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Table of Contents

UNITED STATES
SECURITIES 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, 2021

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 of
Incorporation or Organization)

(I.R.S. Employer
Identification Number)

200 Spectrum Center Drive, 21st Floor
Irvine, California

92618

(Address of Principal Executive Offices)

(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

Common Stock, $0.01 par value

SHO

New York Stock Exchange

Series E Cumulative Redeemable Preferred Stock, $0.01 par value

SHO.PRE

New York Stock Exchange

Series F Cumulative Redeemable Preferred Stock, $0.01 par value

SHO.PRF

New York Stock Exchange

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 April 30, 2021, there were 216,238,328 shares of Sunstone Hotel Investors, Inc.’s common stock, $0.01 par value per share, outstanding.

Table of Contents

SUNSTONE HOTEL INVESTORS, INC.

QUARTERLY REPORT ON

FORM 10-Q

For the Quarterly Period Ended March 31, 2021

TABLE OF CONTENTS

Page

PART I—FINANCIAL INFORMATION

Item 1.

Financial Statements

2

Consolidated Balance Sheets as of March 31, 2021 (unaudited) and December 31, 2020

2

Unaudited Consolidated Statements of Operations for the Three Months Ended March 31, 2021 and 2020

3

Unaudited Consolidated Statements of Equity for the Three Months Ended March 31, 2021 and 2020

4

Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2021 and 2020

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

40

Item 4.

Controls and Procedures

40

PART II—OTHER INFORMATION

Item 1.

Legal Proceedings

42

Item 1A.

Risk Factors

42

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

Item 3.

Defaults Upon Senior Securities

42

Item 4.

Mine Safety Disclosures

42

Item 5.

Other Information

42

Item 6.

Exhibits

43

SIGNATURES

44

Table of Contents

PART I—FINANCIAL INFORMATION

Item 1.

Financial Statements

SUNSTONE HOTEL INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

March 31,

December 31,

    

2021

    

2020

(unaudited)

ASSETS

Current assets:

Cash and cash equivalents

$

320,275

$

368,406

Restricted cash

44,982

47,733

Accounts receivable, net

13,163

8,566

Prepaid expenses and other current assets

11,434

10,440

Total current assets

389,854

435,145

Investment in hotel properties, net

2,439,963

2,461,498

Finance lease right-of-use asset, net

45,814

46,182

Operating lease right-of-use assets, net

25,196

26,093

Deferred financing costs, net

3,879

4,354

Other assets, net

11,968

12,445

Total assets

$

2,916,674

$

2,985,717

LIABILITIES AND EQUITY

Current liabilities:

Accounts payable and accrued expenses

$

34,292

$

37,326

Accrued payroll and employee benefits

13,435

15,392

Dividends and distributions payable

3,207

3,208

Other current liabilities

31,013

32,606

Current portion of notes payable, net

2,295

2,261

Total current liabilities

84,242

90,793

Notes payable, less current portion, net

741,922

742,528

Finance lease obligation, less current portion

15,569

15,569

Operating lease obligations, less current portion

28,649

29,954

Other liabilities

14,679

17,494

Total liabilities

885,061

896,338

Commitments and contingencies (Note 11)

Equity:

Stockholders’ equity:

Preferred stock, $0.01 par value, 100,000,000 shares authorized:

6.95% Series E Cumulative Redeemable Preferred Stock, 4,600,000 shares issued and outstanding at March 31, 2021 and December 31, 2020, stated at liquidation preference of $25.00 per share

115,000

115,000

6.45% Series F Cumulative Redeemable Preferred Stock, 3,000,000 shares issued and outstanding at March 31, 2021 and December 31, 2020, stated at liquidation preference of $25.00 per share

75,000

75,000

Common stock, $0.01 par value, 500,000,000 shares authorized, 216,175,084 shares issued and outstanding at March 31, 2021 and 215,593,401 shares issued and outstanding at December 31, 2020

2,162

2,156

Additional paid in capital

2,585,455

2,586,108

Retained earnings

860,454

913,766

Cumulative dividends and distributions

(1,646,593)

(1,643,386)

Total stockholders’ equity

1,991,478

2,048,644

Noncontrolling interest in consolidated joint venture

40,135

40,735

Total equity

2,031,613

2,089,379

Total liabilities and equity

$

2,916,674

$

2,985,717

See accompanying notes to consolidated financial statements.

