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Sunstone Hotel Investors 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

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

 

For the quarterly period ended September 30, 2010

 

OR

 

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

 

For the transition period from             to           

 

Commission file number 001-32319

 


 

Sunstone Hotel Investors, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Maryland

 

20-1296886

(State or Other Jurisdiction of
Incorporation or Organization)

 

(I.R.S. Employer
Identification Number)

 

 

 

120 Vantis, Suite 350
Aliso Viejo, California

 

92656

(Address of Principal Executive Offices)

 

(Zip Code)

 

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

 


 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

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

98,512,026 shares of Common Stock, $0.01 par value, as of November 1, 2010

 

 

 



Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

QUARTERLY REPORT ON

FORM 10-Q

 

For the Quarterly Period Ended September 30, 2010

 

TABLE OF CONTENTS

 

 

 

Page

 

PART I—FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements:

 

 

 

 

 

Consolidated Balance Sheets as of September 30, 2010 (unaudited) and December 31, 2009

1

 

 

 

 

Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009

2

 

 

 

 

Consolidated Statements of Stockholders’ Equity as of September 30, 2010 (unaudited) and December 31, 2009

3

 

 

 

 

Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2009

4

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

5

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

46

 

 

 

Item 4.

Controls and Procedures

46

 

 

 

 

PART II—OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

47

 

 

 

Item 1A.

Risk Factors

47

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

47

 

 

 

Item 3

Defaults Upon Senior Securities

47

 

 

 

Item 4.

Removed and Reserved

47

 

 

 

Item 5.

Other Information

47

 

 

 

Item 6.

Exhibits

48

 

 

 

SIGNATURES

49

 

i



Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1.                                    Financial Statements

 

SUNSTONE HOTEL INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents ($1,861 and $1,471 related to VIEs)

 

$

71,089

 

$

353,255

 

Restricted cash ($3,974 and $4,711 related to VIEs)

 

72,388

 

36,858

 

Accounts receivable, net ($2,710 and $2,758 related to VIEs)

 

20,246

 

22,624

 

Due from affiliates

 

37

 

62

 

Inventories ($134 and $92 related to VIEs)

 

2,412

 

2,446

 

Prepaid expenses

 

10,035

 

7,423

 

Investment in hotel property of discontinued operations, net

 

 

16,471

 

Other current assets of discontinued operations, net

 

 

1,739

 

Investment in hotel properties of operations held for non-sale disposition, net

 

98,239

 

102,343

 

Other current assets of operations held for non-sale disposition, net

 

35,157

 

14,140

 

Total current assets

 

309,603

 

557,361

 

Investment in hotel properties, net

 

2,028,082

 

1,923,392

 

Other real estate, net

 

11,900

 

14,044

 

Investments in unconsolidated joint ventures

 

449

 

542

 

Deferred financing fees, net

 

4,618

 

7,300

 

Goodwill

 

4,673

 

4,673

 

Other assets, net

 

14,137

 

6,218

 

Total assets

 

$

2,373,462

 

$

2,513,530

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued expenses ($1,134 and $523 related to VIEs)

 

$

17,963

 

$

12,425

 

Accrued payroll and employee benefits ($933 and $1,121 related to VIEs)

 

10,591

 

9,092

 

Due to Third Party Managers

 

8,742

 

9,817

 

Dividends payable

 

5,137

 

5,137

 

Other current liabilities ($1,637 and $1,316 related to VIEs)

 

22,731

 

21,910

 

Current portion of notes payable

 

94,810

 

153,778

 

Note payable of discontinued operations

 

 

25,499

 

Notes payable of operations held for non-sale disposition

 

162,972

 

184,121

 

Other current liabilities of discontinued operations, net

 

 

41,449

 

Other current liabilities of operations held for non-sale disposition

 

26,151

 

6,364

 

Total current liabilities

 

349,097

 

469,592

 

Notes payable, less current portion

 

1,039,757

 

1,050,019

 

Other liabilities ($88 and $12 related to VIEs)

 

7,923

 

7,256

 

Total liabilities

 

1,396,777

 

1,526,867

 

Commitments and contingencies (Note 14)

 

 

 

 

 

Preferred stock, Series C Cumulative Convertible Redeemable Preferred Stock, $0.01 par value, 4,102,564 shares authorized, issued and outstanding at September 30, 2010 and December 31, 2009, liquidation preference of $24.375 per share

 

100,000

 

99,896

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value, 100,000,000 shares authorized. 8.0% Series A Cumulative Redeemable Preferred Stock, 7,050,000 shares issued and outstanding at September 30, 2010 and December 31, 2009, stated at liquidation preference of $25.00 per share

 

176,250

 

176,250

 

Common stock, $0.01 par value, 500,000,000 shares authorized, 97,275,660 shares issued and outstanding at September 30, 2010 and 96,904,075 shares issued and outstanding at December 31, 2009

 

973

 

969

 

Additional paid in capital

 

1,121,460

 

1,119,005

 

Retained earnings (deficit)

 

(6,079

)

(8,949

)

Cumulative dividends

 

(412,938

)

(397,527

)

Accumulated other comprehensive loss

 

(2,981

)

(2,981

)

Total stockholders’ equity

 

876,685

 

886,767

 

Total liabilities and stockholders’ equity

 

$

2,373,462

 

$

2,513,530

 

 

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

 

See accompanying notes to consolidated financial statements.

 

1



Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

 

 

 

 

 

 

 

 

REVENUES

 

 

 

 

 

 

 

 

 

Room

 

$

108,324

 

$

101,754

 

$

307,025

 

$

299,651

 

Food and beverage

 

35,893

 

34,664

 

114,644

 

115,921

 

Other operating

 

12,847

 

12,856

 

37,168

 

38,268

 

Revenues of operations held for non-sale disposition

 

20,646

 

20,790

 

60,638

 

63,712

 

Total revenues

 

177,710

 

170,064

 

519,475

 

517,552

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Room

 

27,542

 

25,873

 

78,343

 

74,316

 

Food and beverage

 

28,544

 

27,215

 

85,327

 

85,637

 

Other operating

 

6,658

 

6,600

 

19,775

 

19,934

 

Advertising and promotion

 

8,012

 

7,070

 

23,397

 

23,344

 

Repairs and maintenance

 

6,660

 

6,402

 

19,737

 

19,703

 

Utilities

 

6,793

 

6,280

 

18,152

 

18,428

 

Franchise costs

 

5,727

 

5,283

 

15,878

 

15,082

 

Property tax, ground lease and insurance

 

11,045

 

10,863

 

32,015

 

30,918

 

Property general and administrative

 

18,673

 

