NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Organization
Pebblebrook Hotel Trust (the "Company") is an internally managed hotel investment company, formed as a Maryland real estate investment trust in October 2009 to opportunistically acquire and invest in hotel properties located primarily in major U.S. cities and resort properties located near our primary target urban markets and select destination resort markets, with an emphasis on major gateway coastal markets.
As of March 31, 2023, the Company owned interests in 49 hotels with a total of 12,451 guest rooms. The hotel properties are located in: Boston, Massachusetts; Chicago, Illinois; Hollywood, Florida; Jekyll Island, Georgia; Key West, Florida; Los Angeles, California (Beverly Hills, Santa Monica, and West Hollywood); Naples, Florida; Newport, Rhode Island; Portland, Oregon; San Diego, California; San Francisco, California; Santa Cruz, California; Seattle, Washington; Stevenson, Washington; and Washington, D.C.
Substantially all of the Company’s assets are held by, and all of the Company's operations are conducted through, Pebblebrook Hotel, L.P. (the "Operating Partnership"). The Company is the sole general partner of the Operating Partnership. As of March 31, 2023, the Company owned 99.2% of the common limited partnership units issued by the Operating Partnership ("common units"). The remaining 0.8% of the common units are owned by the other limited partners of the Operating Partnership. For the Company to maintain its qualification as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"), it cannot operate the hotels it owns. Therefore, the Operating Partnership and its subsidiaries lease the hotel properties to subsidiaries of Pebblebrook Hotel Lessee, Inc. (collectively with its subsidiaries, "PHL"), a taxable REIT subsidiary ("TRS"), which in turn engage third-party eligible independent contractors to manage the hotels. PHL is consolidated into the Company’s financial statements.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and in conformity with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) applicable to interim financial information. As such, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with the rules and regulations of the SEC. These unaudited consolidated financial statements include all adjustments considered necessary for a fair presentation of the consolidated balance sheets, consolidated statements of operations and comprehensive income, consolidated statements of equity and consolidated statements of cash flows for the periods presented. Interim results are not necessarily indicative of full-year performance, as a result of the impact of seasonal and other short-term variations and the acquisitions and or dispositions of hotel properties. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
The Company and its subsidiaries are separate legal entities and maintain records and books of account separate and apart from each other. The consolidated financial statements include all of the accounts of the Company and its subsidiaries and are presented in accordance with U.S. GAAP. All significant intercompany balances and transactions have been eliminated in consolidation. Investments in entities that the Company does not control, but over which the Company has the ability to exercise significant influence regarding operating and financial policies, are accounted for under the equity method.
Certain reclassifications have been made to the prior period's financial statements to conform to the current year presentation.
Use of Estimates
The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and revenues and expenses. These estimates are prepared using management’s best judgment, after considering past, current and expected events and economic conditions. Actual results could differ from these estimates.
Risks and Uncertainties
The state of the overall economy can significantly impact hotel operational performance and thus the Company's financial position. It is uncertain what the future affects of the COVID-19 pandemic will have on the overall economy or travel. In addition, the rise in inflation and corresponding increase in interest rates may also impact the overall economy. A decline in travel or a significant increase in costs may impact the Company's cash flow and ability to service debt or meet other financial obligations.
New Accounting Pronouncements
Business Combinations
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to the recognition of an acquired contract liability and to payment terms and their effect on subsequent revenue recognized by the acquirer. The amendments in ASU 2021-08 require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. The Company adopted ASU 2021-08 effective January 1, 2023, and the adoption did not have a material impact on the Company's consolidated financial statements and disclosures.
Note 3. Acquisition and Disposition of Hotel Properties
Acquisitions
There were no acquisitions of hotel properties during the three months ended March 31, 2023 and 2022.
Dispositions
There were no dispositions of hotel properties during the three months ended March 31, 2022. The following table summarizes disposition transactions during the three months ended March 31, 2023 (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| Hotel Property Name | | Location | | Sale Date | | Sale Price |
| The Heathman Hotel | | Portland, OR | | February 22, 2023 | | $ | 45,000 | |
Retail at The Westin Michigan Avenue Chicago | | Chicago, IL | | March 17, 2023 | | 27,300 | |
| Hotel Colonnade Coral Gables | | Coral Gables, FL | | March 28, 2023 | | 63,000 | |
| 2023 Total | | | | | | $ | 135,300 | |
| | | | | | |
| | | | | | |
| | | | | | |
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| | | | | | |
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For the three months ended March 31, 2023 and March 31, 2022, the accompanying consolidated statements of operations and comprehensive income included operating income (loss) of $1.1 million and $(3.4) million, respectively, excluding impairment loss and gain on sale of hotel properties related to the hotel properties sold.
The sales of the hotel properties described above did not represent a strategic shift that had a major effect on the Company’s operations and financial results, and therefore, did not qualify as discontinued operations.
Held for Sale
As of March 31, 2023, the Company had entered into agreements to sell two hotel properties in separate transactions for an aggregate sales price of approximately $97.0 million. These hotels were classified as held for sale and as a result, the Company classified all of the assets and liabilities related to these hotels as assets and liabilities held for sale in the accompanying consolidated balance sheets and ceased depreciating the assets. The Company expects to complete the sales in the second quarter of 2023. However, no assurances can be given that the sales will be completed on these terms or at all.