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SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

Three Months Ended March 31,

    

2021

    

2020

REVENUES

Room

$

34,219

$

127,400

Food and beverage

4,971

47,990

Other operating

11,443

15,822

Total revenues

50,633

191,212

OPERATING EXPENSES

Room

11,640

44,245

Food and beverage

5,979

41,760

Other operating

1,805

3,764

Advertising and promotion

4,875

12,462

Repairs and maintenance

5,545

10,049

Utilities

4,151

5,842

Franchise costs

991

5,336

Property tax, ground lease and insurance

14,661

20,051

Other property-level expenses

10,477

28,845

Corporate overhead

7,177

7,394

Depreciation and amortization

30,770

36,746

Impairment losses

115,366

Total operating expenses

98,071

331,860

Interest and other income (loss)

(379)

2,306

Interest expense

(7,649)

(17,507)

Gain on extinguishment of debt

222

Loss before income taxes

(55,244)

(155,849)

Income tax provision, net

(43)

(6,670)

NET LOSS

(55,287)

(162,519)

Loss from consolidated joint venture attributable to noncontrolling interest

1,975

458

Preferred stock dividends

(3,207)

(3,207)

LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS

$

(56,519)

$

(165,268)

Basic and diluted per share amounts:

Basic and diluted loss attributable to common stockholders per common share

$

(0.26)

$

(0.75)

Basic and diluted weighted average common shares outstanding

214,438

221,036

See accompanying notes to consolidated financial statements.

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SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY

(In thousands, except share and per share data)

Preferred Stock

Noncontrolling

Series E

Series F

Common Stock

Cumulative

Interest in

Number of

Number of

Number of

Additional

Retained

Dividends and

Consolidated

    

Shares

    

Amount

Shares

    

Amount

    

Shares

    

Amount

    

Paid in Capital

    

 Earnings

    

Distributions

    

    Joint Venture    

    

Total Equity

Balance at December 31, 2020 (audited)

4,600,000

$

115,000

3,000,000

$

75,000

215,593,401

$

2,156

$

2,586,108

$

913,766

$

(1,643,386)

$

40,735

$

2,089,379

Amortization of deferred stock compensation

2,869

2,869

Issuance of restricted common stock, net

581,683

6

(3,522)

(3,516)

Series E preferred stock dividends and dividends payable at $0.434375 per share

(1,998)

(1,998)

Series F preferred stock dividends and dividends payable at $0.403125 per share

(1,209)

(1,209)

Contribution from noncontrolling interest

1,375

1,375

Net loss

(53,312)

(1,975)

(55,287)

Balance at March 31, 2021

4,600,000

$

115,000

3,000,000

$

75,000

216,175,084

$

2,162

$

2,585,455

$

860,454

$

(1,646,593)

$

40,135

$

2,031,613

See accompanying notes to consolidated financial statements.

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SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY

(In thousands, except share and per share data)

Preferred Stock

Noncontrolling

Series E

Series F

Common Stock

Cumulative

Interest in

Number of

Number of

Number of

Additional

Retained

Dividends and

Consolidated

Shares

    

Amount

Shares

    

Amount

    

Shares

    

Amount

    

Paid in Capital

    

 Earnings

    

Distributions

    

    Joint Venture    

    

Total Equity

Balance at December 31, 2019 (audited)

4,600,000

$

115,000

3,000,000

$

75,000

224,855,351

$

2,249

$

2,683,913

$

1,318,455

$

(1,619,779)

$

46,233

$

2,621,071

Amortization of deferred stock compensation

2,324

2,324

Issuance of restricted common stock, net

456,219

4

(3,996)

(3,992)

Forfeiture of restricted common stock

(355)

Common stock distributions and distributions payable at $0.05 per share

(10,777)

(10,777)

Series E preferred stock dividends and dividends payable at $0.434375 per share

(1,998)

(1,998)

Series F preferred stock dividends and dividends payable at $0.403125 per share

(1,209)

(1,209)

Distributions to noncontrolling interest

(2,000)

(2,000)

Repurchases of outstanding common stock

(9,770,081)

(98)

(103,796)

(103,894)

Net loss

(162,061)

(458)

(162,519)

Balance at March 31, 2020

4,600,000

$

115,000

3,000,000

$

75,000

215,541,134

$

2,155

$

2,578,445

$

1,156,394

$

(1,633,763)

$

43,775

$

2,337,006

See accompanying notes to consolidated financial statements.