17,232

 

54,694

 

53,128

 

Corporate overhead

 

11,596

 

4,334

 

21,311

 

14,826

 

Depreciation and amortization

 

23,871

 

23,529

 

70,693

 

70,818

 

Operating expenses of operations held for non-sale disposition

 

17,787

 

19,098

 

53,737

 

58,358

 

Property and goodwill impairment losses

 

 

2,209

 

1,943

 

30,852

 

Goodwill impairment losses of operations held for non-sale disposition

 

 

 

 

3,007

 

Total operating expenses

 

172,908

 

161,988

 

495,002

 

518,351

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

4,802

 

8,076

 

24,473

 

(799

)

Equity in earnings (losses) of unconsolidated joint ventures

 

200

 

(515

)

475

 

(2,616

)

Interest income and other income (loss)

 

(276

)

239

 

(6

)

1,111

 

Interest expense

 

(16,671

)

(18,190

)

(53,727

)

(57,703

)

Interest expense of operations held for non-sale disposition

 

(4,875

)

(2,880

)

(15,272

)

(8,667

)

Gain (loss) on extinguishment of debt

 

 

(20

)

 

54,559

 

Loss from continuing operations

 

(16,820

)

(13,290

)

(44,057

)

(14,115

)

Income (loss) from discontinued operations

 

40,473

 

(4,658

)

46,927

 

(127,528

)

NET INCOME (LOSS)

 

23,653

 

(17,948

)

2,870

 

(141,643

)

 

 

 

 

 

 

 

 

 

 

Dividends paid on unvested restricted stock compensation

 

 

 

 

(447

)

Preferred stock dividends and accretion

 

(5,141

)

(5,187

)

(15,515

)

(15,562

)

Undistributed income allocated to unvested restricted stock compensation

 

(232

)

 

 

 

INCOME AVAILABLE (LOSS ATTRIBUTABLE) TO COMMON STOCKHOLDERS

 

$

18,280

 

$

(23,135

)

$

(12,645

)

$

(157,652

)

 

 

 

 

 

 

 

 

 

 

Basic per share amounts:

 

 

 

 

 

 

 

 

 

Loss from continuing operations attributable to common stockholders

 

$

(0.23

)

$

(0.25

)

$

(0.61

)

$

(0.48

)

Income (loss) from discontinued operations

 

0.42

 

(0.06

)

0.48

 

(2.05

)

Basic income available (loss attributable) to common stockholders per common share

 

$

0.19

 

$

(0.31

)

$

(0.13

)

$

(2.53

)

 

 

 

 

 

 

 

 

 

 

Diluted per share amounts:

 

 

 

 

 

 

 

 

 

Loss from continuing operations attributable to common stockholders

 

$

(0.23

)

$

(0.25

)

$

(0.61

)

$

(0.48

)

Income (loss) from discontinued operations

 

0.42

 

(0.06

)

0.48

 

(2.05

)

Diluted income available (loss attributable) to common stockholders per common share

 

$

0.19

 

$

(0.31

)

$

(0.13

)

$

(2.53

)

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

97,250

 

73,857

 

97,163

 

62,382

 

Diluted

 

97,612

 

73,857

 

97,163

 

62,382

 

Dividends declared per common share

 

$

 

$

 

$

 

$

 

 

See accompanying notes to consolidated financial statements.

 

2



Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Preferred Stock

 

Common Stock

 

Additional

 

 

 

 

 

Other

 

 

 

 

 

Number of

 

 

 

Number of

 

 

 

Paid in

 

Retained

 

Cumulative

 

Comprehensive

 

 

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Earnings (Deficit)

 

Dividends

 

Loss

 

Total

 

Balance at December 31, 2009

 

7,050,000

 

$

176,250

 

96,904,075

 

$

969

 

$

1,119,005

 

$

(8,949

)

$

(397,527

)

$

(2,981

)

$

886,767

 

Vesting of restricted common stock (unaudited)

 

 

 

 

 

371,585

 

4

 

2,559

 

 

 

 

 

 

 

2,563

 

Series A preferred dividends and dividends payable at $1.50 per share year to date (unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

(10,575

)

 

 

(10,575

)

Series C preferred dividends and dividends payable at $1.179 per share year to date (unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,836

)

 

 

(4,836

)

Accretion of discount on Series C preferred stock (unaudited)

 

 

 

 

 

 

 

 

 

(104

)

 

 

 

 

 

 

(104

)

Net income and comprehensive income (unaudited)

 

 

 

 

 

 

 

 

 

 

 

2,870

 

 

 

 

 

2,870

 

Balance at September 30, 2010 (unaudited)

 

7,050,000

 

$

176,250

 

97,275,660

 

$

973

 

$

1,121,460

 

$

(6,079

)

$

(412,938

)

$

(2,981

)

$

876,685

 

 

See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income (loss)

 

$

2,870

 

$

(141,643

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Bad debt expense

 

78

 

236

 

Loss on sale of other assets

 

383

 

12,698

 

Gain on extinguishment of debt

 

(47,220

)

(54,559

)

Depreciation

 

75,446

 

85,186

 

Amortization of franchise fees and other intangibles

 

386

 

317

 

Amortization and write-off of deferred financing fees

 

3,084

 

1,928

 

Amortization of loan discounts

 

743

 

1,576

 

Amortization of deferred stock compensation

 

2,405

 

3,286

 

Property and goodwill impairment losses

 

1,943

 

137,866

 

Equity in (earnings) losses of unconsolidated joint ventures

 

(475

)

2,616

 

Changes in operating assets and liabilities:

 

 

 

 

 

Restricted cash

 

(33,977

)

(3,104

)

Accounts receivable

 

2,846

 

10,092

 

Due from affiliates

 

25

 

30

 

Inventories

 

43

 

423

 

Prepaid expenses and other assets

 

(7,869

)

581

 

Accounts payable and other liabilities

 

22,308

 

2,768

 

Accrued payroll and employee benefits

 

1,488

 

59

 

Due to Third Party Managers

 

(1,111

)

(2,623

)

Discontinued operations

 

584

 

(706

)

Operations held for non-sale disposition

 

(20,152

)

(3,833

)

Net cash provided by operating activities

 

3,828

 

53,194

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Proceeds from sale of hotel properties and other assets

 

61

 

64,052

 

Cash received from unconsolidated joint ventures

 

600

 

250

 

Restricted cash — replacement reserve

 

(1,335

)

(2,376

)

Acquisitions of notes receivable

 

(3,700

)

 

Acquisitions of hotel properties

 

(117,604

)

 

Renovations and additions to hotel properties and other real estate

 

(31,443

)