Note 4. Investment in Hotel Properties
Investment in hotel properties as of March 31, 2023 and December 31, 2022 consisted of the following (in thousands):
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
| Land | $ | 860,206 | | | $ | 897,756 | |
| Buildings and improvements | 5,037,815 | | | 5,170,976 | |
| Furniture, fixtures and equipment | 498,010 | | | 504,518 | |
| Finance lease asset | 91,181 | | | 91,181 | |
| Construction in progress | 23,736 | | | 11,961 | |
| $ | 6,510,948 | | | $ | 6,676,392 | |
| Right-of-use asset, operating leases | 367,976 | | | 370,383 | |
| Investment in hotel properties | $ | 6,878,924 | | | $ | 7,046,775 | |
| Less: Accumulated depreciation | (1,175,478) | | | (1,171,899) | |
| Investment in hotel properties, net | $ | 5,703,446 | | | $ | 5,874,876 | |
Hurricane Ian
On September 27, 2022, LaPlaya Beach Resort and LaPlaya Beach Club ("LaPlaya") and Inn on Fifth, both located in Naples, Florida, and Southernmost Beach Resort located in Key West, Florida were impacted by the effects of Hurricane Ian. Inn on Fifth and Southernmost Beach Resort did not suffer significant damage or disruption. LaPlaya was closed in anticipation of the storm and required remediation and repairs from the damage and remained closed, however, LaPlaya has begun to reopen in stages as the buildings and facilities are repaired. The Company anticipates LaPlaya to reopen fully by the end of 2023.
The Company’s insurance policies provide coverage for property damage, business interruption and reimbursement for other costs that were incurred relating to damages sustained during Hurricane Ian and the Company has recorded a receivable for the expenditures to date which it anticipates to collect from the insurance providers in excess of the deductibles. In 2022, the Company recognized an aggregate impairment loss of $7.9 million for the damage to LaPlaya and Southernmost Beach Resort. During the three months ended March 31, 2023, the Company incurred $2.8 million of costs related to payroll, repair and claims administration for which reimbursement from insurance policies is uncertain and therefore is included in other operating expenses in the Company's consolidated statements of operations and comprehensive income. Through March 31, 2023, the Company has received $29.3 million in preliminary advances from the insurance providers and continues to work with the insurance providers on the settlement of the property and business interruption claims.
Impairment
The Company reviews its investment in hotel properties for impairment whenever events or circumstances indicate potential impairment. The Company periodically adjusts its estimate of future operating cash flows and estimated hold periods for certain properties. As a result of this review, the Company may identify an impairment trigger has occurred and assess its investment in hotel properties for recoverability. For the three months ended March 31, 2023, no impairment losses were incurred. For the three months ended March 31, 2022, the Company recognized an impairment loss of $61.0 million related to two hotels as a result of their fair value being lower than their carrying value. The impairment losses were determined using Level 2 inputs under authoritative guidance for fair value measurements using purchase and sale agreements and information from marketing efforts for these properties.
Right-of-use Assets and Lease Liabilities
The Company recognized right-of-use assets and related liabilities related to its ground leases, all of which are operating leases. When the rate implicit in the lease could not be determined, the Company used incremental borrowing rates, which ranged from 4.7% to 7.6%. In addition, the term used includes any options to exercise extensions when it is reasonably certain the Company will exercise such option. See Note 11. Commitments and Contingencies for additional information about the ground leases.
The right-of-use assets and liabilities are amortized to ground rent expense over the term of the underlying lease agreements. As of March 31, 2023, the Company's lease liabilities consisted of operating lease liabilities of $320.5 million and financing lease liabilities of $42.9 million. As of December 31, 2022, the Company's lease liabilities consisted of operating lease liabilities of $320.4 million and financing lease liabilities of $42.7 million. The financing lease liabilities are included in accounts payable, accrued expenses and other liabilities on the Company's accompanying consolidated balance sheets.
Note 5. Debt
On October 13, 2022, the Company entered into the Fifth Amended and Restated Credit Agreement with Bank of America, N.A., as administrative agent and certain other agents and lenders ("Credit Agreement"). The $2.0 billion Credit Agreement provides for a $650.0 million senior unsecured revolving credit facility and three $460.0 million unsecured term loan facilities totaling $1.38 billion. The Company may request additional lender commitments to increase the aggregate borrowing capacity under the Credit Agreement up to an additional $970.0 million.
The Company's debt consisted of the following as of March 31, 2023 and December 31, 2022 (dollars in thousands):
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| | | | | | | Balance Outstanding as of | |
| | Interest Rate at March 31, 2023 | | Maturity Date | | | March 31, 2023 | | December 31, 2022 | |
| Revolving credit facilities | | | | | | | | | |
| Senior unsecured credit facility | — | (1)(2) | October 2026 | | | $ | — | | | $ | — | | |
| PHL unsecured credit facility | — | (1) | October 2026 | | | — | | | — | | |
| Total revolving credit facilities | | | | | | $ | — | | | $ | — | | |
| | | | | | | | | |
| Unsecured term loans | | | | | | | | | |
| Term Loan 2024 | 6.80% | (1) | October 2024 | | | 460,000 | | | 460,000 | | |
| Term Loan 2025 | 4.73% | (1) | October 2025 | | | 460,000 | | | 460,000 | | |
| Term Loan 2027 | 3.49% | (1) | October 2027 | | | 460,000 | | | 460,000 | | |
| Term loan principal | | | | | | $ | 1,380,000 | | | $ | 1,380,000 | | |
| Convertible senior notes principal | 1.75% | | December 2026 | | | $ | 750,000 | | | $ | 750,000 | | |
| | | | | | | | | |
| Senior unsecured notes | | | | | | | | | |
| Series A Notes | 4.70% | (3) | December 2023 | | | 47,600 | | | 47,600 | | |
| Series B Notes | 4.93% | | December 2025 | | | 2,400 | | | 2,400 | | |
| Senior unsecured notes principal | | | | | | $ | 50,000 | | | $ | 50,000 | | |
| | | | | | | | | |
| Mortgage loans | | | | | | | | | |
| Margaritaville Hollywood Beach Resort | 7.06% | (4) | May 2023 | | | 161,500 | | | 161,500 | | |
| Estancia La Jolla Hotel & Spa | 5.07% | | September 2028 | | | 58,987 | | | 59,485 | | |
| Mortgage loans principal | | | | | | $ | 220,487 | | | $ | 220,985 | | |
| Total debt principal | | | | | | $ | 2,400,487 | | | $ | 2,400,985 | | |
| Unamortized debt premiums, discount and deferred financing costs, net | | | | | | (12,470) | | | (13,692) | | |
| Debt, Net | | | | | | $ | 2,388,017 | | | $ | 2,387,293 | | |
______________________
(1) Borrowings bear interest at floating rates. Interest rate at March 31, 2023 gives effect to interest rate hedges.
