530)
(70.4)
23.7
207.83
49.26
81.8
240.67
196.87
(5,810)
(13.6)
(75.0)
25.5
205.64
52.44
85.4
238.59
203.76
(5,990)
(13.8)
(74.3)
(1) Six Hotels Open During the Entire
Third Quarter of 2020
(2) Six Hotels Open During a Portion of the
Seven Hotels With Operations Suspended During All of the Third Quarter of 2020
Number of Rooms
Boston Park Plaza
1,060
1,190
821
Renaissance Los Angeles Airport
502
807
781
Renaissance Long Beach
374
501
547
419
478
Embassy Suites La Jolla
340
415
361
175
252
348
258
Total Number of Rooms
2,819
3,584
3,594
Summary of Operating Results. The following items significantly impact the year-over-year comparability of our operations:
Room revenue. Room revenue decreased $184.0 million, or 91.9%, for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 as follows:
Room revenue decreased $433.3 million, or 74.6%, for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019 as follows:
Food and beverage revenue. Food and beverage revenue decreased $59.3 million, or 96.6%, for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 as follows:
Food and beverage revenue decreased $155.9 million, or 75.6%, for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019 as follows:
Other operating revenue. Other operating revenue decreased $9.5 million, or 47.4%, for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 as follows:
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Other operating revenue decreased $22.5 million, or 40.8%, for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019 as follows:
Hotel operating expenses. Hotel operating expenses, which are comprised of room, food and beverage, advertising and promotion, repairs and maintenance, utilities, franchise costs, property tax, ground lease and insurance, and other hotel operating expenses decreased $105.1 million, or 64.3%, for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 as follows:
Hotel operating expenses decreased $237.5 million, or 49.0%, for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019 as follows:
Other property-level expenses. Other property-level expenses decreased $21.4 million, or 69.2%, for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 as follows:
Other property-level expenses decreased $50.7 million, or 51.8%, for the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019 as follows:
Corporate overhead expense. Corporate overhead expense decreased $0.8 million, or 11.0%, during the three months ended September 30, 2020 as compared to the three months ended September 30, 2019, due to decreased payroll and related expenses, including the recognition of $0.2 million in employee retention tax credits available under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), and decreased travel expenses. These decreased expenses were partially offset by increased amortization of deferred stock compensation and legal fees.
For the nine months ended September 30, 2020, corporate overhead expense decreased $0.6 million, or 2.5%, as compared to the nine months ended September 30, 2019, due to the same reasons noted above in the discussion regarding the third quarter.
Depreciation and amortization expense. Depreciation and amortization expense decreased $4.6 million, or 12.2%, during the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 as follows:
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Depreciation and amortization expense decreased $6.2 million, or 5.6%, during the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019 as follows:
Impairment losses. Impairment losses totaled zero and $133.5 million for the three and nine months ended September 30, 2020, respectively, and zero for both the three and nine months ended September 30, 2019. During the first quarter of 2020, we recorded impairment losses of $107.9 million on the Hilton Times Square, $5.2 million on the Renaissance Westchester, and $2.3 million related to the abandonment of a potential project to expand one of our hotels. During the second quarter of 2020, we recorded an impairment loss of $18.1 million on the Renaissance Harborplace, which we subsequently sold in July 2020.
Interest and other income. Interest and other income decreased $3.6 million, or 96.3%, during the three months ended September 30, 2020 as compared to the three months ended September 30, 2019, due to decreased cash account balances and to declines in both interest rates and other income. During the third quarter of 2020, we recognized $0.1 million in interest income.
During the third quarter of 2019, we recognized $3.6 million in interest income and $0.1 million in energy rebates due to energy efficient renovations at our hotels.
For the nine months ended September 30, 2020, interest and other income decreased $10.7 million, or 79.6%, as compared to the nine months ended September 30, 2019, due to the same reasons noted above in the discussion regarding the third quarter. During the first nine months of 2020, we recognized $2.5 million in interest income and $0.2 million in energy rebates.
During the first nine months of 2019, we recognized $11.1 million in interest income, $1.0 million related to an area of protection agreement with Hyatt Corporation for the Hyatt Regency San Francisco, $0.9 million related to a contingency funding payment received from the prior owner of one of our hotels, $0.2 million in energy rebates and $0.3 million in vendor rebates and other miscellaneous income.
Interest expense. We incurred interest expense as follows (in thousands):
Interest expense on debt and finance lease obligations
Interest expense decreased $0.5 million, or 3.9%, during the three months ended September 30, 2020 as compared to the three months ended September 30, 2019, and decreased $0.2 million, or 0.5%, during the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019.
Noncash changes in the fair market value of our derivatives caused interest expense to decrease $1.9 million in the third quarter of 2020 as compared to the same period in 2019. Excluding the noncash impact from changes in the fair market values of our derivatives, interest expense would have increased $1.4 million in the third quarter of 2020 as compared to the same period in 2019 due in part to $0.9 million in default interest and penalties recorded in the third quarter of 2020 on the debt secured by the Hilton Times Square. While we are required to record such default interest and penalties, recovery by the lender of these expenses is non-recourse to the Company, and we do not intend to pay the default interest and penalties as part of the ultimate resolution with the lender. Interest expense also increased due to the draw on our credit facility and due to the amendments on our unsecured debt, which increased the amount of interest charged on our term loans and senior notes, as well as increased bank fees and deferred financing costs. These increases were partially offset by decreased interest on our lower debt balances and lower interest on our variable rate debt.
