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 March 31, 2023
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)
15 Enterprise, Suite 200Aliso Viejo, California
92656
(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 H Cumulative Redeemable Preferred Stock, $0.01 par value
SHO.PRH
Series I Cumulative Redeemable Preferred Stock, $0.01 par value
SHO.PRI
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 May 1, 2023, there were 207,102,139 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 March 31, 2023
TABLE OF CONTENTS
Page
PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements
2
Consolidated Balance Sheets as of March 31, 2023 (unaudited) and December 31, 2022
Unaudited Consolidated Statements of Operations for the Three Months Ended March 31, 2023 and 2022
3
Unaudited Consolidated Statements of Equity for the Three Months Ended March 31, 2023 and 2022
4
Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2023 and 2022
6
Notes to Unaudited Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
23
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
36
Item 4.
Controls and Procedures
37
PART II—OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
38
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
39
SIGNATURES
40
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
March 31,
December 31,
2023
2022
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents
$
96,386
101,223
Restricted cash
49,115
55,983
Accounts receivable, net
41,981
42,092
Prepaid expenses and other current assets
20,502
14,668
Total current assets
207,984
213,966
Investment in hotel properties, net
2,836,894
2,840,928
Operating lease right-of-use assets, net
16,100
15,025
Deferred financing costs, net
4,680
5,031
Other assets, net
7,514
7,867
Total assets
3,073,172
3,082,817
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses
53,061
56,849
Accrued payroll and employee benefits
17,475
22,801
Dividends and distributions payable
14,231
13,995
Other current liabilities
74,125
65,213
Current portion of notes payable, net
222,043
222,030
Total current liabilities
380,935
380,888
Notes payable, less current portion, net
590,308
590,651
Operating lease obligations, less current portion
15,425
14,360
Other liabilities
14,102
11,957
Total liabilities
1,000,770
997,856
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock, $0.01 par value, 100,000,000 shares authorized:
Series G Cumulative Redeemable Preferred Stock, 2,650,000 shares issued and outstanding at both March 31, 2023 and December 31, 2022, stated at liquidation preference of $25.00 per share
66,250
6.125% Series H Cumulative Redeemable Preferred Stock, 4,600,000 shares issued and outstanding at both March 31, 2023 and December 31, 2022, stated at liquidation preference of $25.00 per share
115,000
5.70% Series I Cumulative Redeemable Preferred Stock, 4,000,000 shares issued and outstanding at both March 31, 2023 and December 31, 2022, stated at liquidation preference of $25.00 per share
100,000
Common stock, $0.01 par value, 500,000,000 shares authorized, 207,410,059 shares issued and outstanding at March 31, 2023 and 209,320,447 shares issued and outstanding at December 31, 2022
2,074
2,093
Additional paid in capital
2,446,185
2,465,595
Retained earnings
1,056,440
1,035,353
Cumulative dividends and distributions
(1,713,547)
(1,699,330)
Total stockholders’ equity
2,072,402
2,084,961
Total liabilities and stockholders' equity
See accompanying notes to consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended March 31,
REVENUES
Room
152,438
108,772
Food and beverage
70,812
39,583
Other operating
20,193
23,960
Total revenues
243,443
172,315
OPERATING EXPENSES
39,064
30,461
48,535
32,319
5,757
5,436
Advertising and promotion
13,022
10,474
Repairs and maintenance
9,446
9,714
Utilities
7,092
5,705
Franchise costs
3,918
3,004
Property tax, ground lease and insurance
19,233
15,991
Other property-level expenses
31,777
23,910
Corporate overhead
8,468
10,714
Depreciation and amortization
32,342
31,360
Total operating expenses
218,654
179,088
Interest and other income
541
4,380
Interest expense
(13,794)
(5,081)
Gain on sale of assets
—
22,946
Gain (loss) on extinguishment of debt, net
9,909
(213)
Income before income taxes
21,445
15,259
Income tax provision
(358)
(136)
NET INCOME
21,087
15,123
Income from consolidated joint venture attributable to noncontrolling interest
(1,134)
Preferred stock dividends
(3,768)
(3,773)
INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS
17,319
10,216
Basic and diluted per share amounts:
Basic income attributable to common stockholders per common share
0.08
0.05
Diluted income attributable to common stockholders per common share
Basic weighted average common shares outstanding
207,035
217,271
Diluted weighted average common shares outstanding
207,282
UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY
Preferred Stock
Common Stock
Cumulative
Number of
Additional
Retained
Dividends and
Shares
Amount
Paid in Capital
Earnings
Distributions
Total
Balance at December 31, 2022 (audited)
11,250,000
281,250
209,320,447
Amortization of deferred stock compensation
2,545
Issuance of restricted common stock, net
55,970
1
(3,349)
(3,348)
Forfeiture of restricted common stock
(1,435)
Common stock distributions and distributions payable at $0.05 per share
(10,449)
Series G preferred stock dividends and dividends payable at $0.219536 per share
(582)
Series H preferred stock dividends and dividends payable at $0.382813 per share
(1,761)
Series I preferred stock dividends and dividends payable at $0.356250 per share
(1,425)
Repurchase of outstanding common stock
(1,964,923)
(20)
(18,606)
(18,626)
Net income
Balance at March 31, 2023
207,410,059
Noncontrolling
Interest in
Consolidated
Joint Venture
Balance at December 31, 2021 (audited)
219,333,783
2,193
2,631,484
948,064
(1,664,024)
40,807
2,239,774
3,701
213,179
(3,353)
(3,351)
Series G preferred stock dividends and dividends payable at $0.221475 per share
(587)
(3,879,025)
(38)
(43,427)
(43,465)
13,989
1,134
Balance at March 31, 2022
215,667,937
2,157
2,588,405
962,053
(1,667,797)
41,941
2,208,009
5
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Bad debt (recovery) expense
(58)
64
(22,946)
(Gain) loss on extinguishment of debt, net
(9,909)
213
Noncash interest on derivatives, net
1,832
(1,842)
Depreciation
32,214
31,288
Amortization of franchise fees and other intangibles
110
66
Amortization of deferred financing costs
545
680
2,427
3,578
Gain on hurricane-related damage
(4,369)
Changes in operating assets and liabilities:
Accounts receivable
264
(5,931)
Prepaid expenses and other assets
(5,604)
Accounts payable and other liabilities
9,718
3,319
(5,326)
(5,613)
Operating lease right-of-use assets and obligations
(52)
(346)
Net cash provided by operating activities
47,248
13,148
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of assets
191,291
Proceeds from property insurance
3,910
Acquisitions of hotel properties and other assets
(546)
Renovations and additions to hotel properties and other assets
(22,474)
(30,299)
Net cash (used in) provided by investing activities
164,356
CASH FLOWS FROM FINANCING ACTIVITIES
Repurchases of outstanding common stock
Repurchases of common stock for employee tax obligations
Payments on notes payable
(524)
(35,503)
Dividends and distributions paid
(13,981)
(3,513)
Net cash used in financing activities
(36,479)
(85,832)
Net (decrease) increase in cash and cash equivalents and restricted cash
(11,705)
91,672
Cash and cash equivalents and restricted cash, beginning of period
157,206
162,717
Cash and cash equivalents and restricted cash, end of period
145,501
254,389
Supplemental Disclosure of Cash Flow Information
214,905
39,484
Total cash and cash equivalents and restricted cash shown on the consolidated statements of cash flows
Cash paid for interest
14,127
9,761
Cash paid for income taxes
103
Operating cash flows used for operating leases
1,409