(2) The Company has the option to extend the maturity date of October 13, 2026 for up to two six-month periods, pursuant to certain terms and conditions and payment of an extension fee, for a maximum maturity date of October 13, 2027.
(3) The Company intends to pay off the Series A Notes using available cash or borrowings under the revolving credit facility at maturity.
(4) The loan bears interest at a floating rate equal to one-month LIBOR plus a weighted-average spread of 2.37%. The Company has the option to extend the maturity date to May 2024.
Unsecured Revolving Credit Facilities
The $650.0 million senior unsecured revolving credit facility provided for in the Credit Agreement matures in October 2026 and provides for two six-month extension options, subject to certain terms and conditions and payment of an extension fee. All borrowings under the $650.0 million senior unsecured revolving credit facility bear interest at a rate per annum equal to, at the option of the Company, (i) SOFR plus 0.10% (the “SOFR Adjustment”) plus a margin that is based upon the Company’s leverage ratio or (ii) the Base Rate (as defined by the Credit Agreement) plus a margin that is based on the Company’s leverage ratio. The margins for revolving credit facility loans range in amount from 1.45% to 2.50% for SOFR-based loans and 0.45% to 1.50% for Base Rate-based loans, depending on the Company’s leverage ratio. As of March 31, 2023, the Company had no outstanding borrowings, $13.1 million of outstanding letters of credit and a borrowing capacity of $636.9 million remaining on the senior unsecured revolving credit facility. The Company is required to pay an unused commitment fee at an annual rate of 0.20% or 0.30% of the unused portion of the senior unsecured revolving credit facility, depending on the amount of borrowings outstanding. The credit agreement contains certain financial covenants, including a maximum leverage ratio, a minimum fixed charge coverage ratio and a maximum percentage of secured debt to total asset value.
Under the terms of the credit agreement for the senior unsecured revolving credit facility, one or more standby letters of credit, up to a maximum aggregate outstanding balance of $30.0 million, may be issued on behalf of the Company by the lenders under the facility. The Company pays a fee at a rate per annum equal to the applicable margin based upon the Company's leverage ratio. Any outstanding standby letters of credit reduce the available borrowings on the senior unsecured revolving credit facility by a corresponding amount. Standby letters of credit of $13.1 million and $12.6 million were outstanding as of March 31, 2023 and December 31, 2022, respectively.
As of March 31, 2023, the Company also has a $20.0 million unsecured revolving credit facility (the "PHL Credit Facility") to be used for PHL's working capital and general corporate purposes. On October 13, 2022, PHL amended and restated the agreement governing the PHL Credit Facility to extend the maturity to October 2026. The PHL Credit Facility has substantially similar terms as the Company's senior unsecured revolving credit facility. Borrowings on the PHL Credit Facility bear interest at a rate per annum equal to, at the option of the Company, (i) SOFR plus the SOFR Adjustment plus a margin that is based upon the Company’s leverage ratio or (ii) the Base Rate (as defined by the Credit Agreement) plus a margin that is based on the Company’s leverage ratio. The PHL Credit Facility is subject to debt covenants substantially similar to the covenants under the Credit Agreement, which governs the Company's senior unsecured revolving credit facility. As of March 31, 2023, the Company had no borrowings under the PHL Credit Facility and had $20.0 million borrowing capacity remaining available under the PHL Credit Facility.
As of March 31, 2023, the Company was in compliance with all debt covenants of the credit agreements that govern the unsecured revolving credit facilities.
Unsecured Term Loan Facilities
The three $460.0 million term loans provided for in the Credit Agreement mature in October 2024, October 2025 and October 2027, respectively. The term loans bear interest at a rate per annum equal to, at the option of the Company, (i) SOFR plus the SOFR Adjustment plus a margin that is based upon the Company’s leverage ratio or (ii) the Base Rate (as defined by the Credit Agreement) plus a margin that is based on the Company’s leverage ratio. The margins for term loans range in amount from 1.40% to 2.45% for SOFR-based loans and 0.40% to 1.45% for Base Rate-based loans, depending on the Company's leverage ratio. The term loans are subject to the debt covenants in the Credit Agreement. As of March 31, 2023, the Company was in compliance with all debt covenants of its term loans.
The Company entered into interest rate swap agreements to fix the SOFR rate on a portion of these unsecured term loan facilities. See Derivative and Hedging Activities for further discussion on the interest rate swaps.
Convertible Senior Notes
In December 2020, the Company issued $500.0 million aggregate principal amount of 1.75% Convertible Senior Notes due December 2026 (the "Convertible Notes"). The net proceeds from this offering of the Convertible Notes were approximately $487.3 million after deducting the underwriting fees and other expenses paid by the Company.
In February 2021, the Company issued an additional $250.0 million aggregate principal amount of Convertible Notes. These additional Convertible Notes were sold at a 5.5% premium to par and generated net proceeds of approximately $257.2 million after deducting the underwriting fees and other expenses paid by the Company of $6.5 million, which was offset by a premium received in the amount of $13.8 million.
The Convertible Notes are governed by an indenture (the “Base Indenture”) between the Company and The Bank of New York Mellon Trust Company, N.A., as trustee. The Convertible Notes bear interest at a rate of 1.75% per annum, payable semi-annually in arrears on June 15th and December 15th of each year, beginning on June 15, 2021. The Convertible Notes will mature on December 15, 2026.
Prior to June 15, 2026, the Convertible Notes will be convertible upon certain circumstances. On and after June 15, 2026, holders may convert any of their Convertible Notes into the Company’s common shares of beneficial interest (“common shares”) at the applicable conversion rate at any time at their election two days prior to the maturity date. The initial conversion rate is 39.2549 common shares per $1,000 principal amount of Convertible Notes, which represents an initial conversion price of approximately $25.47 per share. The conversion rate is subject to adjustment in certain circumstances. As of March 31, 2023 and December 31, 2022, the if-converted value of the Convertible Notes did not exceed the principal amount.