(33,487

)

Net cash (used in) provided by investing activities

 

(153,421

)

28,439

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from common stock offering

 

 

103,500

 

Payment of common stock offering costs

 

 

(4,802

)

Proceeds from notes payable

 

 

60,000

 

Payments on notes payable and related costs

 

(117,158

)

(71,237

)

Payments for repurchases of notes payable and related costs

 

 

(117,397

)

Payments of deferred financing costs

 

(4

)

(3,158

)

Dividends paid

 

(15,411

)

(22,774

)

Net cash used in financing activities

 

(132,573

)

(55,868

)

Net (decrease) increase in cash and cash equivalents

 

(282,166

)

25,765

 

Cash and cash equivalents, beginning of period

 

353,255

 

176,102

 

Cash and cash equivalents, end of period

 

$

71,089

 

$

201,867

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

 

 

 

 

 

Cash paid for interest

 

$

49,547

 

$

71,682

 

 

 

 

 

 

 

NONCASH INVESTING ACTIVITY

 

 

 

 

 

Deconsolidation of assets of hotel placed into receivership

 

$

18,374

 

$

 

Deconsolidation of liabilities of hotel placed into receivership

 

$

26,854

 

$

 

Amortization of deferred stock compensation — construction activities

 

$

137

 

$

157

 

Amortization of deferred stock compensation — unconsolidated joint venture

 

$

21

 

$

28

 

 

 

 

 

 

 

NONCASH FINANCING ACTIVITY

 

 

 

 

 

Issuance of stock dividend

 

$

 

$

29,056

 

Dividends payable

 

$

5,137

 

$

5,137

 

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

SUNSTONE HOTEL INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Organization and Description of Business

 

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

 

As a REIT, certain tax laws limit the amount of “non-qualifying” income the Company can earn, including income derived directly from the operation of hotels. As a result, the Company leases all of its hotels to its TRS Lessee, which in turn enters into long-term management agreements with third parties to manage the operations of the Company’s hotels. As of September 30, 2010, the Company owned 39 hotels. Pursuant to a secured debt restructuring program initiated by the Company in 2009 which was aimed at reducing leverage and minimizing risk associated with individual hotels (the “2009 secured debt restructuring program”), the Company is currently in the process of transferring ownership and control of eight (the “Mass Mutual eight”) of its 39 hotels to a lender in satisfaction of a non-recourse mortgage (see Footnote 17), leaving 31 hotels (the “31 hotels”) currently held for investment. The Company has reclassified the assets, liabilities and operating results of the Mass Mutual eight to “operations held for non-sale disposition” on its balance sheets, statements of operations and cash flows. The Renaissance Westchester, which was transferred to a receiver pursuant to the 2009 secured debt restructuring program, was reacquired by the Company on June 14, 2010. Operating results for the Renaissance Westchester for 2009, therefore, are included in discontinued operations, whereas operating results from June 14, 2010 forward are included in the Company’s continuing operations.

 

As of September 30, 2010, the Company’s third party managers included Interstate Hotels & Reports, Inc. (“IHR”), manager of 13 of the Company’s 39 hotels, Sunstone Hotel Properties, Inc., a division of Interstate Hotels & Resorts, Inc. (“Interstate SHP”), manager of seven of the Company’s 39 hotels; subsidiaries of Marriott International, Inc. or Marriott Hotel Services, Inc. (collectively, “Marriott”), managers of 13 of the Company’s 39 hotels; and Davidson Hotel Company (“Davidson”), Fairmont Hotels & Resorts (U.S.) (“Fairmont”), GF Management (“GF”), Hilton Worldwide (“Hilton”), Hyatt Corporation (“Hyatt”) and Sage Hospitality Resources (“Sage”), each managers of one of the Company’s 39 hotels.  In addition to its wholly owned hotels, the Company has a 38% equity interest in a joint venture that owns one hotel.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements as of September 30, 2010 and December 31, 2009, and for the three and nine months ended September 30, 2010 and 2009, include the accounts of the Company, the Operating Partnership, the TRS Lessee and their subsidiaries. All significant intercompany balances and transactions have been eliminated.

 

The accompanying interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and in conformity with the rules and regulations of the Securities and Exchange Commission. In the Company’s opinion, the interim financial statements presented herein reflect all adjustments, consisting solely of normal and recurring adjustments, which are necessary to fairly present the interim financial statements. These financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009, filed with the Securities and Exchange Commission on February 23, 2010.

 

Certain prior year amounts have been reclassified in the consolidated financial statements in order to conform to the current year presentation, including reclassifications due to the finalization of a restructuring agreement with Mass Mutual in April 2010 regarding the Mass Mutual eight hotels along with three additional hotels that secured this non-recourse mortgage.

 

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

 

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Use of Estimates

 

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

 

Reporting Periods

 

The results the Company reports in its consolidated statements of operations are based on results reported to the Company by its hotel managers.  These hotel managers use different reporting periods.  Marriott uses a fiscal year ending on the Friday closest to December 31 and reports twelve weeks of operations for each of the first three quarters of the year, and sixteen or seventeen weeks of operations for the fourth quarter of the year.  The Company’s other hotel managers report operations on a standard monthly calendar.  The Company has elected to adopt quarterly close periods of March 31, June 30 and September 30, and an annual year end of December 31. As a result, the Company’s 2010 results of operations for the Marriott-managed hotels include results from January 2 through March 26 for the first quarter, March 27 through June 18 for the second quarter, June 19 through September 10 for the third quarter, and September 11 through December 31 for the fourth quarter. The Company’s 2009 results of operations for the Marriott-managed hotels include results from January 3 through March 27 for the first quarter, March 28 through June 19 for the second quarter, June 20 through September 11 for the third quarter, and September 12 through January 1 for the fourth quarter.

 

Fair Value of Financial Instruments

 

As of September 30, 2010 and December 31, 2009, the carrying amount of certain financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses were representative of their fair values due to the short-term maturity of these instruments.

 

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

 

Level 1

Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

 

Level 2

Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

 

Level 3

Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

 

The Company currently pays the premiums for a $5.0 million split life insurance policy for its former Chief Executive Officer and current Executive Chairman, Robert A. Alter. Under the terms of the policy, the Company is entitled to receive the greater of the cash surrender value of the policy or the premiums paid by the Company following the termination of Mr. Alter’s employment with the Company. Within 60 days following the date of the termination of the split dollar policy during Mr. Alter’s lifetime, Mr. Alter may obtain a release of such obligation by paying the Company the greater of the total amount of the premiums paid by the Company or the then-current cash surrender value. The Company has valued this policy using Level 2 measurements at $1.8 million as of both September 30, 2010 and December 31, 2009. These amounts are included in other assets, net in the accompanying balance sheets.