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SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Three Months Ended March 31,

    

2021

    

2020

CASH FLOWS FROM OPERATING ACTIVITIES

Net loss

$

(55,287)

$

(162,519)

Adjustments to reconcile net loss to net cash used in operating activities:

Bad debt expense

16

318

Loss on sale of assets

70

Gain on extinguishment of debt

(222)

Noncash interest on derivatives

(869)

6,080

Depreciation

30,760

36,736

Amortization of franchise fees and other intangibles

10

10

Amortization of deferred financing costs

735

699

Amortization of deferred stock compensation

2,752

2,207

Impairment losses

115,366

Deferred income taxes, net

7,415

Changes in operating assets and liabilities:

Accounts receivable

(4,613)

11,757

Prepaid expenses and other assets

(776)

(247)

Accounts payable and other liabilities

(8,463)

(12,226)

Accrued payroll and employee benefits

(1,957)

(7,860)

Operating lease right-of-use assets and obligations

(331)

(261)

Net cash used in operating activities

(38,175)

(2,525)

CASH FLOWS FROM INVESTING ACTIVITIES

Disposition deposit

3,500

Acquisition of hotel property

(346)

Renovations and additions to hotel properties and other assets

(6,526)

(17,016)

Net cash used in investing activities

(6,526)

(13,862)

CASH FLOWS FROM FINANCING ACTIVITIES

Repurchases of outstanding common stock

(103,894)

Repurchases of common stock for employee tax obligations

(3,516)

(3,992)

Proceeds from credit facility

300,000

Payments on notes payable

(832)

(1,898)

Dividends and distributions paid

(3,208)

(135,872)

Distributions to noncontrolling interest

(2,000)

Contribution from noncontrolling interest

1,375

Net cash (used in) provided by financing activities

(6,181)

52,344

Net (decrease) increase in cash and cash equivalents and restricted cash

(50,882)

35,957

Cash and cash equivalents and restricted cash, beginning of period

416,139

864,973

Cash and cash equivalents and restricted cash, end of period

$

365,257

$

900,930

See accompanying notes to consolidated financial statements.

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SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Supplemental Disclosure of Cash Flow Information

March 31,

2021

2020

Cash and cash equivalents

$

320,275

$

847,445

Restricted cash

44,982

53,485

Total cash and cash equivalents and restricted cash shown on the consolidated statements of cash flows

$

365,257

$

900,930

Three Months Ended March 31,

2021

2020

Cash paid for interest

$

10,696

$

13,091

Cash (refunds) paid for income taxes, net

$

(28)

$

77

Operating cash flows used for operating leases

$

1,664

$

1,875

Changes in operating lease right-of-use assets

$

897

$

897

Changes in operating lease obligations

(1,228)

(1,158)

Changes in operating lease right-of-use assets and lease obligations, net

$

(331)

$

(261)

Supplemental Disclosure of Noncash Investing and Financing Activities

Three Months Ended March 31,

2021

2020

Accrued renovations and additions to hotel properties and other assets

$

5,402

$

9,382

Amortization of deferred stock compensation — construction activities

$

117

$

117

Dividends and distributions payable

$

3,207

$

13,984

See accompanying notes to consolidated financial statements.

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SUNSTONE HOTEL INVESTORS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Description of Business

Sunstone Hotel Investors, Inc. (the “Company”) was incorporated in Maryland on June 28, 2004 in anticipation of an initial public offering of common stock, which was consummated on October 26, 2004. The Company elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes, commencing with its taxable year ended on December 31, 2004. The Company, through its 100% controlling interest in Sunstone Hotel Partnership, LLC (the “Operating Partnership”), of which the Company is the sole managing member, and the subsidiaries of the Operating Partnership, including Sunstone Hotel TRS Lessee, Inc. (the “TRS Lessee”) and its subsidiaries, is currently engaged in acquiring, owning, asset managing and renovating or repositioning hotel properties, and may also selectively sell hotels that no longer fit its stated strategy.

As a REIT, certain tax laws limit the amount of “non-qualifying” income the Company can earn, including income derived directly from the operation of hotels. The Company leases all of its hotels to its TRS Lessee, which in turn enters into long-term management agreements with third parties to manage the operations of the Company’s hotels, in transactions that are intended to generate qualifying income.

As of March 31, 2021, the Company had interests in 17 hotels (the “17 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”)

6

Crestline Hotels & Resorts

2

Highgate Hotels L.P. and an affiliate

2

Hilton Worldwide

2

Interstate Hotels & Resorts, Inc.

