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EX-31.2 - EXHIBIT 31.2 - STRATEGIC HOTELS & RESORTS, INCbee-2015930xex312.htm
EX-32.2 - EXHIBIT 32.2 - STRATEGIC HOTELS & RESORTS, INCbee-2015930xex322.htm
EX-31.1 - EXHIBIT 31.1 - STRATEGIC HOTELS & RESORTS, INCbee-2015930xex311.htm
EX-32.1 - EXHIBIT 32.1 - STRATEGIC HOTELS & RESORTS, INCbee-2015930xex321.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________
FORM 10-Q 
______________________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 001-32223
STRATEGIC HOTELS & RESORTS, INC.
(Exact name of registrant as specified in its charter)
______________________________________________
Maryland
 
33-1082757
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
200 West Madison Street, Suite 1700, Chicago, Illinois
 
60606-3415
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (312) 658-5000 
______________________________________________
Former name, former address and former fiscal year, if changed since last report:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
x
 
Accelerated filer
 
o
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  o    No  x
The number of shares of common stock (par value $0.01 per share) of the registrant outstanding as of November 4, 2015 was 282,090,156.




STRATEGIC HOTELS & RESORTS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2015
INDEX
 
WHERE TO FIND MORE INFORMATION:
We maintain a website at www.strategichotels.com. Through our website, we make available, free of charge, our annual proxy statement, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). The SEC maintains a website that contains these reports at www.sec.gov.
This report (and Exhibit 99.1 hereto) contains registered trademarks that are the exclusive property of their respective owners, which are companies other than us, including Fairmont®, Four Seasons®, Hyatt®, InterContinental®, JW Marriott®, Loews®, Marriott®, Montage®, Ritz-Carlton® and Westin®. None of the owners of these trademarks, their affiliates or any of their respective officers, directors, agents or employees has or will have any liability or responsibility for any financial statements, projections or other financial information or other information contained in this report.



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES (SHR)
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)

 
 
September 30,
2015
 
December 31,
2014
Assets
 
 
 
 
Investment in hotel properties, net*
 
$
3,248,230

 
$
2,828,400

Goodwill
 
21,629

 
38,128

Intangible assets, net of accumulated amortization of $14,217 and $7,288
 
91,502

 
94,324

Assets held for sale
 
24,674

 

Investment in unconsolidated affiliates
 
21,010

 
22,850

Cash and cash equivalents*
 
128,000

 
442,613

Restricted cash and cash equivalents*
 
77,657

 
81,510

Accounts receivable, net of allowance for doubtful accounts of $563 and $492*
 
68,414

 
51,382

Deferred financing costs, net of accumulated amortization of $9,206 and $7,814*
 
13,873

 
11,440

Deferred tax assets
 
769

 
1,729

Prepaid expenses and other assets*
 
49,164

 
46,781

Total assets
 
$
3,744,922

 
$
3,619,157

Liabilities, Noncontrolling Interests and Equity
 
 
 
 
Liabilities:
 
 
 
 
Mortgages payable, net of discount*
 
$
1,460,206

 
$
1,705,778

Credit facility, including an unsecured term loan of $300,000 and $0
 
302,000

 

Liabilities of assets held for sale
 
6,499

 

Accounts payable and accrued expenses*
 
255,645

 
224,505

Preferred stock redemption liability
 

 
90,384

Distributions payable
 

 
104

Deferred tax liabilities
 
46,117

 
46,137

Total liabilities
 
2,070,467

 
2,066,908

Commitments and contingencies (see note 14)
 


 


Noncontrolling interests in SHR’s operating partnership
 
10,944

 
10,500

Equity:
 
 
 
 
SHR’s shareholders’ equity:
 
 
 
 
Common stock ($0.01 par value per share; 350,000,000 shares of common stock authorized; 282,090,156 and 267,435,799 shares of common stock issued and outstanding)
 
2,821

 
2,674

Additional paid-in capital
 
2,508,756

 
2,348,284

Accumulated deficit
 
(844,699
)
 
(890,469
)
Accumulated other comprehensive loss
 
(5,131
)
 
(13,032
)
Total SHR’s shareholders’ equity
 
1,661,747

 
1,447,457

Noncontrolling interests in consolidated affiliates
 
1,764

 
94,292

Total equity
 
1,663,511

 
1,541,749

Total liabilities, noncontrolling interests and equity
 
$
3,744,922

 
$
3,619,157

See accompanying notes to unaudited condensed consolidated financial statements.


3


STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES (SHR)
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS - Continued
(In Thousands)
 
 
September 30,
2015
 
December 31,
2014
*Consolidated Variable Interest Entity's Assets and Liabilities included in the above balances (see note 6):
 
 
 
 
Investment in hotel properties, net
 
$

 
$
336,243

Cash and cash equivalents
 

 
62,064

Restricted cash and cash equivalents
 

 
3,746

Accounts receivable, net of allowance for doubtful accounts of $0 and $49
 

 
4,920

Deferred financing costs, net of accumulated amortization of $0 and $0
 

 
3,899

Prepaid expenses and other assets
 

 
14,603

Mortgages payable
 

 
225,000

Accounts payable and accrued expenses
 

 
10,228

See accompanying notes to unaudited condensed consolidated financial statements.


4


STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES (SHR)
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
 
Rooms
 
$
198,114

 
$
176,133

 
$
547,355

 
$
428,107

Food and beverage
 
115,296

 
96,642

 
373,288

 
266,687

Other hotel operating revenue
 
40,346

 
31,224

 
113,242

 
77,405

Lease revenue
 
678

 
1,264

 
2,722

 
3,882

Total revenues
 
354,434

 
305,263

 
1,036,607

 
776,081

Operating Costs and Expenses:
 
 
 
 
 
 
 
 
Rooms
 
52,968

 
48,197

 
151,905

 
123,172

Food and beverage
 
83,412

 
70,965

 
254,731

 
192,645

Other departmental expenses
 
89,068

 
74,640

 
260,418

 
194,457

Management fees
 
11,578

 
9,970

 
35,440

 
24,989

Other hotel expenses
 
21,688

 
17,998

 
57,143

 
49,248

Lease expense
 
682

 
1,215

 
2,733

 
3,733

Depreciation and amortization
 
39,633

 
32,932

 
117,628

 
83,195

Impairment losses
 
2,325

 

 
12,726

 

Corporate expenses
 
10,709

 
5,405

 
25,418

 
19,796

Total operating costs and expenses
 
312,063

 
261,322

 
918,142

 
691,235

Operating income
 
42,371

 
43,941

 
118,465

 
84,846

Interest expense
 
(18,575
)
 
(21,844
)
 
(62,069
)
 
(59,705
)
Interest income
 
3

 
46

 
120

 
123

Loss on early extinguishment of debt
 

 
(609
)
 
(34,211
)
 
(609
)
Equity in (losses) earnings of unconsolidated affiliates
 

 
(4
)
 

 
5,267

Foreign currency exchange gain (loss)
 
4

 
(69
)
 
(72
)
 
(75
)
(Loss) gain on consolidation of affiliates
 

 
(15
)
 

 
143,451

Other income (expenses), net
 
2,746

 
(136
)
 
43,054

 
1,082

Income before income taxes and discontinued operations
 
26,549

 
21,310

 
65,287

 
174,380

Income tax expense
 
(3,857
)
 
(370
)
 
(6,528
)
 
(616
)
Income from continuing operations
 
22,692

 
20,940

 
58,759

 
173,764

Income from discontinued operations, net of tax
 

 
63

 

 
159,102

Net Income
 
22,692

 
21,003

 
58,759

 
332,866

Net income attributable to the noncontrolling interests in SHR’s operating partnership
 
(65
)
 
(67
)
 
(169
)
 
(1,197
)
Net loss (income) attributable to the noncontrolling interests in consolidated affiliates
 
634

 
1,854

 
(12,820
)
 
6,112

Net Income Attributable to SHR
 
23,261

 
22,790

 
45,770

 
337,781

Preferred shareholder dividends
 

 
(1,802
)
 

 
(18,795
)
Net Income Attributable to SHR Common Shareholders
 
$
23,261

 
$
20,988

 
$
45,770

 
$
318,986

Amounts Attributable to SHR:
 
 
 
 
 
 
 
 
Income from continuing operations
 
$
23,261

 
$
22,727

 
$
45,770

 
$
179,287

Income from discontinued operations
 

 
63

 

 
158,494

Net income
 
$
23,261

 
$
22,790

 
$
45,770

 
$
337,781

Basic Income Per Common Share:
 
 
 
 
 
 
 
 
Income from continuing operations attributable to SHR common shareholders
 
$
0.08

 
$
0.08

 
$
0.17

 
$
0.71

Income from discontinued operations attributable to SHR common shareholders
 

 

 

 
0.70

Net income attributable to SHR common shareholders
 
$
0.08

 
$
0.08

 
$
0.17

 
$
1.41

Weighted average shares of common stock outstanding
 
279,579

 
248,509

 
276,580

 
225,932

Diluted Income Per Common Share:
 
 
 
 
 
 
 
 
Income from continuing operations attributable to SHR common shareholders
 
$
0.08

 
$
0.07

 
$
0.16

 
$
0.65

Income from discontinued operations attributable to SHR common shareholders
 

 

 

 
0.67

Net income attributable to SHR common shareholders
 
$
0.08

 
$
0.07

 
$
0.16

 
$
1.32

Weighted average shares of common stock outstanding
 
282,659

 
260,257

 
278,583

 
237,680


See accompanying notes to unaudited condensed consolidated financial statements.

5


STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES (SHR)
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(In Thousands)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Net Income
 
$
22,692

 
$
21,003

 
$
58,759

 
$
332,866

Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency exchange translation adjustments
 
(4
)
 
(40
)
 
(130
)
 
18,739

Reclassification of amounts from accumulated other comprehensive loss to net income and effective portion of mark to market adjustments related to cash flow hedges
 
2,459

 
3,114

 
8,031

 
6,604

Other comprehensive income
 
2,455

 
3,074

 
7,901

 
25,343

Comprehensive Income
 
25,147

 
24,077

 
66,660

 
358,209

Comprehensive income attributable to the noncontrolling interests in SHR’s operating partnership
 
(72
)
 
(77
)
 
(192
)
 
(1,290
)
Comprehensive loss (income) attributable to the noncontrolling interests in consolidated affiliates
 
634

 
1,854

 
(12,820
)
 
6,112

Comprehensive Income Attributable to SHR
 
$
25,709

 
$
25,854

 
$
53,648

 
$
363,031

See accompanying notes to unaudited condensed consolidated financial statements.

6


STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES (SHR)
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Operating Activities:
 
 
 
 
Net income
 
$
58,759

 
$
332,866

Adjustments to reconcile net income to net cash provided by operating activities (including discontinued operations):
 
 
 
 
Deferred income tax expense
 
959

 
642

Depreciation and amortization
 
117,628

 
84,470

Amortization of deferred financing and other costs
 
13,124

 
11,761

Non-cash impairment losses
 
12,726

 

Loss on early extinguishment of debt
 
1,212

 
881

Equity in earnings of unconsolidated affiliates
 

 
(5,267
)
Share-based compensation
 
5,598

 
4,330

Gain on consolidation of affiliates
 

 
(143,451
)
Gain on disposal of assets, net of tax
 
(43,274
)
 
(156,492
)
Income tax on sale of assets
 

 
(20,451
)
Foreign currency exchange loss
 
72

 
43

Recognition of deferred gains
 
(116
)
 
(159
)
Mark to market of derivative financial instruments
 
152

 
(2,961
)
Increase in accounts receivable
 
(16,590
)
 
(2,063
)
Increase in prepaid expenses and other assets
 
(2,950
)
 
(1,828
)
Increase in accounts payable and accrued expenses
 
24,067

 
7,078

Net cash provided by operating activities
 
171,367

 
109,399

Investing Activities:
 
 
 
 
Acquisition of hotel and other investments
 
(306,577
)
 
(305,498
)
Proceeds from sales of assets
 
118,293

 
416,100

Cash received from unconsolidated affiliates
 
1,840

 
2,221

Unrestricted cash sold
 
(2,226
)
 
(15,634
)
Unrestricted cash acquired
 
8,994

 
22,160

Capital expenditures
 
(68,060
)
 
(55,155
)
Decrease (increase) in restricted cash and cash equivalents
 
1,063

 
(5,438
)
Net cash (used in) provided by investing activities
 
(246,673
)
 
58,756

Financing Activities:
 
 
 
 
Proceeds from issuance of common stock
 

 
434,700

Equity issuance costs
 
(616
)
 
(18,052
)
Preferred stock redemption
 
(90,391
)
 
(199,489
)
Borrowings under credit facility arrangements
 
535,000

 
148,000

Payments on credit facility arrangements
 
(233,000
)
 
(258,000
)
Proceeds from mortgages
 
115,000

 
127,000

Payments on mortgages
 
(510,253
)
 
(215,592
)
Contributions from holders of noncontrolling interests in consolidated affiliates
 

 
5,723

Debt financing costs
 
(6,475
)
 
(5,392
)
Interest rate swap termination
 

 
(22,325
)
Distributions to preferred shareholders
 
(104
)
 
(11,883
)
Distributions to holders of noncontrolling interests in consolidated affiliates
 
(43,741
)
 
(7
)
Other financing activities
 
(2,609
)
 
(1,034
)
Net cash used in financing activities
 
(237,189
)
 
(16,351
)
Effect of exchange rate changes on cash
 
(164
)
 
43

Net change in cash and cash equivalents
 
(312,659
)
 
151,847

Change in cash of assets held for sale
 
(1,954
)
 
8,903

Cash and cash equivalents, beginning of period
 
442,613

 
73,655

Cash and cash equivalents, end of period
 
$
128,000

 
$
234,405


See accompanying notes to unaudited condensed consolidated financial statements.

7


STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES (SHR)
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – Continued
(In Thousands)

 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Supplemental Schedule of Non-Cash Investing and Financing Activities:
 
 
 
 
Fair value of shares of SHR common stock issued for acquisition of noncontrolling interest in consolidated affiliate (see notes 6 and 10)
 
$
90,621

 
$

Fair value of shares of SHR common stock issued for acquisition of interest in hotel property (see note 3)
 
$
101,396

 
$

Assumption of mortgage loans - hotel investment acquisition (see note 3)
 
$
148,951

 
$
589,507

Gain on mark to market of derivative instruments (see note 11)
 
$

 
$
(2,781
)
Increase (decrease) in capital expenditures recorded as liabilities
 
$
7,144

 
$
(2,687
)
Cash Paid For:
 
 
 
 
Interest, net of interest capitalized
 
$
50,073

 
$
53,596

Income taxes, net of refunds
 
$
4,459

 
$
21,776


See accompanying notes to unaudited condensed consolidated financial statements.


8


STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
Strategic Hotels & Resorts, Inc. (SHR and, together with its subsidiaries, the Company) was incorporated in January 2004 to acquire and asset-manage upper upscale and luxury hotels that are subject to long-term management contracts. As of September 30, 2015, the Company’s portfolio included 17 full-service hotel interests located in urban and resort markets in the United States of America. The Company considers each hotel to be a separate operating segment because the Company allocates resources and assesses performance on an individual hotel basis. The Company aggregates the individual hotels into one reportable business segment, hotel ownership.
SHR operates as a self-administered and self-managed real estate investment trust (REIT), which means that it is managed by its board of directors and executive officers. A REIT is a legal entity that holds real estate interests and, through payments of dividends to stockholders, is permitted to reduce or avoid federal income taxes at the corporate level. For SHR to continue to qualify as a REIT, it cannot operate hotels; instead it employs internationally known hotel management companies to operate its hotels under management contracts. SHR conducts its operations through its direct and indirect subsidiaries, including its operating partnership, Strategic Hotel Funding, L.L.C. (SH Funding), which currently holds substantially all of the Company’s assets. SHR is the sole managing member of SH Funding and holds approximately 99.7% of its membership units as of September 30, 2015. SHR manages all business aspects of SH Funding, including the sale and purchase of hotels, the investment in these hotels and the financing of SH Funding and its assets.
As of September 30, 2015, SH Funding owned interests in the following 17 hotels:
1. Fairmont Chicago
 
10. InterContinental Miami
2. Fairmont Scottsdale Princess (a)
 
11. JW Marriott Essex House Hotel (c)
3. Four Seasons Hotel Austin
 
12. Loews Santa Monica Beach Hotel
4. Four Seasons Jackson Hole
 
13. Marriott Lincolnshire Resort (d)
5. Four Seasons Resort Scottsdale at Troon North
 
14. Montage Laguna Beach
6. Four Seasons Silicon Valley
 
15. Ritz-Carlton Half Moon Bay
7. Four Seasons Washington, D.C.
 
16. Ritz-Carlton Laguna Niguel
8. Hotel del Coronado (b)
 
17. Westin St. Francis
9. InterContinental Chicago
 
 
(a)
This property is owned by an affiliate that was partially-owned by the Company and accounted for as an unconsolidated affiliate prior to March 31, 2014 (see note 7). On March 31, 2014, the Company acquired the remaining ownership interests in the affiliate and began accounting for it as a consolidated affiliate (see note 3). One land parcel at this property is subject to a ground lease arrangement.
(b)
This property is owned by an affiliate that was partially-owned by the Company and accounted for as an unconsolidated affiliate prior to June 11, 2014 (see note 7). On June 11, 2014, the Company acquired the remaining ownership interests in the affiliate and began accounting for it as a consolidated affiliate (see note 3).
(c)
The Company owns 100% of this property after acquiring its joint venture partner's noncontrolling interest on July 24, 2015 (see notes 6 and 10).
(d)
This property is subject to a ground lease arrangement. On August 19, 2015, the Company entered into an agreement to sell this property (see notes 4 and 5).

Agreement and Plan of Merger:

On September 4, 2015, SHR and SH Funding (together with SHR, the Company Parties), entered into an Agreement and Plan of Merger (the Merger Agreement) with BRE Diamond Hotel Holdings LLC, a Delaware limited liability company (BRE Holdings), BRE Diamond Hotel LLC, a Delaware limited liability company whose sole member is BRE Holdings (Merger Sub), and BRE Diamond Hotel Acquisition LLC, a Delaware limited liability company whose sole member is Merger Sub (Merger Opco). BRE Holdings, Merger Sub and Merger Opco (collectively, the Buyer Parties) are affiliates of Blackstone Real Estate Partners VIII L.P. (BRE Partnership VIII), an affiliate of The Blackstone Group L.P. (Blackstone).

Pursuant to the Merger Agreement, SHR will merge with and into Merger Sub (the Company Merger), with the Merger Sub continuing as the surviving limited liability company (the Surviving Company). As a result of the Company Merger, each share

9

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

of common stock, par value $0.01 per share (each, a Share), of SHR issued and outstanding immediately prior to the effective time of the Company Merger (the Company Merger Effective Time) will be converted into the right to receive $14.25 in cash (Merger Consideration), without interest, less any required withholding taxes (other than Shares that are owned of record by SHR, the Buyer Parties or any of their respective wholly-owned subsidiaries, which Shares shall be cancelled and cease to exist as of the Company Merger Effective Time, with no payment being made with respect thereto).

Immediately prior to the Company Merger, Merger Opco will merge with and into SH Funding (the Partnership Merger, and, together with the Company Merger, the Mergers), with SH Funding continuing as the surviving limited liability company (the Surviving Partnership). As a result of the Partnership Merger, each membership unit of SH Funding (the OP Units) issued and outstanding immediately prior to the effective time of the Partnership Merger (the Partnership Merger Effective Time) will be converted into the right to receive the Merger Consideration, without interest, less any required withholding taxes (other than (i) OP Units held by SHR immediately prior to the Partnership Merger Effective Time, which will remain outstanding as OP Units of the Surviving Partnership and (ii) OP Units held by any of the Buyer Parties or any of their wholly-owned Subsidiaries, which will be cancelled and cease to exist as of the Partnership Merger Effective Time, with no payment being made with respect thereto). As a result of the Mergers, the Surviving Company and Surviving Partnership will become wholly-owned subsidiaries of BRE Holdings.

