sho-Current Folio

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, 2016

☐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 ☒ No ☐

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 ☒ No ☐

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 ☒		Accelerated filer ☐

Non-accelerated filer ☐		Smaller reporting company ☐
(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 ☐ No ☒

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

216,582,281 shares of Common Stock, $0.01 par value, as of April 29, 2016

PART I—FINANCIAL INFORMATION

Item 1.Financial Statements

SUNSTONE HOTEL INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)



	March 31,		December 31,
	2016		2015
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	396,669	$	499,067
Restricted cash		68,313		76,180
Accounts receivable, net		46,311		32,024
Inventories		1,356		1,395
Prepaid expenses		12,778		10,879
Total current assets		525,427		619,545
Investment in hotel properties, net		3,243,975		3,229,010
Deferred financing fees, net		3,102		4,310
Other assets, net		9,286		10,386
Total assets	$	3,781,790	$	3,863,251
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	39,460	$	30,193
Accrued payroll and employee benefits		18,911		28,023
Dividends payable		13,592		265,124
Other current liabilities		45,479		41,877
Current portion of notes payable, net		149,021		85,776
Total current liabilities		266,463		450,993
Notes payable, less current portion, net		929,390		1,010,819
Capital lease obligations, less current portion		15,575		15,575
Other liabilities		41,052		34,744
Total liabilities		1,252,480		1,512,131
Commitments and contingencies (Note 10)
Equity:
Stockholders’ equity:
Preferred stock, $0.01 par value, 100,000,000 shares authorized.
8.0% Series D Cumulative Redeemable Preferred Stock, 4,600,000 shares issued and outstanding at March 31, 2016 and December 31, 2015, stated at liquidation preference of $25.00 per share		115,000		115,000
6.95% Series E Cumulative Redeemable Preferred Stock, 4,600,000 shares issued and outstanding at March 31, 2016 and zero shares issued and outstanding at December 31, 2015, stated at liquidation preference of $25.00 per share		115,000		—
Common stock, $0.01 par value, 500,000,000 shares authorized, 216,516,858 shares issued and outstanding at March 31, 2016 and 207,604,391 shares issued and outstanding at December 31, 2015		2,165		2,076
Additional paid in capital		2,535,141		2,458,889
Retained earnings		652,270		652,704
Cumulative distributions		(941,460)		(927,868)
Total stockholders’ equity		2,478,116		2,300,801
Noncontrolling interest in consolidated joint venture		51,194		50,319
Total equity		2,529,310		2,351,120
Total liabilities and equity	$	3,781,790	$	3,863,251

See accompanying notes to consolidated financial statements.

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(In thousands, except per share data)



	Three Months Ended		Three Months Ended
	March 31, 2016		March 31, 2015
REVENUES
Room	$	187,297	$	193,291
Food and beverage		71,234		72,184
Other operating		15,761		18,910
Total revenues		274,292		284,385
OPERATING EXPENSES
Room		51,044		53,842
Food and beverage		51,929		50,219
Other operating		4,056		5,131
Advertising and promotion		14,993		15,360
Repairs and maintenance		11,264		11,558
Utilities		7,514		8,985
Franchise costs		8,096		8,600
Property tax, ground lease and insurance		22,840		23,613
Property general and administrative		34,713		34,449
Corporate overhead		6,717		14,253
Depreciation and amortization		40,047		40,707
Total operating expenses		253,213		266,717
Operating income		21,079		17,668
Interest and other income		489		946
Interest expense		(20,010)		(17,326)
Loss on extinguishment of debt		(105)		—
Income before income taxes		1,453		1,288
Income tax provision		(237)		(85)
NET INCOME		1,216		1,203
Income from consolidated joint ventures attributable to noncontrolling interests		(1,650)		(2,181)
Preferred stock dividends		(2,766)		(2,300)
LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	(3,200)	$	(3,278)

COMPREHENSIVE INCOME	$	1,216	$	1,203
COMPREHENSIVE LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	(3,200)	$	(3,278)
Basic and diluted per share amounts:
Basic and diluted loss attributable to common stockholders per common share	$	(0.02)	$	(0.02)
Basic and diluted weighted average common shares outstanding		212,887		206,600

Dividends declared per common share	$	0.05	$	0.05

See accompanying notes to consolidated financial statements.