2

Davidson Hotels & Resorts

1

Hyatt Corporation

1

Singh Hospitality, LLC

1

Total hotels owned as of March 31, 2021

17

In March 2020, the novel coronavirus (“COVID-19”) pandemic was declared a National Public Health Emergency, which led to significant cancellations, corporate and government travel restrictions and an unprecedented decline in hotel demand. As a result of these cancellations, restrictions and the health concerns related to COVID-19, the Company determined that it was in the best interest of its hotel employees and the communities in which its hotels operate to temporarily suspend operations at 14 of the 17 Hotels, 13 of which have since resumed operations as of May 1, 2021:

Hotel

Suspension Date

Resumption Date

Oceans Edge Resort & Marina

March 22, 2020

June 4, 2020

Embassy Suites Chicago

April 1, 2020

July 1, 2020

Marriott Boston Long Wharf

March 12, 2020

July 7, 2020

Hilton New Orleans St. Charles

March 28, 2020

July 13, 2020

Hyatt Centric Chicago Magnificent Mile

April 6, 2020

July 13, 2020

JW Marriott New Orleans

March 28, 2020

July 14, 2020

Hilton San Diego Bayfront

March 23, 2020

August 11, 2020

Renaissance Washington DC

March 26, 2020

August 24, 2020

Hyatt Regency San Francisco

March 22, 2020

October 1, 2020

Renaissance Orlando at SeaWorld®

March 20, 2020

October 1, 2020

The Bidwell Marriott Portland

March 27, 2020

October 5, 2020

Wailea Beach Resort

March 25, 2020

November 1, 2020

Hilton Garden Inn Chicago Downtown/Magnificent Mile

March 27, 2020

April 1, 2021

Renaissance Westchester

April 4, 2020

The Company is unable to predict when its remaining temporarily suspended hotel will resume its operations, or if those hotels that have resumed operations will be temporarily suspended again. The extent of the effects of the pandemic on the Company’s

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business and the hotel industry at large, however, will ultimately depend on future developments, including, but not limited to, the duration and severity of the pandemic, how quickly and successfully effective vaccines and therapies are distributed and administered, as well as the length of time it takes for demand and pricing to return and normal economic and operating conditions to resume.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements as of March 31, 2021 and December 31, 2020, and for the three months ended March 31, 2021 and 2020, 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, 2020, filed with the Securities and Exchange Commission on February 12, 2021. Operating results for the three months ended March 31, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.

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) are considered participating securities and are included in the computation of earnings per share.

Basic earnings (loss) attributable to common stockholders per common share is computed based on the weighted average number of shares of common stock outstanding during each period. Diluted earnings (loss) attributable to common stockholders per common share is computed based on the weighted average number of shares of common stock outstanding during each period, plus potential common shares considered outstanding during the period, as long as the inclusion of such awards is not anti-dilutive. Potential common shares consist of unvested restricted stock awards, using the more dilutive of either the two-class method or the treasury stock method.

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

Three Months Ended March 31,

    

2021

    

2020

Numerator:

Net loss

$

(55,287)

$

(162,519)

Loss from consolidated joint venture attributable to noncontrolling interest

1,975

458

Preferred stock dividends

(3,207)

(3,207)

Distributions paid on unvested restricted stock compensation

(69)

Numerator for basic and diluted loss attributable to common stockholders

$

(56,519)

$

(165,337)

Denominator:

Weighted average basic and diluted common shares outstanding

214,438

221,036

Basic and diluted loss attributable to common stockholders per common share

$

(0.26)

$

(0.75)

The Company’s unvested restricted shares associated with its long-term incentive plan have been excluded from the above calculation of earnings per share for the three months ended March 31, 2021 and 2020, as their inclusion would have been anti-dilutive.

Restricted Cash

Restricted cash is comprised of reserve accounts for debt service, interest reserves, seasonality reserves, capital replacements, ground leases, property taxes and hotel-generated cash that is held in an account for the benefit of a lender. These restricted funds are subject to disbursement approval based on in-place agreements and policies by certain of the Company’s lenders and/or hotel managers. In addition, restricted cash as of March 31, 2021 and December 31, 2020 includes $11.1 million and $11.6 million, respectively, held in escrow related to certain current and potential employee-related obligations in accordance with the assignment-in-lieu agreement between the Company and the mortgage holder of one of the Company’s former hotels (see Note 11). Restricted cash may also include earnest money received from a buyer or potential buyer of one of the Company’s hotels and held in escrow until either the sale is completed or subject to the terms of the related purchase and sale agreement.