Restricted stock units (RSUs) and performance-based RSUs issued and outstanding under SHR's Second Amended and Restated 2004 Incentive Plan will become fully vested immediately prior to the Company Merger Effective Time and will be cancelled, and, in exchange, each holder of such units will be entitled to receive a cash payment, without interest and less required withholding taxes, in an amount equal to the product of (i) the Merger Consideration and (ii) the number of units held. RSUs and performance-based RSUs that have vested but have not yet been converted to Shares will be cancelled, and, in exchange, each holder of such units will be entitled to receive a cash payment, without interest and less required withholding taxes, in an amount equal to the product of (i) the Merger Consideration and (ii) the number of units held.

The Merger Agreement, Mergers and other transactions contemplated thereby were unanimously approved by SHR's board of directors. The consummation of the Mergers is subject to customary closing conditions, including, among others, receiving the affirmative vote of the holders of a majority of the Shares at a special meeting of stockholders, which will be held on December 8, 2015. The Merger Agreement also contains customary representations, including, among others, covenants by SHR to conduct its business, in all material respects, in the ordinary course of business consistent with past practice, subject to certain exceptions, during the period between the execution of the Merger Agreement and the consummation of the Mergers.

The consummation of the Mergers is not subject to a financing condition. If the Merger Agreement is terminated by SHR under specified circumstances, SHR would be obligated to pay BRE Holdings a termination fee of $100,000,000, including if, after following certain procedures and adhering to certain restrictions, SHR's board of directors approves, and concurrently with the termination of the Merger Agreement, SHR enters into, a definitive agreement providing the implementation of a superior proposal. Under certain other circumstances under which BRE Holdings terminates the Merger Agreement, BRE Holdings would be obligated to pay SHR a termination fee of $400,000,000. The Mergers are expected to close in the fourth quarter of 2015.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and in conformity with the rules and regulations of the SEC applicable to interim financial information. As such, certain information and footnote disclosures normally included in complete annual financial statements prepared in accordance with GAAP have been omitted in accordance with the rules and regulations of the SEC. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary to present fairly the financial position of the Company and its results of operations and cash flows for the interim periods presented. The Company believes the disclosures made are adequate to prevent the information presented from being misleading. However, the unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in SHR’s annual report on Form 10-K for the year ended December 31, 2014.
Basis of Consolidation:
The accompanying unaudited condensed consolidated financial statements include the accounts of SHR, its subsidiaries and other entities in which the Company has a controlling interest. If SH Funding determines that it is the holder of a variable interest in a variable interest entity (VIE), and it is the primary beneficiary, then SH Funding will consolidate the entity (see note

10

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6). For entities that are not considered VIEs, SH Funding consolidates those entities it controls. It accounts for those entities over which it has a significant influence but does not control using the equity method of accounting. At September 30, 2015, SH Funding owned interests in the Four Seasons Residence Club Punta Mita (Four Seasons RCPM) and the Lot H5 Venture (see note 7), which are unconsolidated affiliates in the accompanying unaudited condensed consolidated financial statements that are accounted for using the equity method of accounting.
All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates:
The preparation of condensed 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 condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Restricted Cash and Cash Equivalents:
At September 30, 2015 and December 31, 2014, restricted cash and cash equivalents included $48,360,000 and $37,486,000, respectively, that will be used for property and equipment replacement in accordance with hotel management agreements. At September 30, 2015 and December 31, 2014, restricted cash and cash equivalents also included reserves of $29,297,000 and $44,024,000, respectively, required by loan and other agreements.
Income Taxes:
SHR has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the Tax Code). As a REIT, SHR generally will not be subject to U.S. federal income tax if it distributes 100% of its annual taxable income to its shareholders and complies with certain other requirements. As a REIT, SHR is subject to a number of organizational and operational requirements. If it fails to qualify as a REIT in any taxable year, SHR will be subject to U.S. federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate tax rates. Even if it qualifies for taxation as a REIT, it may be subject to foreign, state and local income taxes and to U.S. federal income tax and excise tax on its undistributed income. In addition, taxable income from SHR’s taxable REIT subsidiaries is subject to federal, foreign, state and local income taxes.
Deferred tax assets and liabilities are established for net operating loss carryforwards and temporary differences between the financial reporting basis and the tax basis of assets and liabilities at the enacted tax rates expected to be in effect when the net operating loss carryforwards are utilized and when the temporary differences reverse. The Company evaluates uncertain tax positions in accordance with applicable accounting guidance. A valuation allowance for deferred tax assets is provided if the Company believes all or some portion of the deferred tax asset may not be realized. Any increase or decrease in the valuation allowance that results from a change in circumstances that causes a change in the estimated realizability of the related deferred tax asset is included in earnings.
For the three and nine months ended September 30, 2015 and 2014, income tax expense is summarized as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Current tax expense
$
(3,207
)
 
$

 
$
(5,569
)
 
$
(699
)
Deferred tax (expense) benefit
(650
)
 
(370
)
 
(959
)
 
83

Total income tax expense
$
(3,857
)
 
$
(370
)
 
$
(6,528
)
 
$
(616
)

11

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Per Share Data:
The Company uses the two-class method to calculate per share data for common stock and participating securities. Under the two-class method, net earnings are allocated to common stock and participating securities as if all of the net earnings for the period had been distributed. Unvested share-based compensation awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing per share data pursuant to the two-class method. The Company's RSUs are considered participating securities because they contain non-forfeitable rights to dividend equivalents. To the extent the Company has undistributed earnings, it will follow the two-class method of computing per share data.
Basic income per common share is computed by dividing the net income attributable to SHR common shareholders by the weighted average shares of common stock outstanding during each period. Diluted income per common share is computed by dividing the net income attributable to SHR common shareholders as adjusted for the impact of dilutive securities, if any, by the weighted average shares of common stock outstanding plus potentially dilutive securities. Dilutive securities may include RSUs, performance-based RSUs, and noncontrolling interests that have an option to exchange their interests to shares of SHR common stock. No effect is shown for securities that are anti-dilutive. Potentially dilutive shares are determined using the more dilutive of either the two-class method or the treasury stock method. The following table sets forth the components of the calculation of net income attributable to SHR common shareholders used for determining per share amounts for the three and nine months ended September 30, 2015 and 2014 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Numerator - Basic:
 
 
 
 
 
 
 
Income from continuing operations attributable to SHR
$
23,261

 
$
22,727

 
$
45,770

 
$
179,287

Preferred shareholder dividends

 
(1,802
)
 

 
(11,883
)
Preferred stock redemption(a)

 

 

 
(6,912
)
Undistributed earnings allocated to participating securities - basic

 
(57
)
 
(111
)
 
(1,011
)
Income from continuing operations attributable to SHR common shareholders - basic
23,261

 
20,868

 
45,659

 
159,481

Discontinued operations attributable to SHR

 
63

 

 
158,494

Net income attributable to SHR common shareholders - basic
$
23,261

 
$
20,931

 
$
45,659

 
$
317,975

 
 
 
 
 
 
 
 
Numerator - Diluted:
 
 
 
 
 
 
 
Income from continuing operations attributable to SHR common shareholders - basic
$
23,261

 
$
20,868

 
$
45,659

 
$
159,481

Undistributed earnings allocated to participating securities - basic

 
57

 
111

 
1,011

Undistributed earnings allocated to participating securities - diluted

 
(51
)
 
(110
)
 
(948
)
Adjustment for noncontrolling interests in consolidated affiliates (see note 6)

 
(1,434
)
 

 
(4,322
)
Income from continuing operations attributable to SHR common shareholders - diluted
23,261

 
19,440

 
45,660

 
155,222

Discontinued operations attributable to SHR

 
63

 

 
158,494

Net income attributable to SHR common shareholders - diluted
$
23,261

 
$
19,503

 
$
45,660

 
$
313,716

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average shares of common stock – basic (b)
279,579

 
248,509

 
276,580

 
225,932

Effect of dilutive securities:
 
 
 
 
 
 
 
Noncontrolling interests in consolidated affiliates (see note 6)

 
9,533

 

 
9,533

Performance-based RSUs
2,003

 
2,215

 
2,003

 
2,215

RSUs
283

 

 

 

Noncontrolling interests in SHR's operating partnership
794

 

 

 

Weighted average shares of common stock - diluted
282,659

 
260,257

 
278,583

 
237,680


12

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(a) In April 2014, SHR redeemed all of the outstanding shares of its 8.50% Series A Cumulative Redeemable Preferred Stock (Series A Preferred Stock) (see note 10). In July 2014, SHR redeemed all of the outstanding shares of its 8.25% Series C Cumulative Redeemable Preferred Stock (Series C Preferred Stock) (see note 10). For purposes of calculating per share amounts for the nine months ended September 30, 2014, the difference between the fair value of the Series A Preferred Stock and the Series C Preferred Stock and the carrying amount of the Series A Preferred Stock and the Series C Preferred Stock is an adjustment to net income attributable to SHR common shareholders.
(b) Includes RSUs and performance-based RSUs of 1,002 and 1,128 at September 30, 2015 and 2014, respectively, that have vested but have not yet been issued to shares of SHR common stock.
Securities that could potentially dilute basic income per share in the future that are not included in the computation of diluted income per share because they are anti-dilutive as of September 30, 2015 and 2014 are as follows (in thousands):
 
Computation For Three Months Ended September 30,
 
Computation For Nine Months
Ended September 30,
 
2015
 
2014
 
2015
 
2014
Noncontrolling interests in SHR's operating partnership

 
794

 
794

 
794

Accumulated Other Comprehensive Loss:
The Company’s accumulated other comprehensive loss (OCL) results from activity related to certain derivative financial instruments and unrealized gains or losses on foreign currency translation adjustments (CTA). The following tables provide the changes in accumulated OCL for the three-month periods ended September 30, 2015 and 2014 (in thousands):
 
Derivative Activity
 
CTA
 
Accumulated OCL
Balance at June 30, 2015
$
(5,326
)
 
$
(2,260
)
 
$
(7,586
)
Other comprehensive loss before reclassifications

 
(4
)
 
(4
)
Amounts reclassified from accumulated OCL
2,459

 

 
2,459

Net other comprehensive income (loss)
2,459

 
(4
)
 
2,455

Balance at September 30, 2015
$
(2,867
)
 
$
(2,264
)
 
$
(5,131
)
 
Derivative Activity
 
CTA
 
Accumulated OCL
Balance at June 30, 2014
$
(17,126
)
 
$
(2,050
)
 
$
(19,176
)
Other comprehensive loss before reclassifications

 
(40
)
 
(40
)
Amounts reclassified from accumulated OCL
3,114

 

 
3,114

Net other comprehensive income (loss)
3,114

 
(40
)
 
3,074

Balance at September 30, 2014
$
(14,012
)
 
$
(2,090
)
 
$
(16,102
)

13

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following tables provide the changes in accumulated OCL for the nine-month periods ended September 30, 2015 and 2014 (in thousands):
 
Derivative Activity
 
CTA
 
Accumulated OCL
Balance at January 1, 2015
$
(10,898
)
 
$
(2,134
)
 
$
(13,032
)
Other comprehensive loss before reclassifications

 
(130
)
 
(130
)
Amounts reclassified from accumulated OCL
8,031

 

 
8,031

Net other comprehensive income (loss)
8,031

 
(130
)
 
7,901

Balance at September 30, 2015
$
(2,867
)
 
$
(2,264
)
 
$
(5,131
)
 
Derivative Activity
 
CTA
 
Accumulated OCL
Balance at January 1, 2014
$
(20,616
)
 
$
(20,829
)
 
$
(41,445
)
Other comprehensive loss before reclassifications
(341
)
 
(156
)
 
(497
)
Amounts reclassified from accumulated OCL
6,945

 
18,895

 
25,840

Net other comprehensive income
6,604

 
18,739

 
25,343

Balance at September 30, 2014
$
(14,012
)
 
$
(2,090
)
 
$
(16,102
)

The reclassifications out of accumulated OCL for the three and nine months ended September 30, 2015 and 2014 are as follows (in thousands):
 
 
Amounts Reclassified from Accumulated OCL
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
Details about Accumulated OCL Components
 
2015
 
2014
 
2015
 
2014
 
Statement of Operations Line Item
Activity related to cash flow hedges
 
$
2,459

 
$
3,114

 
$
8,031

 
$
6,945

 
Interest expense
Activity related to CTA
 
$

 
$

 
$

 
$
18,895

 
Income from discontinued operations, net of tax
New Accounting Guidance:

In April 2015, the Financial Accounting Standards Board (FASB) issued new guidance which changes the presentation of debt issuance costs in financial statements. Under the new guidance, an entity presents debt issuance costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the debt issuance costs is reported as interest expense. The new guidance is effective on January 1, 2016, with early adoption permitted for any annual or interim period for which an entity's financial statements have not yet been made available for issuance. The new guidance must be applied retrospectively to all prior periods presented. In August 2015, the FASB provided clarification on the SEC staff's position on presenting and measuring debt issuance costs incurred in connection with line of credit arrangements. The clarification notes that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line of credit arrangement. The Company expects to adopt the new guidance on January 1, 2016 and will apply the presentation guidance to all periods presented in its consolidated financial statements.

In February 2015, the FASB issued new accounting guidance which makes certain changes to both the variable interest model and the voting model, including changes to (1) the identification of variable interests (fees paid to a decision maker or service provider), (2) the variable interest entity characteristics for a limited partnership or similar entity and (3) the primary beneficiary determination. This guidance is effective beginning January 1, 2016. The Company will apply the guidance prospectively and is evaluating the effect that the guidance will have on its consolidated financial statements and related disclosures.

In August 2014, the FASB issued new accounting guidance which requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. The standard provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. This guidance is effective on January 1, 2017. The Company will apply the guidance prospectively and does not anticipate the guidance will have a material impact on its consolidated financial statements or disclosures.


14

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

In May 2014, the FASB issued new guidance which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The guidance will replace most existing revenue recognition guidance in GAAP when it becomes effective. The new guidance is effective on January 1, 2018 with early adoption permitted on January 1, 2017. The guidance permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that the guidance will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the guidance on its consolidated financial statements.
In April 2014, the FASB issued new guidance which amends the requirements for reporting discontinued operations. Under the guidance, only disposals that represent a strategic shift that has (or will have) a major effect on the entity's results of operations would qualify as discontinued operations. In addition, the guidance expands the disclosure requirements for disposals that meet the definition of a discontinued operation and requires entities to disclose information about disposals of individually significant components. The provisions became effective in the first quarter of 2015, with early adoption permitted for any annual or interim period for which an entity's financial statements have not yet been made available for issuance. The Company adopted the guidance on January 1, 2015 and will apply the guidance prospectively to disposal activity occurring after January 1, 2015.

3. INVESTMENT IN HOTEL PROPERTIES, NET
The following summarizes the Company’s investment in hotel properties as of September 30, 2015 and December 31, 2014 (which excludes the leasehold interest in the Marriott Hamburg hotel at December 31, 2014) (in thousands):
 
 
September 30,
2015
 
December 31,
2014
Land
 
$
1,010,754

 
$
858,670

Leasehold interest
 

 
11,633

Buildings
 
2,187,615

 
1,964,252

Building and leasehold improvements
 
104,709

 
106,303

Site improvements
 
56,369

 
59,038

Furniture, fixtures and equipment
 
654,958

 
611,450

Improvements in progress
 
39,873

 
21,552

Total investment in hotel properties
 
4,054,278

 
3,632,898

Less accumulated depreciation
 
(806,048
)
 
(804,498
)
Total investment in hotel properties, net
 
$
3,248,230

 
$
2,828,400

Consolidated hotel properties
 
17

 
16

Hotel Acquisitions:
The Company's hotel acquisitions, as more fully described below, are consistent with the Company's strategy of focusing on the acquisition of upper upscale and luxury hotels in select urban and resort markets with strong growth characteristics and high barriers to entry where it believes there are opportunities to add value. All of the acquisitions were accounted for under the provisions of business combination guidance. The assets and liabilities of the hotels were consolidated in the Company's condensed consolidated balance sheets at the acquisition-date fair values and the results of operations were consolidated in the Company's condensed consolidated statements of operations from the date of acquisition.
Four Seasons Hotel Austin
On May 12, 2015, the Company acquired the Four Seasons Hotel Austin for a cash payment of approximately $196,258,000, which includes net working capital prorations. For the nine months ended September 30, 2015 and 2014, the Company incurred acquisition costs related to the Four Seasons Hotel Austin of $317,000 and $0, respectively, that are included in corporate expenses on the condensed consolidated statements of operations.
Montage Laguna Beach
On January 29, 2015, the Company acquired the Montage Laguna Beach resort. The acquisition was funded through the issuance of 7,347,539 shares of SHR's common stock to an affiliated designee of the seller, the assumption of a $150,000,000 existing mortgage loan encumbering the property, and a cash payment of approximately $110,319,000, which includes net working capital prorations. For the nine months ended September 30, 2015 and 2014, the Company incurred acquisition costs

15

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

related to the Montage Laguna Beach resort of $735,000 and $0, respectively, that are included in corporate expenses on the condensed consolidated statements of operations.
Four Seasons Resort Scottsdale at Troon North
On December 9, 2014, the Company acquired the Four Seasons Resort Scottsdale at Troon North for a cash payment of approximately $140,920,000, which includes net working capital prorations. For the nine months ended September 30, 2015 and 2014, the Company incurred acquisition costs related to the Four Seasons Resort Scottsdale at Troon North of $57,000 and $0, respectively, that are included in corporate expenses on the condensed consolidated statements of operations.
Hotel del Coronado
On June 11, 2014, the Company closed on the acquisition of the 63.6% equity interests in the entity that owns the Hotel del Coronado, BSK Del Partner, L.P. (the Hotel del Coronado Venture), that were previously owned by certain affiliates of Blackstone Real Estate Partners VI L.P. (BRE Partnership VI) (see note 7) for a cash payment of $210,000,000. Additionally, the Company became fully obligated under the entire $475,000,000 mortgage and mezzanine loans outstanding secured by the Hotel del Coronado. Effective as of the closing of the transaction, the Company wholly owns and consolidates the Hotel del Coronado Venture.
As part of the consolidation of the Hotel del Coronado Venture, the Company recorded $65,547,000 as a gain on the consolidation of affiliates in the condensed consolidated statement of operations for the nine months ended September 30, 2014, which represented the difference between the $120,000,000 fair value of the Company's preexisting equity interest in the Hotel del Coronado Venture and its carrying value. The fair value of the preexisting equity interest in the Hotel del Coronado Venture was determined based on an agreed upon value between the Company and a third party, both of which are market participants, which the Company considered to be a value determined in an orderly transaction in the principal market. For the nine months ended September 30, 2015 and 2014, the Company incurred acquisition costs related to the Hotel del Coronado Venture of $0 and $186,000, respectively, which were recorded as an offset to gain on consolidation of affiliates in the condensed consolidated statements of operations.
Fairmont Scottsdale Princess Hotel
On March 31, 2014, the Company closed on the acquisition of the 50% equity interests in the entities that own the Fairmont Scottsdale Princess hotel, Walton/SHR FPH Holdings, L.L.C. and FMT Scottsdale Holdings, L.L.C. (the Fairmont Scottsdale Princess Venture), that were previously owned by an affiliate of Walton Street Capital, L.L.C. (Walton Street) (see note 7) for a cash payment of $90,616,000. Additionally, the Company became fully obligated under the entire $117,000,000 mortgage loan outstanding secured by the Fairmont Scottsdale Princess hotel, which was repaid in full on April 9, 2015. Effective as of the closing of the transaction, the Company wholly owns and consolidates the Fairmont Scottsdale Princess Venture.
As part of the consolidation of the Fairmont Scottsdale Princess Venture, the Company recorded $78,191,000 as a gain on the consolidation of affiliates in the condensed consolidated statement of operations for the nine months ended September 30, 2014, which represented the difference between the $107,853,000 fair value of the Company's preexisting equity interest in the Fairmont Scottsdale Princess Venture, which included a preferred return to the Company, and its carrying value. The fair value of the preexisting equity interest in the Fairmont Scottsdale Princess Venture was determined based on an agreed upon value between the Company and a third party, both of which are market participants, which the Company considered to be a value determined in an orderly transaction in the principal market. For the nine months ended September 30, 2015 and 2014, the Company incurred acquisition costs related to the the Fairmont Scottsdale Princess Venture of $0 and $101,000, respectively, which were recorded as an offset to gain on consolidation of affiliates in the condensed consolidated statements of operations.