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENT OF EQUITY

(In thousands, except share data)


	Preferred Stock															Noncontrolling
	Series D			Series E			Common Stock									Interests in
	Number of			Number of			Number of			Additional		Retained		Cumulative		Consolidated
	Shares	Amount		Shares	Amount		Shares	Amount		Paid in Capital		Earnings		Distributions		Joint Ventures		Total
Balance at December 31, 2015 (audited)	4,600,000	$	115,000	—	$	—	207,604,391	$	2,076	$	2,458,889	$	652,704	$	(927,868)	$	50,319	$	2,351,120
Net proceeds from sale of preferred stock	—		—	4,600,000		115,000	—		—		(4,016)		—		—		—		110,984
Deferred stock compensation, net	—		—	—		—	1,490,386		15		1,519		—		—		—		1,534
Issuance of common stock dividends declared in 2015 at $1.26 per share	—		—	—		—	7,422,081		74		78,749		—		—		—		78,823
Common stock dividends and dividends payable at $0.05 per share year to date	—		—	—		—	—		—		—		—		(10,826)		—		(10,826)
Series D preferred stock dividends and dividends payable at $0.50 per share year to date	—		—	—		—	—		—		—		—		(2,300)		—		(2,300)
Series E preferred stock dividends and dividends payable at $0.101354 per share year to date	—		—	—		—	—		—		—		—		(466)		—		(466)
Distributions to noncontrolling interest	—		—	—		—	—		—		—		—		—		(775)		(775)
Net income (loss)	—		—	—		—	—		—		—		(434)		—		1,650		1,216
Balance at March 31, 2016	4,600,000	$	115,000	4,600,000	$	115,000	216,516,858	$	2,165	$	2,535,141	$	652,270	$	(941,460)	$	51,194	$	2,529,310

See accompanying notes to consolidated financial statements.

SUNSTONE HOTEL INVESTORS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



	Three Months Ended		Three Months Ended
	March 31, 2016		March 31, 2015
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	1,216	$	1,203
Adjustments to reconcile net income to net cash provided by operating activities:
Bad debt expense		109		138
Gain on sale of assets, net		(7)		—
Loss on extinguishment of debt		105		—
Loss on derivatives, net		6,402		—
Depreciation		39,333		39,465
Amortization of franchise fees and other intangibles		773		2,049
Amortization of deferred financing fees		555		639
Amortization of deferred stock compensation		1,614		2,895
Changes in operating assets and liabilities:
Restricted cash		8,176		6,113
Accounts receivable		(14,396)		(16,818)
Inventories		39		68
Prepaid expenses and other assets		(1,729)		(1,768)
Accounts payable and other liabilities		7,691		17,406
Accrued payroll and employee benefits		(6,790)		(13,184)
Net cash provided by operating activities		43,091		38,206
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of other assets		7		—
Restricted cash — replacement reserve		(309)		(11,299)
Renovations and additions to hotel properties		(48,818)		(36,120)
Net cash used in investing activities		(49,120)		(47,419)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from preferred stock offering		115,000		—
Payment of preferred stock offering costs		(4,016)		—
Repurchase of common stock for employee withholding obligations		(2,641)		(9,224)
Proceeds from note payable		100,000		—
Payments on notes payable		(117,558)		(5,875)
Payments of deferred financing costs		(78)		(10)
Dividends paid		(186,301)		(39,345)
Distributions to noncontrolling interests		(775)		(1,457)
Net cash used in financing activities		(96,369)		(55,911)
Net decrease in cash and cash equivalents		(102,398)		(65,124)
Cash and cash equivalents, beginning of period		499,067		222,096
Cash and cash equivalents, end of period	$	396,669	$	156,972
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest	$	12,455	$	15,240
Cash paid (refunds received) for income taxes, net	$	204	$	(647)
NONCASH INVESTING ACTIVITY
Increase in accounts payable related to renovations and additions to hotel properties and other assets	$	5,844	$	3,808
Amortization of deferred stock compensation — construction activities	$	239	$	165
NONCASH FINANCING ACTIVITY
Issuance of common stock dividends	$	78,823	$	37,349
Dividends payable	$	13,592	$	12,734

See accompanying notes to consolidated financial statements.