The Company may redeem for cash all or a portion of the Convertible Notes, at its option, on or after December 20, 2023 upon certain circumstances. The redemption price will be equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. If certain make-whole fundamental changes occur, the conversion rate for the Convertible Notes may be increased.
In connection with the Convertible Notes issuances, the Company entered into privately negotiated capped call transactions (the “Capped Call Transactions”) with certain of the underwriters of the offerings of the Convertible Notes or their respective affiliates and other financial institutions. The Capped Call Transactions initially cover, subject to anti-dilution adjustments substantially similar to those applicable to the Convertible Notes, the number of common shares underlying the Convertible Notes. The Capped Call Transactions are expected generally to reduce the potential dilution to holders of common shares upon conversion of the Convertible Notes and/or offset the potential cash payments that the Company could be required to make in excess of the principal amount of any converted Convertible Notes upon conversion thereof, with such reduction and/or offset subject to a cap. The upper strike price of the Capped Call Transactions is $33.0225 per share.
Senior Unsecured Notes
The Company has $47.6 million of senior unsecured notes outstanding bearing a fixed interest rate of 4.70% per annum and maturing in December 2023 (the "Series A Notes") and $2.4 million of senior unsecured notes outstanding bearing a fixed interest rate of 4.93% per annum and maturing in December 2025 (the "Series B Notes"). The debt covenants of the Series A Notes and the Series B Notes are substantially similar to those of the Company's senior unsecured revolving credit facility. As of March 31, 2023, the Company was in compliance with all such debt covenants.
Mortgage Loans
On September 23, 2021, the Company assumed a $161.5 million loan secured by a first-lien mortgage on the leasehold interest of Margaritaville Hollywood Beach Resort ("Margaritaville"). The loan requires interest-only payments based on a floating interest rate of one-month LIBOR plus a weighted-average spread of 2.37%. The loan matures on May 9, 2023 and may be extended by one-year. If the loan is extended, the interest rate spread will increase by 20 basis points for the extension period only. The Company expects to exercise this extension, refinance, or use the proceeds from the revolving credit facility to prepay this loan at maturity. The loan is also subject to an interest rate cap agreement.
On December 1, 2021, the Company assumed a $61.7 million loan secured by a first-lien mortgage on the leasehold interest of Estancia La Jolla Hotel & Spa ("Estancia"). The loan requires both principal and interest monthly payments based on a fixed interest rate of 5.07%. The loan matures on September 1, 2028.
The Company's mortgage loans associated with Margaritaville and Estancia are non-recourse to the Company except for customary carve-outs to the general non-recourse liability. The loans contain customary provisions regarding events of default, as well as customary cash management, cash trap and lockbox provisions. Cash trap provisions are triggered if the hotel's performance is below a certain threshold. Once triggered, all of the cash flow generated by the hotel is deposited directly into lockbox accounts and then swept into cash management accounts for the benefit of our lender. These properties are not in a cash trap and no event of default has occurred under the loan documents.
Interest Expense
The components of the Company's interest expense consisted of the following for the three months ended March 31, 2023 and 2022 (in thousands):
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| | For the three months ended March 31, | | |
| | 2023 | | 2022 | | | | |
| Unsecured revolving credit facilities | | $ | 568 | | | $ | 493 | | | | | |
| Unsecured term loan facilities | | 16,551 | | | 13,534 | | | | | |
| Convertible senior notes | | 3,281 | | | 3,281 | | | | | |
| Senior unsecured notes | | 589 | | | 645 | | | | | |
| Mortgage debt | | 3,535 | | | 1,810 | | | | | |
| Amortization of deferred financing fees, (premiums) and discounts | | 1,851 | | | 2,285 | | | | | |
| Other | | 1,055 | | | 524 | | | | | |
| Total interest expense | | $ | 27,430 | | | $ | 22,572 | | | | | |
Fair Value
The Company estimates the fair value of its fixed rate debt by discounting the future cash flows of each instrument at estimated market rates, taking into consideration general market conditions and maturity of the debt with similar credit terms and is classified within Level 2 of the fair value hierarchy. The estimated fair value of the Company’s fixed rate debt (unsecured senior notes, convertible senior notes and the Estancia mortgage loan) as of March 31, 2023 and December 31, 2022 was $695.9 million and $700.5 million, respectively.
Derivative and Hedging Activities
The Company enters into interest rate swap agreements to hedge against interest rate fluctuations. All of the Company's interest rate swaps are cash flow hedges. All unrealized gains and losses on these hedging instruments are reported in accumulated other comprehensive income (loss) and are subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.
The Company's interest rate swaps at March 31, 2023 and December 31, 2022 consisted of the following, by maturity date (dollars in thousands):
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| | | | | | Aggregate Notional Value as of |
| Hedge Type | | Interest Rate Range (SOFR) | | Maturity | | March 31, 2023 | | December 31, 2022 |
| | | | | | | | |
| | | | | | | | |
| Swap-cash flow | | 0.05% - 0.07% | | January 2023 | | $ | — | | | $ | 200,000 | |
| Swap-cash flow | | 1.84% - 1.87% | | November 2023 | | 250,000 | | | 250,000 | |
| Swap-cash flow | | 2.47% - 2.50% | | January 2024 | | 300,000 | | | 300,000 | |
| Swap-cash flow | | 1.33% - 1.36% | | February 2026 | | 290,000 | | | 290,000 | |
| Total | | | | | | $ | 840,000 | | | $ | 1,040,000 | |
The Company records all derivative instruments at fair value in the accompanying consolidated balance sheets. Fair values of interest rate swaps and caps are determined using the standard market methodology of netting the discounted future fixed cash receipts/payments and the discounted expected variable cash payments/receipts. Variable interest rates used in the calculation of projected receipts and payments on the swaps are based on an expectation of future interest rates derived from observable market interest rate curves (Overnight Index Swap curves) and volatilities (Level 2 inputs). Derivatives expose the Company to credit risk in the event of non-performance by the counterparties under the terms of the interest rate hedge agreements. The Company incorporates these counterparty credit risks in its fair value measurements. The Company believes it minimizes the credit risk by transacting with major creditworthy financial institutions.