16

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Purchase Price Allocations of Hotel Acquisitions
The amounts recognized as assets acquired and liabilities assumed for each hotel acquisition are based on the acquisition-date fair values. The following is a summary of the allocation of the fair values for the Company's acquisitions (in thousands):
 
Four Seasons Hotel Austin
 
Montage Laguna Beach
 
Four Seasons Resort Scottsdale at Troon North
 
Hotel del Coronado Venture
 
Fairmont Scottsdale Princess Venture
Land
$
26,890

 
$
138,396

 
$
37,696

 
$
236,497

 
$
26,732

Buildings
138,647

 
175,723

 
75,740

 
404,851

 
213,289

Site improvements
513

 
4,166

 
7,154

 
6,677

 
16,037

Furniture, fixtures and equipment
28,227

 
40,830

 
18,866

 
53,943

 
40,341

Improvements in progress

 

 

 
1,749

 
151

Intangible assets
2,443

 
1,666

 
552

 
87,710

 
9,859

Below market debt discount

 
1,049

 

 

 
2,493

Net working capital
(462
)
 
(115
)
 
912

 
13,573

 
6,568

Total fair value allocated
$
196,258

 
$
361,715

 
$
140,920

 
$
805,000

 
$
315,470

The allocation of fair value attributable to intangible assets acquired as part of these acquisitions include (in thousands):
 
Amounts
 
Weighted-Average Amortization Period
Intangible assets subject to amortization:
 
 
 
Advanced bookings
$
10,049

 
1 year, 5 months
Memberships value
5,973

 
30 years
Below market ground lease
7,656

 
95 years, 9 months
Below market hotel management agreement
18,822

 
9 years, 2 months
Parking garage easement
1,437

 
39 years
 
43,937

 
 
Intangible assets not subject to amortization:
 
 
 
Trade name
58,293

 
 
Total intangible assets acquired
$
102,230

 
 
Pro Forma and Other Financial Information Related to Acquisition of Hotels
The following pro forma and other financial information is provided for the acquisitions of the Fairmont Scottsdale Princess Venture and the Hotel del Coronado Venture that were completed during the nine months ended September 30, 2014, which each had a material effect on the Company's results of operations.
The impact to revenues and net income attributable to SHR common shareholders from these acquisitions for the three and nine months ended September 30, 2015 and 2014, is as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Increase in revenues
 
$
68,288

 
$
64,765

 
$
217,532

 
$
102,758

Increase in net income attributable to SHR common shareholders
 
$
2,983

 
$
331

 
$
21,638

 
$
3,806

The following unaudited pro forma information is provided for informational purposes only and does not purport to represent what the Company's results of operations would have been had it completed the acquisitions on January 1, 2013, nor is it necessarily indicative of the results that may be expected in future periods. For purposes of the pro forma financial information, 20,000,000 shares of SHR common stock (a portion of the shares issued in an underwritten public offering of common stock that was completed in June 2014) are reflected as if the offering occurred on January 1, 2013 because these shares relate directly to the acquisition of the Hotel del Coronado Venture. No adjustments were made to the pro forma

17

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

financial information for the remaining shares of SHR common stock issued in June 2014 because they did not relate directly to the acquisitions. Additionally, for purposes of the pro forma financial information, the gains on the consolidation of affiliates recognized as a result of the acquisitions of the Hotel del Coronado Venture and the Fairmont Scottsdale Princess Venture are assumed to have been recognized on January 1, 2013. On an unaudited pro forma basis, revenues, net income attributable to SHR common shareholders and basic and diluted income attributable to SHR common shareholders per share for the three and nine months ended September 30, 2014 are as follows as if these acquisitions had occurred on January 1, 2013 (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2014
Total revenue
 
$
305,263

 
$
878,949

Net income
 
$
21,003

 
$
193,586

Preferred shareholder dividends
 
$
(1,802
)
 
$
(18,795
)
Net income attributable to SHR common shareholders
 
$
20,988

 
$
180,152

Net income attributable to SHR common shareholders per share:
 
 
 
 
Basic
 
$
0.08

 
$
0.76

Diluted
 
$
0.07

 
$
0.71


4. IMPAIRMENT LOSSES
The Company performed an impairment test of the long-lived assets related to the Marriott Lincolnshire Resort during the second quarter of 2015 as a result of a change in the anticipated holding period for this hotel. The Company determined that the carrying value of the hotel's long-lived assets exceeded the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the hotel. As a result of this impairment test, the Company recorded an impairment loss of $10,401,000, which represented the amount by which the carrying amount of the hotel's long-lived assets exceeded the fair value, with fair value determined based on estimated future discounted cash flows or the relevant market data as to the fair value of the asset (Level 3 inputs). On August 19, 2015, the Company entered into an agreement to sell the Marriott Lincolnshire Resort and the asset was reclassified as held for sale (see note 5). The Company continued to evaluate the asset for subsequent decreases in the fair value less cost to sell, with fair value based on an agreed upon value between the Company and a third party, both of which are market participants, which the Company considered to be a value determined in a orderly transaction in the principal market (Level 2 input). During the third quarter of 2015, the Company recognized additional impairment losses of $2,325,000 related to identified selling costs.

5. DISPOSITION OF HOTEL PROPERTIES
Effective January 1, 2015, the Company adopted new accounting guidance that amends the requirements for reporting discontinued operations. Under the new guidance, only dispositions that represent a strategic shift that has (or will have) a major effect on the Company's results of operations will qualify as discontinued operations.
Asset Held for Sale
On August 19, 2015, the Company entered into an agreement with an unaffiliated third party to sell the Marriott Lincolnshire Resort for $20,650,000. The transaction, which is subject to customary closing conditions, is expected to close in the fourth quarter of 2015.

18

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The hotel's assets and liabilities have been classified as held for sale on the condensed consolidated balance sheet as of September 30, 2015. The significant components of assets held for sale and liabilities of assets held for sale at September 30, 2015 consist of the following (in thousands):
Investment in hotel properties, net
$
18,450

Cash
1,954

Restricted cash
1,826

Accounts receivable, net of allowance for doubtful accounts
1,318

Prepaid expenses and other assets
1,126

Assets held for sale
$
24,674

Accounts payable and accrued expenses
$
6,499

Liabilities of assets held for sale
$
6,499

The disposition of the Marriott Lincolnshire Resort does not represent a strategic shift that will have a major effect on the Company's results of operations; therefore, the hotel's results of operations are included in continuing operations for all periods presented.
2015 Disposition
On May 21, 2015, the Company, along with its joint venture partner, sold the Hyatt Regency La Jolla hotel for sales proceeds of approximately $118,293,000. The $89,228,000 mortgage loan secured by the hotel was repaid at the time of closing. A $40,594,000 gain on the sale was recorded in other income (expenses), net, in the condensed consolidated statements of operations for the nine months ended September 30, 2015. The portion of the gain attributable to the joint venture partner was $16,640,000, which is reflected in net loss (income) attributable to the noncontrolling interests in consolidated affiliates in the condensed consolidated statements of operations for the nine months ended September 30, 2015. The disposition of the Hyatt Regency La Jolla hotel does not represent a strategic shift that has had a major effect on the Company's results of operations; therefore, the hotel's results of operations are included in continuing operations for all periods presented.
2014 Dispositions
Prior to January 1, 2015, and the adoption of the new accounting guidance that changed the criteria for reporting discontinued operations, the Company sold the following hotels:
Hotel
 
Location
 
Date Sold
 
 Sales Proceeds
 
Gain on sale
Four Seasons Punta Mita Resort and La Solana land parcel
 
Punta Mita, Mexico
 
February 28, 2014
 
$
206,867,000

 
$
63,879,000

Marriott London Grosvenor Square
 
London, England
 
March 31, 2014
 
$
209,407,000

(a)
$
92,889,000


(a) There was an outstanding balance of £67,301,000 ($112,150,000) on the mortgage loan secured by the Marriott London Grosvenor Square hotel, which was repaid at the time of closing. The net proceeds received by the Company were $97,257,000.

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STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The results of operations of hotels sold prior to January 1, 2015 are classified as discontinued operations and segregated in the condensed consolidated statements of operations for all periods presented. The following is a summary of income from discontinued operations, net of tax, for the three and nine months ended September 30, 2014 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2014
Hotel operating revenues
$

 
$
17,767

Operating costs and expenses

 
11,485

Depreciation and amortization

 
1,275

Total operating costs and expenses

 
12,760

Operating income

 
5,007

Interest expense

 
(1,326
)
Interest income

 
2

Loss on early extinguishment of debt

 
(272
)
Foreign currency exchange gain

 
32

Income tax expense

 
(833
)
Gain on sale, net of tax
63

 
156,492

Income from discontinued operations, net of tax
$
63

 
$
159,102


6. VARIABLE INTEREST ENTITY

On September 14, 2012, the Company formed a joint venture (the Essex House Hotel Venture) with affiliates of KSL Capital Partners, LLC (KSL) to acquire, own, manage, and operate the JW Marriott Essex House Hotel. The Company contributed cash of $89,147,000 to acquire a 51% equity interest in the Essex House Hotel Venture, and KSL contributed cash of $85,651,000 to acquire a 49% equity interest. Pursuant to the terms of the joint venture agreements establishing the Essex House Hotel Venture, at any time prior to the third anniversary of the formation of the Essex House Hotel Venture, KSL had the right to sell its equity interest in the Essex House Hotel Venture to the Company in exchange for shares of SHR's common stock, as set forth in the joint venture agreements, at a purchase price equal to KSL's net investment plus 8.0% compounded annually (the Put Option). For purposes of paying the purchase price, SHR's common stock was to be valued at the greater of (i) $7.50 per share and (ii) the 20-day volume-weighted average price per share of SHR's common stock as of the date KSL exercised the Put Option. On July 24, 2015, KSL exercised its Put Option. In connection with the exercise of the Put Option, and in accordance with the terms of the joint venture agreements, (a) SHR issued an aggregate of 6,595,449 shares of its common stock to KSL (see note 10), (b) the borrowers under the mortgage loan secured by the JW Marriott Essex House Hotel (see note 9) became wholly owned by certain indirect subsidiaries of SHR, and (c) the joint venture with KSL terminated.

Prior to the exercise of the Put Option, the Essex House Hotel Venture was jointly controlled by the Company and KSL; however, it was considered a VIE because the Company determined that it was the only holder of equity at risk due to the Put Option. The Company also determined that it was the primary beneficiary of the Essex House Hotel Venture due to the Put Option, which impacted the Company's power to direct the activities that most significantly impact the economic performance of the entity, as well as its obligation to absorb the losses and its right to receive benefits from the entity that could potentially be significant to the entity. As such, the transactions and accounts of the Essex House Hotel Venture were included in the condensed consolidated financial statements. The Company and KSL were required to fund additional contributions to the Essex House Hotel Venture, as needed, under the terms of the joint venture agreements. For the nine months ended September 30, 2015, the Company and KSL provided no additional contributions to the Essex House Hotel Venture. For the nine months ended September 30, 2014, the Company and KSL provided additional contributions of $5,958,000 and $5,723,000, respectively, to the Essex House Hotel Venture for property improvements. For the nine months ended September 30, 2015, the Company and KSL received distributions of $33,660,000 and $32,340,000, respectively, from the Essex House Hotel Venture paid from excess cash received from the refinancing of the mortgage loan secured by the JW Marriott Essex House Hotel in December 2014.


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STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Subsequent to the exercise of the Put Option, the Company holds 100% of the equity interests in the entities that own the JW Marriott Essex House Hotel and continues to include the transactions and accounts of the hotel in its condensed consolidated financial statements. The fair value of the consideration transferred to KSL when it exercised its Put Option exceeded the carrying value of KSL's noncontrolling interest immediately prior to the exercise by $33,489,000, which was recorded in additional paid-in capital on the Company's condensed consolidated balance sheet as of September 30, 2015. The Company retained a controlling interest in the hotel; therefore, it did not step up the JW Marriott Essex House Hotel's net assets. Additionally, the entities that own the hotel are no longer considered VIEs because there is sufficient equity at risk and the Company has the power to direct the activities that most significantly impact the economic performance of the hotel and has the obligation to absorb the losses and the right to receive benefits from the hotel.
7. INVESTMENT IN UNCONSOLIDATED AFFILIATES
The Company's investment in unconsolidated affiliates as of September 30, 2015 and December 31, 2014, includes the following (in thousands):
 
2015
 
2014
Four Seasons RCPM
$
1,587

 
$
3,427

Lot H5 Venture
19,423

 
19,423

Total investment in unconsolidated affiliates
$
21,010

 
$
22,850

Four Seasons RCPM
The Company owns a 31% interest in, and acts as asset manager for, an unconsolidated affiliate, formed with two unaffiliated parties, that developed the Four Seasons RCPM, a luxury vacation home product sold in fractional and whole ownership interests on the property adjacent to the Four Seasons Punta Mita Resort in Mexico. The Company earns asset management fees and recognizes income on the percentage not owned by the Company. These fees amounted to $0 and $3,000 for the three months ended September 30, 2015 and 2014, respectively, and $0 and $21,000 for the nine months ended September 30, 2015 and 2014, respectively, and are included in other income (expenses), net, in the condensed consolidated statements of operations. During the nine months ended September 30, 2015, the Company received distributions of $1,840,000 from the Four Seasons RCPM.
Lot H5 Venture
The Company has an interest in an unconsolidated affiliate, formed with an unaffiliated party, that owns an undeveloped, oceanfront land parcel in Punta Mita, Nayarit, Mexico, known as the Lot H5 land parcel (the Lot H5 Venture). The Company has a preferred position in the Lot H5 Venture that entitles it to receive the first $12,000,000 of distributions generated from the Lot H5 land parcel with any excess distributions split equally between the Company and its partner. The Company jointly controls the Lot H5 Venture with its partner and accounts for its interest in the Lot H5 Venture as an equity method investment.
Acquisitions of Unconsolidated Affiliates:
Fairmont Scottsdale Princess Venture
Prior to March 31, 2014, the Company had a 50% ownership interest in the Fairmont Scottsdale Princess Venture. The Company jointly controlled the venture with an unaffiliated third party, Walton Street, and served as the managing member. The Company acted as asset manager and was entitled to earn a quarterly base management fee, as well as certain project management fees. The Company recognized fees of $228,000 for the nine months ended September 30, 2014, which are included in other income (expenses), net, in the condensed consolidated statements of operations.
On March 31, 2014, the Company acquired Walton Street's 50% interest in the Fairmont Scottsdale Princess Venture. The Company now wholly owns the Fairmont Scottsdale Princess Venture. The Company has consolidated the Fairmont Scottsdale Princess Venture and no longer accounts for the investment using the equity method of accounting (see note 3).
Hotel del Coronado Venture
Prior to June 11, 2014, the Company had a 36.4% ownership interest in the Hotel del Coronado Venture. BRE Partnership VI, an unaffiliated third party, had the remaining ownership interest in the Hotel del Coronado Venture and was the general partner. The Company acted as asset manager and was entitled to earn a quarterly asset management fee, certain development fees, and if applicable, certain incentive fees. The Company recognized fees of $422,000 for the nine months ended September 30, 2014, which are included in other income (expenses), net, in the condensed consolidated statements of operations.

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STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

On June 11, 2014, the Company acquired BRE Partnership VI's 63.6% interest in the Hotel del Coronado Venture. The Company now wholly owns the Hotel del Coronado Venture. The Company has consolidated the Hotel del Coronado Venture and no longer accounts for the investment using the equity method of accounting (see note 3).
8. OPERATING LEASE AGREEMENTS
Building Lease
In June 2004, the Company recorded a sale of the Marriott Hamburg hotel, and the Company’s simultaneous leaseback of the hotel was reflected as an operating lease. A deferred gain was recorded in conjunction with the sale and was being recognized as a reduction of lease expense over the life of the lease. As part of the leaseback, the Company provided a euro-denominated security deposit to secure rent payments. The Company subleased its interest in the Marriott Hamburg hotel to a third party and reflected the sublease arrangement as an operating lease and recorded lease revenue.
Effective September 1, 2015, the Company transferred its leasehold interests in the Marriott Hamburg hotel to an unaffiliated third party. As of the transfer date, the Company was released from all of its obligations under the lease arrangements and recognized the previously deferred gain of $2,680,000 during the three and nine months ended September 30, 2015 in other income (expenses), net, in the condensed consolidated statement of operations. As of September 30, 2015, the euro-denominated security deposit was €1,900,000 ($2,124,000 based on the foreign exchange rate as of September 30, 2015) and is included in prepaid expenses and other assets on the Company's condensed consolidated balance sheet. The security deposit will be released back to the Company in four equal installments over four years beginning on March 1, 2017.
Prior to the transfer of its leasehold interests in the Marriott Hamburg hotel, the Company recognized $29,000 and $52,000 of the deferred gain as an offset to lease expense for the three months ended September 30, 2015 and 2014, respectively, and for the nine months ended September 30, 2015 and 2014, recognized $116,000 and $159,000, respectively. As of December 31, 2014, the deferred gain on the sale of the Marriott Hamburg hotel recorded in accounts payable and accrued expenses on the condensed consolidated balance sheet amounted to $2,933,000. The euro-denominated security deposit at December 31, 2014, was $2,299,000 and is included in prepaid expenses and other assets on the Company’s condensed consolidated balance sheet.
Ground Leases
The Company is subject to a ground lease agreement with a third party landlord whereby it leases one parcel of land at the Fairmont Scottsdale Princess hotel, which became a consolidated property in March 2014 (see note 3). The ground lease expires in December 2109. Annual rent payments through December 2020 are equal to $1,500,000 plus a percentage of gross revenue, as defined by the terms of the ground lease agreement. Subsequent to December 2020, annual rent payments are a percentage of gross revenue.
The Company is subject to a ground lease agreement with a third party landlord whereby it leases the land for the Marriott Lincolnshire Resort. The term of the ground lease goes through December 31, 2112, and annual rent payments are a fixed amount, subject to indexation. On August 19, 2015, the Company entered into an agreement to sell the Marriott Lincolnshire Resort (see note 5).
Lease payments related to hotel ground leases are included in other hotel expenses on the condensed consolidated statements of operations.
Office Space Lease
The Company is subject to a lease agreement with a third party landlord for its office space. The office lease expires in September 2017. Lease payments related to the office space are included in corporate expenses on the condensed consolidated statements of operations.