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, 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 March 31, 2016, the Company had interests in 29 hotels (the “29 hotels”) held for investment, and the Company’s third-party managers included the following:



		Number of Hotels
Subsidiaries of Marriott International, Inc. or Marriott Hotel Services, Inc. (collectively, “Marriott”)		11
Interstate Hotels & Resorts, Inc.		6
Highgate Hotels L.P. and an affiliate		3
Crestline Hotels & Resorts		2
Hilton Worldwide		2
Hyatt Corporation		2
Davidson Hotels & Resorts		1
Fairmont Hotels & Resorts (U.S.)		1
HEI Hotels & Resorts		1

Total hotels held for investment		29

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements as of March 31, 2016 and December 31, 2015, and for the three months ended March 31, 2016 and 2015, include the accounts of the Company, the Operating Partnership, the TRS Lessee and their subsidiaries. All significant intercompany balances and transactions have been eliminated. If the Company determines that it has an interest in a variable interest entity within the meaning of the Consolidation Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), the Company will consolidate the entity when it is determined to be the primary beneficiary of the entity. Based on its review, the Company determined that all of its subsidiaries were properly consolidated as of March 31, 2016 and December 31, 2015, and for the three months ended March 31, 2016 and 2015.

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, 2015, filed with the Securities and Exchange Commission on February 23, 2016.

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

Adjustment of Previously Issued Financial Statements

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU No. 2016-09”), which changes certain aspects of accounting for share-based payments to employees. The new guidance will require all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also will allow an employer to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as

they occur. ASU No. 2016-09 will become effective during the first quarter of 2017, with early adoption permitted, and will require a modified retrospective approach. The Company chose to early adopt ASU No. 2016-09 effective January 1, 2016. Upon adoption of ASU No. 2016-09, the Company elected to account for forfeitures as they occur. In addition, pursuant to employee statutory withholding obligations, the Company may repurchase more of an employee’s shares for tax withholding purposes up to the maximum statutory tax rate in the employee’s applicable jurisdictions.

In accordance with the transition provisions of the new guidance, the Company adjusted items on its consolidated balance sheet, consolidated statement of equity and consolidated statement of cash flows. The following financial statement line items have been adjusted on the Company’s consolidated balance sheet and consolidated statement of equity for the year ended December 31, 2015 in order to reverse the effects of forfeitures recognized in prior years, and on the consolidated statement of cash flows for the three months ended March 31, 2015 to reclassify the repurchase of employee common stock for employee withholding obligations from an operating activity to a financing activity (in thousands):


			Effect of Change in
	As Originally Reported		Accounting Principle		As Adjusted
			(unaudited)		(unaudited)
Consolidated Balance Sheet and Consolidated Statement of Equity as of December 31, 2015 (audited):
Additional paid in capital	$	2,458,735	$	154	$	2,458,889
Retained earnings	$	652,858	$	(154)	$	652,704

Consolidated Statement of Cash Flows for the three months ended March 31, 2015 (unaudited):
Accounts payable and other liabilities	$	8,182	$	9,224	$	17,406
Net cash provided by operating activities	$	28,982	$	9,224	$	38,206
Repurchase of common stock for employee withholding obligations	$	—	$	(9,224)	$	(9,224)
Net cash used in financing activities	$	(46,687)	$	(9,224)	$	(55,911)

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.

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 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 includes an allowance for doubtful accounts of $0.1 million at both March 31, 2016 and December 31, 2015.

Acquisitions of Hotel Properties and Other Entities

Accounting for the acquisition of a hotel property or other entity as a purchase transaction requires an allocation of the purchase price to the assets acquired and the liabilities assumed in the transaction at their respective estimated fair values. The most difficult estimations of individual fair values are those involving long-lived assets, such as property, equipment, intangible assets and any capital lease obligations that are assumed as part of the acquisition of a leasehold interest. When the Company acquires a hotel property or other entity, the Company uses all available information to make these fair value determinations, and engages an independent valuation specialist to assist in the fair value determination of the long-lived assets acquired and the liabilities assumed. Due to the inherent subjectivity in determining the estimated fair value of long-lived assets, the Company believes that the recording of acquired assets and liabilities is a critical accounting policy.