1,730
Changes in operating lease right-of-use assets
1,088
1,007
Changes in operating lease obligations
(1,140)
(1,353)
Changes in operating lease right-of-use assets and lease obligations, net
Supplemental Disclosure of Noncash Investing and Financing Activities
Accrued renovations and additions to hotel properties and other assets
15,382
19,049
Disposition deposit received in prior year in connection with sale of hotel
4,000
Operating lease right-of-use asset obtained in exchange for operating lease obligation
2,163
Assignment of finance lease right-of-use asset in connection with sale of hotel
44,712
Assignment of finance lease obligation in connection with sale of hotel
15,569
Assignment of operating lease right-of-use asset in connection with sale of hotel
2,275
Assignment of operating lease obligation in connection with sale of hotel
2,609
Amortization of deferred stock compensation — construction activities
118
123
3,773
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, invests in hotels where it can add value through capital investment, hotel repositioning and asset management. In addition, the Company seeks to capitalize on its portfolio’s embedded value and balance sheet strength to actively recycle past investments into new growth and value creation opportunities in order to deliver strong stockholder returns and superior per share net asset value growth.
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 March 31, 2023, the Company owned 15 hotels (the “15 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”)
Hyatt Hotels Corporation
Four Seasons Hotels Limited
Highgate Hotels L.P. and an affiliate
Hilton Worldwide
Interstate Hotels & Resorts, Inc.
Montage North America, LLC
Sage Hospitality Group
Singh Hospitality, LLC
Total hotels owned as of March 31, 2023
15
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements as of March 31, 2023 and December 31, 2022, and for the three months ended March 31, 2023 and 2022, 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 year ended December 31, 2022, filed with the Securities and Exchange Commission on February 23, 2023. Operating results for the three months ended March 31, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023.
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.
The Company has evaluated subsequent events through the date of issuance of these financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.
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), which include the Company’s time-based restricted stock awards, are considered participating securities and are included in the computation of earnings per share.
Basic earnings 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 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 and units, 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 earnings per common share (unaudited and in thousands, except per share data):
Numerator:
Distributions paid to participating securities
Undistributed income allocated to participating securities
(40)
(67)
Numerator for basic and diluted income attributable to common stockholders
17,227
10,149
Denominator:
Weighted average basic common shares outstanding
Unvested restricted stock units
247
Weighted average diluted common shares outstanding
At March 31, 2023 and 2022, the Company excluded 1,039,023 and 1,323,953 anti-dilutive unvested time-based restricted stock awards, respectively, from its calculation of diluted earnings per share (see Note 10).
The Company also had unvested performance-based restricted stock units as of March 31, 2023 and 2022 that are not considered participating securities as the awards contain forfeitable rights to dividends or dividend equivalents. The performance-based restricted stock units were granted based on either target market condition thresholds or pre-determined price targets. Based on the Company’s common stock performance for the three months ended March 31, 2023 and 2022, the Company excluded 188,004 and 612,584 anti-dilutive performance-based restricted stock units, respectively, from its calculations of diluted earnings per share (see Note 10).
9
Restricted Cash
Restricted cash primarily includes lender reserves required by the Company’s debt agreements and reserves for operating expenses and capital expenditures required by certain of the Company’s management and franchise agreements. At times, restricted cash also includes hotel acquisition or disposition-related earnest money held in escrow reserves pending completion of the associated transaction. In addition, restricted cash as of March 31, 2023 and December 31, 2022 included $0.3 million and $10.2 million, respectively, held in escrow related to certain current and potential employee-related obligations of one of the Company’s former hotels and $0.2 million held as collateral for certain letters of credit as of both March 31, 2023 and December 31, 2022. Restricted cash as of December 31, 2022 also included $3.1 million held in escrow for the purpose of satisfying any potential employee-related obligations that should arise in connection with the termination of hotel personnel and any employment claim by hotel personnel at the Four Seasons Resort Napa Valley (see Note 11).
Investments in Hotel Properties
Investments in hotel properties, including land, buildings, furniture, fixtures and equipment (“FF&E”) and identifiable intangible assets are recorded at their respective relative fair values for an asset acquisition or at their estimated fair values for a business 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 of the assets 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 years to 40 years for buildings and improvements and three years to 12 years for FF&E. 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 15 years to 20 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 investments in hotel properties 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 investments in hotel properties 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. The Company considers indicators of impairment such as, but not limited to, hotel disposition strategy and hold period, a significant decline in operating results not related to renovations or repositioning, physical damage to the property due to unforeseen events such as natural disasters, and an estimate or belief that the fair value is less than net book value. The Company performs an analysis to determine the recoverability of the hotel by comparing the future undiscounted cash flows expected to be generated by the hotel to the hotel’s carrying amount.
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 Company performs a fair value assessment using valuation techniques such as discounted cash flows and comparable sales transactions in the market to estimate the fair value of the hotel and, if appropriate and available, current estimated net sales proceeds from pending offers. The Company’s judgment is required in determining the discount rate, terminal capitalization rate, the estimated growth of revenues and expenses, net operating income and margins, as well as specific market and economic conditions. Based on the Company’s review, no hotels were impaired during either the three months ended March 31, 2023 or 2022.
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
10
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.
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. The Company has elected to not separate lease components from nonlease components, resulting in the Company accounting for lease and nonlease components as one single lease component.
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 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.
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.
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, no ROU assets were impaired during either the three months ended March 31, 2023 or 2022.