Noncash changes in the fair market value of our derivatives and on our finance lease obligations caused interest expense to decrease $1.2 million and $0.2 million, respectively, in the first nine months of 2020 as compared to the same period in 2019. Noncash interest expense on our finance lease obligations decreased due to our sale of the Courtyard by Marriott Los Angeles in October 2019. Excluding the impact of these noncash expenses, interest expense would have increased $1.2 million in the first nine months of 2020 as compared to the same period in 2019 due in part to $1.7 million in default interest and penalties recorded in the first
nine months of 2020 on the debt secured by the Hilton Times Square. While we are required to record such default interest and penalties, recovery by the lender of these expenses is non-recourse to the Company, and we do not intend to pay the default interest and penalties as part of the ultimate resolution with the lender. The additional interest expense due to the Hilton Times Square loan default, the draw on our credit facility, and the amendments to our unsecured debt noted above were partially offset in the first nine months of 2020 as compared to the same period in 2019 by decreased interest on our lower debt balances and lower interest on our variable rate debt.
Our weighted average interest rate per annum, including our variable rate debt obligation, was approximately 4.0% and 4.2% at September 30, 2020 and 2019, respectively. Approximately 76.5% and 77.5% of our outstanding notes payable had fixed interest rates at September 30, 2020 and 2019, respectively.
Gain on sale of assets. Gain on sale of assets totaled $0.2 million for both the three and nine months ended September 30, 2020, and zero for both the three and nine months ended September 30, 2019. In July 2020, we recognized a $0.2 million gain on the sale of the Renaissance Harborplace.
Loss on extinguishment of debt. Loss on extinguishment of debt totaled $0.2 million for both the three and nine months ended September 30, 2020, and zero for both the three and nine months ended September 30, 2019. In September 2020, we recognized a loss of $0.2 million related to the write-off of deferred financing fees associated with repayments of a portion of our unsecured senior notes.
Income tax benefit (provision), net. Income tax benefit (provision), net was incurred as follows (in thousands):
Current income tax benefit, net
1,139
840
939
Deferred income tax (provision) benefit, net
(390)
246
Change in deferred tax asset valuation allowance
(7,415)
Total income tax benefit (provision), net
We lease our hotels to the TRS Lessee and its subsidiaries, which are subject to federal and state income taxes. In addition, we and the Operating Partnership may also be subject to various state and local income taxes.
During the third quarter and first nine months of 2020, we recognized $0.1 million and $0.8 million, respectively, of net current income tax benefits, resulting from tax credits and refunds, net of combined current federal and state income tax expense. In addition, during the nine months ended September 30, 2020, we recorded a full valuation allowance of $7.4 million on our deferred tax assets because we can no longer be assured that we will be able to realize these assets due to uncertainties regarding how long the COVID-19 pandemic will last or what the long-term impact will be on our hotel operations.
During the third quarter and first nine months of 2019, we recognized a current income tax benefit of $1.1 million and $0.9 million, respectively, which includes combined current federal and state income tax expense based on 2019 projected taxable income net of tax credits available under the Tax Cuts & Jobs Act of 2017 and operating loss carryforwards for our taxable entities. During the third quarter and first nine months of 2019, we also recognized a deferred income tax provision of $0.4 million and a deferred income tax benefit of $0.2 million, respectively, related to adjustments to our deferred tax assets, net.
Loss (income) from consolidated joint venture attributable to noncontrolling interest. Loss (income) from consolidated joint venture attributable to noncontrolling interest, which represents the outside 25.0% interest in the entity that owns the Hilton San Diego Bayfront, totaled a loss of $1.8 million and income of $2.5 million for the three months ended September 30, 2020 and 2019, respectively, and a loss of $4.4 million and income of $6.1 million for the nine months ended September 30, 2020 and 2019, respectively.
Preferred stock dividends. Preferred stock dividends totaled $3.2 million for both the three months ended September 30, 2020 and 2019, and $9.6 million for both the nine months ended September 30, 2020 and 2019.
Non-GAAP Financial Measures. We use the following “non-GAAP financial measures” that we believe are useful to investors as key supplemental measures of our operating performance: EBITDAre; Adjusted EBITDAre, excluding noncontrolling interest; FFO attributable to common stockholders; and Adjusted FFO attributable to common stockholders. These measures should not be considered in isolation or as a substitute for measures of performance in accordance with GAAP. In addition, our calculation of these measures may not be comparable to other companies that do not define such terms exactly the same as the Company. These non-GAAP measures are used in addition to and in conjunction with results presented in accordance with GAAP. They should not be considered as alternatives to net income (loss), cash flow from operations, or any other operating performance measure prescribed by GAAP. These non-GAAP financial measures reflect additional ways of viewing our operations that we believe, when viewed with our
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GAAP results and the reconciliations to the corresponding GAAP financial measures, provide a more complete understanding of factors and trends affecting our business than could be obtained absent this disclosure. We strongly encourage investors to review our financial information in its entirety and not to rely on a single financial measure.