Assets Held for Sale

The Company considers a hotel or other asset held for sale if it is probable that the sale will be completed within twelve months, among other requirements. A sale may be considered to be probable once the buyer completes its due diligence of the asset, there is an executed purchase and sale agreement between the Company and the buyer, the buyer waives any closing contingencies, there are no third party approvals necessary and the Company has received a substantial non-refundable deposit. Depreciation ceases when a property is held for sale. Should an impairment loss be required for assets held for sale, the related assets are adjusted to their estimated fair values, less costs to sell. If the sale of a hotel or other asset represents a strategic shift that will have a major effect on the Company’s operations and financial results, the hotel or other asset is included in discontinued operations, and operating results

are removed from income from continuing operations and reported as discontinued operations. The operating results for any such assets for any prior periods presented must also be reclassified as discontinued operations. As of both March 31, 2016 and December 31, 2015, the Company had no hotels or other assets held for sale.

Deferred Financing Fees

Deferred financing fees consist of loan fees and other financing costs related to the Company’s outstanding indebtedness and credit facility commitments. Deferred financing fees associated with a loan are presented on the balance sheet as a deduction from the corresponding loan liability. Deferred financing fees associated with the Company’s credit facility, and any undrawn unsecured term loans, are presented on the balance sheet as an asset. All deferred financing fees are amortized to interest expense over the terms of the related debt or commitment. If a loan is refinanced or paid before its maturity, any unamortized deferred financing costs will generally be expensed unless specific rules are met that would allow for the carryover of such costs to the refinanced debt.

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 all 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 the Earnings Per Share Topic of the FASB ASC, 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 March 31, 2016 and 2015, distributed earnings representing nonforfeitable dividends of $60,000 and $58,000, respectively, were allocated to the participating securities. For the three months ended March 31, 2016 and 2015, there were no undistributed earnings representing nonforfeitable dividends allocated to the participating securities.

In accordance with the Earnings Per Share Topic of the FASB ASC, 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 and the incremental common shares issuable upon the exercise of stock options, using the more dilutive of either the two-class method or the treasury stock method.

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


	Three Months Ended		Three Months Ended
	March 31, 2016		March 31, 2015
	(unaudited)		(unaudited)
Numerator:
Net income	$	1,216	$	1,203
Income from consolidated joint ventures attributable to noncontrolling interests		(1,650)		(2,181)
Preferred stock dividends		(2,766)		(2,300)
Dividends paid on unvested restricted stock compensation		(60)		(58)
Numerator for basic and diluted loss attributable to common stockholders	$	(3,260)	$	(3,336)
Denominator:
Weighted average basic and diluted common shares outstanding		212,887		206,600
Basic and diluted loss attributable to common stockholders per common share	$	(0.02)	$	(0.02)

The Company’s unvested restricted shares associated with its long-term incentive plan and shares associated with common stock options have been excluded from the above calculation of earnings per share for the three months ended March 31, 2016 and 2015, as their inclusion would have been anti-dilutive.

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 hotel properties and other assets 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 or other asset (the reporting unit) including the allocated goodwill to the fair value determined for that reporting unit (see Note 4 for detail on the Company’s valuation methodology). If the aggregate carrying value of the reporting unit exceeds the fair value, the goodwill of the reporting unit 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 includes goodwill with other assets, net on its consolidated balance sheets, and the annual impairment evaluation is performed each year as of December 31.

Noncontrolling Interests

The Company’s financial statements include entities 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 interests are reported on the consolidated balance sheets within equity, separately from the Company’s equity. On the consolidated statements of operations and comprehensive income, revenues, expenses and net income or loss from less-than-wholly-owned subsidiaries are reported at the consolidated amounts, including both the amounts attributable to the Company and noncontrolling interests. Income or loss is allocated to noncontrolling interests based on their 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 shareholders’ equity, noncontrolling interests and total equity.