As of March 31, 2023, the Company's derivative instruments were in an asset position with an aggregate fair value of $30.1 million. None of the Company's derivative instruments were in a liability position as of March 31, 2023. Derivative assets are included in prepaid expenses and other assets and derivative liabilities are included in accounts payable, accrued expenses and other liabilities in the accompanying consolidated balance sheets. The Company expects approximately $20.9 million will be reclassified from accumulated other comprehensive income (loss) to interest expense within the next 12 months. In January 2023, the Company entered into interest rate swap agreements with an aggregate notional amount of $400.0 million, which will be effective in November 2023. In April 2023, the Company entered into an interest rate swap agreement with an aggregate notional amount of $82.5 million, which will be effective in May 2023.
Note 6. Revenue
The Company presents revenue on a disaggregated basis in the accompanying consolidated statements of operations and comprehensive income. The following table presents revenues by geographic location for the three months ended March 31, 2023 and 2022 (in thousands):
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| | For the three months ended March 31, | | |
| | 2023 | | 2022 | | | | |
| Southern Florida/Georgia | | $ | 71,029 | | | $ | 85,241 | | | | | |
| San Diego, CA | | 66,847 | | | 52,879 | | | | | |
| Los Angeles, CA | | 43,359 | | | 36,221 | | | | | |
| Boston, MA | | 42,671 | | | 33,936 | | | | | |
| San Francisco, CA | | 31,814 | | | 14,067 | | | | | |
| Portland, OR | | 14,640 | | | 13,524 | | | | | |
| Washington, D.C. | | 13,695 | | | 6,276 | | | | | |
| Chicago, IL | | 10,557 | | | 6,668 | | | | | |
| Seattle, WA | | 3,420 | | | 1,973 | | | | | |
Other (1) | | 7,687 | | | 7,283 | | | | | |
| Total Revenues | | $ | 305,719 | | | $ | 258,068 | | | | | |
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(1) Other includes: Philadelphia, PA, Newport, RI, and Santa Cruz, CA.
Payments from customers are primarily made when services are provided. Due to the short-term nature of the Company's contracts and the almost simultaneous receipt of payment, almost all of the contract liability balance at the beginning of the period is expected to be recognized as revenue over the following 12 months.
Note 7. Equity
Common Shares
The Company is authorized to issue up to 500,000,000 common shares. Each outstanding common share entitles the holder to one vote on each matter submitted to a vote of shareholders. Holders of common shares are entitled to receive dividends when authorized by the Board of Trustees.
Common Share Repurchase Programs
On July 27, 2017, the Company announced that the Board of Trustees authorized a share repurchase program of up to $100.0 million of common shares. Under this program, the Company may repurchase common shares from time to time in transactions on the open market or by private agreement. The Company may suspend or discontinue this program at any time. During the three months ended March 31, 2023, the Company repurchased 2,923,978 common shares for an aggregate purchase price of $41.0 million, or an average of approximately $14.04 per share. Upon repurchase by the Company, these common shares ceased to be outstanding and became authorized but unissued common shares. As of March 31, 2023, $46.0 million of common shares remained available for repurchase under this program.
On February 21, 2023, the Company announced that the Board of Trustees authorized a share repurchase program of up to $150.0 million of common shares. Under this program, the Company may repurchase common shares from time to time in transactions on the open market or by private agreement. This $150.0 million common share repurchase program will commence upon completion of the Company's $100.0 million share repurchase program.
ATM Program
On April 29, 2021, the Company filed a prospectus supplement with the SEC to sell up to $200.0 million of common shares under an "at the market" offering program (the "ATM program"). No common shares were issued or sold under the ATM program during the three months ended March 31, 2023. On February 21, 2023, the ATM program expired.
Common Dividends
The Company declared the following dividends on common shares/units for the three months ended March 31, 2023:
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| Dividend per Share/Unit | | For the Quarter Ended | | Record Date | | Payable Date |
| $ | 0.01 | | | March 31, 2023 | | March 31, 2023 | | April 17, 2023 |
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Preferred Shares
The Company is authorized to issue up to 100,000,000 preferred shares of beneficial interest, $0.01 par value per share (“preferred shares”).
The following preferred shares were outstanding as of March 31, 2023 and December 31, 2022:
| | | | | | | | | | | | | | |
| Security Type | | March 31, 2023 | | December 31, 2022 |
| | | | |
| | | | |
6.375% Series E | | 4,400,000 | | | 4,400,000 | |
6.30% Series F | | 6,000,000 | | | 6,000,000 | |
6.375% Series G | | 9,200,000 | | | 9,200,000 | |
5.70% Series H | | 9,000,000 | | | 9,000,000 | |
| | 28,600,000 | | | 28,600,000 | |
The Series E, Series F, Series G and Series H Cumulative Redeemable Preferred Shares (collectively, the “Preferred Shares”) rank senior to the common shares and on parity with each other with respect to payment of distributions. The Preferred Shares do not have any maturity date and are not subject to mandatory redemption. The Company may redeem the Series E and Series F Preferred Shares at any time. The Series G and Series H Preferred Shares may not be redeemed prior to May 13, 2026 and July 27, 2026, respectively, except in limited circumstances relating to the Company’s continuing qualification as a REIT or as discussed below. On or after such dates, the Company may, at its option, redeem the Preferred Shares, in each case in whole or from time to time in part, by payment of $25.00 per share, plus any accumulated, accrued and unpaid distributions through the date of redemption. Upon the occurrence of a change of control, as defined in the Company's declaration of trust, the result of which the common shares and the common securities of the acquiring or surviving entity are not listed on the New York Stock Exchange, the NYSE American or Nasdaq, or any successor exchanges, the Company may, at its option, redeem the Preferred Shares in whole or in part within 120 days following the change of control by paying $25.00 per share, plus any accrued and unpaid distributions through the date of redemption. If the Company does not exercise its right to redeem the Preferred Shares upon a change of control, the holders of the Preferred Shares have the right to convert some or all of their shares into a number of common shares based on defined formulas subject to share caps. The share cap on each Series E Preferred Share is 1.9372 common shares, on each Series F Preferred Share is 2.0649 common shares, on each Series G Preferred Share is 2.1231 common shares, and on each Series H Preferred Share is 2.2311 common shares.