We present EBITDAre in accordance with guidelines established by the National Association of Real Estate Investment Trusts (“NAREIT”), as defined in its September 2017 white paper “Earnings Before Interest, Taxes, Depreciation and Amortization for Real Estate.” We believe EBITDAre is a useful performance measure to help investors evaluate and compare the results of our operations from period to period in comparison to our peers. NAREIT defines EBITDAre as net income (calculated in accordance with GAAP) plus interest expense, income tax expense, depreciation and amortization, gains or losses on the disposition of depreciated property (including gains or losses on change in control), impairment write-downs of depreciated property and of investments in unconsolidated affiliates caused by a decrease in the value of depreciated property in the affiliate, and adjustments to reflect the entity’s share of EBITDAre of unconsolidated affiliates.
We make additional adjustments to EBITDAre when evaluating our performance because we believe that the exclusion of certain additional items described below provides useful information to investors regarding our operating performance, and that the presentation of Adjusted EBITDAre, excluding noncontrolling interest, when combined with the primary GAAP presentation of net income, is beneficial to an investor’s complete understanding of our operating performance. In addition, we use both EBITDAre and Adjusted EBITDAre, excluding noncontrolling interest as measures in determining the value of hotel acquisitions and dispositions. We adjust EBITDAre for the following items, which may occur in any period, and refer to this measure as Adjusted EBITDAre, excluding noncontrolling interest:
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The following table reconciles our unaudited net (loss) income to EBITDAre and Adjusted EBITDAre, excluding noncontrolling interest for our total portfolio for the three and nine months ended September 30, 2020 and 2019 (in thousands):
Operations held for investment:
Income tax (benefit) provision, net
(83)
(749)
6,575
(1,185)
Impairment loss - hotel properties
131,164
EBITDAre
(45,632)
83,628
(86,087)
250,079
Amortization of right-of-use assets and liabilities
(330)
(253)
Finance lease obligation interest — cash ground rent
(351)
(589)
(1,053)
(1,768)
Property-level severance
6,844
7,957
Prior year property tax adjustments, net
(12)
(9)
214
289
Prior owner contingency funding
(900)
Impairment loss - abandoned development costs
2,302
Noncontrolling interest:
(808)
(793)
(2,418)
(2,072)
(244)
(532)
(970)
(1,650)
Amortization of right-of-use asset and liability
72
217
(449)
Adjustments to EBITDAre, net
9,435
(2,466)
17,032
(5,301)
Adjusted EBITDAre, excluding noncontrolling interest
(36,197)
81,162
(69,055)
244,778
Adjusted EBITDAre, excluding noncontrolling interest decreased $117.4 million, or 144.6%, and $313.8 million, or 128.2%, in the third quarter and first nine months of 2020, respectively, as compared to the same periods in 2019 primarily due to the following:
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We believe that the presentation of FFO attributable to common stockholders provides useful information to investors regarding our operating performance because it is a measure of our operations without regard to specified noncash items such as real estate depreciation and amortization, any real estate impairment loss and any gain or loss on sale of real estate assets, all of which are based on historical cost accounting and may be of lesser significance in evaluating our current performance. Our presentation of FFO attributable to common stockholders conforms to the NAREIT definition of “FFO applicable to common shares.” Our presentation may not be comparable to FFO reported by other REITs that do not define the terms in accordance with the current NAREIT definition, or that interpret the current NAREIT definition differently than we do.
We also present Adjusted FFO attributable to common stockholders when evaluating our operating performance because we believe that the exclusion of certain additional items described below provides useful supplemental information to investors regarding our ongoing operating performance, and may facilitate comparisons of operating performance between periods and our peer companies. We adjust FFO attributable to common stockholders for the following items, which may occur in any period, and refer to this measure as Adjusted FFO attributable to common stockholders:
The following table reconciles our unaudited net (loss) income to FFO attributable to common stockholders and Adjusted FFO attributable to common stockholders for our total portfolio for the three and nine months ended September 30, 2020 and 2019 (in thousands):
Real estate depreciation and amortization
32,383
36,951
102,422
108,621
FFO attributable to common stockholders
(61,113)
63,987
(145,333)
188,244
Real estate amortization of right-of-use assets and liabilities
80
146
298
443
Noncash income tax provision (benefit), net
390
Real estate amortization of right-of-use asset and liability
Noncash interest on derivatives, net
(27)
Adjustments to FFO attributable to common stockholders, net
6,431
1,754
23,671
6,711
Adjusted FFO attributable to common stockholders
(54,682)
65,741
(121,662)
194,955
Adjusted FFO attributable to common stockholders decreased $120.4 million, or 183.2%, and $316.6 million, or 162.4%, in the third quarter and first nine months of 2020, respectively, as compared to the same periods in 2019 primarily due to the same reasons noted in the discussion above regarding Adjusted EBITDAre, excluding noncontrolling interest.