 

The Company also has a Retirement Benefit Agreement with Mr. Alter. Pursuant to the Retirement Benefit Agreement, Mr. Alter may defer a portion of his compensation. Mr. Alter may amend the amount of his compensation to be deferred from time to time; provided, however, that any such amendment must be in compliance with Section 409A of the Internal Revenue Code. The Company will match 50% of Mr. Alter’s deferrals for each year, up to a maximum of $1,500 for that year. Earnings on Mr. Alter’s deferrals and the Company’s matching contributions are an amount equal to the amount which would have been earned on such deferrals and matching contributions had they been paid as premiums on the life insurance policy noted above in accordance with the investment designations made by Mr. Alter. The balance in Mr. Alter’s deferred compensation account is payable over a period of time following the termination of his employment with the Company, regardless of the reason for such termination. The Company has valued this agreement using Level 2 measurements at $1.8 million as of both September 30, 2010 and December 31, 2009. These amounts are included in accrued payroll and employee benefits in the accompanying balance sheets.

 

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The Company has analyzed the carrying values of its hotel properties using Level 3 measurements, including a discounted cash flow analysis to estimate the fair value of its hotel properties taking into account each property’s expected cash flow from operations, holding period and estimated proceeds from the disposition of the property. The factors addressed in determining estimated proceeds from disposition included anticipated operating cash flow in the year of disposition and terminal capitalization rate. In June 2010, the Company recognized a $1.9 million impairment on an office building and land adjacent to one of its hotels based on estimated proceeds expected to be received from the possible sale of this property. When indicators of impairment existed in 2009 and the undiscounted cash flows were less than the carrying value of the asset, the Company used terminal capitalization rates in its 2009 analyses ranging between 8.1% and 9.6%, based on the Company’s weighted average cost of capital, a hurdle rate assigned to each hotel to account for a hotel’s individual characteristics including, but not limited to, size, age and market supply, and an estimated average annual growth rate.

 

On an annual basis and periodically when indicators of impairment exist, the Company has analyzed the carrying value of its goodwill using Level 3 measurements including a discounted cash flow analysis to estimate the fair value of its reporting units. For the three and nine months ended September 30, 2010, the Company did not identify any properties with indicators of goodwill impairment. When indicators of goodwill impairment existed in 2009 and the discounted cash flows were less than the carrying value of the reporting unit, the Company used discount rates ranging between 13.0% and 13.8% in its 2009 analyses, taking into account each related reporting unit’s expected cash flow from operations, holding period and proceeds from the potential disposition of the property. The factors addressed in determining estimated proceeds from disposition include anticipated operating cash flow in the year of potential disposition and terminal capitalization rate. The Company used terminal capitalization rates in its 2009 analyses ranging between 8.1% and 9.6%, based on the Company’s weighted average cost of capital, a hurdle rate assigned to each hotel to account for a hotel’s individual characteristics including, but not limited to, size, age and market supply, and an estimated average annual growth rate. The Company’s judgment is required in determining the discount rate applied to estimated cash flows, the terminal capitalization rate, the growth rate of each property’s projected revenues and expenses, the need for capital expenditures, as well as specific market and economic conditions.

 

As of September 30, 2010 and December 31, 2009, all of the Company’s outstanding debt had fixed interest rates. The Company’s carrying value of its debt, including the debt secured by the Mass Mutual eight hotels, totaled $1.3 billion and $1.4 billion as of September 30, 2010 and December 31, 2009, respectively. Using Level 3 measurements, including the Company’s weighted average cost of capital ranging between 6.0% and 9.6%, the Company estimates that the fair market value of its debt totaled $1.3 billion and $1.2 billion as of September 30, 2010 and December 31, 2009, respectively.

 

The following table presents the impairment charges recorded as a result of applying Level 3 measurements included in earnings for the three and nine months ended September 30, 2010 and 2009 (in thousands):

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Investment in hotel properties, net

 

$

 

$

 

$

 

$

25,488

 

Investment in hotel properties of discontinued operations, net

 

 

 

 

104,007

 

Other real estate, net

 

 

 

1,943

 

 

Goodwill

 

 

2,209

 

 

3,948

 

Other current assets of operations held for non-sale disposition, net (1)

 

 

 

 

3,007

 

Other assets, net

 

 

 

 

1,416

 

Total Level 3 measurement impairment losses included in earnings

 

$

 

$

2,209

 

$

1,943

 

$

137,866

 

 


(1)         Includes goodwill impairment losses recorded on operations held for non-sale disposition.

 

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The following tables present our assets and liabilities measured at fair value on a recurring and non-recurring basis at September 30, 2010 and December 31, 2009 (in thousands):

 

 

 

Total

 

Fair Value Measurements at Reporting Date

 

 

 

September 30, 2010

 

Level 1

 

Level 2

 

Level 3

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Assets:

 

 

 

 

 

 

 

 

 

Life insurance policy

 

$

1,796

 

$

 

$

1,796

 

$

 

Goodwill

 

4,673

 

 

 

4,673

 

Goodwill of operations held for non-sale disposition (1)

 

1,174

 

 

 

1,174

 

Total assets

 

$

7,643

 

$

 

$

1,796

 

$

5,847

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Retirement benefit agreement

 

$

1,796

 

$

 

$

1,796

 

$

 

Total liabilities

 

$

1,796

 

$

 

$

1,796

 

$

 

 

 

 

Total

 

Fair Value Measurements at Reporting Date

 

 

 

December  31, 2009

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Investment in hotel properties of operations held for non-sale disposition, net (2)

 

$

69,272

 

$

 

$

 

$

69,272

 

Life insurance policy

 

1,814

 

 

1,814

 

 

Goodwill

 

4,673

 

 

 

4,673

 

Goodwill of operations held for non-sale disposition (1)

 

1,174

 

 

 

1,174

 

Total assets

 

$

76,933

 

$

 

$

1,814

 

$

75,119

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Retirement benefit agreement

 

$

1,814

 

$

 

$

1,814

 

$

 

Total liabilities

 

$

1,814

 

$

 

$

1,814

 

$

 

 


(1)     Goodwill of operations held for non-sale disposition is included in other current assets of operations held for non-sale disposition, net.

(2)     Includes the six hotel properties that were impaired and recorded at fair value as of December 31, 2009.