At both March 31, 2016 and December 31, 2015, the noncontrolling interest reported in the Company’s financial statements included Hilton Worldwide’s 25.0% ownership in the Hilton San Diego Bayfront. During the three months ended March 31, 2015, noncontrolling interests recorded in the Company’s financial statements also included preferred investors that owned a $0.1 million preferred equity interest in a subsidiary captive REIT that owned the Doubletree Guest Suites Times Square. The Company sold its interests in the Doubletree Guest Suites Times Square in December 2015.

Segment Reporting

The Company considers each of its hotels to be an operating segment, none of which meets the threshold for a reportable segment in accordance with the Segment Reporting Topic of the FASB ASC. Currently, the Company operates in one segment, hotel ownership.

3. Investment in Hotel Properties

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



	March 31,		December 31,
	2016		2015
	(unaudited)
Land	$	542,660	$	542,660
Buildings and improvements		3,130,034		3,109,562
Furniture, fixtures and equipment		491,464		480,832
Intangibles		45,365		45,249
Franchise fees		1,082		1,082
Construction in process		121,724		97,974
Investment in hotel properties, gross		4,332,329		4,277,359
Accumulated depreciation and amortization		(1,088,354)		(1,048,349)
Investment in hotel properties, net	$	3,243,975	$	3,229,010

4. Fair Value Measurements and Interest Rate Derivatives

Fair Value of Financial Instruments

As of March 31, 2016 and December 31, 2015, 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 Measurement and Disclosure Topic of the FASB 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.

On an annual basis and periodically when indicators of impairment exist, the Company analyzes the carrying values of its hotel properties and other assets using Level 3 measurements, including a discounted cash flow analysis to estimate the fair value of its hotel properties and other assets 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 include anticipated operating cash flow in the year of disposition and terminal capitalization rate. The Company did not identify any properties or other assets with indicators of impairment during the three months ended March 31, 2016 and 2015.

On an annual basis and periodically when indicators of impairment exist, the Company also analyzes 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. The Company did not identify any properties or other assets with indicators of goodwill impairment during the three months ended March 31, 2016 and 2015.

As of March 31, 2016 and December 31, 2015, the only financial instruments that the Company measures at fair value are its interest rate derivatives, along with a life insurance policy and a related retirement benefit agreement. In accordance with the Fair Value Measurement and Disclosure Topic of the FASB ASC, the Company estimates 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. Both the life insurance policy and the related retirement benefit agreement, which are for a former Company associate, are valued using Level 2 measurements.

The following table presents the Company’s assets measured at fair value on a recurring and non-recurring basis at March 31, 2016 and December 31, 2015 (in thousands):



			Fair Value Measurements at Reporting Date
	Total		Level 1		Level 2		Level 3

March 31, 2016 (unaudited):
Interest rate cap derivatives	$	1	$	—	$	1	$	—
Life insurance policy (1)		985		—		985		—
Total assets measured at fair value at March 31, 2016	$	986	$	—	$	986	$	—
December 31, 2015:
Interest rate cap derivatives	$	1	$	—	$	1	$	—
Interest rate swap derivative		759		—		759		—
Life insurance policy (1)		964		—		964		—
Total assets measured at fair value at December 31, 2015	$	1,724	$	—	$	1,724	$	—

(1)

Includes the split life insurance policy for one of the Company’s former associates, which the Company values using Level 2 measurements. These amounts are included in other assets, net on the accompanying consolidated balance sheets, and will be used to reimburse the Company for payments made to the former associate from the related retirement benefit agreement, which is included in accrued payroll and employee benefits on the accompanying consolidated balance sheets.