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 the previously agreed upon daily rate. 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 typically recognized as revenue in the period the Company determines it is probable that a significant reversal in the amount of revenue recognized will not occur, which is generally the period in which these fees are collected.
Food and beverage revenue and other ancillary services revenue are generated when a customer chooses to purchase goods or services. The revenue is recognized when 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 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.
11
Additionally, the Company collects sales, use, occupancy and other similar taxes from customers at its hotels at the time of purchase, which 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)
21,848
19,751
Contract liabilities (2)
58,921
50,219
During the three months ended March 31, 2023 and 2022, the Company recognized approximately $27.5 million and $13.8 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 one single reportable segment, hotel ownership.
New Accounting Standards and Accounting Changes
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 was effective upon issuance, applied prospectively from any date beginning March 12, 2020, and generally could not be applied to contract modifications that occurred after December 31, 2022. In December 2022, the FASB issued Accounting Standards Update No. 2022-06, “Reference Rate Reform
(Topic 848): Deferral of the Sunset Date of Topic 848” (“ASU No. 2022-06”), which deferred the sunset date from December 31, 2022 to December 31, 2024.
Currently, the Company’s $220.0 million loan secured by the Hilton San Diego Bayfront and its related interest rate cap derivative are subject to LIBOR. Both the loan and its related interest rate cap derivative mature and expire, respectively, in December 2023. The adoptions of ASU No. 2020-04 and ASU No. 2022-06 are 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 consisted of the following (in thousands):
Land
672,531
Buildings and improvements
2,799,778
2,793,771
Furniture, fixtures and equipment
428,282
426,189
Intangible assets
42,187
Construction in progress
91,710
71,689
Investment in hotel properties, gross
4,034,488
4,006,367
Accumulated depreciation and amortization
(1,197,594)
(1,165,439)
4. Fair Value Measurements and Interest Rate Derivatives
Fair Value Measurements
As of March 31, 2023 and December 31, 2022, the carrying amount of certain financial instruments, including cash and cash equivalents, restricted cash, accounts receivable and 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 March 31, 2023 and December 31, 2022, 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.
Fair Value of Debt
As of March 31, 2023 and December 31, 2022, 51.6% and 42.4%, respectively, of the Company’s outstanding debt had fixed interest rates, including the effects of interest rate swap derivatives and forward starting interest rate swap derivatives. 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 March 31, 2023 (unaudited) and December 31, 2022 were as follows (in thousands):
March 31, 2023
December 31, 2022
Carrying Amount (1)
Fair Value (2)
Debt
815,612
794,202
816,136
809,141
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Interest Rate Derivatives
The Company’s interest rate derivatives, which are not designated as effective cash flow hedges, consisted of the following at March 31, 2023 (unaudited) and December 31, 2022 (in thousands):
Estimated Fair Value of Assets (Liabilities) (1)
Strike / Capped
Effective
Maturity
Notional
Hedged Debt
Type
Rate
Index
Date
Hilton San Diego Bayfront
Cap
6.000
%
1-Month LIBOR
December 9, 2022
December 9, 2023
220,000
17
60
Term Loan 1
Swap
3.675
CME Term SOFR
March 17, 2023
March 17, 2026
75,000
30
N/A
3.931
September 14, 2023
September 14, 2026
(1,611)
Term Loan 2
1.853
January 29, 2016
January 31, 2023
208
(1,564)
268
Noncash changes in the fair values of the Company’s interest rate derivatives resulted in increases (decreases) to interest expense for the three months ended March 31, 2023 and 2022 as follows (unaudited and in thousands):
5. Other Assets
Other assets, net consisted of the following (in thousands):
Property and equipment, net
3,733
3,685
Deferred rent on straight-lined third-party tenant leases
2,392
2,413
Liquor licenses
930
933
Other
459
836
Total other assets, net
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6. Notes Payable
Notes payable consisted of the following (in thousands):
Balance Outstanding as of
Interest Rate
Rate Type
at March 31, 2023
Maturity Date
Mortgage Loans
Partially fixed
(1)
LIBOR + 1.30%
JW Marriott New Orleans
Fixed
4.15%
December 11, 2024
75,612
76,136
Total mortgage loans
295,612
296,136
Corporate Credit Facilities
(2)
SOFR + 0.10% + (1.35% to 2.20%)
July 25, 2027
175,000
Variable
(3)
January 25, 2028
Total corporate credit facilities
350,000
Unsecured Senior Notes
Series A
4.69%
January 10, 2026
65,000
Series B
4.79%
January 10, 2028
105,000
Total unsecured senior notes
170,000
Total notes payable
As of March 31, 2023, the Company had no amount outstanding on its credit facility, with $500.0 million of capacity available for borrowing under the facility. The Company’s ability to draw on the credit facility is subject to the Company’s compliance with various financial covenants.
Notes payable on the Company’s accompanying consolidated balance sheets are presented net of deferred financing costs as follows (in thousands):
Current portion of notes payable
222,100
222,086
Less: current portion of deferred financing costs
(57)
(56)
Carrying value of current portion of notes payable
Notes payable, less current portion
593,512
594,050
Less: long-term portion of deferred financing costs
(3,204)
(3,399)
Carrying value of notes payable, less current portion
Interest Expense
Total interest incurred and expensed on the notes payable and finance lease obligation was as follows (unaudited and in thousands):
Interest expense on debt and finance lease obligation
11,417
6,243
Total interest expense
13,794
5,081
7. Other Current Liabilities and Other Liabilities
Other Current Liabilities
Other current liabilities consisted of the following (in thousands):
Property, sales and use taxes payable
11,199
7,500
Accrued interest
4,205
6,915
Advance deposits
51,288
44,224
Management fees payable
1,857
1,584
5,576
4,990
Total other current liabilities
Other Liabilities
Other liabilities consisted of the following (in thousands):
Deferred revenue
7,718
6,088
Deferred rent
2,391
2,718
Interest rate swap derivative
1,611
2,382
3,151
Total other liabilities
8. Leases
As of both March 31, 2023 and December 31, 2022, the Company had operating leases for ground, office, equipment and airspace leases with maturity dates ranging from 2024 through 2097, excluding renewal options. Including renewal options available to the Company, the lease maturity date extends to 2147.
Operating leases were included on the Company’s consolidated balance sheets as follows (in thousands):
Right-of-use assets, net
4,704
4,652
Lease obligations, less current portion
Total lease obligations
20,129
19,012
Weighted average remaining lease term
34 years
Weighted average discount rate
5.3
In January 2023, the Company relocated its corporate headquarters and recognized a $2.2 million operating lease right-of-use asset and related lease obligation.