 

Accounts Receivable

 

Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize hotel services. Accounts receivable also includes, among other things, receivables from customers who utilize the Company’s commercial laundry facilities in Salt Lake City, Utah, and Rochester, Minnesota, as well as tenants who lease space in the Company’s hotels. The Company maintains an allowance for doubtful accounts sufficient to cover potential credit losses. The Company’s accounts receivable at both September 30, 2010 and December 31, 2009 includes an allowance for doubtful accounts of $0.1 million, all of which is included in continuing operations. At September 30, 2010 and December 31, 2009, the Company had approximately $0.6 million and $2.6 million, respectively, in accounts receivable with one customer who is operating under a contract with the United States government. No amounts have been reserved for this receivable as of either September 30, 2010 or December 31, 2009 as all amounts have been deemed to be collectible.

 

Deferred Financing Fees

 

Deferred financing fees consist of loan fees and other financing costs related to the Company’s outstanding indebtedness and are amortized to interest expense over the terms of the related debt. Upon repayment or refinancing of the underlying debt, any related unamortized deferred financing fee is charged to interest expense. Upon any loan modification, any related unamortized deferred financing fee is amortized over the remaining terms of the modified loan. Unamortized deferred financing fees written off and charged to interest expense due to the repayment or modification of the underlying debt totaled zero and $1.6 million for the three and nine months ended September 30, 2010, respectively. During the first quarter of 2010, the Company wrote-off $1.5 million in deferred financing fees related to the termination of its credit facility, and during the second quarter of 2010 the Company wrote off $0.1 million in deferred financing fees related to the release of three hotels from the Mass Mutual loan. During the three and nine months ended September 30, 2009, the Company wrote off zero and $0.3 million, respectively, in deferred financing fees associated with the amendment of its credit facility during the second quarter 2009.

 

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Total amortization and write-off of deferred financing fees for the three and nine months ended September 30, 2010 and 2009 was as follows (in thousands):

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Operations held for investment:

 

 

 

 

 

 

 

 

 

Amortization of deferred financing fees

 

$

303

 

$

582

 

$

1,102

 

$

1,217

 

Write-off of deferred financing fees

 

 

 

1,585

 

284

 

Total deferred financing fees — operations held for investment

 

303

 

582

 

2,687

 

1,501

 

Operations held for non-sale disposition:

 

 

 

 

 

 

 

 

 

Amortization of deferred financing fees

 

131

 

131

 

395

 

395

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Amortization of deferred financing fees

 

 

11

 

2

 

32

 

Total amortization and write-off of deferred financing fees

 

$

434

 

$

724

 

$

3,084

 

$

1,928

 

 

Earnings Per Share

 

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

 

The Company follows the requirements of ASC 260-10, which states that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. For the three months ended September 30, 2010 and 2009, undistributed earnings representing nonforfeitable dividends of $0.2 million and zero, respectively, were allocated to the participating securities. For the nine months ended September 30, 2010 and 2009, distributed earnings representing nonforfeitable dividends of zero and $0.4 million, respectively, were allocated to the participating securities.

 

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

 

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

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

23,653

 

$

(17,948

)

$

2,870

 

$

(141,643

)

Less dividends paid on unvested restricted stock compensation

 

 

 

 

(447

)

Less preferred stock dividends and accretion

 

(5,141

)

(5,187

)

(15,515

)

(15,562

)

Less undistributed income allocated to unvested restricted stock compensation

 

(232

)

 

 

 

Numerator for basic and diluted income available (loss attributable) to common stockholders

 

$

18,280

 

$

(23,135

)

$

(12,645

)

$

(157,652

)

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average basic common shares outstanding

 

97,250

 

73,857

 

97,163

 

62,382

 

Unvested restricted stock awards

 

362

 

 

 

 

Weighted average diluted common shares outstanding

 

97,612

 

73,857

 

97,163

 

62,382

 

Basic income available (loss attributable) to common stockholders per common share

 

$

0.19

 

$

(0.31

)

$

(0.13

)

$

(2.53

)

Diluted income available (loss attributable) to common stockholders per common share

 

$

0.19

 

$

(0.31

)

$

(0.13

)

$

(2.53

)

 

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Shares associated with the Company’s long-term incentive plan have been excluded from the above calculation of earnings per share for the three months ended September 30, 2009 and the nine months ended September 30, 2010 and 2009 as their inclusion would have been anti-dilutive. The Company’s shares of Series C preferred stock issuable upon conversion and shares associated with common stock options and unvested restricted stock units have been excluded from the above calculation of earnings per share for the three and nine months ended September 30, 2010 and 2009, as their inclusion would have been anti-dilutive.

 

Segment Reporting

 

The Company reports its consolidated financial statements in accordance with the Segment Reporting Topic of the FASB ASC. Currently, the Company operates in two segments, operations held for investment and operations held for non-sale disposition.

 

3. Investment in Hotel Properties

 

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

 

 

 

September 30,
2010

 

December 31,
2009

 

 

 

(unaudited)

 

 

 

Land

 

$

274,591

 

$

233,812

 

Buildings and improvements

 

1,958,697

 

1,848,435

 

Furniture, fixtures and equipment

 

254,893

 

243,415

 

Intangibles

 

34,454

 

34,081

 

Franchise fees

 

983

 

1,133

 

Construction in process

 

17,734

 

6,182

 

 

 

2,541,352

 

2,367,058

 

Accumulated depreciation and amortization

 

(513,270

)

(443,666

)

 

 

$

2,028,082

 

$

1,923,392

 

 

In August 2009, pursuant to the 2009 secured debt restructuring program, the Company elected to cease the subsidization of debt service on the $29.2 million non-recourse mortgage secured by the 347-room Renaissance Westchester. In December 2009, a stipulation for the appointment of a receiver for the entity that owns the Renaissance Westchester was filed in the New York Superior Court, County of Westchester, and the Company transferred possession and control of the Renaissance Westchester to a receiver, who was operating the property for the benefit of the lender of the non-recourse loan. As such, and in conjunction with the Consolidation Topic of the FASB ASC, the Company effectively transferred control of the asset to the receiver in December 2009, and accordingly deconsolidated the Renaissance Westchester. The Company had no rights to the profit or loss associated with the Renaissance Westchester upon the hotel’s appointment to the receiver; however since the Company was still not released from the non-recourse mortgage, the net liability was still recorded on the Company’s balance sheet. On June 14, 2010, the Company reacquired the Renaissance Westchester for $26.0 million, including related costs. In connection with the repurchase of the Renaissance Westchester, the $29.2 million non-recourse mortgage was cancelled. The Company recorded a $6.7 million gain on the extinguishment of this debt, which is included in discontinued operations. Operating results for the Renaissance Westchester for 2009, therefore, are included in discontinued operations, whereas operating results from June 14, 2010 forward are included in the Company’s continuing operations.