Liquidity and Capital Resources
During the periods presented, our sources of cash included our operating activities and working capital, as well as proceeds from our credit facility and a contribution from our joint venture partner. Our primary uses of cash were for capital expenditures for hotels and other assets, acquisitions of assets, operating expenses, including funding the negative cash flow at our hotels, repurchases of our common stock, repayments of notes payable and our credit facility, dividends and distributions on our common and preferred stock and distributions to our joint venture partner. We cannot be certain that traditional sources of funds will be available in the future.
Operating activities. Our net cash provided by or used in operating activities fluctuates primarily as a result of changes in hotel revenue and the operating cash flow of our hotels. Our net cash provided by or used in operating activities may also be affected by changes in our portfolio resulting from hotel acquisitions, dispositions or renovations. Net cash used in operating activities was $87.3 million for the nine months ended September 30, 2020, as compared to net cash provided of $210.6 million for the nine months ended September 30, 2019. The net decrease to cash provided by operating activities during the first nine months of 2020 as compared to the same period in 2019 was primarily due to the temporary suspensions and reduced operations at the 19 Hotels caused by the COVID-19 pandemic.
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Investing activities. Our net cash provided by or used in investing activities fluctuates primarily as a result of acquisitions, dispositions and renovations of hotels and other assets. Net cash provided by (used in) investing activities during the first nine months of 2020 as compared to the first nine months of 2019 was as follows (in thousands):
During the first nine months of 2020, we received proceeds of $76.9 million from our sale of the Renaissance Harborplace. This cash inflow was offset as we paid $1.3 million and $0.1 million to purchase additional wet boat and dry boat slips, respectively, at the Oceans Edge Resort & Marina, invested $44.0 million for renovations and additions to our portfolio and other assets and paid $0.1 million for an interest rate cap derivative on debt secured by the Hilton San Diego Bayfront.
During the first nine months of 2019, we paid $0.2 million to purchase an additional wet boat slip at the Oceans Edge Resort & Marina, and we invested $75.3 million for renovations and additions to our portfolio and other assets.
Financing activities. Our net cash provided by or used in financing activities fluctuates primarily as a result of our distributions paid, issuance and repurchase of common stock, issuance and repayment of notes payable and our credit facility, and our issuance and redemption of other forms of capital, including preferred equity. Net cash used in financing activities during the first nine months of 2020 as compared to the first nine months of 2019 was as follows (in thousands):
During the first nine months of 2020, we drew $300.0 million from our credit facility and received a $0.5 million contribution from our joint venture partner. These cash inflows were offset as we paid the following: $103.9 million to repurchase 9,770,081 shares of our outstanding common stock; $4.0 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees; $300.0 million to repay all amounts outstanding on our credit facility; $40.2 million in principal payments on our notes payable, including $35.0 million to repay a portion of our senior notes and $5.2 million in scheduled principal payments on our notes payable; $2.7 million in deferred financing costs related to the amendments on our unsecured debt; $153.1 million in dividends and distributions to our common and preferred stockholders; and $2.0 million in distributions to our joint venture partner.
During the first nine months of 2019, we paid the following: $50.0 million to repurchase 3,777,309 shares of our outstanding common stock; $4.4 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees; $5.8 million in principal payments on our notes payable; $155.7 million in dividends and distributions to our common and preferred stockholders; and $5.4 million in distributions to our joint venture partner.
Future. We believe the ongoing effects of the COVID-19 pandemic and the current economic downturn on our operations will continue to have a material negative impact on our financial results and liquidity throughout the remainder of 2020 and into 2021. As previously noted, operations at three of the 19 Hotels remain suspended as of November 1, 2020, with the remainder operating at reduced capacities due to COVID-19; therefore, our traditional source of cash from operating activities has been significantly reduced. Despite these challenges, we believe that we have sufficient liquidity, as well as access to our credit facility and capital markets, to withstand the current decline in our operating cash flow. We expect our primary sources of cash will continue to be our working capital and credit facility, dispositions of hotel properties, and proceeds from public and private offerings of debt securities and
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common and preferred stock. However, there can be no assurance that the capital markets will be available to us on favorable terms or at all.
We expect our primary uses of cash to be for operating expenses, including funding the cash flow needs at our hotels, capital investments in our hotels (albeit reduced from pre-COVID-19 levels for the remainder of 2020), repayment of principal on our notes payable and possibly on our unsecured debt, interest expense, and dividends on our preferred stock. At this time, we do not expect to pay a quarterly common stock dividend through the remainder of the year. The resumption in quarterly common dividends will be determined by our Board of Directors after considering our obligations under our various financing agreements, projected taxable income, compliance with our debt covenants, long-term operating projections, expected capital requirements, and risks affecting our business. We have taken additional steps to preserve our liquidity, including the deferral of a portion of our planned 2020 non-essential capital improvements into our portfolio, as well as the temporary suspension of our stock repurchase program.
In July 2020, we completed amendments to our unsecured debt, consisting of our revolving credit facility, term loans and senior notes (the “Unsecured Debt Amendments”). Key terms of the Unsecured Debt Amendments include:
At September 30, 2020, we have no amount outstanding on the revolving portion of our amended credit facility, with $500.0 million of capacity available for additional borrowing under the facility. Our ability to draw on the revolving portion of the amended credit facility may be subject to our compliance with various financial covenants on our secured and unsecured debt. The revolving portion of the amended credit agreement matures in April 2023, but may be extended for two six-month periods to April 2024, upon the payment of applicable fees and satisfaction of certain customary conditions.