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The components of lease expense were as follows (unaudited and in thousands):
Finance lease cost (1):
Interest on lease obligation
117
Operating lease cost
1,359
1,389
Variable lease cost (2)
2,086
881
Sublease income (3)
(297)
Total lease cost
3,148
2,387
9. Stockholders’ Equity
Series G Cumulative Redeemable Preferred Stock
Contemporaneous with the Company’s April 2021 purchase of the Montage Healdsburg, the Company issued 2,650,000 shares of its Series G Cumulative Redeemable Preferred Stock (“Series G preferred stock”) to the hotel’s seller as partial payment of the hotel. The Series G preferred stock, which is callable at its $25.00 redemption price plus accrued and unpaid dividends by the Company at any time, accrues dividends at an initial rate equal to the Montage Healdsburg’s annual net operating income yield on the Company’s investment in the resort. The annual dividend rate is expected to increase in 2024 to the greater of 3.0% or the rate equal to the Montage Healdsburg’s annual net operating income yield on the Company’s total investment in the resort. The Series G preferred stock is not convertible into any other security.
Series H Cumulative Redeemable Preferred Stock
In May 2021, the Company issued 4,600,000 shares of its 6.125% Series H Cumulative Redeemable Preferred Stock (“Series H preferred stock”) with a liquidation preference of $25.00. On or after May 24, 2026, the Series H 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 H preferred stock, the Company may at its option redeem the Series H preferred stock for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to, but not including, the redemption date. If the Company chooses not to redeem the Series H preferred stock upon the occurrence of a change of control, holders of the Series H preferred stock may convert their preferred shares into shares of the Company’s common stock.
Series I Cumulative Redeemable Preferred Stock
In July 2021, the Company issued 4,000,000 shares of its 5.70% Series I Cumulative Redeemable Preferred Stock (“Series I preferred stock”) with a liquidation preference of $25.00. On or after July 16, 2026, the Series I 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 I preferred stock, the Company may at its option redeem the Series I preferred stock for cash at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to, but not including, the redemption date. If the Company chooses not to redeem the Series I preferred stock upon the occurrence of a change of control, holders of the Series I preferred stock may convert their preferred shares into shares of the Company’s common stock.
Stock Repurchase Program. In February 2021, the Company’s board of directors reauthorized the Company’s existing stock repurchase program, allowing the Company to acquire up to $500.0 million of the Company’s common and preferred stock. The stock repurchase program has no stated expiration date. In February 2023, the Company’s board of directors reauthorized the existing stock
repurchase program and restored the $500.0 million of aggregate common and preferred stock allowed to be repurchased under the program.
Details of the Company’s repurchases were as follows (dollars in thousands):
Number of common shares repurchased
1,964,923
3,879,025
Cost, including fees and commissions
18,626
43,465
Number of preferred shares repurchased
As of March 31, 2023, $492.4 million remains available for repurchase under the stock repurchase program (see Note 12). Future repurchases will depend on various factors, including the Company’s capital needs and restrictions under its various financing agreements, as well as the price of the Company’s common and preferred stock.
ATM Agreements. In February 2017, the Company entered into separate “At the Market” Agreements (the “2017 ATM Agreements”) with several financial institutions. In accordance with the terms of the 2017 ATM Agreements, the Company could from time to time offer and sell shares of its common stock having an aggregate offering price of up to $300.0 million. In February 2023, the Company’s board of directors reauthorized the $300.0 million 2017 ATM Agreements, or new similar agreements.
In March 2023, the Company terminated the 2017 ATM Agreements and entered into similar separate “At the Market” Agreements (the “2023 ATM Agreements”) with several financial institutions. In accordance with the terms of the 2023 ATM Agreements, the Company may from time to time offer and sell shares of its common stock having an aggregate offering price of up to $300.0 million. No common stock was issued under either the 2017 ATM Agreements or the 2023 ATM Agreements during the three months ended March 31, 2023 and 2022, leaving $300.0 million available for sale.
10. Incentive Award Plan
The Company’s Incentive Award Plan (the “Plan”) provides for granting discretionary awards to employees, consultants and non-employee directors. The awards may be made in the form of options, restricted stock awards, dividend equivalents, stock payments, restricted stock units, other incentive awards, LTIP units or share appreciation rights.
Should a stock grant be forfeited prior to its vesting, the shares covered by the stock grant are added back to the Plan 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 Plan.
Restricted shares and units are measured at fair value on the date of grant and amortized as compensation expense over the relevant requisite service period or derived service period. The Company has elected to account for forfeitures as they occur.
As of both March 31, 2023 and 2022, the Company’s issued and outstanding awards consisted of both time-based and performance-based restricted stock grants. The Company’s amortization expense, including forfeitures related to restricted shares was as follows (unaudited and in thousands):
Amortization expense, including forfeitures
Capitalized compensation cost (1)
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Restricted Stock Awards
The Company’s restricted stock awards are time-based restricted shares that generally vest over periods ranging from three years to five years from the date of grant. The following is a summary of non-vested restricted stock award activity for the three months ended March 31, 2023:
Weighted-Average
Grant Date
Number of Shares
Fair Value
Unvested at January 1, 2023
1,289,146
11.65
Granted
368,412
10.72
Vested
(617,100)
12.00
Forfeited
11.13
Unvested at March 31, 2023
1,039,023
11.11
Restricted Stock Units
The Company’s restricted stock units are performance-based restricted shares that generally vest based on the Company’s total relative shareholder return and the achievement of pre-determined stock price targets during performance periods ranging from two years to five years. The following is a summary of non-vested restricted stock unit activity, at target performance, for the three months ended March 31, 2023:
Target Number
of Shares
612,584
10.40
463,576
11.07
1,076,160
10.69
The restricted stock units granted during the first quarter of 2023 vest based on the Company’s total relative shareholder return following a three year performance period. The number of shares that may become vested ranges from zero to 200%. The grant date fair values of the restricted stock units were determined using a Monte Carlo simulation model with the following assumptions:
Expected volatility
38.0
Dividend yield (1)
Risk-free rate
4.18
Expected term
3 years
11. Commitments and Contingencies
Management Agreements
Management agreements with the Company’s third-party hotel managers currently require the Company to pay between 2.0% 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 management and incentive management fees were included in other property-level expenses on the Company’s consolidated statements of operations as follows (unaudited and in thousands):
Basic management fees
6,728
4,669
Incentive management fees
3,527
1,558
Total basic and incentive management fees
10,255
6,227
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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. The license and franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of the hotels which are established by the franchisors to maintain uniformity in the system created by each such franchisor. Such standards generally regulate the appearance of the hotel, quality and type of goods and services offered, signage and protection of trademarks. Compliance with such standards may from time to time require the Company to make significant expenditures for capital improvements.