The following table presents the Company’s liabilities measured at fair value on a recurring and non-recurring basis at March 31, 2016 and December 31, 2015 (in thousands):



			Fair Value Measurements at Reporting Date
	Total		Level 1		Level 2		Level 3

March 31, 2016 (unaudited):
Interest rate swap derivative	$	6,080	$	—	$	6,080	$	—
Retirement benefit agreement (1)		985		—		985		—
Total liabilities measured at fair value at March 31, 2016	$	7,065	$	—	$	7,065	$	—

December 31, 2015:
Interest rate swap derivative	$	437	$	—	$	437	$	—
Retirement benefit agreement (1)		964		—		964		—
Total liabilities measured at fair value at December 31, 2015	$	1,401	$	—	$	1,401	$	—

(1)

Includes the retirement benefit agreement for one of the Company’s former associates, which the Company values using Level 2 measurements. The agreement calls for the balance of the retirement benefit to be paid out to the former associate in 10 annual installments, beginning in 2011. As such, the Company has paid the former associate a total of $1.0 million through March 31, 2016, which was reimbursed to the Company using funds from the related split life insurance policy noted above. These amounts are included in accrued payroll and employee benefits on the accompanying consolidated balance sheets.

Interest Rate Derivatives

The Company’s interest rate derivatives, which are not designated as effective cash flow hedges, consisted of the following at March 31, 2016 (unaudited) and December 31, 2015 (in thousands):


									Estimated Fair Value Asset (Liability)
		Strike / Capped			Effective	Maturity	Notional		March 31,		December 31,
Hedged Debt	Type	Rate		Index	Date	Date	Amount		2016		2015
Hilton San Diego Bayfront (1)	Cap	4.250	%	1-Month LIBOR	April 15, 2015	May 1, 2017	$	112,454	$	1	$	1
$85.0 million term loan (2)	Swap	3.391	%	1-Month LIBOR	October 29, 2015	September 2, 2022	$	85,000	$	(2,072)	$	759
$100.0 million term loan (2)	Swap	3.653	%	1-Month LIBOR	January 29, 2016	January 31, 2023	$	100,000	$	(4,008)	$	(437)
									$	(6,079)	$	323

(1)

The fair value of the Hilton San Diego Bayfront cap agreement is included in other assets, net on the accompanying consolidated balance sheets.

(2)

The fair values of both the $85.0 million term loan and the $100.0 million term loan swap agreements are included in other liabilities on the Company’s consolidated balance sheets. The 1-month LIBOR rate related to the $85.0 million term loan was swapped to a fixed rate of 1.591%. The 1-month LIBOR rate related to the $100.0 million term loan was swapped to a fixed rate of 1.853%.

Changes in the fair values of the Company’s interest rate derivatives resulted in increases to interest expense for the three months ended March 31, 2016 and 2015 as follows (in thousands):


	Three Months Ended		Three Months Ended
	March 31, 2016		March 31, 2015
Loss on derivatives, net	$	6,402	$	—

Fair Value of Debt

As of March 31, 2016 and December 31, 2015, 79.3% and 79.5%, respectively, of the Company’s outstanding debt had fixed interest rates, including the effects of interest rate swap agreements. The Company’s principal value of its consolidated debt totaled $1.1 billion as of both March 31, 2016 and December 31, 2015. Using Level 3 measurements, the Company estimates that the fair market value of its debt totaled $1.1 billion as of both March 31, 2016 and December 31, 2015.

5. Other Assets

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


	March 31,		December 31,
	2016		2015
	(unaudited)
Property and equipment, net	$	1,185	$	1,341
Land held for development		188		188
Goodwill		990		990
Deferred expense on straightlined third-party tenant leases		3,619		3,336
Interest rate derivatives		1		760
Other receivables		1,658		2,201
Other		1,645		1,570
Total other assets, net	$	9,286	$	10,386

Property and equipment, net consisted of the following (in thousands):


	March 31,		December 31,
	2016		2015
	(unaudited)
Cost basis	$	10,782	$	10,785
Accumulated depreciation		(9,597)		(9,444)
Property and equipment, net	$	1,185	$	1,341

6. Notes Payable

Notes payable consisted of the following (in thousands):