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STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. INDEBTEDNESS
Mortgages Payable, Net of Discount:
Certain subsidiaries of SHR are the borrowers under various financing arrangements. These subsidiaries are separate legal entities and their respective assets and credit are not available to satisfy the debt of SHR or any of its other subsidiaries.
Mortgages payable, net of discount, at September 30, 2015 and December 31, 2014, consisted of the following (in thousands):
 
 
 
 
 
 
 
 
Balance Outstanding at
Debt
 
Spread (a)
 
 Initial Maturity
 
Maturity Including Extension Options
 
September 30, 2015
 
December 31, 2014
Hotel del Coronado(b)
 
3.65%
 
March 2016
 
March 2018
 
$
475,000

 
$
475,000

Loews Santa Monica Beach Hotel(c)
 
2.55%
 
May 2017
 
May 2021
 
120,000

 
120,000

Four Seasons Washington, D.C.(c)
 
2.25%
 
June 2017
 
June 2019
 
120,000

 
120,000

JW Marriott Essex House Hotel(c)
 
2.95%
 
January 2018
 
January 2020
 
225,000

 
225,000

Ritz-Carlton Half Moon Bay(d)
 
2.40%
 
May 2020
 
May 2022
 
115,000

 

InterContinental Chicago
 
Fixed
 
August 2021
 
August 2021
 
141,147

 
142,442

Montage Laguna Beach(e)
 
Fixed
 
August 2021
 
August 2021
 
150,000

 

InterContinental Miami
 
Fixed
 
September 2024
 
September 2024
 
115,000

 
115,000

Fairmont Scottsdale Princess(f)
 
 
 
 
 
 
 

 
117,000

Fairmont Chicago(g)
 
 
 
 
 
 
 

 
93,124

Westin St. Francis(g)
 
 
 
 
 
 
 

 
209,588

Hyatt Regency La Jolla(h)
 
 
 
 
 
 
 

 
89,247

Total mortgages payable(i)
 
 
 
 
 
 
 
1,461,147

 
1,706,401

Unamortized discount(e) (f)
 
 
 
 
 
 
 
(941
)
 
(623
)
Total mortgages payable, net of discount
 
 
 
 
 
 
 
$
1,460,206

 
$
1,705,778

(a)
Interest on mortgage loans is paid monthly at the applicable spread over London Interbank Offered Rate (LIBOR) (0.19% at September 30, 2015) for all variable-rate mortgage loans. Interest on the InterContinental Chicago mortgage loan is paid monthly at an annual fixed rate of 5.61%, interest on the Montage Laguna Beach mortgage loan is paid monthly at an annual fixed rate of 3.90%, and interest on the InterContinental Miami mortgage loan is paid monthly at an annual fixed rate of 3.99%.
(b)
On June 11, 2014, the Company acquired the remaining 63.6% equity interest in the Hotel del Coronado Venture, resulting in the Hotel del Coronado Venture becoming wholly-owned by the Company. In connection with the acquisition, the Company consolidated the Hotel del Coronado Venture and became fully obligated under the entire outstanding balance of the mortgage and mezzanine loans secured by the Hotel del Coronado (see note 3). The first of three extension options related to the mortgage and mezzanine loans was exercised in March 2015 leaving two, one-year extension options available, subject to certain conditions.
(c)
The mortgage loan secured by the Loews Santa Monica Beach Hotel has four, one-year extension options, subject to certain conditions. The mortgage loans secured by the Four Seasons Washington, D.C. hotel and the JW Marriott Essex House Hotel each have two, one-year extension options, subject to certain conditions.
(d)
On May 27, 2015, the Company closed on a new $115,000,000 mortgage loan secured by the Ritz-Carlton Half Moon Bay hotel. The mortgage loan has two, one-year extension options, subject to certain conditions.
(e)
On January 29, 2015, the Company closed on the acquisition of the Montage Laguna Beach resort. In connection with the acquisition, the Company assumed the existing mortgage loan secured by the Montage Laguna Beach resort (see note 3). The Company recorded the mortgage loan at its fair value, which included a debt discount, which is being amortized as additional interest expense over the maturity period of the loan.
(f)
On March 31, 2014, the Company acquired the remaining 50% equity interest in the Fairmont Scottsdale Princess Venture, resulting in the Fairmont Scottsdale Princess Venture becoming wholly-owned by the Company. In connection with the acquisition, the Company consolidated the Fairmont Scottsdale Princess Venture and became fully obligated under the entire outstanding balance of the mortgage loan secured by the Fairmont Scottsdale Princess hotel

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STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(see note 3). The Company recorded the mortgage loan at its fair value, which included a debt discount, which was being amortized as additional interest expense over the maturity period of the loan. On April 9, 2015, the Company repaid the entire mortgage loan balance outstanding.
(g)
On May 27, 2015, the Company repaid the mortgage loans secured by the Westin St. Francis and the Fairmont Chicago hotels using proceeds from the new mortgage loan secured by the Ritz-Carlton Half Moon Bay hotel (see (d) above) and proceeds from a new unsecured term loan (as described within "—Credit Facility Arrangements" below). The Company recorded a $23,559,000 loss on early extinguishment of debt related to the Westin St. Francis loan repayment and a $10,455,000 loss on early extinguishment of debt related to the Fairmont Chicago loan repayment in the condensed consolidated statements of operations for the nine months ended September 30, 2015, which included prepayment penalties of $22,791,000 related to the Westin St. Francis loan and $10,126,000 related to the Fairmont Chicago loan, as well as the write off of unamortized deferred financing costs related to these mortgage loans.
(h)
The Company sold the Hyatt Regency La Jolla hotel on May 21, 2015, and the outstanding mortgage loan secured by the hotel was repaid at closing.
(i)
All of the mortgage loan agreements require maintenance of certain financial covenants, all of which the Company was in compliance with at September 30, 2015.
Credit Facility Arrangements:
On May 27, 2015, the Company entered into a new $750,000,000 senior unsecured credit facility. The unsecured credit facility is comprised of a $450,000,000 unsecured revolving credit facility and a $300,000,000 unsecured term loan. The unsecured credit facility contains an accordion feature, which provides the option to increase the borrowing capacity up to $1,000,000,000, subject to the satisfaction of customary conditions set forth in the agreement. The accordion feature may be exercised in the form of additional revolving loan or term loan commitments. SH Funding has a letter of credit sub-facility of $60,000,000 under the unsecured credit facility. The unsecured credit facility replaced the previous $300,000,000 secured credit facility that was set to initially expire in April 2018. The following summarizes key financial terms and conditions of the unsecured credit facility:
interest on the unsecured revolving facility is payable monthly based upon a leverage-based pricing grid with annual rates ranging from LIBOR plus 1.65% to LIBOR plus 2.40% in the case of a LIBOR loan or base rate plus 0.65% to base rate plus 1.40% in the case of a base rate loan, and interest on the unsecured term loan is payable monthly based upon a leverage-based pricing grid with annual rates ranging from LIBOR plus 1.60% to LIBOR plus 2.35% in the case of a LIBOR loan or base rate plus 0.60% to base rate plus 1.35% in the case of a base rate loan;
an unused commitment fee is payable monthly under the unsecured revolving facility based on the unused revolver balance at a rate of 0.30% per annum in the event that the unsecured revolving facility usage is less than 50% and a rate of 0.20% per annum in the event that the unsecured revolving facility usage is equal to or greater than 50%;
the maturity date of both the unsecured revolving facility and the unsecured term loan is May 27, 2020;
the unsecured credit facility requires that SH Funding own, at all times, a minimum of five unencumbered assets, exclusive of assets located in Mexico, and is initially supported by a pool of unencumbered assets that as of September 30, 2015, consisted of the Fairmont Chicago hotel, the Fairmont Scottsdale Princess hotel, the Four Seasons Hotel Austin, the Four Seasons Jackson Hole hotel, the Four Seasons Resort Scottsdale at Troon North, the Four Seasons Silicon Valley hotel, the Marriott Lincolnshire Resort (which the Company entered into an agreement to sell (see note 5)), the Ritz-Carlton Laguna Niguel hotel, and the Westin St. Francis hotel;
the borrowing capacity under the unsecured revolving facility is reduced by any amounts previously borrowed and not repaid and any outstanding letters of credit;
financial covenants include: (a) minimum corporate fixed charge coverage of 1.50, (b) maximum corporate leverage of 60%, (c) maximum secured leverage of 50%; (d) maximum secured recourse leverage of 10%, (e) maximum unsecured leverage of 60%, (f) minimum unsecured interest coverage of 2.00, and (g) minimum tangible net worth of approximately $1,834,362,000, excluding goodwill and currency translation adjustments, plus an amount equal to 75% of the net proceeds of any new issuances of our common stock, which is not used to reduce indebtedness or used in a transaction or series of transactions to redeem outstanding capital stock; and

24

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

certain restrictions on SHR and SH Funding’s ability to pay dividends.
Other terms and conditions exist including a limitation on mortgaging the unencumbered assets and limitations on the Company's ability to incur costs for discretionary capital programs and to redeem, retire or repurchase common stock.
The annual interest rate of the unsecured revolving facility at September 30, 2015, was 1.84%. The annual interest rate of the unsecured term loan at September 30, 2015 was 1.79%. The weighted average annual interest rate for the credit facility arrangements for the nine months ended September 30, 2015 was 1.83%, which included interest under the previous secured bank credit facility for a portion of the nine-month period. At September 30, 2015, the maximum availability under the unsecured credit facility was $448,000,000, which was reduced by $2,000,000 outstanding under the unsecured revolving facility and $300,000,000 outstanding under the unsecured term loan. Additionally, at September 30, 2015, there were no outstanding letters of credit. SH Funding and SHR were in compliance with all financial covenants under the unsecured credit facility at September 30, 2015.
Debt Maturity:
The following table summarizes the aggregate maturities as of September 30, 2015, for all mortgages and the Company’s unsecured credit facility based on initial maturity dates and maturity dates that assume all extension options have been exercised (in thousands):
Years ending December 31,
Initial Maturities
 
Extended Maturities
2015 (remainder)
$
655

 
$
655

2016
477,040

 
2,040

2017
243,066

 
3,066

2018
230,033

 
480,033

2019
5,276

 
125,276

Thereafter
807,077

 
1,152,077

 
1,763,147

 
1,763,147

Unamortized discount
(941
)
 
(941
)
Total
$
1,762,206

 
$
1,762,206

Interest Expense:
Total interest expense in continuing and discontinued operations includes a reduction related to capitalized interest of $329,000 and $212,000 for the three months ended September 30, 2015 and 2014, respectively, and $644,000 and $607,000 for the nine months ended September 30, 2015 and 2014, respectively. Total interest expense in continuing and discontinued operations includes amortization of deferred financing costs of $1,003,000 and $962,000 for the three months ended September 30, 2015 and 2014, respectively, and $2,830,000 and $3,516,000 for the nine months ended September 30, 2015 and 2014, respectively.

10. EQUITY AND DISTRIBUTION ACTIVITY
Common Stock:
The following table presents the changes in the issued and outstanding shares of SHR common stock since December 31, 2014 (excluding 793,618 OP Units outstanding at both September 30, 2015 and December 31, 2014, which are redeemable for shares of SHR common stock on a one-for-one basis, or the cash equivalent thereof, subject to certain restrictions and at the option of SHR) (in thousands):
Outstanding at December 31, 2014
267,436

RSUs and performance-based RSUs redeemed for shares of SHR common stock
711

Common stock issued
13,943

Outstanding at September 30, 2015
282,090

On August 19, 2015, SHR issued 6,595,449 shares of its common stock in connection with the exercise of KSL's Put Option related to the JW Marriott Essex House Hotel on July 24, 2015, valued at a price of $12.82 per share based on the 20-day

25

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

volume-weighted average price per share of SHR's common stock as of the date KSL exercised its Put Option (see note 6 and Noncontrolling Interests below).
On January 29, 2015, the Company issued 7,347,539 shares of SHR's common stock valued at a price of $13.61 per share based on the volume-weighted average price per share of SHR's common stock over the 10 trailing days ending on an including the date that was five business days prior to January 28, 2015 to partially fund the acquisition of the Montage Laguna Beach resort (see note 3).
In February 2015, the Company entered into a stock distribution agreement whereby the Company may sell, from time to time, through certain agents, shares of SHR's common stock, having an aggregate offering price of up to $250,000,000 by means of ordinary brokers' transactions at market prices or as otherwise agreed between the Company and the agents. The net proceeds from any sale of shares of SHR's common stock are expected to be used for working capital and general corporate purposes, which may include the repayment of indebtedness. However, any transactions under the stock distribution agreement are limited by restrictions under the Merger Agreement. No shares were sold under the stock distribution agreement during the nine months ended September 30, 2015.
Distributions to Shareholders and Unitholders
On November 4, 2008, SHR’s board of directors elected to suspend the quarterly dividend to holders of shares of SHR common stock. Under the terms of the Merger Agreement, SHR may not declare or pay any other dividends to holders of SHR common stock (unless such distribution is of a minimum amount necessary for SHR to maintain REIT status or to avoid the incurrence of certain taxes) without the prior written consent of BRE Holdings.
Preferred Stock:
On January 5, 2015, the Company redeemed all of the outstanding 3,615,375 shares of it 8.25% Series B Cumulative Redeemable Preferred Stock (Series B Preferred Stock). The shares of Series B Preferred Stock were redeemed at a redemption price of $25.00 per share, or approximately $90,384,000 in total, plus accrued and unpaid dividends up to and including the redemption date in the amount of $0.028646 per share, or approximately $104,000 in total. Following the redemption, dividends on the Series B Preferred Stock ceased to accrue.
On July 3, 2014, the Company redeemed all of the outstanding 3,827,727 shares of its Series C Preferred Stock. The shares of Series C Preferred Stock were redeemed at a redemption price of $25.00 per share, or approximately $95,693,000 in total, plus accrued and unpaid dividends up to and including the redemption date in the amount of $0.01719 per share, or $66,000 in total. Following the redemption, dividends on the Series C Preferred Stock ceased to accrue.
On April 3, 2014, the Company redeemed all of the outstanding 4,148,141 shares of its Series A Preferred Stock. The shares of Series A Preferred Stock were redeemed at a redemption price of $25.00 per share, or approximately $103,704,000 in total, plus accrued and unpaid dividends up to and including the redemption date in the amount of $0.54896 per share, or $2,227,000 in total. Following the redemption, dividends on the Series A Preferred Stock ceased to accrue.
After the redemption of the Series B Preferred Stock in January 2015, there are no remaining shares of preferred stock outstanding.
Noncontrolling Interests:
On July 24, 2015, the Company acquired the 49% interest in the JW Marriott Essex House Hotel previously owned by KSL when KSL exercised its Put Option. Effective July 24, 2015, the Company wholly owns the hotel (see note 6). As part of the transaction, on August 19, 2015, SHR issued 6,595,449 shares of its common stock to KSL at a price of $12.82 per share.
The following table discloses the effects of changes in the Company’s ownership interests in the Essex House Hotel Venture on the SHR shareholder's equity (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2015
Net income attributable to SHR
$
23,261

 
$
45,770

Acquisition of additional ownership interests in consolidated affiliates
(33,489
)
 
(33,489
)
Change from net income attributable to SHR and transfers from noncontrolling interests
$
(10,228
)
 
$
12,281


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STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following tables reflect the reconciliation of the beginning and ending balances of the equity attributable to SHR and the noncontrolling owners (in thousands):
 
 
SHR Shareholders’ Equity
 
Nonredeemable Noncontrolling Interests
 
Total Permanent Shareholders’ Equity
 
Total Redeemable Noncontrolling Interests (Temporary Equity)(a)
Balance at December 31, 2014
 
$
1,447,457

 
$
94,292

 
$
1,541,749

 
$
10,500

Common stock issued
 
190,847

 

 
190,847

 
554

Net income
 
45,770

 
12,820

 
58,590

 
169

CTA
 
(130
)
 

 
(130
)
 

Derivative activity
 
8,008

 

 
8,008

 
23

Share-based compensation
 
2,980

 

 
2,980

 
9

Preferred stock redemption
 
(7
)
 

 
(7
)
 

Redemption value adjustment
 
54

 

 
54

 
(54
)
Distributions to holders of noncontrolling interests in consolidated affiliates
 

 
(43,741
)
 
(43,741
)
 

Adjustment of noncontrolling interest in consolidated affiliate (b)
 

 
(4,628
)
 
(4,628
)
 

Acquisition of noncontrolling interest in consolidated affiliate (c)
 
(33,489
)
 
(56,979
)
 
(90,468
)
 

Other
 
257

 

 
257

 
(257
)
Balance at September 30, 2015
 
$
1,661,747

 
$
1,764

 
$
1,663,511

 
$
10,944

 
 
SHR Shareholders’ Equity
 
Nonredeemable Noncontrolling Interests
 
Total Permanent Shareholders’ Equity
 
Total Redeemable Noncontrolling Interests (Temporary Equity)(a)
Balance at December 31, 2013
 
$
710,513

 
$
92,355

 
$
802,868

 
$
7,534

Common stock issued
 
415,314

 

 
415,314

 
1,334

Net income (loss)
 
337,781

 
(6,112
)
 
331,669

 
1,197

CTA
 
18,667

 

 
18,667

 
72

Derivatives and other activity
 
6,583

 

 
6,583

 
21

Share-based compensation
 
3,283

 

 
3,283

 
10

Preferred stock redemption
 
(199,489
)
 

 
(199,489
)
 

Declared distributions to preferred shareholders
 
(11,883
)
 

 
(11,883
)
 

Redemption value adjustment
 
436

 

 
436

 
(436
)
Contributions from holders of noncontrolling interests in consolidated affiliates
 

 
5,723

 
5,723

 

Distributions to holders of noncontrolling interests in consolidated affiliates
 

 
(7
)
 
(7
)
 

Other
 
486

 

 
486

 
(486
)
Balance at September 30, 2014
 
$
1,281,691

 
$
91,959

 
$
1,373,650

 
$
9,246

(a)
The historical cost of the redeemable noncontrolling interests is based on the proportional relationship between the carrying value of equity associated with SHR’s common shareholders relative to that of the unitholders of SH Funding, as OP Units may be exchanged into shares of SHR common stock on a one-for-one basis. The interests held by the noncontrolling partners are stated at the greater of carrying value or their redemption value.
(b)
On May 21, 2015, the Company, along with its joint venture partner, sold the Hyatt Regency La Jolla hotel. The noncontrolling interest in the consolidated affiliate that owns that Hyatt Regency La Jolla hotel was adjusted as part of the disposition transaction.

27

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(c)
On July 24, 2015, KSL exercised its Put Option related to the JW Marriott Essex House Hotel, and SHR subsequently issued an aggregate of 6,595,449 shares of its common stock to KSL (see note 6). The fair value of the consideration transferred to KSL when it exercised its Put Option exceeded the carrying value of KSL's noncontrolling interest immediately prior to the exercise of $56,979,000 by $33,489,000.
As of September 30, 2015 and December 31, 2014, the redeemable noncontrolling interests had a redemption value of approximately $10,944,000 (based on the September 30, 2015 SHR common stock closing price of $13.79 per share) and $10,500,000 (based on the December 31, 2014 SHR common stock closing price of $13.23 per share), respectively. As of September 30, 2014 and December 31, 2013, the redeemable noncontrolling interests had a redemption value of approximately $9,246,000 (based on the September 30, 2014 SHR common stock closing price of $11.65 per share) and $7,534,000 (based on the December 31, 2013 SHR common stock closing price of $9.45 per share), respectively.

11. DERIVATIVES
The Company manages its interest rate risk by varying its exposure to fixed and variable rates while attempting to minimize its interest costs. The Company manages its variable interest rate risk through the use of interest rate derivative instruments. The Company enters into interest rate derivative instruments with high credit quality counterparties and diversifies its positions among such counterparties in order to reduce its exposure to credit losses. The Company uses interest rate caps to limit exposure on its variable-rate debt that would result from an increase in interest rates. The Company’s lenders, as stipulated in the respective loan agreements, generally require such caps. The Company records all derivatives at fair value in either prepaid expenses and other assets or accounts payable and accrued expenses in the condensed consolidated balance sheets.
The valuation of the interest rate derivative instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The Company incorporates credit valuation adjustments (CVA) to appropriately reflect its own nonperformance risk and the respective counterparty’s nonperformance risk. When assessing nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Except for the CVA, all inputs used to measure fair value of the derivative financial instruments are Level 2 inputs. The Company has concluded that the inputs used to measure its CVA are Level 3 inputs. If the inputs used to measure fair value fall in different levels of the fair value hierarchy, the level in the fair value hierarchy within which the fair value measurement in its entirety falls shall be determined based on the lowest level input that is significant to the fair value measurement in its entirety.
The Company reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers into and out of Level 3, or between other levels, at the fair value at the beginning of the reporting period in which the changes occur. The Company assessed the impact of the CVA on the overall fair value of its derivative instruments and concluded that the CVA does not have a significant impact to the fair values as of September 30, 2015. As of September 30, 2015 and December 31, 2014, all derivative liabilities are categorized as Level 2.
Derivatives in Cash Flow Hedging Relationships:
Historically, the Company has used interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involved the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The effective portion of changes in the fair value of derivatives designated and that qualified as cash flow hedges were recorded in accumulated OCL and was subsequently reclassified into earnings in the period that the hedged forecasted transaction affected earnings. During the nine months ended September 30, 2014, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivatives was recognized directly in earnings.
In April 2014, the Company paid $17,428,000, which included accrued and unpaid interest, to terminate its two interest rate swaps that were in cash flow hedging relationships. There was no immediate charge to earnings based on the Company's forecasted levels of LIBOR-based debt at the date of the termination. Amounts previously recorded in accumulated OCL related to these interest rate swaps will be reclassified into earnings as additional interest expense on a straight-line basis over the original maturity period of the interest rate swaps. During the next twelve months, an additional $2,867,000 will be reclassified as an increase to interest expense.