Total license and franchise fees were included in franchise costs on the Company’s consolidated statements of operations as follows (unaudited and in thousands):
Franchise assessments (1)
3,611
Franchise royalties
307
286
Total franchise costs
Renovation and Construction Commitments
At March 31, 2023, the Company had various contracts outstanding with third parties in connection with the ongoing renovations of certain of its hotels. The remaining commitments under these contracts at March 31, 2023 totaled $51.0 million.
Concentration of Risk
The concentration of the Company’s hotels in California, Florida, Hawaii 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 March 31, 2023, 11 of the 15 Hotels were geographically concentrated as follows (unaudited):
Trailing 12-Month
Percentage of
Total Consolidated
Total Rooms
Revenue
California
34
Florida
Hawaii
Massachusetts
In accordance with the assignment-in-lieu agreement executed in December 2020 between the Company and the mortgage holder of the Hilton Times Square, the Company was required to retain approximately $11.6 million related to certain current and potential employee-related obligations (the “potential obligation”), of which the Company was relieved of $1.0 million as of December 31, 2022. In February 2023, the Company was relieved of an additional $9.8 million of the potential obligation and the funds were released from escrow to the Company, resulting in a $9.8 million gain on extinguishment of debt. The remaining potential obligation is reassessed at the end of every quarter, resulting in a total gain on extinguishment of debt of $9.9 million included on the accompanying consolidated statement of operations for the three months ended March 31, 2023. As of March 31, 2023 and December 31, 2022, restricted cash on the accompanying consolidated balance sheets included $0.3 million and $10.2 million, respectively, which will continue to be held in escrow until the potential obligation is resolved. The potential obligation balances of $0.3 million and $10.2 million were included in accounts payable and accrued expenses on the accompanying consolidated balance sheets as of March 31, 2023 and December 31, 2022, respectively.
Coterminous with the Company’s acquisition of the Four Seasons Resort Napa Valley in 2021, the Company was required to deposit $3.1 million into a restricted bank account owned by the Company, but to which the hotel’s management company, Four Seasons, had sole and unrestricted access to withdraw funds for the purpose of satisfying any potential employee-related obligations that should arise in connection with potential future severance obligations, if those claims were not previously satisfied. The estimated
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future severance obligations total of $3.1 million was included in restricted cash on the accompanying consolidated balance sheet as of December 31, 2022. In January 2023, Four Seasons released the $3.1 million to the Company and the Company agreed to provide an unconditional guaranty to Four Seasons for the full and prompt payment of all amounts payable by the Company to Four Seasons relating to employee liability.
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 March 31, 2023, the Company had $0.2 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 the letters of credit in the event of a contractual default by the Company relating to each respective obligation. No draws have been made through March 31, 2023. The letters of credit are collateralized with $0.2 million held in a restricted bank account owned by the Company, which is included in restricted cash on the accompanying consolidated balance sheets as of both March 31, 2023 and December 31, 2022.
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.
12. Subsequent Events
Subsequent to the end of the first quarter of 2023 and through the date of issuance of these financial statements, the Company repurchased 301,461 shares of its common stock for $2.9 million, including fees and commissions, leaving $489.5 million remaining for repurchase under the program.
On May 1, 2023, the Company entered into a term loan agreement with several financial institutions which provides for a $225.0 million term loan facility. The term loan facility will bear interest pursuant to a leverage-based pricing grid ranging from 1.35% to 2.20% over the applicable adjusted term SOFR. The term loan facility has an initial term of two years with one 12-month extension option, which would result in an extended maturity of May 2026. The Company expects to use substantially all of the proceeds received from the term loan facility to fully repay the $220.0 million mortgage loan secured by the Hilton San Diego Bayfront.
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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 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 23, 2023, 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 hotels. 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 in urban and resort destinations that benefit from significant barriers to entry by competitors and diverse economic drivers. As of March 31, 2023, we owned 15 hotels, which average 516 rooms in size. All but two of our hotels (the Boston Park Plaza and the Oceans Edge Resort & Marina) are operated under nationally recognized brands. Our two unbranded hotels are located in top urban and resort destination markets that have enabled them to establish awareness with both group and transient customers.
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:
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.
25
Operating Results. The following table presents our unaudited operating results for our total portfolio for the three months ended March 31, 2023 and 2022, including the amount and percentage change in the results between the two periods.
Change $
Change %
(in thousands, except statistical data)
43,666
40.1
31,229
78.9
(3,767)
(15.7)
71,128
41.3
Hotel operating
146,067
113,104
32,963
29.1
32.9
(2,246)
(21.0)
982
3.1
39,566
22.1
(3,839)
(87.6)
(8,713)
(171.5)
(100.0)
10,122
4,752.1
6,186
40.5
(222)
(163.2)
5,964
39.4
100.0
0.1
7,103
69.5
Summary of Operating Results. The following items significantly impact the year-over-year comparability of our operations:
Room revenue. Room revenue increased $43.7 million, or 40.1%, for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 as follows:
Change
Occ%
ADR
RevPAR
Existing Portfolio
69.0
311.05
214.62
53.0
301.44
159.76
1,600
bps
3.2
34.3
The Confidante Miami Beach
83.9
365.88
306.97
26
Food and beverage revenue. Food and beverage revenue increased $31.2 million, or 78.9%, for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 as follows:
Other operating revenue. Other operating revenue decreased $3.8 million, or 15.7%, for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 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 increased $33.0 million, or 29.1%, for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 as follows:
Other property-level expenses. Other property-level expenses increased $7.9 million, or 32.9%, for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 as follows:
Corporate overhead expense. Corporate overhead expense decreased $2.2 million, or 21.0%, during the three months ended March 31, 2023 as compared to the three months ended March 31, 2022, primarily due to decreased payroll expenses, deferred stock amortization expense and board of director expenses related to the chief executive officer transition costs recognized in the first quarter of 2022. Additional decreases to corporate overhead expense included due diligence expenses and legal fees, along with office rent expense due to the relocation of our corporate office in January 2023. These decreased expenses were partially offset by increased entity-level state franchise and minimum taxes and environmental, social and governance expenses.