 

On August 16, 2010, the Company acquired the Royal Palm hotel in Miami Beach, Florida at a foreclosure auction for a gross purchase price of $126.1 million excluding transaction costs. Prior to the auction, the Company purchased a portion of the hotel’s outstanding debt at a discount to par resulting in an economic net purchase price of approximately $117.6 million, excluding transaction costs. On August 27, 2010, title to the hotel was transferred to the Company. The results of operations for the Royal Palm Miami Beach have been included in the Company’s statement of operations from the title transfer date of August 27, 2010 through the third quarter ended September 30, 2010.

 

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The following unaudited pro forma results of operations reflect the Company’s results as if the reacquisition of the Renaissance Westchester and the acquisition of the Royal Palm Miami Beach had occurred on January 1, 2009. In the Company’s opinion, all significant adjustments necessary to reflect the effects of these transactions have been made (in thousands, except per share data):

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

179,790

 

$

177,175

 

$

539,833

 

$

543,281

 

Loss attributable to common stockholders from continuing operations

 

$

(17,939

)

$

(14,778

)

$

(44,762

)

$

(15,919

)

Loss per diluted share attributable to common stockholders from continuing operations

 

$

(0.23

)

$

(0.27

)

$

(0.62

)

$

(0.52

)

 

Pursuant to its 2009 secured debt restructuring program, the Company finalized a restructuring agreement in April 2010 with Massachusetts Mutual Life Insurance Company, or Mass Mutual, the lender’s representative for a $246.0 million, 5.95% non-recourse mortgage loan secured by 11 of the Company’s hotels comprised of 2,587 rooms. As part of this agreement, the Company agreed to pay down $83.0 million of the Mass Mutual loan in exchange for the release of three hotels from the loan. The three hotels include the 179-room Courtyard by Marriott Los Angeles Airport, the 271-room Kahler Inn & Suites Rochester and the 203-room Marriott Rochester. Also pursuant to this agreement, the Company expects to complete the deed back of the Mass Mutual eight hotels in satisfaction of the remaining $163.0 million loan balance during 2010. The Mass Mutual eight hotels include the following: Renaissance Atlanta Concourse; Hilton Huntington; Residence Inn by Marriott Manhattan Beach; Marriott Provo; Courtyard by Marriott San Diego (Old Town); Holiday Inn Downtown San Diego; Holiday Inn Express San Diego (Old Town); and Marriott Salt Lake City (University Park). Pending the completion of the deed back or appointment of a receiver, the Company has reclassified the assets, liabilities and results of operations of the Mass Mutual eight to “operations held for non-sale disposition” on its balance sheets, statements of operations and statements of cash flows. Upon the completion of the deed back or appointment of a receiver, the assets and liabilities associated with the Mass Mutual eight will be deconsolidated (see Footnote 17).

 

As of September 30, 2010 and December 31, 2009, the assets and liabilities of operations held for non-sale disposition associated with the Mass Mutual eight hotels consisted of the following (in thousands):

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

26,016

 

$

5,864

 

Restricted cash

 

5,137

 

4,683

 

Accounts receivable, net

 

1,732

 

1,137

 

Inventories

 

234

 

245

 

Prepaid expenses

 

265

 

208

 

Deferred financing fees, net

 

307

 

702

 

Goodwill

 

1,174

 

1,174

 

Other assets, net

 

292

 

127

 

Other current assets of operations held for non-sale disposition, net

 

35,157

 

14,140

 

Investment in hotel properties, net

 

98,239

 

102,343

 

Total assets

 

$

133,396

 

$

116,483

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

$

986

 

$

989

 

Due to Third Party Managers

 

1,325

 

1,148

 

Other current liabilities

 

23,801

 

4,192

 

Other liabilities

 

39

 

35

 

Other current liabilities of operations held for non-sale disposition

 

26,151

 

6,364

 

Notes payable

 

162,972

 

184,121

 

Total liabilities

 

$

189,123

 

$

190,485

 

 

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4. Discontinued Operations

 

On June 14, 2010, the Company reacquired the Renaissance Westchester for $26.0 million, including related costs. In connection with the repurchase of the Renaissance Westchester, the $29.2 million non-recourse mortgage secured by the hotel was cancelled. The Company recorded a $6.7 million gain on the extinguishment of this debt, which is included in discontinued operations. Operating results for the Renaissance Westchester for 2009, therefore, are included in discontinued operations, whereas operating results from June 14, 2010 forward are included in the Company’s continuing operations.

 

In September 2009, pursuant to the 2009 secured debt restructuring program, the Company elected to cease the subsidization of debt service on the $25.5 million non-recourse mortgage secured by the 299-room Marriott Ontario Airport. In March 2010, a stipulation for the appointment of a receiver for the entity that owns the Marriott Ontario Airport was filed in the California Superior Court, County of San Bernardino, and the Company transferred possession and control of the Marriott Ontario Airport to the receiver, who operated the property for the benefit of the lender of the non-recourse loan until the hotel was sold by the receiver in August 2010, and title to the hotel was transferred to the hotel’s new owner. In conjunction with the receiver’s sale of the hotel, the Company removed the net assets and liabilities from its 2010 balance sheet and recorded a gain on extinguishment of debt of $5.1 million in the third quarter of 2010. The Company reclassified the Marriott Ontario Airport’s results of operations and cash flows for the three months ended March 31, 2010, as well as any expenses incurred as owner of the property for the nine months ended September 30, 2010, along with the hotel’s results of operations for the three and nine months ended September 30, 2009 to discontinued operations on its statements of operations and cash flows.

 

In June 2009, pursuant to the 2009 secured debt restructuring program, the Company elected to cease the subsidization of debt service on the $65.0 million non-recourse mortgage secured by the 258-room W San Diego. In September 2009, a stipulation for the appointment of a receiver for the entity that owns the W San Diego was filed in the California Superior Court, County of San Diego, and the Company transferred possession and control of the W San Diego to the receiver, who operated the property for the benefit of the lender of the non-recourse loan until the deed back was completed in July 2010, and title to the hotel was transferred to the lender. In conjunction with the deed back of the hotel, the Company removed the net assets and liabilities from its 2010 balance sheet and recorded a gain on extinguishment of debt of $35.4 million in the third quarter 2010. The Company has reclassified the W San Diego’s results of operations and cash flows for the three and nine months ended September 30, 2009 to discontinued operations on its statements of operations and cash flows.