We are subject to various financial covenants on our secured and unsecured debt. Due to COVID-19’s negative impact on our operations throughout 2020 and its expected impact into 2021, it is possible that we may not meet the terms of our unsecured debt financial covenants once such covenants are effective again in 2021. As noted above, due to COVID-19, operations at three of the 19 Hotels remain suspended as of November 1, 2020, with the remainder operating at reduced capacities. Our future liquidity will depend on the gradual return of guests, particularly group business, to our hotels and the stabilization of demand throughout our portfolio. We are currently working with our lenders to extend the Covenant Relief Period, however, there is no assurance that we will be able to obtain an extension in a timely manner, or on acceptable terms. If we are unable to obtain an extension of the Covenant Relief Period and are not able to satisfy the financial covenants following the end of the existing waiver period, the lenders of our unsecured debt may require us to repay the loans, which could raise doubt about our ability to continue as a going concern.
We believe that the steps we have taken to increase our cash position and preserve our financial flexibility, combined with the amendments to our unsecured debt, our anticipated waiver to further extend our unsecured debt’s Covenant Relief Period, our already strong balance sheet, and our low leverage will be sufficient to allow us to navigate through this crisis. Given the unprecedented impact of COVID-19 on the global market and our hotel operations, we cannot, however, assure you that our forecast or the assumptions we used to estimate our liquidity requirements will be correct. In addition, the magnitude and duration of the COVID-19
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pandemic is uncertain. We cannot accurately estimate the impact on our business, financial condition or operational results with reasonable certainty; however, we anticipate a net loss on our operations for the year ending December 31, 2020.
Cash Balance. As of September 30, 2020, our unrestricted cash balance was $461.3 million. We believe that our current unrestricted cash balance and our ability to draw the $500.0 million of capacity available for borrowing under the unsecured revolving credit facility will enable us to successfully manage our Company while operations at the 19 Hotels are either temporarily suspended or greatly reduced.
Certain of our loan agreements contain cash trap provisions that may be triggered if the performance of the hotels securing the loans decline. During 2019, these provisions were triggered for the loan secured by the Hilton Times Square, and, as of September 30, 2020, $1.4 million in excess cash generated by the hotel was held in a lockbox account for the benefit of the lender and included in restricted cash on our consolidated balance sheet.
Debt. As of September 30, 2020, we had $934.7 million of consolidated debt, $503.6 million of cash and cash equivalents, including restricted cash, and total assets of $3.2 billion.
The $77.2 million mortgage secured by the Hilton Times Square matured on November 1, 2020. We have not made our debt payments on the loan since April 2020. In addition, the hotel’s ground leases require monthly payments be paid to the respective landlords, which we have not made since March 2020. As such, we have received default notices from the lender and landlords, and we are working with the lender to explore various options, which could include a negotiated transfer of the hotel to the lender or its landlords or a discounted payoff of the loan.
The $220.0 million mortgage secured by the Hilton San Diego Bayfront initially matures in December 2020, but has three one-year options to extend. At this time, we have provided notice to the lender of our intent to exercise the first extension, and we intend to exercise the remaining two one-year options to extend the maturity to December 2023.
In March 2020, we drew $300.0 million under the revolving portion of our credit facility as a precautionary measure to increase our cash position and preserve financial flexibility. In June 2020 and August 2020, we repaid $250.0 million and $11.2 million, respectively, of the outstanding credit facility balance after determining that we had sufficient cash on hand in addition to access to our credit facility. In addition, in August 2020, we used a portion of the proceeds we received from the sale of the Renaissance Harborplace to repay $38.8 million of the outstanding credit facility balance as stipulated in the Unsecured Debt Amendments. As of September 30, 2020, we have no amount outstanding under the credit facility.
In September 2020, we repaid $35.0 million towards our senior notes, including $30.0 million to the Series A note holders and $5.0 million to the Series B note holders, using a portion of the proceeds we received from the sale of the Renaissance Harborplace as stipulated in the Unsecured Debt Amendments.
As of September 30, 2020, all of our outstanding debt had fixed interest rates or had been swapped to fixed interest rates, except the $220.0 million non-recourse mortgage on the Hilton San Diego Bayfront, which is subject to an interest rate cap agreement that caps the interest rate at 6.0% until December 2020. We have an additional interest rate cap agreement that will continue to cap the interest rate at 6.0% until December 2021. Our remaining mortgage debt is in the form of single asset non-recourse loans rather than cross-collateralized multi-property pools. In addition to our mortgage debt, as of September 30, 2020, we have two unsecured corporate-level term loans as well as two unsecured corporate-level senior notes.