Depreciation and amortization expense. Depreciation and amortization expense increased $1.0 million, or 3.1%, during the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 as follows:
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Interest and other income. Interest and other income decreased $3.8 million, or 87.6%, during the three months ended March 31, 2023 as compared to the three months ended March 31, 2022. During the first quarter of 2023, we recognized interest income of $0.5 million.
During the first quarter of 2022, we recognized $4.4 million in insurance proceeds for Hurricane Ida-related property damage at our New Orleans hotels and a nominal amount of interest income.
Interest expense. We incurred interest expense as follows (in thousands):
Interest expense increased $8.7 million, or 171.5%, during the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 as follows:
Interest expense on our debt and finance lease obligation increased $5.2 million in the first quarter of 2023 as compared to the same period in 2022 primarily due to the additional amounts borrowed under our term loans in July 2022, as well as increased interest on our variable rate debt. These increases were partially offset due to our partial repayments of the senior notes in February 2022, decreases in the interest rates on our senior notes due to our exiting the covenant relief period in March 2022, and by decreased interest on our finance lease obligation due to our sale of the Hyatt Centric Chicago Magnificent Mile in February 2022.
Noncash changes in the fair market value of our derivatives caused interest expense to increase $3.7 million in the first quarter of 2023 as compared to the same period in 2022.
The amortization of deferred financing costs caused interest expense to decrease $0.1 million in the first quarter of 2023 as compared to the same period in 2022.
Our weighted average interest rate per annum, including our variable rate debt obligation, was approximately 5.55% and 3.6% at March 31, 2023 and 2022, respectively. Approximately 51.6% and 61.8% of our outstanding notes payable had fixed interest rates or had been swapped to fixed interest rates, including forward starting interest rate swap derivatives, at March 31, 2023 and 2022, respectively.
Gain on sale of assets. Gain on sale of assets totaled zero and $22.9 million for the three months ended March 31, 2023 and 2022, respectively. In the first quarter of 2022, we recognized an $11.3 million gain on the sale of the Hyatt Centric Chicago Magnificent Mile and an $11.6 million gain on the combined sale of the Embassy Suites Chicago and the Hilton Garden Inn Chicago Downtown/Magnificent Mile.
Gain (loss) on extinguishment of debt, net. Gain (loss) on extinguishment of debt, net totaled a gain of $9.9 million and a loss of $0.2 million for the three months ended March 31, 2023 and 2022, respectively. During the first quarter of 2023, we recognized a gain of $9.9 million associated with potential employee-related obligations arising from the assignment of the Hilton Times Square to the hotel’s mortgage holder in December 2020. In February 2023, we were relieved of $9.8 million of the potential employee-related obligations and the funds were released to us from escrow. In addition, during the first quarter of 2023, we recorded a gain of $0.1 million due to reassessments of the remaining potential employee-related obligations currently held in escrow.
During the first quarter of 2022, we recognized a loss of $0.2 million related to the accelerated amortization of deferred financing fees associated with the repayment of a portion of our senior notes.
Income tax provision. 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 three months ended March 31, 2023, we recognized a current income tax provision of $0.4 million, resulting from current state and federal income tax expenses.
During the three months ended March 31, 2022, we recognized a current income tax provision of $0.1 million, resulting from current state income tax expense.
28
Income from consolidated joint venture attributable to noncontrolling interest. Income from consolidated joint venture attributable to noncontrolling interest, which represented the outside 25.0% interest in the entity that owned the Hilton San Diego Bayfront, totaled zero and $1.1 million for the three months ended March 31, 2023 and 2022, respectively.
In June 2022, we acquired the outside 25.0% interest in the entity that owned the Hilton San Diego Bayfront, resulting in our 100% ownership of the hotel.
Preferred stock dividends. Preferred stock dividends were incurred as follows (in thousands):
Series G preferred stock
582
587
Series H preferred stock
1,761
Series I preferred stock
1,425
Total preferred stock dividends
3,768
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 accounting principles generally accepted in the United States (“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 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:
29
The following table reconciles our unaudited net income to EBITDAre and Adjusted EBITDAre, excluding noncontrolling interest for our total portfolio for the three months ended March 31, 2023 and 2022 (in thousands):
Operations held for investment:
358
136
EBITDAre
67,581
28,754
Amortization of right-of-use assets and obligations
Amortization of contract intangibles, net
(18)
(6)
Finance lease obligation interest — cash ground rent
(117)
Hurricane-related insurance restoration proceeds net of losses
(2,893)
Noncontrolling interest
(2,020)
Adjustments to EBITDAre, net
(7,552)
(1,591)
Adjusted EBITDAre, excluding noncontrolling interest
60,029
27,163
Adjusted EBITDAre, excluding noncontrolling interest increased $32.9 million, or 121.0%, in the first quarter of 2023 as compared to the same period in 2022 due to the following:
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:
31
The following table reconciles our unaudited net income to FFO attributable to common stockholders and Adjusted FFO attributable to common stockholders for our total portfolio for the three months ended March 31, 2023 and 2022 (in thousands):
Real estate depreciation and amortization
32,191
31,027
(1,924)
FFO attributable to common stockholders
49,510
17,507
Real estate amortization of right-of-use assets and obligations
(119)
(286)
83
74
Adjustments to FFO attributable to common stockholders, net
(5,686)
(1,096)
Adjusted FFO attributable to common stockholders
43,824
16,411
Adjusted FFO attributable to common stockholders increased $27.4 million, or 167.0%, in the first quarter of 2023 as compared to the same period in 2022 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 hotel dispositions and business interruption and property insurance. Our primary uses of cash were for capital expenditures for hotels and other assets, acquisitions of hotels and other assets, operating expenses, repurchases of our common stock, repayments of notes payable and dividends and distributions on our preferred and common stock. 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 provided by operating activities was $47.2 million for the three months ended March 31, 2023 as compared to $13.1 million for the three months ended March 31, 2022. The net increase in cash provided by operating activities during the first quarter of 2023 as compared to the same period in 2022 was primarily due to the increase in travel demand benefiting our hotels and additional operating cash provided by the newly-acquired The Confidante Miami Beach, partially offset by a decrease in operating cash caused by the sales of the Three Disposed Hotels.
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 (used in) provided by investing activities during the first quarter of 2023 as compared to the first quarter of 2022 was as follows (in thousands):
During the first quarter of 2023, we invested $22.5 million for renovations and additions to our portfolio and other assets.