 

In addition to the deed backs noted above, the Company sold the Marriott Napa Valley and the Marriott Riverside during the second quarter of 2009, and the Hyatt Suites Atlanta Northwest during the third quarter of 2009. The following sets forth the discontinued operations for the three and nine months ended September 30, 2010 and 2009, related to the three hotel properties sold during 2009, as well as the two hotel properties deeded back in 2010 and the Renaissance Westchester held in receivership until its reacquisition by the Company in June 2010 (in thousands):

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Operating revenues

 

$

 

$

11,259

 

$

1,842

 

$

44,889

 

Operating expenses

 

 

(10,340

)

(1,736

)

(40,550

)

Interest expense

 

 

(4,846

)

(275

)

(8,306

)

Depreciation and amortization expense

 

 

(749

)

(124

)

(6,502

)

Property and goodwill impairment losses

 

 

 

 

(104,007

)

Gain on extinguishment of debt

 

40,473

 

 

47,220

 

 

Gain (loss) on sale of hotels

 

 

18

 

 

(13,052

)

Income (loss) from discontinued operations

 

$

40,473

 

$

(4,658

)

$

46,927

 

$

(127,528

)

 

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5. Other Real Estate

 

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

 

 

 

September 30,
2010

 

December 31,
2009

 

 

 

(unaudited)

 

 

 

Land

 

$

2,768

 

$

3,824

 

Buildings and improvements

 

9,296

 

10,179

 

Furniture, fixtures and equipment

 

6,497

 

6,058

 

Construction in process

 

 

27

 

 

 

18,561

 

20,088

 

Accumulated depreciation

 

(6,849

)

(6,232

)

 

 

11,712

 

13,856

 

Land held for investment

 

188

 

188

 

 

 

$

11,900

 

$

14,044

 

 

In June 2010, the Company recorded an impairment loss of $1.9 million on an office building and land adjacent to one of its hotels in anticipation of a possible sale.

 

As of September 30, 2010, other real estate, net included the Company’s two commercial laundry facilities, an office building and one vacant parcel of land.

 

6. Investments in Unconsolidated Joint Ventures

 

In December 2007, the Company entered into a joint venture agreement with Strategic Hotels & Resorts, Inc. (“Strategic”) to own and operate BuyEfficient, LLC (“BuyEfficient”), an electronic purchasing platform that allows members to procure food, operating supplies, furniture, fixtures and equipment. Under the terms of the agreement, Strategic acquired a 50% interest in BuyEfficient from the Company. In December 2006, the Company entered into a joint venture agreement to obtain a 38% interest in the 460-room Doubletree Guest Suites Times Square in New York City, New York. In April 2010, the Company purchased a $30.0 million, 8.5% mezzanine loan maturing in January 2017 for $3.45 million. The mezzanine loan is secured by the equity interests in the Company’s Doubletree Guest Suites Times Square joint venture, and is included in other assets, net on the Company’s balance sheets (see Footnote 8).  The Company accounts for both of these ownership interests using the equity method. The Company’s accounting policies are consistent with those of the unconsolidated joint ventures.

 

As part of the Company’s agreement with Strategic, the cost of BuyEfficient’s participation in the Company’s Long-Term Incentive Plan continues to be borne solely by the Company. In accordance with the Investments — Equity Method and Joint Ventures Topic of the FASB ASC, the Company expenses the cost of stock-based compensation granted to employees of BuyEfficient as incurred to the extent the Company’s claim on BuyEfficient’s book value has not been increased. The Company recognizes this stock-based compensation expense based on fair value in accordance with the Compensation — Stock Compensation Topic and the Equity Topic of the FASB ASC. The Company recognized stock-based compensation expense for BuyEfficient for the three and nine months ended September 30, 2010 and 2009, all of which was included in equity in earnings (losses) of unconsolidated joint ventures, as follows (in thousands):

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Stock-based compensation expense

 

$

7

 

$

20

 

$

33

 

$

44

 

 

The Company received $0.3 million in distributions from its BuyEfficient joint venture during both the three months ended September 30, 2010 and 2009, and $0.6 million and $0.3 million for the nine months ended September 30, 2010 and 2009, respectively.

 

During the fourth quarter of 2009, the Doubletree Guest Suites Times Square recorded an impairment loss in accordance with the Property, Plant and Equipment Topic of the FASB ASC, reducing the members’ equity in the joint venture to a deficit.  The Company has no guaranteed obligations to fund any losses of the partnership; therefore, in accordance with the Investments — Equity Method and Joint Ventures Topic of the FASB ASC, the Company’s impairment loss was limited to its remaining $26.0 million investment in the partnership. The impairment charge effectively reduced the value of the Company’s 38% interest in the partnership to zero. Although the Doubletree Guest Suites Times Square joint venture earned income of $0.5 million and $0.1 million during the three and nine months ended September 30, 2010, respectively, the Company did not recognize any portion of this income as the value of its interest in the partnership was reduced to zero at December 31, 2009. The Company will not recognize any future income from this joint venture until its share of such earnings exceeds its share of cumulative losses in excess of the zero book value of its 38% interest in the joint venture.

 

Annual dividends on the Company’s equity investment in the Doubletree Guest Suites Times Square are senior to the returns on equity to other investors in this joint venture.  The annual dividend accrual rates, which are calculated as a percentage of the Company’s original $40.0 million investment, were initially 8.0%, are currently 8.5%, and will increase to 9.25% over a nine-year period. In addition, the Company’s equity investment is entitled to receive a pro-rata share of any excess equity distributions made by the joint venture. The Company received no distributions during either the three or nine months ended September 30, 2010 or 2009.

 

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7. Goodwill

 

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

 

As of September 30, 2010 and December 31, 2009, goodwill consisted of the following (in thousands):

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

(unaudited)

 

 

 

Beginning balance

 

$

4,673

 

$

8,621

 

Goodwill impairment loss — operations held for investment

 

 

(3,948

)

Ending balance

 

$

4,673

 

$

4,673

 

 

8. Other Assets

 

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

 

 

 

September 30,
2010

 

December 31,
2009

 

 

 

(unaudited)

 

 

 

Property and equipment, net

 

$

1,819

 

$

1,125

 

Deposits

 

2,358

 

 

Other receivables

 

7,535

 

2,567

 

Other

 

2,425

 

2,526

 

 

 

$

14,137

 

$

6,218

 

 

In September 2010, the Company paid a good faith deposit of $2.4 million related to the expected refinancing of the $81.0 million mortgage on its Hilton Times Square, which is scheduled to mature in December 2010. Once the refinance has been completed, a portion of this deposit will be refunded to the Company and a portion will be applied to deferred financing fees and amortized over the life of the loan (see Footnote 17).