28

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Derivatives Not Designated as Hedging Instruments:
Derivatives not designated as hedges are not speculative and are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet hedge accounting requirements. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings.
In April 2014, the Company paid $5,281,000, which included accrued and unpaid interest, to terminate its two interest rate swaps that were not designated as hedging instruments. These interest rate swaps were marked to market through earnings through the date of termination, with no additional gain or loss recognized in earnings at the date of termination.
As of September 30, 2015, the Company had the following outstanding interest rate derivatives that were not designated as hedging instruments:
Interest Rate Derivatives
Number of Instruments
 
Notional Amount
(in thousands)
Interest rate caps
8
 
$
1,127,000

At September 30, 2015 and December 31, 2014, the aggregate notional amount of the Company’s interest rate cap agreements was $1,127,000,000 and $1,429,000,000, respectively. The Company’s interest rate caps have LIBOR strike rates ranging from 2.05% to 4.55% and maturity dates ranging from November 2015 to July 2017.
Fair Values of Derivative Instruments:
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the condensed consolidated balance sheets as of September 30, 2015 and December 31, 2014 (in thousands):
 
 
 
Fair Value as of
 
Balance Sheet Location
 
September 30, 2015
 
December 31, 2014
Derivatives not designated as hedging instruments:
 
 
 
 
 
Interest rate caps
Prepaid expenses and other assets
 
$
6

 
$
113


29

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The Company does not have any fair value measurements using inputs based on quoted prices in active markets (Level 1) or significant unobservable inputs (Level 3) as of September 30, 2015 or December 31, 2014. The following tables reflect changes in interest rate swap liabilities categorized as Level 2 for the nine months ended September 30, 2014 (in thousands):
Balance as of January 1, 2014
$
(27,921
)
Interest rate swap terminations
22,325

Mark to market adjustments
5,596

Balance as of September 30, 2014
$

Effect of Derivative Instruments on the Condensed Consolidated Statements of Operations:
The tables below present the effect of the Company’s derivative financial instruments on the condensed consolidated statements of operations for the three and nine months ended September 30, 2015 and 2014 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Derivatives in Cash Flow Hedging Relationships
 
 
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
 
 
Effective portion of loss recognized in accumulated OCL
$

 
$

 
$

 
$
(358
)
Effective portion of loss reclassified into interest expense
$
(2,459
)
 
$
(3,114
)
 
$
(8,031
)
 
$
(9,611
)
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
Interest rate swaps:
 
 
 
 
 
 
 
Ineffective losses recognized in interest expense
$

 
$

 
$

 
$
(129
)
Interest rate caps:
 
 
 
 
 
 
 
Loss recognized in other income (expenses), net
$
(6
)
 
$
(93
)
 
$
(152
)
 
$
(127
)
12. SHARE-BASED EMPLOYEE COMPENSATION PLANS
Second Amended and Restated 2004 Incentive Plan:
On June 21, 2004, SHR adopted the 2004 Incentive Plan (the Plan). The Plan provided for the grant of equity-based awards in the form of, among others, options to purchase shares of SHR common stock (Options), RSUs, and stock appreciation rights (SARs), which are collectively referred to as the Awards. On May 22, 2008, SHR’s shareholders approved SHR’s Amended and Restated 2004 Incentive Plan (the Amended Plan). The Amended Plan: (a) added OP Units as an additional type of award; (b) adjusted the number of authorized shares from 3,000,000 shares of SHR common stock to 4,200,000 shares of SHR common stock or OP Units; (c) limited the maximum term of Options and SARs to no more than 10 years and prohibited the repricing of Options and SARs; and (d) established minimum vesting periods for certain awards. On May 19, 2011, SHR’s shareholders approved SHR’s Second Amended and Restated 2004 Incentive Plan (the Amended and Restated Plan) pursuant to which the number of securities authorized and reserved for issuance increased from 4,200,000 shares of SHR common stock or OP Units to 9,700,000 shares of SHR common stock or OP Units. The termination date of the Amended and Restated Plan was also extended from June 21, 2014 to December 31, 2016.
RSUs and Performance-Based RSUs:
During the nine months ended September 30, 2015, SHR granted 294,243 RSUs to certain employees, officers and directors under the Amended and Restated Plan. These RSUs represent awards of shares of SHR’s common stock that will generally vest over three years.
In February 2015, SHR granted certain employees a target grant of 322,285 performance-based RSUs under a performance share plan that provides the recipient the opportunity to earn between 0.0% and 200.0% of the target (up to a maximum of 644,570 performance-based RSUs), based on the relative total shareholder return of the shares of SHR common stock, as defined in the agreement, over the period from January 2, 2015 through December 31, 2017.

30

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The Company measures compensation expense for RSUs based on the per share fair market value of SHR's common stock at the date of grant, adjusted for estimated forfeitures. The Company measures compensation expense for performance-based RSUs based on a Monte Carlo simulation to estimate the fair value on the date of grant. Compensation expense for RSUs and performance-based RSUs is recognized on a straight-line basis over the service period and is included in corporate expenses in the condensed consolidated statements of operations. The Company recorded compensation expense of $1,858,000 and $1,480,000 related to RSUs and performance-based RSUs for the three months ended September 30, 2015 and 2014, respectively, and $5,598,000 and $4,330,000 for the nine months ended September 30, 2015 and 2014, respectively. As of September 30, 2015, there was unrecognized compensation expense of $3,966,000 related to unvested RSUs and $5,296,000 related to performance-based RSUs granted under the Amended and Restated Plan. The unrecognized compensation expense is expected to be recognized over a weighted average period of 1.69 years for unvested RSUs and 1.88 years for performance-based RSUs.

Pursuant to the Merger Agreement, RSUs and performance-based RSUs issued and outstanding under the Amended and Restated Plan will become fully vested immediately prior to the Company Merger Effective Time and will be cancelled, and, in exchange, each holder of such units will be entitled to receive a cash payment, without interest and less required withholding taxes, in an amount equal to the product of (i) the Merger Consideration and (ii) the number of units held (see note 1). Additionally, on October 12, 2015, the Company amended its performance-based RSU awards agreements. The amendment states that if a change of control occurs prior to the end of the performance period defined in the original agreements or is publicly announced prior to and is pending as of the end of that performance period, the relative total shareholder return of the shares of SHR common stock will be determined based on the 60-day trading average closing price with the last trading day of such 60-day period ending immediately prior to the date of the public announcement of the change in control (see note 17).
13. RELATED PARTY TRANSACTIONS

On February 28, 2014, certain direct and indirect wholly-owned subsidiaries of SH Funding sold the Four Seasons Punta Mita Resort and adjacent La Solana land parcel to affiliates of Cascade Investment, L.L.C. (Cascade) for proceeds of $206,867,000 (see note 5). Cascade beneficially owned approximately 6.4% of SHR's common stock as of the closing date.

Additionally, the Company has entered into month-to-month agreements with an affiliate of Cascade pursuant to which the Company provides advisory services for certain hotels not owned by the Company. The Company currently receives fees of $46,000 per month under these agreements (see note 16).
14. COMMITMENTS AND CONTINGENCIES
Environmental Matters:
Generally, the properties acquired by the Company have been subjected to environmental site assessments. While some of these assessments have led to further investigation and sampling, none of the environmental assessments have revealed, nor is the Company aware of any environmental liability that it believes would have a material effect on its business or financial statements. 
Litigation:
The Company is party to various claims and routine litigation arising in the ordinary course of business. Based on discussions with legal counsel, the Company does not believe that the results of these claims and litigation, individually or in the aggregate, will have a material effect on its business or financial statements.
Between September 10, 2015 and November 4, 2015, eight putative class action lawsuits purportedly on behalf of holders of SHR common stock were filed in the Circuit Court for Baltimore City, Maryland against members of SHR's board of directors, as well as the Buyer Parties in connection with the Mergers (see note 1).  Certain of the lawsuits also name SH Funding, Blackstone, BRE Partnership VIII and/or SHR as defendants. One lawsuit also purports to bring a derivative claim on behalf of SHR. 
The lawsuits generally allege that members of SHR's board of directors breached their fiduciary duties to holders of SHR common stock by, among other things:  (i) failing to undertake an adequate sales process; (ii) failing to maximize stockholder value and agreeing to a sales price that undervalues SHR; (iii) implementing preclusive or coercive deal protection devices; (iv) engaging in self-dealing and failing to act in the best interests of holders of SHR common stock; and (v) failing to act with good faith, due care and loyalty.  The lawsuits also allege that SHR, SH Funding, and/or certain of the Buyer Parties aided and abetted the members of SHR's board of directors in allegedly breaching their fiduciary duties.  The lawsuits seek, among other things, declaration of the action as a proper class action, equitable relief that would enjoin the consummation of the Mergers,

31

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

rescinding, to the extent already implemented, the Merger Agreement and the terms thereof and fees and costs associated with the litigation.
On October 26, 2015, the defendants filed an Unopposed Motion to Consolidate Actions and Designate the Consolidated Action to the Business and Technology Case Management Program and to Stay Defendants’ Obligation to Answer or Otherwise Plead.  Also on October 26, 2015, certain plaintiffs filed a Motion for Consolidation and Appointment of Interim Co-Lead Counsel and Interim Liaison Counsel, and a certain plaintiff also filed a Motion for Expedited Discovery as well as a First Amended Class Action Complaint (“Amended Complaint”).  The Amended Complaint includes the same claims set forth in the initial complaint and includes additional allegations for breach of fiduciary duty with respect to the definitive proxy statement that SHR filed with the SEC on October 20, 2015.  On October 28, 2015, the court issued an order which, inter alia, consolidated the eight pending actions under the caption In re Strategic Hotels & Resorts, Incorporated Shareholder Litigation, Case No. 24-C-15-004668.
Letters of Credit:
As of September 30, 2015, the Company provided a $75,000 letter of credit related to its office space lease. In January 2015, the Company terminated the letter of credit that was previously provided in connection with an obligation to complete property improvements at the JW Marriott Essex House Hotel.
Purchase Commitments:
Construction Contracts
The Company has executed various contracts related to construction activities. As of September 30, 2015, the Company’s obligations under these contracts amounted to approximately $35,240,000. The construction activities are expected to be completed in the next twelve months.
JW Marriott Essex House Hotel Property Improvement Plan
As required by the JW Marriott Essex House Hotel management agreement, the Essex House Hotel Venture has an obligation to renovate and improve the property. As of September 30, 2015, the Essex House Hotel Venture's obligation under this agreement is approximately $411,000. The improvements are expected to be completed by December 2015.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
As of September 30, 2015 and December 31, 2014, the carrying amounts of certain financial instruments employed by the Company, including cash and cash equivalents, restricted cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses were representative of their fair values because of the short-term maturity of these instruments.
At September 30, 2015 and December 31, 2014, the Company estimated the fair value of mortgages and credit facility arrangements to be approximately $1,751,000,000 and $1,726,000,000, respectively.
The Company estimated the fair value of the debt using a future discounted cash flow analysis based on the use and weighting of multiple market inputs being considered. Based on the frequency and availability of market data, all inputs used to measure the estimated fair value of the debt are Level 2 inputs. The primary sensitivity in these calculations is based on the selection of appropriate discount rates.
Derivative financial instruments have been recorded at their estimated fair values.
16. MANAGEMENT AND ADVISORY AGREEMENTS
JW Marriott Essex House Hotel Performance Guarantee
In connection with the acquisition of the JW Marriott Essex House Hotel in September 2012, the Essex House Hotel Venture entered into a management agreement with an affiliate of Marriott International, Inc. (Marriott). In connection with the management agreement, Marriott provided the Essex House Hotel Venture with a limited performance guarantee that will ensure, subject to certain limitations, a target level of net operating profit. Guarantee payments are calculated and paid to the Essex House Hotel Venture on a monthly basis based on the cumulative year-to-date results with a final true-up at the end of each year. Monthly interim payments are recorded as deferred revenue and are recognized as other hotel operating revenue at the end of the year when the final guarantee payment for the year is determined. The maximum guarantee that could be paid to the Essex House Hotel Venture during the guarantee period is $40,000,000. Any guarantee payments that exceed $20,000,000 may be recoverable by Marriott in accordance with the terms of the limited performance guarantee. Any amounts that are recoverable will be deferred and will not be recognized in earnings. Since the commencement of the performance guarantee,

32

STRATEGIC HOTELS & RESORTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

the Essex House Hotel Venture has received payments of $20,000,000 which have been recognized in earnings, and has received payments of an additional $12,594,000, which have been recorded as deferred revenues in accounts payable and accrued expenses on the condensed consolidated balance sheet. The guarantee period began on September 17, 2012 and will continue through the earlier of (a) December 31, 2020, (b) the date at which the maximum guarantee has been funded, or (c) the termination of the management agreement.
Asset Management and Advisory Agreements
The Company has entered into asset management and advisory agreements with third parties to provide such services to hotels not owned by the Company. The Company earns base fees and may have the potential to earn additional incentive fees. The Company earned fees of $263,000 and $255,000 for the three months ended September 30, 2015 and 2014, respectively, and fees of $788,000 and $455,000 for the nine months ended September 30, 2015 and 2014, respectively, under these agreements, which are included in other income (expenses), net, in the condensed consolidated statements of operations.
17. SUBSEQUENT EVENTS

On October 12, 2015, the Company amended its performance-based RSU awards agreements. The amendment states that if a change of control occurs prior to the end of the performance period defined in the original agreements or is publicly announced prior to and is pending as of the end of that performance period, the relative total shareholder return of the shares of SHR common stock will be determined based on the 60-day trading average closing price with the last trading day of such 60-day period ending immediately prior to the date of the public announcement of the change in control (see note 12).




33


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section, references to “we”, “our”, “us”, and “the Company” are references to SHR together, except as the context otherwise requires, with its consolidated subsidiaries, including SH Funding.
Note on Forward-Looking Statements
This quarterly report on Form 10-Q may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which involve certain risks and uncertainties. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. These forward-looking statements are identified by their use of such terms and phrases such as “intends,” “intend,” “intended,” “goal,” “estimate,” “estimates,” “expects,” “expect,” “expected,” “project,” “projected,” “projections,” “plans,” “predicts,” “potential,” “seeks,” “anticipates,” “anticipated,” “should,” “could,” “may,” “will,” “designed to,” “foreseeable future,” “believe,” “believes” and “scheduled” and similar expressions. Forward-looking statements reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause actual results or outcomes to differ materially from those expressed in any forward-looking statement. We caution that while we make such statements in good faith and we believe such statements are based on reasonable assumptions, including, without limitation, management's examination of historical operating trends, data contained in records and other data available from third parties, we cannot assure you that our projections will be achieved. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Our actual results may differ significantly from any results expressed or implied by these forward looking statements. Some, but not all, of the factors that might cause such a difference include, but are not limited to: the failure to satisfy conditions to completion of the Mergers (as defined below), including receipt of stockholder approval; the failure of the Mergers to close for any other reason; the occurrence of any change, effect, event, circumstance, occurrence or state of facts that could give rise to the termination of the Merger Agreement (as defined below); the outcome of the legal proceedings that have been, or may be, instituted against us and others following the announcement of our entering into the Merger Agreement; risks that the proposed merger transaction disrupts current plans and operations including potential difficulties in relationships with employees; the amounts of the costs, fees, expenses and charges relating to the Mergers; the effects of economic conditions and disruptions in financial markets upon business and leisure travel and the hotel markets in which we invest; our liquidity and refinancing demands; our ability to obtain, refinance or extend maturing debt; our ability to maintain compliance with covenants contained in our debt facilities; stagnation or deterioration in economic and market conditions, particularly impacting business and leisure travel spending in the markets where our hotels and resorts operate and in which we invest, including luxury and upper upscale product; general volatility of the capital markets and the market price of our shares of common stock; availability of capital; our ability to dispose of properties in a manner consistent with our investment strategy and liquidity needs; hostilities and security concerns, including future terrorist attacks, or the apprehension of hostilities, in each case that affect travel within or to the United States or other countries where we invest; difficulties in identifying properties to acquire and completing acquisitions; our failure to maintain effective internal control over financial reporting and disclosure controls and procedures; risks related to natural disasters; increases in interest rates and operating costs, including insurance premiums and real property taxes; contagious disease outbreaks; delays and cost-overruns in construction and development; marketing challenges associated with entering new lines of business or pursuing new business strategies; our failure to maintain our status as a real estate investment trust, or REIT; changes in the competitive environment in our industry and the markets where we invest; changes in real estate and zoning laws or regulations; legislative or regulatory changes, including changes to laws governing the taxation of REITs; changes in generally accepted accounting principles, policies and guidelines; litigation, judgments or settlements; and the risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2014.
Pending Mergers
On September 4, 2015, SHR and SH Funding entered into an Agreement and Plan of Merger (the Merger Agreement) with BRE Diamond Hotel Holdings LLC, a Delaware limited liability company (BRE Holdings), BRE Diamond Hotel LLC, a Delaware limited liability company (Merger Sub), and BRE Diamond Hotel Acquisition LLC, a Delaware limited liability company (Merger Opco), whereby Merger Opco will merge with and into SH Funding, and SHR will merge with and into Merger Sub (the Mergers). See “Item 1. Financial Statements -1. General - Agreement and Plan of Merger” for a more detailed discussion of the pending Mergers. The Mergers are expected to close in the fourth quarter of 2015, although closing is subject to various closing conditions, including the approval by SHR's common stockholders, and therefore, we cannot provide any assurance that the Mergers will close in a timely manner or at all. Our ability to execute on our business plan could be

34


adversely impacted by operating restrictions included in the Merger Agreement, including restrictions on acquiring new assets and raising additional capital. We have incurred and will continue to incur a variety of merger-related costs, which while not recurring in nature, will not be recoverable if the Mergers are not consummated.
On October 20, 2015, we filed a definitive proxy statement with the Securities and Exchange Commission in connection with the Mergers. See our definitive proxy statement on Schedule 14A and the risk factors contained below under the heading "Part II - Other Information - Item 1A. Risk Factors" and elsewhere in the report for a description of conditions related to the Mergers that could adversely affect our results of operations.
Overview
Our core business is to acquire and asset-manage upper upscale and luxury hotels (as defined by Smith Travel Research, an independent provider of lodging industry statistical data). We own a unique portfolio of hotels that includes complex assets with multiple revenue streams located in select urban and resort markets that have strong growth characteristics and high barriers to entry. See “Item 1. Financial Statements -1. General” for the hotel interests owned by us as of September 30, 2015. We are committed to enhancing shareholder value through a disciplined strategy that includes internal growth through exceptional asset management; conservative balance sheet management; disciplined capital allocation; and opportunistic dispositions of hotels upon completion of our value enhancement and cash flow generating strategies.
We were incorporated in Maryland in January 2004 and completed our initial public offering of our common stock in June 2004. We made an election to be taxed as a real estate investment trust (REIT) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the Tax Code). A REIT is a legal entity that holds real estate interests and, through payments of dividends to stockholders, is permitted to reduce or avoid federal income taxes at the corporate level. To continue to qualify as a REIT, we cannot operate hotels; instead we employ internationally known hotel management companies to operate our hotels under management contracts. We operate as a self-administered and self-managed REIT, which means that we are managed by our board of directors and executive officers. We conduct our operations through our direct and indirect subsidiaries including our operating partnership, SH Funding, which currently holds substantially all of our assets. We are the managing member of SH Funding and hold approximately 99.7% of its membership units as of September 30, 2015. We manage all business aspects of SH Funding, including the sale and purchase of hotels, the investment in such hotels and the financing of SH Funding and its assets.
When presenting the U.S. dollar equivalent amount for any amounts expressed in a foreign currency, the U.S. dollar equivalent amount has been computed based on the exchange rate on the date of the transaction or the exchange rate prevailing on September 30, 2015, as applicable, unless otherwise noted.
Key Indicators of Operating Performance
We evaluate the operating performance of our business using a variety of operating and other information that includes financial information prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) such as total revenues, operating income (loss), net income (loss), and earnings per share, as well as non-GAAP financial information. In addition, we use other information that may not be financial in nature, including statistical information and comparative data. We use this information to measure the performance of individual hotels, groups of hotels, and/or our business as a whole. Key performance indicators that we evaluate include average daily occupancy, average daily rate (ADR), revenue per available room (RevPAR), and Total RevPAR, which are more fully discussed under “—Factors Affecting Our Results of Operations—Revenues.” We also evaluate Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), Comparable EBITDA, Funds from Operations (FFO) attributable to SHR common shareholders, FFO-Fully Diluted, and Comparable FFO as supplemental non-GAAP measures to GAAP performance measures. We provide a more detailed discussion of the non-GAAP financial measures under “—Non-GAAP Financial Measures.”
Outlook

The current cyclical recovery of the lodging industry, which is viewed as positive RevPAR growth on a trailing twelve month basis for the industry, has been characterized by steadily improving demand, despite somewhat muted macroeconomic growth, and very limited new supply, particularly in the luxury and upper upscale segment. From a historical perspective, 2015 represents the sixth year of the current lodging recovery. The previous two upcycles lasted just over nine years (June 1992 through August 2001) and over five years (June 2003 through October 2008), respectively. Supply growth on a trailing twelve month moving average during the current upcycle has been 0.8% and has consistently run below the 2% long-term average.