During the first quarter of 2022, we received total proceeds of $191.3 million from our sales of three hotels, consisting of $63.2 million for the Hyatt Centric Chicago Magnificent Mile (having already received a $4.0 million disposition deposit in December
32
2021) and $128.1 million for the Embassy Suites Chicago and the Hilton Garden Inn Chicago Downtown/Magnificent Mile. In addition, we received insurance proceeds of $3.9 million for hurricane-related property damage at the Hilton New Orleans St. Charles. These cash inflows were partially offset by $0.5 million paid to acquire additional wet and dry boat slips at the Oceans Edge Resort & Marina and $30.3 million invested 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 dividends and distributions paid, issuance and repurchase of common stock, issuance and repayment of notes payable and our credit facility, debt restructurings and issuance and redemption of other forms of capital, including preferred equity. Net cash used in financing activities during the first quarter of 2023 as compared to the first quarter of 2022 was as follows (in thousands):
During the first quarter of 2023, we paid $18.6 million to repurchase 1,964,923 shares of our outstanding common stock. We also paid $3.3 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees, $0.5 million in scheduled principal payments on our notes payable and $14.0 million in dividends and distributions to our preferred and common stockholders.
During the first quarter of 2022, we paid $43.5 million to repurchase 3,879,025 shares of our outstanding common stock. In addition, we paid $35.5 million in principal payments on our notes payable, including $35.0 million to repay a portion of our senior notes and $0.5 million in scheduled principal payments on our notes payable. We also paid $3.4 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees and $3.5 million in dividends to our preferred stockholders.
Future. We expect our primary sources of cash will continue to be our working capital, credit facility, dispositions of hotel properties and proceeds from public and private offerings of debt securities and common and preferred stock. However, there can be no assurance that our future asset sales will be successfully completed. As a result of rising inflation rates and interest rates, as well as a possible recession in 2023, certain sources of capital may not be as readily available to us as they have in the past or may come at higher costs.
We expect our primary uses of cash to be for operating expenses, capital investments in our hotels, repayment of principal on our notes payable and credit facility, interest expense, repurchases of our common stock, distributions on our common stock, dividends on our preferred stock and acquisitions of hotels or interests in hotels.
The recent increases in inflation and interest rates have had, and we expect will continue to have, a negative effect on our operations. We have experienced increases in wages, employee-related benefits, food costs, commodity costs, including those used to renovate or reposition our hotels, property taxes, property and liability insurance, utilities and borrowing costs. The ability of our hotel operators to adjust rates has mitigated the impact of increased operating costs on our financial position and results of operations. However, the increases in interest rates is negatively affecting our variable rate debt, resulting in increased interest payments.
Cash Balance. As of March 31, 2023, our unrestricted cash balance was $96.4 million. We believe that our current unrestricted cash balance and our ability to draw the $500.0 million capacity available for borrowing under the unsecured revolving credit facility will enable us to successfully manage our Company.
Debt. As of March 31, 2023, we had $815.6 million of debt, $145.5 million of cash and cash equivalents, including restricted cash, and total assets of $3.1 billion. We believe that by maintaining appropriate debt levels, staggering maturity dates and maintaining a highly flexible structure, we will have lower capital costs than more highly leveraged companies, or companies with limited flexibility due to restrictive corporate-level financial covenants.
As of March 31, 2023, we have no amount outstanding under the revolving portion of our credit facility, with $500.0 million of capacity available for additional borrowing under the facility. The Company’s ability to draw on the credit facility is subject to the Company’s compliance with various financial covenants.
As of March 31, 2023, 51.6% of our outstanding debt had fixed interest rates or either had been swapped or was under contract to be swapped to fixed interest rates, including the loan secured by the JW Marriott New Orleans, unsecured corporate-level Term
33
Loan 1 and two unsecured corporate-level senior notes. In March 2023, we entered into two interest rate swaps on Term Loan 1, the first of which was effective March 17, 2023, expires March 17, 2026, and fixes the SOFR rate on $75.0 million of Term Loan 1 to 3.675%, resulting in an effective interest rate of 5.125% as of March 31, 2023. The second interest rate swap will be effective September 14, 2023, expires September 14, 2026, and fixes the SOFR rate on the remaining $100.0 million of Term Loan 1 to 3.931%.
The Company’s floating rate debt as of March 31, 2023 includes the $220.0 million non-recourse mortgage on the Hilton San Diego Bayfront, which is subject to an interest rate cap derivative that caps the underlying floating rate interest benchmark at 6.0% until December 2023, $100.0 million of Term Loan 1 and the $175.0 million unsecured corporate-level Term Loan 2, which was subject to an interest rate swap derivative until the derivative matured in January 2023.
On May 1, 2023, we entered into a new term loan agreement with several financial institutions which provides for a $225.0 million term loan facility. The term loan facility will bear interest pursuant to a leverage-based pricing grid ranging from 1.35% to 2.20% over the applicable adjusted term SOFR. The term loan facility has an initial term of two years with one 12-month extension option, which would result in an extended maturity of May 2026. We expect to use substantially all of the proceeds received from the term loan facility to fully repay the $220.0 million mortgage loan secured by the Hilton San Diego Bayfront, which is scheduled to mature in December 2023.
We may in the future seek to obtain mortgages on one or more of our 13 unencumbered hotels (subject to certain stipulations under our unsecured term loans and senior notes), all of which were held by subsidiaries whose interests were pledged to our credit facility as of March 31, 2023. Our 13 unencumbered hotels include: Boston Park Plaza; Four Seasons Resort Napa Valley; Hilton New Orleans St. Charles; Hyatt Regency San Francisco; Marriott Boston Long Wharf; Montage Healdsburg; Oceans Edge Resort & Marina; Renaissance Long Beach; Renaissance Orlando at SeaWorld®; Renaissance Washington DC; The Bidwell Marriott Portland; The Confidante Miami Beach; 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 or future unsecured borrowings may be reduced. Following the repayment of the loan secured by the Hilton San Diego Bayfront, we will have 14 unencumbered hotels, all of which will be held by subsidiaries whose interests are pledged to our credit facility.
Contractual Obligations. The following table summarizes our payment obligations and commitments as of March 31, 2023 (in thousands):
Payment due by period
Less Than
1 to 3
3 to 5
More than
1 year
years
5 years
Notes payable
138,512
455,000
Interest obligations on notes payable (1)
149,235
42,758
60,757
45,720
Operating lease obligations, including imputed interest (2) (3)
20,094
5,479
10,524
1,802
2,289
Construction commitments
51,039
1,035,980
321,376
209,793
502,522
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 lease, 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 $22.5 million in our portfolio and other assets during the first quarter of 2023. As of March 31, 2023, we have contractual construction commitments totaling $51.0 million for ongoing renovations. If we renovate additional hotels 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 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 1.0% and 5.0% of the respective hotel’s applicable annual revenue. As of March 31, 2023, our balance sheet includes restricted cash of $46.9 million, which was held in FF&E reserve accounts for future capital expenditures at the majority of our 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.