Investments in Hotel Properties

Investments in hotel properties, including land, buildings, furniture, fixtures and equipment (“FF&E”) and identifiable intangible assets are recorded at fair value upon acquisition. Property and equipment purchased after the hotel acquisition date is recorded at cost. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation is removed from the Company’s accounts and any resulting gain or loss is included in the consolidated statements of operations.

Depreciation expense is based on the estimated life of the Company’s assets. The life 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 to 40 years for buildings and improvements and three to 12 years for FF&E. Finance lease right-of-use assets other than land are depreciated using the straight-line method over the shorter of either their estimated useful life or the life of the related finance lease obligation. Intangible assets are amortized using the straight-line method over the shorter of their estimated useful life or over the length of the related agreement.

The Company’s investment in hotel properties, net also includes initial franchise fees which are recorded at cost and amortized using the straight-line method over the terms of the franchise agreements ranging from 14 to 27 years. All other franchise fees that are based on the Company’s results of operations are expensed as incurred.

While the Company believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income or the gain or loss on the sale of any of the Company’s hotels. The Company has not changed the useful lives of any of its assets during the periods discussed.

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Impairment losses are recorded on long-lived assets to be held and used by the Company when indicators of impairment are present and the future undiscounted net cash flows, including potential sale proceeds, expected to be generated by those assets, based on the Company’s anticipated investment horizon, are less than the assets’ carrying amount. The Company evaluates its long-lived assets to determine if there are indicators of impairment on a quarterly basis. No single indicator would necessarily result in the Company preparing an estimate to determine if a hotel’s future undiscounted cash flows are less than the book value of the hotel. The Company uses judgment to determine if the severity of any single indicator, or the fact there are a number of indicators of less severity that when combined, would result in an indication that a hotel requires an estimate of the undiscounted cash flows to determine if an impairment has occurred. If a hotel is considered to be impaired, the related assets are adjusted to their estimated fair value and an impairment loss is recognized. The impairment loss recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. The Company performs a fair value assessment, using one or more discounted cash flow analyses to estimate the fair value of the hotel, taking into account the hotel’s expected cash flow from operations, the Company’s estimate of how long it will own the hotel and the estimated proceeds from the disposition of the hotel. When multiple cash flow analyses are prepared, a probability is assigned to each cash flow analysis based upon the estimated likelihood of each scenario occurring. The factors addressed in determining estimated proceeds from disposition include anticipated operating cash flow in the year of disposition and terminal capitalization rate. The Company’s judgment is required in determining the discount rate applied to estimated cash flows, the estimated growth of revenues and expenses, net operating income and margins, the need for capital expenditures, as well as specific market and economic conditions. Based on the Company’s review, no hotels were impaired during the first quarter of 2021.

Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than a forced or liquidation sale. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of current market yields as well as future events and conditions. Such future events and conditions include economic and market conditions, as well as the availability of suitable financing. The realization of the Company’s investment in hotel properties is dependent upon future uncertain events and conditions and, accordingly, the actual timing and amounts realized by the Company may be materially different from their estimated fair values.

Finance and Operating Leases

The Company determines if a contract is a lease at inception. Leases with an initial term of 12 months or less are not recorded on the balance sheet. Expense for these short-term leases is recognized on a straight-line basis over the lease term. For leases with an initial term greater than 12 months, the Company records a right-of-use (“ROU”) asset and a corresponding lease obligation. ROU assets represent the Company’s right to use an underlying asset for the lease term, and lease obligations represent the Company’s obligation to make fixed lease payments as stipulated by the lease. 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.

Operating lease ROU assets are recognized at the lease commencement date and include the amount of the initial operating lease obligation, any lease payments made at or before the commencement date, excluding any lease incentives received, and any initial direct costs incurred. For leases that have extension options that the Company can exercise at its discretion, management uses judgment to determine if it is reasonably certain that the Company will in fact exercise such option. If the extension option is reasonably certain to occur, the Company includes the extended term’s lease payments in the calculation of the respective lease liability. None of the Company’s leases contain any material residual value guarantees or material restrictive covenants.