Preferred Share Repurchase Program
On February 21, 2023, the Company announced that the Board of Trustees approved a repurchase program of up to $100.0 million of the Preferred Shares. Under the terms of the program, the Company may repurchase up to an aggregate of $100.0 million of the Preferred Shares. The timing, manner, price and amount of any repurchases will be determined by the Company in its discretion and will depend on a variety of factors, including legal requirements, price, liquidity and economic considerations, and market conditions. The program does not require the Company to repurchase any specific number of shares. The program does not have an expiration date and may be suspended, modified or discontinued at any time.
Preferred Dividends
The Company declared the following dividends on preferred shares for the three months ended March 31, 2023:
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| Security Type | | Dividend per Share/Unit | | For the Quarter Ended | | Record Date | | Payable Date |
6.375% Series E | | $ | 0.40 | | | March 31, 2023 | | March 31, 2023 | | April 17, 2023 |
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| | | | | | | | |
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6.30% Series F | | $ | 0.39 | | | March 31, 2023 | | March 31, 2023 | | April 17, 2023 |
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| | | | | | | | |
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6.375% Series G | | $ | 0.40 | | | March 31, 2023 | | March 31, 2023 | | April 17, 2023 |
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| | | | | | | | |
| | | | | | | | |
5.70% Series H | | $ | 0.36 | | | March 31, 2023 | | March 31, 2023 | | April 17, 2023 |
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Non-controlling Interest of Common Units in Operating Partnership
Holders of Operating Partnership units ("OP units") have certain redemption rights that enable OP unit holders to cause the Operating Partnership to redeem their units in exchange for, at the Company’s option, cash per unit equal to the market price of common shares at the time of redemption or common shares on a one-for-one basis. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of share splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have the effect of diluting the ownership interests of the Operating Partnership's limited partners or the Company's shareholders.
On November 30, 2018, in connection with the merger with LaSalle Hotel Properties ("LaSalle"), the Company issued 133,605 OP units in the Operating Partnership to third-party limited partners of LaSalle's operating partnership.
On May 11, 2022, in connection with the acquisition of Inn on Fifth in Naples, Florida, the Company issued 16,291 OP units in the Operating Partnership.
As of March 31, 2023 and December 31, 2022, the Operating Partnership had 149,896 OP units held by third parties, excluding LTIP units.
As of March 31, 2023, the Operating Partnership had two classes of long-term incentive partnership units ("LTIP units"), LTIP Class A units and LTIP Class B units. All of the outstanding LTIP units are held by officers of the Company.
On February 17, 2023, the Board of Trustees granted 131,276 LTIP Class B units to its executive officers. These LTIP units will vest ratably on January 1, 2024, 2025 and 2026, contingent upon continued employment with the Company. The fair value of each award was determined based on the closing price of the Company’s common shares on the grant date of $15.04 per unit with an aggregate grant date fair value of $2.0 million.
As of March 31, 2023, the Operating Partnership had 858,484 LTIP units outstanding, of which 277,136 LTIP units have vested. As of December 31, 2022, the Operating Partnership had 727,208 LTIP units outstanding, of which 127,111 LTIP units have vested. Only vested LTIP units may be converted to OP units, which in turn can be tendered for redemption as described above.
Non-controlling Interest of Preferred Units in Operating Partnership
On May 11, 2022, in connection with the acquisition of Inn on Fifth, the Company issued 3,104,400 preferred units in the Operating Partnership, designated as 6.0% Series Z Cumulative Perpetual Preferred Units ("Series Z Preferred Units"). The Series Z Preferred Units rank senior to the OP units and on parity with the Operating Partnership's Series E, Series F, Series G and Series H Preferred Units. Holders of Series Z Preferred Units are entitled to receive quarterly distributions at an annual rate of 6.0% of the liquidation preference value of $25.00 per share.
At any time, holders of Series Z Preferred Units may elect to convert some or all of their units into any other series of the Operating Partnership’s preferred units outstanding at that time. After the second anniversary of the issuance of the Series Z Preferred Units, holders may elect to redeem some or all of their units for, at the Company’s election, cash, common shares having an equivalent value or preferred shares on a one-for-one basis. After the fifth anniversary of their issuance, the Company may redeem the Series Z Preferred Units for cash, common shares having an equivalent value or preferred shares on a one-for-one basis. At any time following a change of control of the Company, holders of Series Z Preferred Units may elect to redeem some or all of their units for, at the Company’s election, cash or common shares having an equivalent value.
As of March 31, 2023, the Operating Partnership had 3,104,400 Series Z Preferred Units outstanding.
Note 8. Share-Based Compensation Plan
Available Shares
The Company maintains the 2009 Equity Incentive Plan, as amended and restated (as amended, the "Plan"), to attract and retain independent trustees, executive officers and other key employees and service providers. The Plan provides for the grant of options to purchase common shares, share awards, share appreciation rights, performance units and other equity-based awards. Share awards under the Plan vest over a period determined by the Board of Trustees, generally over three to five years. The Company pays or accrues for dividends on share-based awards. All outstanding share awards are subject to full or partial accelerated vesting upon a change in control and upon death or disability or certain other employment termination events as set forth in the award agreements. As of March 31, 2023, there were 1,454,457 common shares available for issuance under the Plan.