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, New Orleans and Orlando, the second quarter is strong for the Mid-Atlantic business hotels, both the second and third quarters are strong for the California counties of Napa and Sonoma and the fourth quarter is strong for Hawaii and Key West). 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 economic and business conditions, including a U.S. recession or increased inflation, trade conflicts and tariffs, changes impacting global travel, regional or global economic slowdowns, any flu or disease-related pandemic that impacts travel or the ability to travel, including the COVID-19 pandemic, the adverse effects of climate change, the threat of terrorism, terrorist events, civil unrest, government shutdowns, events that reduce the capacity or availability of air travel, increased competition from other hotels in our markets, new hotel supply or alternative lodging options and unexpected changes in business, commercial travel, leisure travel and tourism.
Inflation
Inflation affects our expenses, including, without limitation, by increasing such costs as wages, employee-related benefits, food costs, commodity costs, including those used to renovate or reposition our hotels, property taxes, property and liability insurance, utilities and borrowing costs. We rely on our hotel operators to adjust room rates and pricing for hotel services to reflect the effects of inflation. However, previously contracted rates, competitive pressures or other factors may limit the ability of our operators to respond to inflation. As a result, our hotel expenses may increase at higher rates than hotel revenue.
Critical Accounting Estimates
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 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.
If a hotel is considered to be impaired, the related assets are adjusted to their estimated fair value and an impairment loss is recognized. We perform a fair value assessment using valuation techniques such as discounted cash flows and comparable sales transactions in the market to estimate the fair value of the hotel and, if appropriate and available, current estimated net sales proceeds from pending offers. Our judgment is required in determining the discount rate, terminal capitalization rate, the estimated growth of revenues and expenses, net operating income and margins, as well as specific market and economic conditions.
35
Accounting for the acquisition of a hotel property or other entity requires either allocating the purchase price to the assets acquired and the liabilities assumed in the transaction at their respective relative fair values for an asset acquisition or recording the assets and liabilities at their estimated fair values with any excess consideration above net assets going to goodwill for a business combination. The most difficult estimations of individual fair values are those involving long-lived assets, such as property, equipment and intangible assets, together with any finance or operating lease right-of-use assets and their related obligations. When we acquire a hotel property or other entity, we use all available information to make these fair value determinations, including discounted cash flow analyses, market comparable data and replacement cost data. In addition, we make significant estimations regarding capitalization rates, discount rates, average daily rates, revenue growth rates and occupancy. We also engage independent valuation specialists to assist in the fair value determinations of the long-lived assets acquired and the liabilities assumed. The determination of fair value is subjective and is based in part on assumptions and estimates that could differ materially from actual results in future periods.
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.
Item 3. 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 March 31, 2023, 78.5% of our debt obligations are fixed in nature or are subject to interest rate cap or swap derivatives, including forward starting interest rate swap derivatives, 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 50 basis points, interest expense would increase or decrease, respectively, our future consolidated earnings and cash flows by approximately $2.5 million based on the variable rates at March 31, 2023.
Item 4. Controls and Procedures
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 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.
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c)Issuer Purchases of Equity Securities
In February 2021, the Company’s board of directors reauthorized the Company’s existing stock repurchase program, allowing the Company to acquire up to an aggregate of $500.0 million of the Company’s common and preferred stock. In February 2023, the Company’s board of directors reauthorized the existing stock repurchase program and restored the $500.0 million amount of aggregate common and preferred stock allowed to be repurchased under the program. During the three months ended March 31, 2023, the Company repurchased 1,964,923 shares of its common stock for a total purchase price of $18.6 million, including fees and commissions, leaving $492.4 million remaining under the stock repurchase program. The stock repurchase program has no stated expiration date. Future repurchases will depend on various factors, including the Company’s capital needs and restrictions under its various financing agreements, as well as the price of the Company’s common and preferred stock.
In February and March 2023, the Company withheld 305,842 shares and 6,600 shares of its restricted common stock, respectively, at average market values of $10.72 per share and $10.38 per share, respectively, and used the proceeds to satisfy the tax obligations in connection with the vesting of restricted common shares issued to employees.
Maximum Number (or
Total Number of
Appropriate Dollar
Shares Purchased
Value) of Shares that
Total Number
as Part of Publicly
May Yet Be Purchased
Average Price Paid
Announced Plans
Under the Plans or
Period
Purchased
per Share
or Programs
Programs
January 1, 2023 - January 31, 2023
1,149,805
9.55
380,786,109
February 1, 2023 - February 28, 2023
305,842
500,000,000
March 1, 2023 - March 31, 2023
821,718
9.34
815,118
492,390,700
2,277,365
9.63
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
The following Exhibits are filed as a part of this report:
Exhibit Number
Description
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).
Third Amended and Restated Bylaws of Sunstone Hotel Investors, Inc. effective as of February 9, 2023 (incorporated by reference to Exhibit 3.1 to Form 8-K, filed by the Company on February 10, 2023).
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 G preferred stock (incorporated by reference to Exhibit 3.1 to Form 8-K, filed by the Company on April 28, 2021).
3.5
Articles Supplementary for Series H preferred stock (incorporated by reference to Exhibit 3.3 to the registration statement on Form 8-A, filed by the Company on May 20, 2021).
3.6
Articles Supplementary for Series I preferred stock (incorporated by reference to Exhibit 3.3 to the registration statement on Form 8-A, filed by the company on July 15, 2021).
3.7
Eighth Amended and Restated Limited Liability Agreement of Sunstone Hotel Partnership LLC (incorporated by reference to Exhibit 3.2 to Form 8-K, filed by the Company on July 16, 2021).
10.1
Equity Distribution Agreement (incorporated by reference to Exhibit 1.1 to Form 8-K, filed by the Company on March 1, 2023).
10.2
Form of Master Confirmation (incorporated by reference to Exhibit 1.2 to Form 8-K, filed by the Company on March 1, 2023).
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 March 31, 2023 formatted in Inline XBRL (included in Exhibit 101).
*
Filed herewith.
#
Management contract or compensatory plan or arrangement.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 5, 2023
By:
/s/ Aaron R. Reyes
Aaron R. Reyes(Chief Financial Officer and Duly Authorized Officer)