As we assess lodging supply and demand dynamics looking forward, we are optimistic about the long-term prospects for the current recovery continuing, particularly in the product niche and markets in which we own assets. Group bookings pace remains our best forward indicator of demand. Definite group room nights for 2016 as of September 30, 2015 for our Total

35


Portfolio (which is defined within "—Factors Affecting Our Results of Operations - Total Portfolio and Same Store Assets Definitions"), excluding the Hyatt Regency La Jolla hotel, which was sold on May 21, 2015, are expected to exceed 2015 definite group room nights by 10.7% and are booked at 3.1% higher rates. With the exception of the New York City and Austin markets and select areas of the Miami market, new supply in the luxury and upper upscale segments remains very well contained in our markets and the current significant gap between hotel trading values and replacement costs bodes favorably for very limited supply growth into the future.
Factors Affecting Our Results of Operations
Acquisitions of Consolidated Properties. On May 12, 2015, we acquired the Four Seasons Hotel Austin for a cash payment of approximately $196.3 million, which includes net working capital prorations.
On January 29, 2015, we acquired the Montage Laguna Beach resort. The acquisition was funded through the issuance of 7,347,539 shares of SHR's common stock to an affiliated designee of the seller, the assumption of a $150.0 million existing mortgage loan encumbering the property, and a cash payment of approximately $110.3 million, which includes net working capital prorations.
On December 9, 2014, we acquired the Four Seasons Resort Scottsdale at Troon North for a cash payment of approximately $140.9 million, which includes net working capital prorations.
Acquisitions of Interests in Consolidated Properties. On July 24, 2015, affiliates of KSL Capital Partners, LLC (KSL) exercised their right to sell us their equity interests in a joint venture formed with us to acquire, own, manage, and operate the JW Marriott Essex House Hotel (the Essex House Hotel Venture) (the Put Option). In connection with the exercise of the Put Option, and in accordance with the terms of the joint venture agreements, (a) on August 19, 2015, we issued an aggregate of 6,595,449 shares of our common stock to KSL, (b) the borrowers under the mortgage loan secured by the JW Marriott Essex House Hotel became wholly owned by certain of our indirect subsidiaries, and (c) the joint venture with KSL terminated.
On June 11, 2014, we acquired the 63.6% equity interests in the entity that owns the Hotel del Coronado, BSK Del Partners, L.P. (the Hotel del Coronado Venture), that were previously owned by certain affiliates of Blackstone Real Estate Partners VI L.P. for a cash payment of $210.0 million. Additionally, we became fully obligated under the entire $475.0 million mortgage and mezzanine loans outstanding. Effective as of the closing of the transaction, we consolidated the Hotel del Coronado Venture.
On March 31, 2014, we acquired the 50% equity interests in the entities that own the Fairmont Scottsdale Princess hotel, Walton/SHR FPH Holdings, L.L.C. and FMT Scottsdale Holdings, L.L.C. (the Fairmont Scottsdale Princess Venture), that were previously owned by an affiliate of Walton Street Capital, L.L.C. for a cash payment of $90.6 million. Additionally, we became fully obligated under the entire $117.0 million mortgage loan, which was previously outstanding and repaid in full on April 9, 2015. Effective as of the closing of the transaction, we consolidated the Fairmont Scottsdale Princess Venture.

Sales of Interests in Consolidated Properties. On August 19, 2015, we entered into an agreement with an unaffiliated third party to sell the Marriott Lincolnshire Resort for $20.7 million. The transaction, which is subject to certain closing conditions, is expected to close in the fourth quarter of 2015.

On May 21, 2015, we, along with our joint venture partner, sold the Hyatt Regency La Jolla hotel for sales proceeds of approximately $118.3 million. The $89.2 million mortgage loan secured by the hotel was repaid at the time of closing. In accordance with newly adopted accounting guidance that amends the requirements for reporting discontinued operations, the sale of the Hyatt Regency La Jolla hotel did not represent a strategic shift that has a major effect on our results of operations; therefore, the results of operations for this property have been classified as continuing operations for all periods presented.

On March 31, 2014, we sold our interest in the Marriott London Grosvenor Square hotel for sales proceeds, net of working capital prorations and closing costs, of approximately $209.4 million. There was an outstanding balance of £67.3 million ($112.2 million) on the mortgage loan secured by the Marriott London Grosvenor Square hotel, which was repaid at the time of closing. We received net proceeds of approximately $97.3 million. The results of operations for this property have been classified as discontinued operations for all periods presented.

On February 28, 2014, we sold our interest in the Four Seasons Punta Mita Resort and the adjacent La Solana land parcel for proceeds of $206.9 million. The results of operations for this property and the adjacent land parcel have been classified as discontinued operations for all periods presented.


36


Total Portfolio and Same Store Assets Definitions. We define our Total Portfolio as properties that we wholly or partially own or lease and whose operations are included in our consolidated operating results. Our Total Portfolio excludes all sold properties and assets held for sale, if any, classified as discontinued operations.
We present certain information about our hotel operating results and key performance indicators on a comparable hotel basis, which we refer to as our Same Store analysis. We define our Same Store Assets as those hotels (a) that are owned by us, and whose operations are included in our consolidated operating results and (b) for which we reported operating results throughout the entire reporting periods presented. Our Same Store Assets Portfolio excludes all sold properties and assets held for sale, if any, classified as continuing and discontinued operations. We present the results of Same Store Assets because we believe that doing so provides useful information for evaluating the period-to-period performance of our hotels and facilitates comparisons with other hotel REITs and hotel owners. In particular, these measures assist in distinguishing whether increases or decreases in revenues and/or expenses are due to operations of the Same Store Assets or from acquisition or disposition activity.
The following table summarizes the properties that are included in our Same Store Assets Portfolio and Total Portfolio for the reporting periods presented:
 
Same Store Assets Portfolio
 
Total Portfolio
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
Three and Nine Months Ended September 30,
 
2015 and 2014
 
2015 and 2014
 
2015
 
2014
Marriott Lincolnshire Resort (1)
 
 
 
 
X
 
X
Loews Santa Monica Beach Hotel
X
 
X
 
X
 
X
Hyatt Regency La Jolla (2)
 
 
 
 
X
 
X
Ritz-Carlton Half Moon Bay
X
 
X
 
X
 
X
InterContinental Chicago
X
 
X
 
X
 
X
InterContinental Miami
X
 
X
 
X
 
X
Fairmont Chicago
X
 
X
 
X
 
X
Four Seasons Washington, D.C.
X
 
X
 
X
 
X
Westin St. Francis
X
 
X
 
X
 
X
Ritz-Carlton Laguna Niguel
X
 
X
 
X
 
X
Four Seasons Jackson Hole
X
 
X
 
X
 
X
Four Seasons Silicon Valley
X
 
X
 
X
 
X
JW Marriott Essex House Hotel
X
 
X
 
X
 
X
Fairmont Scottsdale Princess
X
 
 
 
X
 
X
Hotel del Coronado
X
 
 
 
X
 
X
Four Seasons Resort Scottsdale at Troon North
 
 
 
 
X
 
 
Montage Laguna Beach
 
 
 
 
X
 
 
Four Seasons Hotel Austin
 
 
 
 
X
 
 
 
 
 
 
 
 
 
 
(1) On August 19, 2015, we entered into an agreement with an unaffiliated third party to sell the Marriott Lincolnshire Resort. The transaction, which is subject to certain closing conditions, is expected to close in the fourth quarter of 2015.
(2) The results of operations for the Hyatt Regency La Jolla hotel are included in our Total Portfolio results of operations for our period of ownership. The Hyatt Regency La Jolla hotel was sold on May 21, 2015, and the results of operations are classified as continuing operations for all periods presented.

37


Revenues. Substantially all of our revenue is derived from the operation of our hotels. Specifically, our revenue for the nine months ended September 30, 2015 and 2014, consisted of:
 
Total Portfolio % of Total Revenues
 
Same Store Assets % of Total Revenues
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Rooms
52.8
%
 
55.1
%
 
56.9
%
 
57.4
%
Food and beverage
36.0
%
 
34.4
%
 
34.0
%
 
33.5
%
Other hotel operating revenue
10.9
%
 
10.0
%
 
8.7
%
 
8.5
%
Lease revenue
0.3
%
 
0.5
%
 
0.4
%
 
0.6
%
Total revenues
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Rooms revenue. Occupancy and ADR are the major drivers of rooms revenue.
Food and beverage revenue. Occupancy, local catering and banquet events are the major drivers of food and beverage revenue.
Other hotel operating revenue. Other hotel operating revenue consists primarily of cancellation fees, spa, telephone, parking, golf course, internet access, space rentals, retail and other guest services and is also driven by occupancy.
Lease revenue. We subleased our interest in the Marriott Hamburg hotel to a third party and earned annual base rent plus additional rent contingent on the hotel meeting performance thresholds. Effective September 1, 2015, we transferred our leasehold interests in the Marriott Hamburg hotel to an unaffiliated third party and no longer receive rent payments.
Changes in our revenues are most easily explained by performance indicators that are used in the hotel real estate industry:
average daily occupancy;
ADR, which stands for average daily rate, is equal to rooms revenue divided by the number of occupied rooms;
RevPAR, which stands for revenue per available room, is equal to rooms revenue divided by the number of rooms available; and
Total RevPAR, which stands for total revenue per available room, is equal to the sum of rooms revenue, food and beverage revenue and other hotel operating revenue, divided by the number of rooms available.
We generate a significant portion of our revenue from two broad categories of customers, transient and group.
Our transient customers include individual or group business and leisure travelers that occupy fewer than 10 rooms per night. Transient customers for our Total Portfolio accounted for approximately 56.2% and 58.6% of the rooms sold during the nine months ended September 30, 2015 and 2014, respectively. We divide our transient customers into the following subcategories:
Transient Leisure – This category generates the highest room rates and includes travelers that receive published rates offered to the general public that do not have access to negotiated or discounted rates.
Transient Negotiated – This category includes travelers, who are typically associated with companies and organizations that generate high volumes of business, that receive negotiated rates that are lower than the published rates offered to the general public.
Our group customers include groups of 10 or more individuals that occupy 10 or more rooms per night. Group customers for our Total Portfolio accounted for approximately 43.8% and 41.4% of the rooms sold during the nine months ended September 30, 2015 and 2014, respectively. We divide our group customers into the following subcategories:
Group Association – This category includes group bookings related to national and regional association meetings and conventions.
Group Corporate – This category includes group bookings related to corporate business.
Group Other – This category generally includes group bookings related to social, military, education, religious, fraternal and youth and amateur sports teams.

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Fluctuations in revenues, which, for our domestic hotels, historically have been correlated with changes in the United States gross domestic product (U.S. GDP), are driven largely by general economic and local market conditions, which in turn affect levels of business and leisure travel. Guest demographics also affect our revenues.
In addition to economic conditions, supply is another important factor that can affect revenues. Room rates and occupancy tend to fall when supply increases unless the supply growth is offset by an equal or greater increase in demand. One reason we target upper upscale and luxury hotels in select urban and resort markets, including major business centers and leisure destinations, is because they tend to be in locations that have greater supply constraints such as lack of available land, high development costs, long development and entitlement lead times, and brand trade area restrictions that prevent the addition of a certain brand or brands in close proximity. Nevertheless, our hotels are not insulated from competitive pressures and our hotel operators will lower room rates to compete more aggressively for guests in periods when occupancy declines.
Hotel Operating Expenses. Our hotel operating expenses for the nine months ended September 30, 2015 and 2014 consisted of the costs and expenses to provide hotel services, including:
 
Total Portfolio % of Total Hotel Operating Expenses
 
Same Store Assets % of Total Hotel 
Operating Expenses
 
2015
 
2014
 
2015
 
2014
Hotel Operating Expenses:
 
 
 
 
 
 
 
Rooms
20.0
%
 
21.1
%
 
21.6
%
 
22.0
%
Food and beverage
33.5
%
 
32.9
%
 
33.8
%
 
33.8
%
Other departmental expenses
34.3
%
 
33.3
%
 
32.0
%
 
31.6
%
Management fees
4.7
%
 
4.3
%
 
4.5
%
 
4.2
%
Other hotel expenses
7.5
%
 
8.4
%
 
8.1
%
 
8.4
%
Total hotel operating expenses
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Rooms expense. Occupancy is a major driver of rooms expense, which has a significant correlation with rooms revenue.
Food and beverage expense. Occupancy, local catering and banquet events are the major drivers of food and beverage expense, which has a significant correlation with food and beverage revenue.
Other departmental expenses. Other departmental expenses consist of general and administrative, marketing, repairs and maintenance, utilities and expenses related to earning other operating revenue.
Management fees. We pay base and incentive management fees to our hotel operators. Base management fees are computed as a percentage of revenue. Incentive management fees are incurred when operating profits exceed levels prescribed in our management agreements.
Other hotel expenses. Other hotel expenses consist primarily of insurance costs and property taxes.
Salaries, wages and related benefits are included within the categories of hotel operating expenses described above and represented approximately 50.1% and 50.2% of the Total Portfolio total hotel operating expenses for the nine months ended September 30, 2015 and 2014, respectively.
Most categories of variable operating expenses, such as utilities and certain labor such as housekeeping, fluctuate with changes in occupancy. Increases in RevPAR attributable to increases in occupancy are accompanied by increases in most categories of variable operating costs and expenses while increases in RevPAR attributable to increases in ADR typically only result in increases in limited categories of operating costs and expenses, such as management fees charged by our operators, which are based on hotel revenues. Therefore, changes in ADR have a more significant impact on operating margins.
Lease Expense. As a result of the sale-leaseback transaction of the Marriott Hamburg hotel, we recorded lease expense in our condensed consolidated statements of operations. In conjunction with the sale-leaseback transaction, we also recorded a deferred gain, which was amortized as an offset to lease expense. Effective September 1, 2015, we transferred our leasehold interests in the Marriott Hamburg hotel to an unaffiliated third party. As of the transfer date, we were released from all of our obligations under the lease arrangements.
Corporate Expenses. Corporate expenses include payroll and related costs, professional fees, travel expenses, office rent and transaction costs.

39


Recent Events. In addition to the pending Mergers and the changes to the consolidated hotel properties and unconsolidated affiliates noted above, we expect that the following events will cause our future results of operations to differ from our historical performance:
Marriott Hamburg hotel. Effective September 1, 2015, we transferred our leasehold interest in the Marriott Hamburg hotel to an unaffiliated third party and were released from all of our obligations under the lease arrangements. We are still entitled to a euro-denominated security deposit in the amount of €1,900,000 ($2,124,000 based on the foreign exchange rate as of September 30, 2015), which will be released back to us in four equal installments over four years beginning on March 1, 2017. As a result of this transfer, we have now completed our exit from Europe.
Unsecured Credit Facility. On May 27, 2015, we entered into a new $750.0 million senior unsecured credit facility, which also includes a $250.0 million accordion feature. The unsecured credit facility is comprised of a $450.0 million unsecured revolving credit facility and a $300.0 million unsecured term loan. The unsecured credit facility replaced the $300.0 million secured credit facility that was set to initially expire in April 2018. Interest on the unsecured revolving credit facility is payable monthly based upon a leverage-based pricing grid with annual rates ranging from London Interbank Offered Rate (LIBOR) plus 1.65% to LIBOR plus 2.40%. Interest on the unsecured term loan is also payable monthly based upon a leverage-based pricing grid with annual rates ranging from LIBOR plus 1.60% to LIBOR plus 2.35%. The facility expires on May 27, 2020. See "—Liquidity and Capital Resources—Unsecured Credit Facility."
Mortgage Loan Agreements. On May 27, 2015, we closed on a new $115.0 million mortgage loan secured by the Ritz-Carlton Half Moon Bay hotel. Interest on the loan is payable monthly at an annual rate of LIBOR plus 2.40%, and the loan has a five-year initial term with two, one-year extension options, subject to certain conditions.
On May 27, 2015, we also repaid the previously outstanding $209.6 million mortgage loan secured by the Westin St. Francis hotel and the $93.1 million mortgage loan secured by the Fairmont Chicago hotel that were cross-collateralized and set to mature in June 2017 using proceeds from the new mortgage loan secured by the Ritz-Carlton Half Moon Bay hotel and proceeds from the new unsecured term loan.
On April 9, 2015, we repaid the entire balance outstanding of the mortgage loan secured by the Fairmont Scottsdale Princess hotel.
On December 30, 2014, the Essex House Hotel Venture refinanced the mortgage loan secured by the JW Marriott Essex House Hotel and entered into a new $225.0 million limited recourse loan agreement. The initial mortgage loan maturity was extended to January 2018 with two, one-year extension options, subject to certain conditions. The interest rate decreased to an annual rate of LIBOR plus 2.95% from the previous annual rate of LIBOR plus 4.00%, subject to a 0.75% LIBOR floor. On July 24, 2015, KSL exercised its Put Option related to the Essex House Hotel Venture, and the borrowers under the mortgage loan secured by the JW Marriott Essex House Hotel became wholly owned by certain of our indirect subsidiaries.
On July 7, 2014, we paid off the outstanding balance of an $85.0 million mortgage loan secured by the InterContinental Miami hotel. On August 29, 2014, we closed on a new $115.0 million mortgage loan secured by the InterContinental Miami hotel. The interest rate changed to an annual fixed rate of 3.99% from the previous annual rate of LIBOR plus 3.50%. The loan has a maturity date of September 6, 2024.
On June 30, 2014, we refinanced the mortgage loan secured by the Four Seasons Washington, D.C. hotel. The principal was reduced to $120.0 million and the annual interest rate was reduced to LIBOR plus 2.25% from LIBOR plus 3.15%. The loan has an initial maturity date of June 30, 2017 with two, one-year extension options, subject to certain conditions.
On May 29, 2014, we refinanced the mortgage loan secured by the Loews Santa Monica Beach Hotel. The principal was increased to $120.0 million and the annual interest rate was reduced to LIBOR plus 2.55% from LIBOR plus 3.85%. The loan has an initial maturity date of May 29, 2017 with four, one-year extension options, subject to certain conditions.
Preferred Stock Redemptions. On January 5, 2015, we redeemed all of the outstanding 3,615,375 shares of our 8.25% Series B Cumulative Redeemable Preferred Stock (Series B Preferred Stock). The shares of the Series B Preferred Stock were redeemed at a redemption price of $25.00 per share, plus accrued and unpaid dividends from January 1, 2015 up to and including January 5, 2015 in the amount of $0.028646 per share, for a total redemption cost of approximately $90.5 million. Following the redemption, dividends on the Series B Preferred Stock ceased to accrue.
On July 3, 2014, we redeemed all of the outstanding 3,827,727 shares of our 8.25% Series C Cumulative Redeemable Preferred Stock (Series C Preferred Stock). The shares of the Series C Preferred Stock were redeemed at a redemption price of $25.00 per share, plus accrued and unpaid dividends from July 1, 2014 up to and including July 3, 2014 in the amount of $0.01719 per

40


share, for a total redemption cost of approximately $95.8 million. Following the redemption, dividends on the Series C Preferred Stock ceased to accrue.
On April 3, 2014, we redeemed all of the outstanding 4,148,141 shares of our 8.50% Series A Cumulative Redeemable Preferred Stock (Series A Preferred Stock). The shares of the Series A Preferred Stock were redeemed at a redemption price of $25.00 per share, plus accrued and unpaid dividends up to and including April 3, 2014 in the amount of $0.54896 per share, for a total redemption cost of approximately $106.0 million. Following the redemption, dividends on the Series A Preferred Stock ceased to accrue.
Common Stock. In December 2014, we completed an underwritten public offering of common stock by issuing 20.0 million shares at a price of $12.57 per share. After transaction expenses, we raised net proceeds of approximately $250.9 million. These proceeds were used to fund the acquisition of the Four Seasons Resort Scottsdale at Troon North, to redeem all of the issued and outstanding shares of our Series B Preferred Stock on January 5, 2015, and for general corporate purposes, including, without limitation, reducing debt and funding capital expenditures and working capital.
In June 2014, we completed an underwritten public offering of common stock by issuing 41.4 million shares at a public offering price of $10.50 per share. After underwriting discounts and commissions and transaction expenses, we raised net proceeds of approximately $416.7 million. These proceeds were used to fund the acquisition of the remaining equity interest in the Hotel del Coronado, to redeem all of the issued and outstanding shares of our Series C Preferred Stock, and for general corporate purposes, including, without limitation, reducing our borrowings under our credit facility arrangements, repaying other debt and funding capital expenditures and working capital.
Interest Rate Swap Terminations. On April 21, 2014, we paid $22.7 million, including accrued and unpaid interest, to terminate all of our remaining interest rate swaps with a combined notional amount of $400.0 million.