We may in the future seek to obtain mortgages on one or more of our 14 unencumbered hotels (subject to certain stipulations under our Unsecured Debt Amendments), 13 of which are currently held by subsidiaries whose interests are pledged to our credit facility. Our 14 unencumbered hotels include: Boston Park Plaza; Embassy Suites Chicago; Hilton Garden Inn Chicago Downtown/Magnificent Mile; Hilton New Orleans St. Charles; Hyatt Centric Chicago Magnificent Mile; Hyatt Regency San Francisco; Marriott Boston Long Wharf; Oceans Edge Resort & Marina; Renaissance Long Beach; Renaissance Los Angeles Airport; Renaissance Orlando at SeaWorld®; Renaissance Westchester; The Bidwell Marriott Portland; and Wailea Beach Resort. Should we obtain secured financing on any or all of our unencumbered hotels, the amount of capital available through our credit facility may be reduced.
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Contractual Obligations. The following table summarizes our payment obligations and commitments as of September 30, 2020 (in thousands):
Payment due by period
Less Than
1 to 3
3 to 5
More than
1 year
years
5 years
Notes payable (1)
191,966
348,518
205,000
Interest obligations on notes payable (2)
126,327
35,966
47,391
27,088
15,882
Finance lease obligation, including imputed interest
108,363
1,403
2,806
101,348
Operating lease obligations, including imputed interest (3)
106,914
8,004
15,270
15,491
68,149
Payments-in-lieu of taxes obligation (4)
63,405
1,341
1,789
58,486
Construction commitments
17,408
Employment obligations
1,352
1,358,442
254,663
259,222
395,692
448,865
Capital Expenditures and Reserve Funds
We believe we maintain each of our hotels in good repair and condition and in general conformity with applicable franchise and management agreements, ground, building and airspace 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 for cyclical renovations, hotel repositionings and development. We invested $44.0 million in our portfolio and other assets during the first nine months of 2020. As of September 30, 2020, we have contractual construction commitments totaling $17.4 million for ongoing renovations. As noted above, in light of the COVID-19 global pandemic, we have elected to conserve cash by deferring a portion of our planned 2020 non-essential capital improvements into our portfolio. If we renovate or develop additional hotels or other assets in the future, our capital expenditures will likely increase.
With respect to our hotels that are operated under management or franchise agreements with major national hotel brands and for all of our hotels subject to first mortgage liens, we are obligated to maintain an 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 zero and 5.0% of the respective hotel’s applicable annual revenue. As of September 30, 2020, our balance sheet includes restricted cash of $40.1 million, which was held in FF&E reserve accounts for future capital expenditures at the majority of the 19 Hotels. According to certain loan agreements, reserve funds are to be held by the lenders or managers in restricted cash accounts, and we are not required to spend the entire amount in such reserve accounts each year. In light of the COVID-19 global pandemic, some of our third-party managers have suspended the requirement to fund into the FF&E reserves for the remainder of 2020. Additionally, some of our third-party managers are permitting
44
owners the ability to draw from the FF&E reserve to fund operating expenses, subject to certain conditions including a future repayment to the reserve.
Seasonality and Volatility
As is typical of the lodging industry, we experience some seasonality in our business. Revenue for certain of our hotels is generally affected by seasonal business patterns (e.g., the first quarter is strong in Hawaii, Key West and Orlando, the second quarter is strong for the Mid-Atlantic business hotels, and the fourth quarter is strong for Hawaii, Key West and New York City). Quarterly revenue also may be adversely affected by renovations and repositionings, our managers’ effectiveness in generating business and by events beyond our control, such as the COVID-19 outbreak and other public health concerns, extreme weather conditions, natural disasters, terrorist attacks or alerts, civil unrest, government shutdowns, airline strikes or reduced airline capacity, economic factors and other considerations affecting travel.
Inflation
Inflation may affect our expenses, including, without limitation, by increasing such costs as labor, employee-related benefits, food, commodities, 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 financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“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 consolidated financial statements.
In addition, the acquisition of a hotel property or other entity requires an analysis to determine if it qualifies as the purchase of a business or an asset. If the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, then the transaction is an asset acquisition. Transaction costs associated with asset acquisitions are capitalized and subsequently depreciated over the life of the related asset, while the same costs associated
45
with a business combination are expensed as incurred and included in corporate overhead on our consolidated statements of operations. Also, asset acquisitions are not subject to a measurement period, as are business combinations.
We review any uncertain tax positions and, if necessary, we will record the expected future tax consequences of uncertain tax positions in the consolidated financial statements. Tax positions not deemed to meet the “more-likely-than-not” threshold are recorded as a tax benefit or expense in the current year. We are required to analyze all open tax years, as defined by the statute of limitations, for all major jurisdictions, which includes federal and certain states.
Quantitative and Qualitative Disclosures About Market Risk
To the extent that we incur debt with variable interest rates, 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. We have no derivative financial instruments held for trading purposes. We use derivative financial instruments, which are intended to manage interest rate risks on our floating rate debt.
As of September 30, 2020, 76.5% of our debt obligations are fixed in nature, which mitigates the effect of changes in interest rates on our cash interest payments. If the market rate of interest on our variable-rate debt increases or decreases by 100 basis points, interest expense would increase or decrease, respectively, our future consolidated earnings and cash flows by approximately $2.2 million based on the variable rate at September 30, 2020. After adjusting for the noncontrolling interest in the Hilton San Diego Bayfront, this increase or decrease in interest expense would increase or decrease, respectively, our future consolidated earnings and cash flows by $1.7 million, based on the variable rate at September 30, 2020.