Service Condition Share Awards
From time to time, the Company awards restricted common shares under the Plan to members of the Board of Trustees, officers and employees. These shares generally vest over three to five years based on continued service or employment. The following table provides a summary of service condition restricted share activity as of March 31, 2023:
| | | | | | | | | | | |
| Shares | | Weighted-Average
Grant Date
Fair Value |
Unvested at December 31, 2022 | 567,317 | | | $ | 21.60 | |
| Granted | 113,084 | | | $ | 15.04 | |
| Vested | (183,721) | | | $ | 23.14 | |
| Forfeited | (8,200) | | | $ | 22.67 | |
| | | |
Unvested at March 31, 2023 | 488,480 | | | $ | 19.49 | |
For the three months ended March 31, 2023 and 2022, the Company recognized approximately $0.9 million and $0.8 million, respectively, of share-based compensation expense related to these awards in the accompanying consolidated statements of operations and comprehensive income.
Performance-Based Equity Awards
On February 17, 2023, the Board of Trustees approved a target award of 314,235 performance-based equity awards to officers and employees of the Company. These awards will vest, if at all, in 2026. The actual number of common shares that ultimately vest will be from 0% to 200% of the target award and will be determined in 2026 based on the performance criteria defined in the award agreements for the period of performance from January 1, 2023 through December 31, 2025.
For the three months ended March 31, 2023 and 2022, the Company recognized approximately $1.2 million and $0.9 million, respectively, of share-based compensation expense related to performance-based equity awards in the accompanying consolidated statements of operations and comprehensive income.
Long-Term Incentive Partnership Units
As of March 31, 2023, the Operating Partnership had two classes of LTIP units, LTIP Class A units and LTIP Class B units. All of the outstanding LTIP units are held by officers of the Company.
On February 17, 2023, the Board of Trustees granted 131,276 LTIP Class B units to its executive officers. These LTIP units will vest ratably on January 1, 2024, 2025 and 2026, contingent upon continued employment with the Company. The fair value of each award was determined based on the closing price of the Company’s common shares on the grant date of $15.04 per unit with an aggregate grant date fair value of $2.0 million.
As of March 31, 2023, the Operating Partnership had 858,484 LTIP units outstanding, of which 277,136 LTIP units have vested. As of December 31, 2022, the Operating Partnership had 727,208 LTIP units outstanding, of which 127,111 LTIP units have vested. Only vested LTIP units may be converted to OP units, which in turn can be tendered for redemption as described in Note 7. Equity.
For the three months ended March 31, 2023 and 2022, the Company recognized approximately $0.8 million and $0.7 million, respectively, in expense related to these LTIP units. The aggregate expense related to the LTIP unit grants is presented as non-controlling interest in the Company’s accompanying consolidated balance sheets.
Note 9. Income Taxes
PHL is subject to federal and state corporate income taxes at statutory tax rates. Given the continued negative impact of the COVID-19 pandemic on the Company's financial results and uncertainties about the Company's ability to utilize its net operating loss in future years, the Company has recorded a valuation allowance on its income tax benefit for the three months ended March 31, 2023, and has recorded a valuation allowance on all deferred tax assets.
The Company files tax returns as prescribed by the tax laws of the jurisdictions in which it operates. In the normal course of business, the Company is subject to examination by federal, state and local jurisdictions, where applicable. As of March 31, 2023 and December 31, 2022, the statute of limitations remains open for all major jurisdictions for tax years dating back to 2019.
Note 10. Earnings (Loss) Per Share
The following is a reconciliation of basic and diluted earnings (loss) per common share (in thousands, except share and per-share data):
| | | | | | | | | | | | | | | |
| | For the three months ended March 31, | | |
| | 2023 | | 2022 | | | | |
| Numerator: | | | | | | | |
| Net income (loss) attributable to common shareholders | $ | (33,916) | | | $ | (110,874) | | | | | |
| Less: Dividends paid on unvested share-based compensation | (11) | | | (10) | | | | | |
| | | | | | | |
| Net income (loss) available to common shareholders — basic and diluted | $ | (33,927) | | | $ | (110,884) | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Denominator: | | | | | | | |
| Weighted-average number of common shares — basic and diluted | 125,488,415 | | | 130,904,299 | | | | | |
| | | | | | | |
| | | | | | | |
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| Net income (loss) per share available to common shareholders — basic | $ | (0.27) | | | $ | (0.85) | | | | | |
| Net income (loss) per share available to common shareholders — diluted | $ | (0.27) | | | $ | (0.85) | | | | | |
For the three months ended March 31, 2023 and 2022, 1,158,282 and 787,871, respectively, of unvested service condition restricted shares and performance-based equity awards were excluded from diluted weighted-average number of common shares, as their effect would have been anti-dilutive. For the three months ended March 31, 2023 and 2022, 29,441,175 of common shares underlying the Convertible Notes have been excluded from diluted shares as their effect would have been anti-dilutive. The LTIP units and OP units held by the non-controlling interest holders have been excluded from the denominator of the diluted earnings per share as there would be no effect on the amounts since the limited partners' share of income (loss) would also be added or subtracted to derive net income (loss) available to common shareholders.
Note 11. Commitments and Contingencies
Hotel Management Agreements
The Company’s hotel properties are operated pursuant to management agreements with various management companies. The remaining terms of these management agreements are up to 11 years, not including renewals, and up to 29 years, including renewals. The majority of the Company’s management agreements are terminable at will by the Company upon paying a termination fee and some are terminable by the Company upon sale of the property, with, in some cases, the payment of termination fees. Most of the agreements also provide the Company the ability to terminate based on failure to achieve defined operating performance thresholds. Termination fees range from zero to up to four times the annual base management and incentive management fees, depending on the agreement and the reason for termination. Certain of the Company’s management agreements are non-terminable except upon the manager’s breach of a material representation or the manager’s failure to meet performance thresholds as defined in the management agreement.