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Comparison of Three Months Ended September 30, 2015 to Three Months Ended September 30, 2014
Operating Results
The following table presents the operating results for the three months ended September 30, 2015 and 2014, including the amount and percentage change in these results between the two periods of our Total Portfolio and Same Store Assets (in thousands, except operating data).
 
 
Total Portfolio
 
Same Store Assets
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rooms
$
198,114

 
$
176,133

 
$
21,981

 
12.5
 %
 
$
170,106

 
$
166,891

 
$
3,215

 
1.9
 %
Food and beverage
115,296

 
96,642

 
18,654

 
19.3
 %
 
93,710

 
89,522

 
4,188

 
4.7
 %
Other hotel operating revenue
40,346

 
31,224

 
9,122

 
29.2
 %
 
31,599

 
28,032

 
3,567

 
12.7
 %
Lease revenue
678

 
1,264

 
(586
)
 
(46.4
)%
 
678

 
1,264

 
(586
)
 
(46.4
)%
Total revenues
354,434

 
305,263

 
49,171

 
16.1
 %
 
296,093

 
285,709

 
10,384

 
3.6
 %
Operating Costs and Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Hotel operating expenses
258,714

 
221,770

 
(36,944
)
 
(16.7
)%
 
212,278

 
205,735

 
(6,543
)
 
(3.2
)%
Lease expense
682

 
1,215

 
533

 
43.9
 %
 
682

 
1,215

 
533

 
43.9
 %
Depreciation and amortization
39,633

 
32,932

 
(6,701
)
 
(20.3
)%
 
31,540

 
30,344

 
(1,196
)
 
(3.9
)%
Impairment losses
2,325

 

 
(2,325
)
 
(100.0
)%
 

 

 

 
 %
Corporate expenses
10,709

 
5,405

 
(5,304
)
 
(98.1
)%
 

 

 

 
 %
Total operating costs and expenses
312,063

 
261,322

 
(50,741
)
 
(19.4
)%
 
244,500

 
237,294

 
(7,206
)
 
(3.0
)%
Operating income
42,371

 
43,941

 
(1,570
)
 
(3.6
)%
 
$
51,593

 
$
48,415

 
$
3,178

 
6.6
 %
Interest expense, net
(18,572
)
 
(21,798
)
 
3,226

 
14.8
 %
 
 
 
 
 
 
 
 
Loss on early extinguishment of debt

 
(609
)
 
609

 
100.0
 %
 
 
 
 
 
 
 
 
Equity in losses of unconsolidated affiliates

 
(4
)
 
4

 
100.0
 %
 
 
 
 
 
 
 
 
Foreign currency exchange gain (loss)
4

 
(69
)
 
73

 
105.8
 %
 
 
 
 
 
 
 
 
Loss on consolidation of affiliates

 
(15
)
 
15

 
100.0
 %
 
 
 
 
 
 
 
 
Other income (expenses), net
2,746

 
(136
)
 
2,882

 
2,119.1
 %
 
 
 
 
 
 
 
 
Income before income taxes and discontinued operations
26,549

 
21,310

 
5,239

 
24.6
 %
 
 
 
 
 
 
 
 
Income tax expense
(3,857
)
 
(370
)
 
(3,487
)
 
(942.4
)%
 
 
 
 
 
 
 
 
Income from continuing operations
22,692

 
20,940

 
1,752

 
8.4
 %
 
 
 
 
 
 
 
 
Income from discontinued operations, net of tax

 
63

 
(63
)
 
(100.0
)%
 
 
 
 
 
 
 
 
Net income
22,692

 
21,003

 
1,689

 
8.0
 %
 
 
 
 
 
 
 
 
Net income attributable to the noncontrolling interests in SHR’s operating partnership
(65
)
 
(67
)
 
2

 
3.0
 %
 
 
 
 
 
 
 
 
Net loss attributable to the noncontrolling interests in consolidated affiliates
634

 
1,854

 
(1,220
)
 
(65.8
)%
 
 
 
 
 
 
 
 
Net income attributable to SHR
$
23,261

 
$
22,790

 
$
471

 
2.1
 %
 
 
 
 
 
 
 
 
Reconciliation of Same Store Assets Operating Income to Total Portfolio Operating Income:
Same Store Assets operating income
 
 
 
 
 
$
51,593

 
$
48,415

 
$
3,178

 
6.6
 %
Corporate expenses
 
 
 
 
 
 
(10,709
)
 
(5,405
)
 
(5,304
)
 
(98.1
)%
Corporate depreciation and amortization
 
 
 
 
 
(126
)
 
(124
)
 
(2
)
 
(1.6
)%
Non-Same Store Assets operating income
 
 
 
1,613

 
1,055

 
558

 
52.9
 %
Total Portfolio operating income
 
 
 
 
 
$
42,371

 
$
43,941

 
$
(1,570
)
 
(3.6
)%


42


Rooms. Our Same Store Assets contributed to a $3.2 million, or 1.9%, increase in rooms revenue for the three months ended September 30, 2015 from the three months ended September 30, 2014. The components of RevPAR from our Same Store Assets for the three months ended September 30, 2015 and 2014 are summarized as follows:
 
Three Months Ended September 30,
 
2015
 
2014
 
Change (%)
Favorable/
(Unfavorable)
Occupancy
80.7
%
 
80.5
%
 
0.2
%
ADR
$
337.93

 
$
332.45

 
1.6
%
RevPAR
$
272.63

 
$
267.48

 
1.9
%

The increase in RevPAR for the Same Store Assets resulted from a 1.6% increase in ADR and a 0.2 percentage-point increase in occupancy. RevPAR increased primarily due to growth in group ADR for our Same Store Assets for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014. Rooms revenue for many of the hotels included in our Same Store Assets did not change significantly when compared to the same period in the prior year. However, there were notable increases in RevPAR at the InterContinental Miami hotel, the Ritz-Carlton Half Moon Bay hotel, and the JW Marriott Essex House Hotel all due to significant growth in group demand during the three months ended September 30, 2015 when compared to the same period in the prior year. The only significant decline in RevPAR was at the Four Seasons Washington, D.C. hotel, which had a decline in occupancy due to competitors offering exceptionally low rates and displacement from a rooms renovation.
For our Total Portfolio, rooms revenue increased $22.0 million, or 12.5%, for the three months ended September 30, 2015 from the three months ended September 30, 2014. In addition to the increase in the rooms revenue at our Same Store Assets, the increase in our Total Portfolio rooms revenue includes $24.4 million of additional rooms revenue from hotel acquisitions. The increase in the Total Portfolio rooms revenue was offset by a decline of $5.7 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
The components of RevPAR from our Total Portfolio for the three months ended September 30, 2015 and 2014 are summarized as follows:
 
Three Months Ended September 30,
 
2015
 
2014
 
Change (%)
Favorable/
(Unfavorable)
Occupancy
79.6
%
 
80.2
%
 
(0.7
)%
ADR
$
341.46

 
$
314.53

 
8.6
 %
RevPAR
$
271.77

 
$
252.30

 
7.7
 %

Food and Beverage. Our Same Store Assets had a $4.2 million, or 4.7%, increase in food and beverage revenue for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014, primarily due to an increase in banquet, catering, and audio-visual revenues from strong group spend at many of our Same Store Assets, including significant group spend at the InterContinental Miami hotel, the Ritz-Carlton Half Moon Bay hotel, the Fairmont Scottsdale Princess hotel and the JW Marriott Essex House Hotel. The InterContinental Miami hotel also had an increase in outlet revenue due to strong volume at its Toro Toro restaurant and the Ritz-Carlton Half Moon Bay hotel had growth in outlet revenue due to favorable weather conditions. For our Total Portfolio, food and beverage revenue increased $18.7 million, or 19.3%, when comparing the three months ended September 30, 2015 to the three months ended September 30, 2014. In addition to the increase in food and beverage revenue at our Same Store Assets, the increase in our Total Portfolio food and beverage revenue includes $17.7 million of additional food and beverage revenue from hotel acquisitions. The increase in the Total Portfolio food and beverage revenue was offset by a decline of $3.4 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
 
Other Hotel Operating Revenue. Our Same Store Assets had a $3.6 million, or 12.7%, increase in other hotel operating revenue for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014, primarily due significant demand for the rental of residential units at the Four Seasons Jackson Hotel hotel. For our Total Portfolio, other hotel operating revenue increased $9.1 million, or 29.2%, when comparing the three months ended September 30, 2015 to the three months ended September 30, 2014, which includes $6.3 million of additional other hotel operating revenue from hotel acquisitions. The increase in the Total Portfolio other hotel operating revenue was offset by a decline of $0.5 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.

43


Hotel Operating Expenses. The following table presents the components of our hotel operating expenses for the three months ended September 30, 2015 and 2014, including the amount and percentage changes in these expenses between the two periods of our Total Portfolio and Same Store Assets (in thousands):
 
Total Portfolio
 
Same Store Assets
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
Hotel operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rooms
$
52,968

 
$
48,197

 
$
(4,771
)
 
(9.9
)%
 
$
46,147

 
$
45,749

 
$
(398
)
 
(0.9
)%
Food and beverage
83,412

 
70,965

 
(12,447
)
 
(17.5
)%
 
68,380

 
66,204

 
(2,176
)
 
(3.3
)%
Other departmental expenses
89,068

 
74,640

 
(14,428
)
 
(19.3
)%
 
70,338

 
68,063

 
(2,275
)
 
(3.3
)%
Management fees
11,578

 
9,970

 
(1,608
)
 
(16.1
)%
 
9,746

 
9,160

 
(586
)
 
(6.4
)%
Other hotel expenses
21,688

 
17,998

 
(3,690
)
 
(20.5
)%
 
17,667

 
16,559

 
(1,108
)
 
(6.7
)%
Total hotel operating expenses
$
258,714

 
$
221,770

 
$
(36,944
)
 
(16.7
)%
 
$
212,278

 
$
205,735

 
$
(6,543
)
 
(3.2
)%
Hotel operating expenses for our Same Store Assets increased by $6.5 million, or 3.2%, for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014. The increase in hotel operating expenses is not significant and was expected as it correlates with the increase in rooms, food and beverage and other hotel operating revenue noted above. There were no notable variances in individual cost categories.
For our Total Portfolio, hotel operating expenses increased by $36.9 million, or 16.7%, for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014, due to the increase in our Same Store Assets as well as $37.5 million of additional hotel operating expenses related to hotel acquisitions. The increase in the Total Portfolio hotel operating expenses was offset by a decline of $7.9 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
Depreciation and Amortization. For our Total Portfolio, depreciation and amortization increased $6.7 million, or 20.3%, for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014, primarily due to $8.0 million of additional depreciation and amortization expense from hotel acquisitions. The increase in the Total Portfolio depreciation and amortization was offset by a decline of $1.3 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
Impairment Losses. On August 19, 2015, we entered into an agreement to sell the Marriott Lincolnshire Resort and reclassified the asset as held for sale. During the three months ended September 30, 2015, we recorded a non-cash impairment loss of $2.3 million to write down the value of the hotel to an amount equal to the fair value less the cost to sell.
Corporate Expenses. Corporate expenses increased $5.3 million, or 98.1%, for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014. Corporate expenses consist primarily of payroll and related costs, professional fees, travel expenses, office rent, and transaction costs. The increase in corporate expenses is primarily due to costs incurred related to the Mergers more fully described in “Item 1. Financial Statements -1. General - Agreement and Plan of Merger.”

44


Interest Expense, Net. There was a $3.2 million, or 14.8%, decrease in interest expense, net, for the three months ended September 30, 2015 when compared to the three months ended September 30, 2014. The components of interest expense, net, for the three months ended September 30, 2015 and 2014, are summarized as follows (in thousands):
 
Three Months Ended September 30,
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
Mortgages
$
(13,586
)
 
$
(17,058
)
 
$
3,472

 
20.4
 %
Credit facility arrangements
(1,816
)
 
(299
)
 
(1,517
)
 
(507.4
)%
Amortization of deferred financing costs
(1,003
)
 
(962
)
 
(41
)
 
(4.3
)%
Amortization of debt discount
(40
)
 
(623
)
 
583

 
93.6
 %
Amortization of interest rate swap costs
(2,459
)
 
(3,114
)
 
655

 
21.0
 %
Interest income
3

 
46

 
(43
)
 
(93.5
)%
Capitalized interest
329

 
212

 
117

 
55.2
 %
Total interest expense, net
$
(18,572
)
 
$
(21,798
)
 
$
3,226

 
14.8
 %
The change in interest expense, net, is primarily due to the following:
a decrease in mortgage interest due to the repayment of the mortgage loans secured by the Fairmont Chicago hotel, the Westin St. Francis hotel, and the Hyatt Regency La Jolla hotel in 2015 and lower annual interest rates resulting from refinancing activity; partially offset by
an increase in interest related to credit facility arrangements due to a higher average balance outstanding under the credit facility arrangements during the three months ended September 30, 2015 as compared to the three months ended September 30, 2014.
The weighted average debt outstanding for the three months ended September 30, 2015 and 2014 amounted to $1.8 billion and $1.6 billion, respectively. At September 30, 2015, approximately 23.0% of our total debt had fixed interest rates.
Other Income (Expenses), Net. Other income, net, includes asset management fee income, non-income related state, local and franchise taxes, as well as miscellaneous income and expenses. The $2.9 million change in other income, net, for the three months ended September 30, 2015, when compared to the three months ended September 30, 2014, is primarily due to the recognition of a $2.7 million gain previously deferred related to the Marriott Hamburg hotel, which was recognized in full when our leasehold interest in the hotel was transferred to an unaffiliated third party effective September 1, 2015.
Income Tax Expense. The $3.5 million, or 942.4%, increase in income tax expense is due to higher current income tax expense resulting from improved profitability and operations of the hotels as well as higher deferred income tax expense related to the Hotel del Coronado, which was consolidated in June 2014.
Net Income Attributable to the Noncontrolling Interests in Consolidated Affiliates. We record net loss or income attributable to noncontrolling interests in consolidated affiliates for the non-ownership interests in hotels that are partially owned by us. The change in net income attributable to noncontrolling interests in consolidated affiliates is primarily due to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015 and KSL's exercise of its Put Option related to the JW Marriott Essex House Hotel on July 24, 2015, both of which resulted in the elimination of the noncontrolling interests related to these two hotels.


45


Comparison of Nine Months Ended September 30, 2015 to Nine Months Ended September 30, 2014
Operating Results

The following table presents the operating results for the nine months ended September 30, 2015 and 2014, including the amount and percentage change in these results between the two periods of our Total Portfolio and Same Store Assets (in thousands, except operating data).

 
Total Portfolio
 
Same Store Assets
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rooms
$
547,355

 
$
428,107

 
$
119,248

 
27.9
 %
 
$
372,891

 
$
357,310

 
$
15,581

 
4.4
 %
Food and beverage
373,288

 
266,687

 
106,601

 
40.0
 %
 
222,559

 
208,218

 
14,341

 
6.9
 %
Other hotel operating revenue
113,242

 
77,405

 
35,837

 
46.3
 %
 
56,755

 
53,022

 
3,733

 
7.0
 %
Lease revenue
2,722

 
3,882

 
(1,160
)
 
(29.9
)%
 
2,722

 
3,882

 
(1,160
)
 
(29.9
)%
Total revenues
1,036,607

 
776,081

 
260,526

 
33.6
 %
 
654,927

 
622,432

 
32,495

 
5.2
 %
Operating Costs and Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hotel operating expenses
759,637

 
584,511

 
(175,126
)
 
(30.0
)%
 
483,125

 
463,932

 
(19,193
)
 
(4.1
)%
Lease expense
2,733

 
3,733

 
1,000

 
26.8
 %
 
2,733

 
3,733

 
1,000

 
26.8
 %
Depreciation and amortization
117,628

 
83,195

 
(34,433
)
 
(41.4
)%
 
62,013

 
60,139

 
(1,874
)
 
(3.1
)%
Impairment losses
12,726

 

 
(12,726
)
 
(100.0
)%
 

 

 

 
 %
Corporate expenses
25,418

 
19,796

 
(5,622
)
 
(28.4
)%
 

 

 

 
 %
Total operating costs and expenses
918,142

 
691,235

 
(226,907
)
 
(32.8
)%
 
547,871

 
527,804

 
(20,067
)
 
(3.8
)%
Operating income
118,465

 
84,846

 
33,619

 
39.6
 %
 
107,056

 
94,628

 
$
12,428

 
13.1
 %
Interest expense, net
(61,949
)
 
(59,582
)
 
(2,367
)
 
(4.0
)%
 
 
 
 
 
 
 
 
Loss on early extinguishment of debt
(34,211
)
 
(609
)
 
(33,602
)
 
(5,517.6
)%
 
 
 
 
 
 
 
 
Equity in earnings of unconsolidated affiliates

 
5,267

 
(5,267
)
 
(100.0
)%
 
 
 
 
 
 
 
 
Foreign currency exchange loss
(72
)
 
(75
)
 
3

 
4.0
 %
 
 
 
 
 
 
 
 
Gain on consolidation of affiliates

 
143,451

 
(143,451
)
 
(100.0
)%
 
 
 
 
 
 
 
 
Other income, net
43,054

 
1,082

 
41,972

 
3,879.1
 %
 
 
 
 
 
 
 
 
Income before income taxes and discontinued operations
65,287

 
174,380

 
(109,093
)
 
(62.6
)%
 
 
 
 
 
 
 
 
Income tax expense
(6,528
)
 
(616
)
 
(5,912
)
 
(959.7
)%
 
 
 
 
 
 
 
 
Income from continuing operations
58,759

 
173,764

 
(115,005
)
 
(66.2
)%
 
 
 
 
 
 
 
 
Income from discontinued operations, net of tax

 
159,102

 
(159,102
)
 
(100.0
)%
 
 
 
 
 
 
 
 
Net income
58,759

 
332,866

 
(274,107
)
 
(82.3
)%
 
 
 
 
 
 
 
 
Net income attributable to the noncontrolling interests in SHR’s operating partnership
(169
)
 
(1,197
)
 
1,028

 
85.9
 %
 
 
 
 
 
 
 
 
Net (income) loss attributable to the noncontrolling interests in consolidated affiliates
(12,820
)
 
6,112

 
(18,932
)
 
(309.8
)%
 
 
 
 
 
 
 
 
Net income attributable to SHR
$
45,770

 
$
337,781

 
$
(292,011
)
 
(86.4
)%
 
 
 
 
 
 
 
 
Reconciliation of Same Store Assets Operating Income to Total Portfolio Operating Income:
Same Store Assets operating income
 
 
 
 
 
 
$
107,056

 
$
94,628

 
$
12,428

 
13.1
 %
Corporate expenses
 
 
 
 
 
 
(25,418
)
 
(19,796
)
 
(5,622
)
 
(28.4
)%
Corporate depreciation and amortization
 
 
 
 
 
(381
)
 
(370
)
 
(11
)
 
(3.0
)%
Non-Same Store Assets operating income
 
 
 
 
 
37,208

 
10,384

 
26,824

 
258.3
 %
Total Portfolio operating income
 
 
 
 
 
$
118,465

 
$
84,846

 
$
33,619

 
39.6
 %


46


Rooms. Our Same Store Assets contributed to a $15.6 million, or 4.4%, increase in rooms revenue for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. The components of RevPAR from our Same Store Assets for the nine months ended September 30, 2015 and 2014 are summarized as follows:
 
Nine Months Ended September 30,
 
2015
 
2014
 
Change (%)
Favorable/
(Unfavorable)
Occupancy
78.9
%
 
79.6
%
 
(0.9
)%
ADR
$
322.12

 
$
306.09

 
5.2
 %
RevPAR
$
254.07

 
$
243.60

 
4.3
 %
The increase in RevPAR for the Same Store Assets resulted from a 5.2% increase in ADR offset by a 0.7 percentage-point decrease in occupancy. RevPAR increased primarily due to growth in group and transient ADR of 6.5% and 4.9%, respectively, for our Same Store Assets for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014. Significant contributors to growth in rooms revenue at our Same Store Assets include: the Westin St. Francis hotel, which had increased transient demand over the prior year that helped drive higher transient and group ADR, the Four Seasons Silicon Valley hotel, which had strong transient demand that helped drive higher transient and group ADR, and the Ritz-Carlton Laguna hotel, which had strong group demand that helped drive higher transient and group ADR.
For our Total Portfolio, rooms revenue increased $119.2 million, or 27.9%, for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. In addition to the increase in the rooms revenue at our Same Store Assets, the increase in our Total Portfolio rooms revenue includes $108.2 million of additional rooms revenue from hotel acquisitions. The increase in rooms revenue in our Total Portfolio was partially offset by a decline of $5.3 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
The components of RevPAR from our Total Portfolio for the nine months ended September 30, 2015 and 2014 are summarized as follows:
 
Nine Months Ended September 30,
 
2015
 
2014
 
Change (%)
Favorable/
(Unfavorable)
Occupancy
77.1
%
 
76.9
%
 
0.3
%
ADR
$
326.39

 
$
294.73

 
10.7
%
RevPAR
$
251.55

 
$
226.54

 
11.0
%
Food and Beverage. Our Same Store Assets had a $14.3 million, or 6.9%, increase in food and beverage revenue for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014 primarily due to an increase in banquet and catering revenues due to increased banquet volume and strong group spend at many of our Same Store Assets, including the InterContinental Miami hotel, the JW Marriott Essex House Hotel, and the Ritz-Carlton Laguna Niguel hotel. Additionally, the InterContinental Miami hotel had an increase in outlet revenue due to strong volume at its Toro Toro restaurant and the Ritz-Carlton Half Moon Bay hotel had strong outlet revenues, especially in the first and third quarters of 2015, due to favorable weather conditions. For our Total Portfolio, food and beverage revenue increased $106.6 million, or 40.0%, when comparing the nine months ended September 30, 2015 to the nine months ended September 30, 2014. In addition to the increase in food and beverage revenue at our Same Store Assets, the increase in our Total Portfolio food and beverage revenue includes $94.6 million of additional food and beverage revenue from hotel acquisitions. The increase in food and beverage revenue in our Total Portfolio was partially offset by a decline of $3.6 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
Other Hotel Operating Revenue. Our Same Store Assets had a $3.7 million, or 7.0%, increase in other hotel operating revenue for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014, primarily due significant demand for the rental of residential units at the Four Seasons Jackson Hotel hotel. For the Total Portfolio, other hotel operating revenue increased $35.8 million, or 46.3%, for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014 primarily due to an additional $33.8 million of other hotel operating revenue from hotel acquisitions.