Attached as exhibits to this Form 10-Q are the certifications required by Rule 13a-14 of the Securities Exchange Act of 1934, as amended. This section includes information concerning the controls and control evaluations referred to in the certifications.
Evaluation of Disclosure Controls and Procedures. Based upon an evaluation of the effectiveness of disclosure controls and procedures, our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were effective to provide reasonable assurance
that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Securities and Exchange Commission and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting. During our fiscal quarter to which this Quarterly Report on Form 10-Q relates, there has not occurred any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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None.
The Company is providing this additional risk factor to supplement the risk factors contained in Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2019.
COVID-19 has had, and is expected to continue to have, a significant impact on our financial condition and results of operations. The current, and uncertain future, impact of the COVID-19 outbreak, including its effect on the ability or desire of people to travel for leisure or for business, is expected to continue to impact our financial condition, results of operations, cash flows, liquidity, business plans, distributions to our common and preferred stockholders and their respective stock prices.
The COVID-19 global pandemic, along with federal, state and local government mandates have disrupted and are expected to continue to disrupt our business. In the United States, individuals are being encouraged to practice social distancing, are restricted from gathering in groups, and in some areas, either have been or are subject to mandatory shelter-in-place orders, all of which have restricted or prohibited social gatherings, travel and non-essential activities outside of their homes. In response to the COVID-19 pandemic, during the first half of 2020, we temporarily suspended operations at 15 of the 19 Hotels. As of November 1, 2020, we have resumed operations at twelve hotels. All operating hotels are currently running at limited capacity with significantly reduced staffing, limited food and beverage operations and materially reduced amenity offerings. We may determine in the future that it is in the best interest of our Company, guests and employees to temporarily suspend operations at some or all of our open hotels. With hotel operations temporarily suspended or reduced, we may be required to use a substantial portion of our available cash to pay hotel payroll expenses, maintenance expenses, fixed hotel costs such as ground rent, insurance expenses, property taxes and scheduled debt payments. Use of the Company’s cash will reduce the amount of cash available for hotel capital expenditures, future business opportunities and other purposes, including distributions to our common and preferred stockholders. We have suspended paying dividends on our common stock in order to conserve cash. We cannot predict how long the COVID-19 pandemic will last or what the long-term impact will be on hotel operations and our cash position.
To date we have incurred, and expect to continue to incur, significant costs directly related to COVID-19. In the first nine months of 2020, we incurred $28.9 million in costs related to additional wages, benefits and severance for furloughed or laid off hotel employees. We may be subject to increased risks related to employee matters, including increased employment litigation and claims for severance or other benefits tied to termination or furloughs as a result of temporary hotel suspensions or reduced hotel operations due to COVID-19.
We are subject to various financial covenants on our secured and unsecured debt, which includes our revolving credit facility, term loans, and senior notes. In July 2020, we completed amendments to the agreements governing our unsecured debt, which provide financial covenant relief through the first quarter of 2021, with the first quarterly covenant test as of the period ended June 30, 2021. Due to COVID-19’s negative impact on our operations throughout 2020 and its expected impact into 2021, it is possible that we may not meet the terms of our unsecured debt financial covenants once such covenants are effective again in 2021. As noted above, due to COVID-19, operations at three of the 19 Hotels remain suspended as of November 1, 2020, with the remainder operating at reduced capacities. Our future liquidity will depend on the gradual return of guests, particularly group business, to our hotels and the stabilization of demand throughout our portfolio. We are currently working with our lenders to extend the covenant waiver period, however, there is no assurance that we will be able to obtain an extension of the covenant waivers in a timely manner, or on acceptable terms. If we are unable to obtain an extension of the covenant waivers and are not able to satisfy the financial covenants following the end of the existing waiver period, the lenders of our unsecured debt may require us to repay the loans. In addition, due to the suspension of operations at certain hotels and the reduced cash flows at other hotels, our mortgage loans will likely require a cash sweep be put in place, restricting the use of that cash until the cash sweep requirement is terminated. Failure to meet any financial covenants of our secured and unsecured debt would adversely affect our financial conditions and results from operations, and may raise doubt about our ability to continue as a going concern.
We are unable to predict when any of our hotels with temporarily suspended operations will resume operations. Moreover, once travel advisories and restrictions, which may be continued or reinstituted due to the continued outbreak or a resurgent outbreak of COVID-19 (such as has occurred in many states in the U.S. in July 2020 and October 2020), are lifted, travel demand may remain weak for a significant length of time as individuals may fear traveling, and we are unable to predict if and when occupancy and the average daily rate at each of the 19 Hotels will return to pre-pandemic levels. Additionally, our hotels may be negatively impacted by adverse changes in the economy, including higher unemployment rates, declines in income levels, loss of personal wealth and possibly a national and/or global recession resulting from the impact of COVID-19. Declines in demand trends, occupancy and the average
daily rate at our hotels may indicate that one or more of our hotels is impaired, which would adversely affect our financial condition and results of operations.