The management agreements require the payment of a base management fee generally between 1% and 4% of hotel revenues. Under certain management agreements, the management companies are also eligible to receive an incentive management fee if hotel operating income, cash flows or other performance measures, as defined in the agreements, exceed certain performance thresholds. The incentive management fee is generally calculated as a percentage of hotel operating income after the Company has received a priority return on its investment in the hotel.
For the three months ended March 31, 2023 and 2022, combined base and incentive management fees were $8.0 million and $7.7 million, respectively. Base and incentive management fees are included in other direct and indirect expenses in the Company's accompanying consolidated statements of operations and comprehensive income.
Reserve Funds
Certain of the Company’s agreements with its hotel managers, franchisors, ground lessors and lenders have provisions for the Company to provide funds, typically 4.0% of hotel revenues, sufficient to cover the cost of (a) certain non-routine repairs and maintenance to the hotels and (b) replacements and renewals to the hotels’ furniture, fixtures and equipment.
Restricted Cash
At March 31, 2023 and December 31, 2022, the Company had $8.0 million and $11.2 million, respectively, in restricted cash, which consisted of funds held in cash management accounts held by a lender, reserves for replacement of furniture and fixtures, and reserves to pay for real estate taxes, ground rent or property insurance under certain hotel management agreements or loan agreements.
Hotel, Ground and Finance Leases
As of March 31, 2023, the following hotels were subject to leases as follows:
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| Lease Properties | | Lease Type | | Lease Expiration Date | |
| Restaurant at Southernmost Beach Resort | | Operating lease | | April 2029 | |
| Paradise Point Resort & Spa | | Operating lease | | May 2050 | |
| Hotel Monaco Washington DC | | Operating lease | | November 2059 | |
| Argonaut Hotel | | Operating lease | | December 2059 | |
| Hotel Zephyr Fisherman's Wharf | | Operating lease | | February 2062 | |
| Viceroy Santa Monica Hotel | | Operating lease | | September 2065 | |
| Estancia La Jolla Hotel & Spa | | Operating lease | | January 2066 | |
| San Diego Mission Bay Resort | | Operating lease | | July 2068 | |
| | | | | |
| 1 Hotel San Francisco | | Operating lease | | March 2070 | (1) |
| Hyatt Regency Boston Harbor | | Operating lease | | April 2077 | |
| The Westin Copley Place, Boston | | Operating lease | | December 2077 | (2) |
| The Liberty, a Luxury Collection Hotel, Boston | | Operating lease | | May 2080 | |
| Jekyll Island Club Resort and Restaurant | | Operating lease | | January 2089 | |
| Hotel Zelos San Francisco | | Operating lease | | June 2097 | |
| Hotel Palomar Los Angeles Beverly Hills | | Operating lease | | January 2107 | (3) |
| Margaritaville Hollywood Beach Resort | | Operating lease | | July 2112 | |
| Hotel Zeppelin San Francisco | | Operating and finance lease | | June 2089 | (4) |
| Harbor Court Hotel San Francisco | | Finance lease | | August 2052 | |
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(1) The expiration date assumes the exercise of a 14-year extension option.
(2) No payments are required through maturity.
(3) The expiration date assumes the exercise of all 19 five-year extension options.
(4) The expiration date assumes the exercise of a 30-year extension option.
The Company's leases may require minimum fixed rent payments, percentage rent payments based on a percentage of revenues in excess of certain thresholds or rent payments equal to the greater of a minimum fixed rent or percentage rent. Minimum fixed rent may be adjusted annually by increases in the consumer price index and may be subject to minimum and maximum increases. Some leases also contain certain restrictions on modifications that can be made to the hotel structures due to their status as national historic landmarks.
The Company records expense on a straight-line basis for leases that provide for minimum rental payments that increase in pre-established amounts over the remaining terms of the leases. Ground rent expense is included in real estate taxes, personal property taxes, property insurance and ground rent in the Company's accompanying consolidated statements of operations and comprehensive income.
The components of ground rent expense for the three months ended March 31, 2023 and 2022 are as follows (in thousands):
| | | | | | | | | | | | | | | | | | |
| | For the three months ended March 31, | | |
| | 2023 | | 2022 | | | | |
| Fixed ground rent | | $ | 4,782 | | | $ | 4,456 | | | | | |
| Variable ground rent | | 3,867 | | | 3,054 | | | | | |
| Total ground rent | | $ | 8,649 | | | $ | 7,510 | | | | | |
Litigation
The nature of the operations of hotels exposes the Company's hotels, the Company and the Operating Partnership to the risk of claims and litigation in the normal course of their business. The Company has insurance to cover certain potential material losses. The Company is not presently subject to any material litigation nor, to the Company’s knowledge, is any material litigation threatened against the Company.
Note 12. Supplemental Information to Statements of Cash Flows (in thousands)
| | | | | | | | | | | |
| | For the three months ended March 31, |
| | 2023 | | 2022 |
| | | |
| Interest paid, net of capitalized interest | $ | 20,338 | | | $ | 16,613 | |
| Interest capitalized | $ | — | | | $ | 769 | |
| Income taxes paid (refunded) | $ | (2,911) | | | $ | — | |
| | | |
| Non-Cash Investing and Financing Activities: | | | |
| | | |
| Distributions payable on common shares/units | $ | 1,279 | | | $ | 1,345 | |
| Distributions payable on preferred shares/units | $ | 10,902 | | | $ | 10,219 | |
| Issuance of common shares for Board of Trustees compensation | $ | 754 | | | $ | 738 | |
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| Accrued additions and improvements to hotel properties | $ | 14,492 | | | $ | 2,848 | |
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| | | |
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| Write-off of fully amortized deferred financing costs | $ | — | | | $ | 5,466 | |
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Note 13. Subsequent Events
The Company repurchased an aggregate of 1,007,134 of its common shares at an average price of $13.92 per share subsequent to March 31, 2023.