Sunstone Hotel Investors, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; filed November 9, 2011. Sunstone is a hotel-owning REIT. At quarter-end it held interests in 33 hotels, including one classified as held for sale, and operated 32 hotels held for investment. Unless noted otherwise, dollar amounts below are in millions.
Financial and operating performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $212.3 | $152.5 | $589.6 | $447.7 |
| Operating income | $3.7 | $8.9 | $30.1 | $24.5 |
| Income (loss) from continuing operations | $(16.6) | $(7.6) | $41.6 | $(28.3) |
| Net income (loss) | $(16.6) | $23.7 | $73.7 | $2.9 |
| Income (loss) available to common stockholders | $(24.0) | $18.3 | $53.0 | $(12.6) |
| Basic and diluted EPS | $(0.20) | $0.19 | $0.45 | $(0.13) |
| Adjusted EBITDA (non-GAAP) | $52.4 | $39.4 | $148.5 | $114.0 |
| Adjusted FFO (non-GAAP) | $23.7 | $14.2 | $67.6 | $36.3 |
Q3 operating margin was approximately 1.7%, versus 5.9% a year earlier; nine-month operating margin was approximately 5.1%, versus 5.5%. These are calculated from reported operating income and revenue. Q3 revenue rose 39.3%, but expenses rose 45.4%; operating income declined 59.0%. For the nine-month period, revenue increased 31.7% and operating income increased 23.0%.
- Hotel indicators: Portfolio occupancy was 78.1% in Q3 versus 74.7%; ADR was $165.26 versus $159.05; RevPAR was $129.07 versus $118.81, up 8.6%. For nine months, RevPAR increased 7.9% to $124.21. These portfolio statistics include prior-period results for acquired hotels, so growth is not solely same-store growth.
- Cash flow: Nine-month operating cash flow was $119.6, compared with $2.9 in 2010. Investing used $311.1, including $263.3 for acquisitions and $82.4 for renovations and additions. Financing provided $75.4. Cash and cash equivalents ended at $160.0, down $116.1; restricted cash was $63.8, making combined cash and restricted cash $223.7.
- Liquidity and debt: Notes payable were $1.668 billion at September 30, including $324.3 current, and total liabilities were $1.783 billion. Management reported a roughly five-year weighted-average debt maturity, 69.5% fixed-rate debt, a 5.5% weighted rate on fixed-rate debt, and a 4.5% weighted rate on all debt including derivatives. Total assets were $3.210 billion.
Material changes and unusual items
- Revenue and expenses increased substantially in part because Sunstone acquired the Doubletree Guest Suites Times Square, JW Marriott New Orleans, and a 75% interest in the Hilton San Diego Bayfront during 2011; it also consolidated BuyEfficient. The three hotel acquisitions contributed $70.3 of Q3 revenue and $159.8 for the first nine months.
- Nine-month net income included a $69.2 gain from remeasuring previously held interests in Doubletree and BuyEfficient when Sunstone acquired the remaining ownership interests. It also included $32.1 of discontinued-operations income, including an $18.1 gain from resolving Mass Mutual franchise termination-fee contingencies and a $14.0 gain on the Royal Palm sale. These items materially affect comparisons with 2010.
- Q3 included a $10.9 impairment charge on the Royal Palm purchase-money note, recorded ahead of its October sale. Nine-month impairment charges were $10.9 continuing operations and $1.5 discontinued operations. Q3 also included $1.6 of accrued employee-litigation settlement costs.
- Preferred stock dividends and accretion were $19.9 for nine months, up from $15.5, partly reflecting the April issuance of $115.0 of 8% Series D preferred stock; net proceeds were approximately $110.9.
Outlook, risks and contingencies
Management said it believed the lodging cycle was in an early recovery phase and expected demand to remain strong over the next several quarters, while acknowledging that growth may be uneven. It cited 8.6% Q3 and 7.9% nine-month comparable-portfolio RevPAR growth and expected constrained new hotel supply. The filing gives no quantified earnings or RevPAR guidance. Management expected near-term acquisitions, if pursued, to use a greater proportion of equity than debt, and stated that cash, operating cash flow, capital-market access, and unencumbered properties should provide liquidity for at least the next 12 months.
- Subsequent events: In October, Sunstone sold the Royal Palm note for net proceeds of approximately $79.2. It refinanced Doubletree’s $270.0 of debt with a $180.0 mortgage maturing in 2018, used approximately $90.0 of unrestricted cash to fund the balance, and obtained an interest-rate cap through October 2015. The new loan has a higher spread. Valley River Inn was sold for $16.4 gross, including assumption of its $11.6 mortgage.
- Commitments and legal matters: Renovation and construction commitments totaled $25.3. Sunstone accrued $1.6 for employee litigation; one tentative settlement of approximately $0.7 remained subject to court approval, and the company estimated up to $0.9 for two other claims. It also disclosed $1.7 of letters of credit and uncapped customary environmental indemnities.
- Principal risks: Lodging demand and local economic conditions; rising operating costs; hotel manager, brand and franchise requirements; renovation needs; leverage and refinancing; floating-rate exposure; asset impairments; and geographic concentration. California represented about 34% of Q3 portfolio revenue and New York about 17%. A 100-basis-point move in rates was estimated to change 2011 interest expense by about $5.2, before considering other effects.
- Management reported no defaults upon senior securities, no expected Series C preferred financial-ratio violation, and effective disclosure controls at quarter-end.
Important facts for investors to verify
- How much of reported revenue and Adjusted EBITDA growth reflects acquisitions and consolidation versus improvement at comparable hotels.
- The contribution of the $69.2 remeasurement gain and discontinued-operation gains to nine-month earnings, and the ongoing earnings and cash-flow trend excluding these items.
- Post-quarter effects of the Doubletree refinancing, including the use of $90.0 cash, higher loan spread, interest cap, and revised maturity profile.
- Liquidity after acquisitions, renovations, dividends, and debt repayments, including restricted cash and upcoming principal and interest obligations.
- Resolution and final costs of the employee litigation, as well as progress and spending against the $25.3 renovation commitment.