To preserve additional liquidity, we have temporarily suspended both our stock repurchase program and our common stock quarterly dividend, and deferred a portion of our portfolio’s planned 2020 non-essential capital improvements. We believe that the steps we have taken to increase our cash position and preserve our financial flexibility, combined with the amendments to our unsecured debt, our anticipated waiver to further extend our unsecured debt’s covenant relief period, our already strong balance sheet, and our low leverage, will be sufficient to allow us to navigate through this crisis. Given the unprecedented impact of COVID-19 on the global market and our hotel operations, we cannot, however, assure you that our forecast or the assumptions we used to estimate our liquidity requirements will be correct. In addition, the magnitude and duration of the COVID-19 pandemic is uncertain. We cannot accurately estimate the impact on our business, financial condition or operational results with reasonable certainty; however, we anticipate a net loss on our operations for the year ending December 31, 2020.
The market price of our common stock has been and may continue to be negatively affected by the impact of the COVID-19 pandemic on our hotel operations and future earnings. The extent of the effects of the pandemic on our business and the hotel industry at large is significant and highly uncertain, and will ultimately depend on future developments, including, but not limited to, the duration and severity of the pandemic, the development, distribution and administration of a successful vaccine or therapy, the length of time it takes for demand and pricing to return and normal economic and operating conditions to resume. To the extent COVID-19 adversely affects our business, operations, financial condition and operating results, it may also have the effect of heightening many of the other risks described in Item 1A. “Risk Factors” included in our Form 10-K.
(c)Issuer Purchases of Equity Securities
In February 2017, the Company’s board of directors authorized a stock repurchase program to acquire up to an aggregate of $300.0 million of the Company’s common and preferred stock. In February 2020, the Company’s board of directors authorized an increase to the existing 2017 stock repurchase program to acquire up to $500.0 million of the Company’s common and preferred stock. During the three months ended March 31, 2020, the Company repurchased 9,770,081 shares of its common stock for a total purchase price of $103.9 million, including fees and commissions, of which $3.7 million was repurchased under the 2017 stock repurchase program and $100.2 million was repurchased under the 2020 stock repurchase program, leaving $400.0 million remaining under the 2020 stock repurchase program. The 2020 stock repurchase program has no stated expiration date. Future repurchases will depend on various factors, including the Company’s capital needs, as well as the price of the Company’s common and preferred stock.
Maximum Number (or
Total Number of
Appropriate Dollar
Shares Purchased
Value) of Shares that
Total Number
as Part of Publicly
May Yet Be Purchased
of Shares
Average Price Paid
Announced Plans
Under the Plans or
Period
Purchased
per Share
or Programs
Programs
July 1, 2020 - July 31, 2020
400,000,001
August 1, 2020 - August 31, 2020
September 1, 2020 - September 30, 2020
The following Exhibits are filed as a part of this report:
ExhibitNumber
Description
3.1
Articles of Amendment and Restatement of Sunstone Hotel Investors, Inc. (incorporated by reference to Exhibit 3.1 to the registration statement on Form S-11 (File No. 333-117141) filed by the Company).
3.2
Second Amended and Restated Bylaws of Sunstone Hotel Investors, Inc. effective as of November 15, 2018 (incorporated by reference to Exhibit 3.1 to Form 8-K, filed by the Company on November 15, 2018).
3.3
Articles Supplementary Prohibiting the Company From Electing to be Subject to Section 3-803 of the Maryland General Corporation Law Absent Shareholder Approval (incorporated by reference to Exhibit 3.1 to Form 8-K, filed by the Company on April 29, 2013).
3.4
Articles Supplementary for Series E preferred stock (incorporated by reference to Exhibit 3.5 to the registration statement on Form 8-A, filed by the Company on March 10, 2016).
3.5
Articles Supplementary for Series F preferred stock (incorporated by reference to Exhibit 3.5 to the registration statement on Form 8-A, filed by the Company on May 16, 2016).
10.1
First Amendment to Amended and Restated Credit Agreement, dated July 15, 2020, among Sunstone Hotel Partnership, LLC, Sunstone Hotel Investors, Inc., certain lenders party thereto and Wells Fargo Bank, N.A. as administrative agent (incorporated by reference to Exhibit 10.1 to Form 8-K, filed by the Company on July 17, 2020).
10.2
First Amendment to Note and Guarantee Agreement dated July 15, 2020, among Sunstone Hotel Partnership, LLC, Sunstone Hotel Investors, Inc., the subsidiary guarantors from time to time party thereto, and the Purchasers named therein (incorporated by reference to Exhibit 10.2 to Form 8-K, filed by the Company on July 17, 2020).
31.1
Certification of Principal Executive Officer Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
31.2
Certification of Principal Financial Officer Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
32.1
Certification of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
101.INS
XBRL Instance Document - The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document.*
101.SCH
Inline XBRL Taxonomy Extension Schema Document. *
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document. *
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document. *
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document. *
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document. *
104
Cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020 formatted in Inline XBRL (included in Exhibit 101).
*
Filed herewith.
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: November 6, 2020
By:
/s/ Bryan A. Giglia
Bryan A. Giglia(Chief Financial Officer and Duly Authorized Officer)