 

Prior to its acquisition of the Royal Palm Miami Beach in August 2010, the Company purchased a portion of the hotel’s debt with a principal amount of $17.1 million for $3.0 million. In conjunction with the purchase of the hotel, the Company received $5.4 million, net of related costs, as a partial payment of this debt, and will receive an additional $3.1 million no later than February 2012. The Company has included the additional $3.1 million receivable in other assets.

 

In April 2010, the Company purchased two hotel loans for $3.7 million that have a combined principal amount of $32.5 million. The loans include (i) a $30.0 million, 8.5% mezzanine loan maturing in January 2017 secured by the equity interests in the Company’s Doubletree Guest Suites Times Square joint venture (see Footnote 6), and (ii) a $2.5 million, 8.075% subordinate note maturing in November 2010 secured by the 101-room boutique hotel known as Twelve Atlantic Station in Atlanta, Georgia. The Company purchased the mezzanine loan for $3.45 million and the subordinate note for $250,000. None of the debt on the Doubletree Guest Suites Times Square is in default, however interest payments on the mezzanine loan are currently being deferred in accordance with the provisions of the loan. The subordinate note secured by the Twelve Atlantic Station is currently in default. The Company will account for both loans using the cost recovery method until such time as the expected cash flows from the loans are reasonably probable and estimable. No amounts were received for either note during the three and nine months ended September 30, 2010.

 

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Table of Contents

 

In 2006, the Company sold 13 hotels for gross proceeds of $144.1 million. As a condition of the transaction, the Company currently holds a promissory note from the buyer of the 13 hotels (the “Buyer”) for $5.6 million, with interest accruing at 8% per annum. The note is interest only and is secured by an equity pledge in the Buyer’s legal investment entity. In December 2009, the Company received notice that the Buyer requested a loan modification from the Senior Note Lender, indicating that the Company’s $5.6 million mezzanine loan along with the accrued interest may not be collectible. As such, the Company recorded an allowance for bad debt of $5.6 million to other assets, net in December 2009, which reserved both the discounted note and the related interest receivable in full at December 31, 2009. The Company suspended recording interest receivable on the note, and any amounts received from the Buyer in the future will be applied first towards the principal amount of the note. During the three and nine months ended September 30, 2010, the Company received zero and $0.1 million, respectively, from the Buyer and applied these receipts towards the principal amount of the note as recoveries of bad debt which were included in corporate overhead.

 

9. Notes Payable

 

Notes payable consisted of the following (in thousands):

 

 

 

September 30,
2010

 

December 31,
2009

 

 

 

(unaudited)

 

 

 

Notes payable requiring payments of interest and principal, with fixed rates ranging from 4.98% to 9.88%; maturing at dates ranging from December 2010 through May 2021. The notes are collateralized by first deeds of trust on 27 hotel properties and one laundry facility at September 30, 2010, and 30 hotel properties and one laundry facility at December 31, 2009.

 

$

1,237,489

 

$

1,328,611

 

 

 

 

 

 

 

Senior Notes, with a fixed interest rate of 4.60%, maturing in July 2027. The notes are guaranteed by the Company and certain of its subsidiaries.

 

62,500

 

62,500

 

 

 

1,299,989

 

1,391,111

 

Less: discount on Senior Notes

 

(2,450

)

(3,193

)

 

 

1,297,539

 

1,387,918

 

Less: notes payable of operations held for non-sale disposition

 

(162,972

)

(184,121

)

Less: current portion

 

(94,810

)

(153,778

)

 

 

$

1,039,757

 

$

1,050,019

 

 

The Company’s 2009 secured debt restructuring program was initiated to address cash flow and value deficits among certain of its hotels securing non-recourse mortgage debt. The status of the final four loans included in the 2009 secured debt restructuring program is discussed further below.

 

W San Diego. On July 2, 2010, the Company completed its previously announced deed back of the W San Diego, and title to the hotel was transferred to the lender. The Company recorded a $35.4 million gain on extinguishment of this debt, which is included in discontinued operations, and the net assets and liabilities were removed from its 2010 balance sheet.

 

Renaissance Westchester. On June 14, 2010, the Company reacquired the Renaissance Westchester for $26.0 million, including related costs. In connection with the repurchase of the Renaissance Westchester, the $29.2 million non-recourse mortgage secured by the hotel was cancelled. The Company recorded a $6.7 million gain on the extinguishment of this debt, which is included in discontinued operations. Operating results for the Renaissance Westchester for 2009, therefore, are included in discontinued operations, whereas operating results from June 14, 2010 forward are included in the Company’s continuing operations.

 

Marriott Ontario Airport. On August 12, 2010, the Marriott Ontario Airport was sold by the receiver, and title to the hotel was transferred to the hotel’s new owner. The Company recorded a $5.1 million gain on extinguishment of this debt, which is included in discontinued operations, and the net assets and liabilities were removed from its 2010 balance sheet.

 

Massachusetts Mutual Life Insurance Company. In April 2010, the Company finalized an agreement with Massachusetts Mutual Life Insurance Company, or Mass Mutual, the lender’s representative for a $246.0 million, 5.95% non-recourse mortgage loan secured by 11 of the Company’s hotels comprised of 2,587 rooms. As part of the agreement, the Company agreed to pay down $83.0 million of the Mass Mutual loan in exchange for the release of three hotels from the loan. Also pursuant to this agreement, the Company expects to complete the deed back of the Mass Mutual eight hotels in satisfaction of the remaining $163.0 million loan balance during 2010. Pending the completion of the deed back or appointment of a receiver, the Company has reclassified the assets, liabilities and results of operations of the Mass Mutual eight to “operations held for non-sale disposition” on its balance sheets, statements of operations and statements of cash flows. Upon completion of the deed back or appointment of a receiver, the assets and liabilities associated with the Mass Mutual eight will be deconsolidated (see Footnote 17).

 

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Table of Contents

 

Total interest incurred and expensed on the notes payable was as follows (in thousands):

 

 

 

Three Months Ended
September 30, 2010

 

Three Months Ended 
September 30, 2009

 

Nine Months Ended
September 30, 2010

 

Nine Months Ended
September 30, 2009

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Operations held for investment:

 

 

 

 

 

 

 

 

 

Interest expense

 

$

16,116

 

$

17,371

 

$

49,239

 

$

54,626

 

Interest expense — default rate (1)

 

 

 

884

 

 

Accretion of Senior Notes

 

252

 

237

 

743

 

1,576

 

Amortization of deferred financing fees

 

303

 

582

 

1,102

 

1,217

 

Write-off of deferred financing fees

 

 

 

1,585

 

284

 

Loan penalties and fees (2)

 

 

 

174

 

 

 

 

$

16,671

 

$

18,190

&