Operating lease obligations are recognized at the lease commencement date based on the present value of lease payments over the lease term. As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate (“IBR”) based on information available at the commencement date in determining the present value of lease payments over the lease term. The IBR is the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. In order to estimate the Company’s IBR, the Company first looks to its own unsecured debt offerings, and adjusts the rate for both length of term and secured borrowing using available market data as well as consultations with leading national financial institutions that are active in the issuance of both secured and unsecured notes.

The Company reviews its right-of-use assets for indicators of impairment. If such assets are considered to be impaired, the related assets are adjusted to their estimated fair value and an impairment loss is recognized. The impairment loss recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Based on the Company’s review, no operating lease ROU assets were impaired during the first quarter of 2021.

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Noncontrolling Interest

The Company’s consolidated financial statements include an entity in which the Company has a controlling financial interest. Noncontrolling interest is the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. Such noncontrolling interest is reported on the consolidated balance sheets within equity, separately from the Company’s equity. On the consolidated statements of operations, revenues, expenses and net income or loss from the less-than-wholly owned subsidiary are reported at their consolidated amounts, including both the amounts attributable to the Company and the noncontrolling interest. Income or loss is allocated to the noncontrolling interest based on its weighted average ownership percentage for the applicable period. The consolidated statements of equity include beginning balances, activity for the period and ending balances for each component of stockholders’ equity, noncontrolling interest and total equity.

At both March 31, 2021 and December 31, 2020, the noncontrolling interest reported in the Company’s consolidated financial statements consisted of a third-party’s 25.0% ownership interest in the Hilton San Diego Bayfront.

Revenue Recognition

Revenues are recognized when control of the promised goods or services is transferred to hotel guests, which is generally defined as the date upon which a guest occupies a room and/or utilizes the hotel’s services. Room revenue and other occupancy based fees are recognized over a guest’s stay at 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 separately from a hotel room. 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.

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):

March 31,

December 31,

2021

2020

(unaudited)

Trade receivables, net (1)

$

7,336

$

8,110

Contract liabilities (2)

$

16,985

$

16,815

(1)Trade receivables are included in accounts receivable, net on the accompanying consolidated balance sheets.
(2)Contract liabilities consist of advance deposits and are included in either other current liabilities or other liabilities on the accompanying consolidated balance sheets.

During the three months ended March 31, 2021 and 2020, the Company recognized approximately $0.8 million and $10.2 million, respectively, in revenue related to its outstanding contract liabilities.

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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, and is applied prospectively from any date beginning March 12, 2020. The relief is temporary and generally cannot be applied to contract modifications that occur after December 31, 2022. The Company intends to take advantage of the expedients offered by ASU No. 2020-04 when it modifies its variable rate debt, which includes the Company’s $220.0 million loan secured by the Hilton San Diego Bayfront, its credit facility and its unsecured term loans. The adoption of ASU No. 2020-04 is not expected to have a material impact on the Company’s consolidated financial statements.

3. Investment in Hotel Properties

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

March 31,

December 31,

    

2021

    

2020

(unaudited)

Land

$

571,212

$

571,212

Buildings and improvements

2,527,654

2,523,750

Furniture, fixtures and equipment

432,493

431,918

Intangible assets

21,192

21,192

Franchise fees

743

743

Construction in progress

19,933

15,831

Investment in hotel properties, gross

3,573,227

3,564,646

Accumulated depreciation and amortization

(1,133,264)

(1,103,148)

Investment in hotel properties, net

$

2,439,963

$

2,461,498

4. Fair Value Measurements and Interest Rate Derivatives

Fair Value Measurements

As of March 31, 2021 and December 31, 2020, the carrying amount of certain financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses were representative of their fair values due to the short-term maturity of these instruments.

A fair value measurement is based on the assumptions that market participants would use in pricing an asset or liability in an orderly transaction. The hierarchy for inputs used in measuring fair value is as follows:

Level 1

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

Level 2

Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or

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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, 2021 and December 31, 2020, the Company measured its interest rate derivatives at fair value on a recurring basis. The Company estimated the fair value of its interest rate derivatives using Level 2 measurements based on quotes obtained from the counterparties, which are based upon the consideration that would be required to terminate the agreements.

The following table presents the Company’s assets measured at fair value on a recurring and nonrecurring basis at March 31, 2021 and December 31, 2020 (in thousands):

Fair Value Measurements at Reporting Date

    

Total

    

Level 1

    

Level 2

    

Level 3

March 31, 2021 (unaudited):

Interest rate cap derivative

$

$