	March 31,		December 31,
	2016		2015
	(unaudited)
Notes payable requiring payments of interest and principal, with fixed rates ranging from 4.12% to 5.95%; maturing at dates ranging from July 2016 through January 2025. The notes are collateralized by first deeds of trust on seven hotel properties at March 31, 2016, and eight hotel properties at December 31, 2015.	$	674,265	$	791,073
Note payable requiring payments of interest and principal, bearing a blended rate of one-month LIBOR plus 225 basis points; maturing in August 2019. The note is collateralized by a first deed of trust on one hotel property.		224,657		225,407
Unsecured term loan requiring payments of interest only, with a blended interest rate based on a pricing grid with a range of 180 to 255 basis points over LIBOR, depending on the Company's leverage ratios. LIBOR has been swapped to a fixed rate of 1.591%, reflecting an interest rate of 3.391% based on the Company's current leverage. Matures in September 2022.		85,000		85,000
Unsecured term loan requiring payments of interest only, with a blended interest rate based on a pricing grid with a range of 180 to 255 basis points over LIBOR, depending on the Company's leverage ratios. LIBOR has been swapped to a fixed rate of 1.853%, reflecting an interest rate of 3.653% based on the Company's current leverage. Matures in January 2023.		100,000		—
Total notes payable	$	1,083,922	$	1,101,480

Current portion of notes payable	$	150,170	$	86,840
Less: current portion of deferred financing fees		(1,149)		(1,064)
Carrying value of current portion of notes payable	$	149,021	$	85,776

Notes payable, less current portion	$	933,752	$	1,014,640
Less: long-term portion of deferred financing fees		(4,362)		(3,821)
Carrying value of notes payable, less current portion	$	929,390	$	1,010,819

Notes Payable Transactions - 2016

In January 2016, the Company drew the total available funds of $100.0 million under an unsecured term loan agreement, and used the proceeds in February 2016, combined with cash on hand, to repay the $114.2 million loan secured by the Boston Park Plaza. The Boston Park Plaza loan was scheduled to mature in February 2018, and was available to be repaid without penalty in February 2016. The $100.0 million unsecured term loan matures in January 2023, and bears interest based on a pricing grid with a range of 180 to 255 basis points over LIBOR, depending on the Company’s leverage ratios. The Company entered into a forward swap agreement in December 2015 that fixed the LIBOR rate at 1.853% for the duration of the $100.0 million term loan. Based on the Company’s current leverage, the loan bears interest at a rate of 3.653%.

Deferred Financing Fees

During the three months ended March 31, 2016, the Company incurred a $0.1 million loss on extinguishment of debt related to the accelerated amortization of deferred financing fees due to the early repayment of the loan secured by the Boston Park Plaza.

During the three months ended March 31, 2016, the Company paid $0.1 million in deferred financing fees related to its new $100.0 million unsecured term loan.

Interest Expense

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



	Three Months Ended		Three Months Ended
	March 31, 2016		March 31, 2015
	(unaudited)		(unaudited)
Interest expense on debt and capital lease obligations	$	13,053	$	16,687
Loss on derivatives, net		6,402		—
Amortization of deferred financing fees		555		639
Total interest expense	$	20,010	$	17,326

7. Other Current Liabilities and Other Liabilities

Other current liabilities consisted of the following (in thousands):



	March 31,		December 31,
	2016		2015
	(unaudited)
Property, sales and use taxes payable	$	20,303	$	17,988
Income tax payable		489		470
Accrued interest		3,537		3,012
Advance deposits		14,905		12,727
Management fees payable		1,030		3,001
Other		5,215		4,679
Total other current liabilities	$	45,479	$	41,877

Other liabilities consisted of the following (in thousands):



	March 31,		December 31,
	2016		2015
	(unaudited)
Deferred gain on sale of asset	$	7,000	$	7,000
Interest rate swap derivatives


		Page
PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements:	2

	Consolidated Balance Sheets as of March 31, 2016 (unaudited) and December 31, 2015	2

	Unaudited Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended March 31, 2016 and 2015	3

	Unaudited Consolidated Statement of Equity for the Three Months Ended March 31, 2016	4

	Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015	5

	Notes to Unaudited Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	36

Item 4.	Controls and Procedures	37

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	37

Item 1A.	Risk Factors	37

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37

Item 3.	Defaults Upon Senior Securities	37

Item 4.	Mine Safety Disclosures	37

Item 5.	Other Information	37

Item 6.	Exhibits	38

SIGNATURES		39