47


Hotel Operating Expenses. The following table presents the components of our hotel operating expenses for the nine months ended September 30, 2015 and 2014, including the amount and percentage changes in these expenses between the two periods of our Total Portfolio and Same Store Assets (in thousands):
 
Total Portfolio
 
Same Store Assets
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
Hotel operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rooms
$
151,905

 
$
123,172

 
$
(28,733
)
 
(23.3
)%
 
$
104,160

 
$
102,208

 
$
(1,952
)
 
(1.9
)%
Food and beverage
254,731

 
192,645

 
(62,086
)
 
(32.2
)%
 
163,515

 
156,662

 
(6,853
)
 
(4.4
)%
Other departmental expenses
260,418

 
194,457

 
(65,961
)
 
(33.9
)%
 
154,699

 
146,742

 
(7,957
)
 
(5.4
)%
Management fees
35,440

 
24,989

 
(10,451
)
 
(41.8
)%
 
21,845

 
19,441

 
(2,404
)
 
(12.4
)%
Other hotel expenses
57,143

 
49,248

 
(7,895
)
 
(16.0
)%
 
38,906

 
38,879

 
(27
)
 
(0.1
)%
Total hotel operating expenses
$
759,637

 
$
584,511

 
$
(175,126
)
 
(30.0
)%
 
$
483,125

 
$
463,932

 
$
(19,193
)
 
(4.1
)%
Hotel operating expenses for our Same Store Assets increased by $19.2 million, or 4.1%, for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014. Payroll and related costs increased $6.1 million, most notably in the food and beverage department, which had higher banquet volume compared to prior year. Additionally, sales and marketing costs increased $1.3 million, food and beverage acquisition costs increased $0.6 million, credit card commissions increased $0.6 million, and travel agent commissions increased $0.2 million. Management fees increased $2.4 million due to higher gross revenues and improved operating profit at many of our Same Store Assets.
For the Total Portfolio, hotel operating expenses increased by $175.1 million, or 30.0%, for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014, due to the increase in our Same Store Assets as well as $164.9 million of additional hotel operating expenses from hotel acquisitions. The increase in hotel operating expenses in our Total Portfolio was partially offset by a decline of $9.8 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
Depreciation and Amortization. For the Total Portfolio, depreciation and amortization increased $34.4 million, or 41.4%, for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014, primarily due to $35.7 million of additional depreciation and amortization expense from hotel acquisitions. The increase in depreciation and amortization in our Total Portfolio was partially offset be a decline of $1.7 million related to the disposition of the Hyatt Regency La Jolla hotel on May 21, 2015.
Impairment Losses. During the nine months ended September 30, 2015, we performed an impairment test of long-lived assets related to the Marriott Lincolnshire Resort as a result of a change in the anticipated holding period for this hotel and subsequently entered into an agreement to sell the hotel on August 19, 2015 and reclassified the asset as held for sale. For the nine months ended September 30, 2015, we recorded a non-cash impairment charge of $12.7 million to write down the value of the hotel to an amount equal to the fair value less the cost to sell.
Corporate Expenses. Corporate expenses increased $5.6 million, or 28.4%, for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014. Corporate expenses consist primarily of payroll and related costs, professional fees, travel expenses, office rent, and transaction costs. The increase in corporate expenses is primarily due to costs incurred related to the Mergers more fully described in “Item 1. Financial Statements -1. General - Agreement and Plan of Merger.”

48


Interest Expense, Net. There was a $2.4 million, or 4.0%, increase in interest expense, net, for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014. The components of interest expense, net, for the nine months ended September 30, 2015 and 2014 are summarized as follows (in thousands):
 
Nine Months Ended September 30,
 
2015
 
2014
 
Change ($)
Favorable/
(Unfavorable)
 
Change (%)
Favorable/
(Unfavorable)
Mortgages
$
(48,094
)
 
$
(50,366
)
 
$
2,272

 
4.5
 %
Credit facility arrangements
(3,027
)
 
(1,643
)
 
(1,384
)
 
(84.2
)%
Amortization of deferred financing costs
(2,830
)
 
(3,400
)
 
570

 
16.8
 %
Amortization of debt discount
(731
)
 
(1,246
)
 
515

 
41.3
 %
Amortization of interest rate swap costs
(8,031
)
 
(6,472
)
 
(1,559
)
 
(24.1
)%
Mark to market of certain interest rate swaps

 
2,815

 
(2,815
)
 
(100.0
)%
Interest income
120

 
123

 
(3
)
 
(2.4
)%
Capitalized interest
644

 
607

 
37

 
6.1
 %
Total interest expense, net
$
(61,949
)
 
$
(59,582
)
 
$
(2,367
)
 
(4.0
)%
The change in interest expense, net, is primarily due to the following:
    
a decrease in mortgage interest due to the repayment of the mortgage loans secured by the Fairmont Chicago hotel, the Westin St. Francis hotel, and the Hyatt Regency La Jolla hotel in 2015, the elimination of cash swap settlement payments due to the termination of all of our remaining interest rate swaps in April 2014, and lower annual interest rates resulting from refinancing activity, partially offset by additional interest related to mortgages secured by recently acquired properties;

an increase in interest related to the credit facility arrangements due to a higher average balance outstanding under the credit facility arrangements during the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014; and

an increase in interest expense related to the amortization and mark to market related to interest rate swaps, which was impacted by the swap terminations that increased amortization of amounts previously recorded in accumulated other comprehensive loss and also eliminated mark to market gains.
The weighted average debt outstanding for each of the nine months ended September 30, 2015 and 2014 amounted to $1.8 billion and $1.3 billion, respectively. At September 30, 2015 approximately 23.0% of our total debt had fixed interest rates.
Loss on Early Extinguishment of Debt. During the nine months ended ended September 30, 2015, we recognized a loss on early extinguishment of debt of $34.2 million, which includes $32.9 million of prepayment penalties and other fees incurred in connection with the repayments of the mortgage loans secured by the Westin St. Francis and the Fairmont Chicago hotels. Additionally, we wrote off unamortized deferred financing costs related to the mortgage loans secured by the Westin St. Francis hotel, the Fairmont Chicago hotel, and the Hyatt Regency La Jolla hotel, which was repaid upon the sale of the hotel.
Equity in Earnings of Unconsolidated Affiliates. There was no activity related to unconsolidated affiliates for the nine months ended September 30, 2015. The change in equity in earnings of unconsolidated affiliates is due to the acquisitions of the remaining equity interests in the Fairmont Scottsdale Princess Venture and the Hotel del Coronado Venture in 2014. Subsequent to each acquisition, the operating results of the Fairmont Scottsdale Princess Venture and the Hotel del Coronado Venture were consolidated and no longer accounted for using the equity method of accounting.
Gain on Consolidation of Affiliates. On March 31, 2014, we acquired the 50% interest in the Fairmont Scottsdale Princess Venture that was not previously owned by us and recorded a gain on consolidation of affiliate of $78.1 million for the nine months ended September 30, 2014. On June 11, 2014, we acquired the 63.6% interest in the Hotel del Coronado Venture that was not previously owned by us and recorded a gain on consolidation of affiliate of $65.4 million for the nine months ended September 30, 2014.
Other Income, Net. Other income, net, includes asset management fee income, non-income related state, local and franchise taxes, as well as miscellaneous income and expenses. The $42.0 million increase in other income, net, is primarily due to the $40.6 million gain recorded on the sale of the Hyatt Regency La Jolla hotel during the nine months ended September 30, 2015 as

49


well as the recognition of a $2.7 million gain previously deferred related to the Marriott Hamburg hotel, which was recognized in full when our leasehold interests in the hotel were transferred to an unaffiliated third party effective September 1, 2015.
Income Tax Expense. The $5.9 million, or 959.7%, increase in income tax expense is due to higher current income tax expense resulting from improved profitability and operations of the hotels as well as higher deferred income tax expense related to the Hotel del Coronado, which was consolidated in June 2014.
Income from Discontinued Operations, Net of Tax. Income from discontinued operations, net of tax, decreased by $159.1 million due to gains recognized on the sale of the Marriott London Grosvenor Square hotel and the Four Seasons Punta Mita Resort during the nine months ended September 30, 2014. Effective January 1, 2015, we adopted new accounting guidance that amends the requirements for reporting discontinued operations. Based on the new guidance, the disposal of the Hyatt Regency La Jolla hotel on May 21, 2015 and the reclassification of the Marriott Lincolnshire Resort to held for sale do not represent strategic shifts that have a major effect on our results of operations; therefore, the results of operations for the Hyatt Regency La Jolla hotel and the Marriott Lincolnshire Resort are classified as continuing operations.
Net Income Attributable to the Noncontrolling Interests in SHR's Operating Partnership. We record net income or loss attributable to the noncontrolling interests in SHR's operating partnership based on the percentage of SH Funding we do not own. The $1.0 million decrease in net income attributable to the noncontrolling interests in SHR's partnership is due to lower net income during the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014. During the nine months ended September 30, 2014, we recorded significant gains related to the consolidation of affiliates and the disposition of two hotels. During the nine months ended September 30, 2015, we recorded fewer gains because we only had one hotel disposition. Additionally, we recorded an impairment loss of $12.7 million and loss on early extinguishment of debt of $34.2 million during the nine months ended September 30, 2015.
Net (Income) Loss Attributable to the Noncontrolling Interests in Consolidated Affiliates. We record net loss or income attributable to noncontrolling interests in consolidated affiliates for the non-ownership interests in hotels that are partially owned by us. The change in net (income) loss attributable to noncontrolling interests is primarily due to the gain recorded on the sale of the Hyatt Regency La Jolla hotel for the nine months ended September 30, 2015, of which 46.5% was attributable to our joint venture partner.
Liquidity and Capital Resources
The Merger Agreement related to the Mergers discussed in “Item 1. Financial Statements -1. General - Agreement and Plan of Merger” and elsewhere within this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section, contain provisions which restrict or prohibit certain capital expenditures as well as certain capital transactions typically used to fund our short and long-term liquidity requirements. In particular, we are subject to various restrictions on raising additional capital, issuing additional equity or debt, repurchasing equity or debt, and entering into certain acquisition and disposition transactions, among other restrictions. Until the Mergers close, or the Merger Agreement is terminated, our liquidity requirements will primarily be funded with net cash provided by operating activities and certain other capital activities allowed under the Merger Agreement.
Our short-term liquidity requirements consist primarily of funds necessary to pay for operating expenses and other expenditures, including:
interest expense and scheduled principal payments on outstanding indebtedness; and
recurring maintenance and capital expenditures necessary to maintain our properties properly.
Capital expenditures for the nine months ended September 30, 2015 and 2014 amounted to $68.1 million and $55.2 million, respectively. Included in the September 30, 2015 and 2014 capital expenditure amounts were $0.6 million and $0.6 million of capitalized interest, respectively. For the remainder of the year ending December 31, 2015, we expect to spend approximately $20.0 million on hotel property and equipment replacement projects in accordance with hotel management agreements and approximately $14.0 million on owner-funded projects, subject to adjustments based on continued evaluation and restrictions under the Merger Agreement. Major expected capital expenditures include guestroom renovations at the Loews Santa Monica Beach Hotel and the Four Seasons Washington, D.C. hotel, as well as a 100-room expansion at the Fairmont Scottsdale Princess hotel.
Historically, we have satisfied our short-term liquidity requirements through our existing working capital, cash provided by operations, and our credit facility arrangements. As of September 30, 2015, we had approximately $10.8 million of available corporate level cash, not including restricted cash and cash currently held by the hotels. Additionally, we anticipate our $750.0 million senior unsecured credit facility, which includes a $250.0 million accordion feature, will continue to provide sufficient

50


borrowing capacity to meet our short-term liquidity requirements during the next twelve months (see – “Unsecured Credit Facility” below) as long as we are in compliance with financial covenants, although our ability to borrow under the unsecured credit facility is subject to the restrictions under the Merger Agreement. Our compliance with financial covenants in future periods will depend substantially on the financial results of our hotels, and in particular, the operating results and gross asset values of the pool of unencumbered assets that support the unsecured credit facility, which currently include the Fairmont Chicago hotel, the Fairmont Scottsdale Princess hotel, the Four Seasons Hotel Austin, the Four Seasons Jackson Hole hotel, the Four Seasons Resort Scottsdale at Troon North, the Four Seasons Silicon Valley hotel, the Marriott Lincolnshire Resort (which we entered into an agreement to sell), the Ritz-Carlton Laguna Niguel hotel, and the Westin St. Francis hotel. As of September 30, 2015, we were in compliance with our financial and other restrictive covenants contained in the unsecured credit facility agreement. As of November 4, 2015, the outstanding borrowings and letters of credit under the unsecured credit facility in the aggregate were $300.0 million, and the available borrowing capacity under the unsecured credit facility was $450.0 million.
We believe that the following measures we have taken should be sufficient to satisfy our liquidity needs for the next 12 months.
On May 27, 2015, we entered into a new $750.0 million senior unsecured credit facility. The unsecured credit facility is comprised of a $450.0 unsecured revolving credit facility and a $300.0 unsecured term loan. The unsecured credit facility contains an accordion feature, which provides the option to increase the borrowing capacity up to $1.0 billion, subject to the satisfaction of customary conditions set forth in the agreement and the restrictions under the Merger Agreement. On May 27, 2015, we also closed a $115.0 million term loan secured by the Ritz-Carlton Half Moon Bay hotel. Simultaneously, we used the proceeds from these transaction to repay the previously outstanding $209.6 million loan secured by the Westin St. Francis hotel and the $93.1 million loan secured by the Fairmont Chicago hotel that were cross-collateralized and set to mature in June 2017. These transactions allowed us to reduce interest expense, lower our overall weighted average cost of debt and increase the weighted average maturity of our debt. We currently have nine unencumbered assets that will allow for increased financing flexibility in future periods.
On May 21, 2015, we, along with our joint venture partner, sold our interest in the Hyatt Regency La Jolla hotel for $118.3 million. The $89.2 million mortgage loan secured by the Hyatt Regency La Jolla hotel was repaid upon the close of the transaction.
In February 2015, we entered into a stock distribution agreement whereby we may sell, from time to time, through certain agents, shares of SHR's common stock, having an aggregate offering price of up to $250.0 million by means of ordinary brokers' transactions at market prices or as otherwise agreed to between us and the agents. However, any transactions under the stock distribution agreement are limited by restrictions under the Merger Agreement.
In December 2014, we completed an underwritten public offering of common stock and raised net proceeds of approximately $250.9 million. We used a portion of the proceeds to fund the acquisition of the Four Seasons Resort Scottsdale at Troon North and to redeem all of the issued and outstanding shares of our Series B Preferred Stock in January 2015, which eliminates future preferred dividend distributions related to these shares, and for general corporate purposes, including, without limitation, repaying other debt and funding capital expenditures and working capital. In June 2014, we completed an underwritten public offering of common stock and raised net proceeds of approximately $416.6 million. We used the proceeds to fund the acquisition of the remaining 63.6% interest in the Hotel del Coronado Venture not previously owned by us, to redeem all of the issued and outstanding shares of our Series C Preferred Stock, which eliminates future preferred dividend distributions related to these shares, and for general corporate purposes, including, without limitation, reducing our borrowings under our credit facility arrangements, repaying other debt and funding capital expenditures and working capital.
In December 2014, the Essex House Hotel Venture entered into a new $225.0 million mortgage loan secured by the JW Marriott Essex House Hotel, whereby we reduced the interest rate spread and extended the maturity of the mortgage loan to 2020, assuming extension options are exercised. In August 2014, we entered into a new $115.0 million mortgage loan secured by the InterContinental Miami hotel, whereby we were able to obtain a favorable fixed annual rate and extend the maturity of the mortgage loan to 2024. In May and June 2014, we refinanced the mortgage loans secured by the Loews Santa Monica Beach Hotel and the Four Seasons Washington, D.C. hotel whereby we reduced the interest rate spreads on both loans and staggered and extended maturities to 2021 and 2019, respectively, assuming extension options are exercised (see – “Mortgages payable, net of discount” below).
In March 2014, we sold the Marriott London Grosvenor Square hotel for proceeds of approximately $209.4 million, which included amounts used to repay the outstanding mortgage loan balance, and used the proceeds to acquire the remaining 50.0% equity interest in the Fairmont Scottsdale Princess Venture not previously owned by us.
In February 2014, we sold our interest in the Four Seasons Punta Mita Resort and the adjacent La Solana land parcel for proceeds of approximately $206.9 million. We used the proceeds to redeem all of the issued and outstanding shares of our

51


Series A Preferred Stock, which eliminates future preferred dividend distributions related to these shares, and repay indebtedness under our credit facility arrangements.
In November 2008, our board of directors elected to suspend the quarterly dividend to holders of shares of our common stock beginning in the fourth quarter of 2008. Under the terms of the Merger Agreement, we may not declare or pay any other dividends to holders of SHR common stock (unless such distribution is of a minimum amount necessary for SHR to maintain REIT status or to avoid the incurrence of certain taxes) without the prior written consent of BRE Holdings.
Unsecured credit facility. On May 27, 2015, we entered into a new $750.0 million senior unsecured credit facility. The unsecured credit facility is comprised of a $450.0 million unsecured revolving credit facility and a $300.0 million unsecured term loan. The unsecured credit facility contains an accordion feature, which provides the option to increase the borrowing capacity up to $1.0 billion, subject to the satisfaction of customary conditions set forth in the agreement. SH Funding has a letter of credit sub-facility of $60.0 million under the unsecured credit facility. The following summarizes key financial terms and conditions of the unsecured credit facility:
interest on the unsecured revolving facility is payable monthly at LIBOR plus an applicable margin in the case of each LIBOR loan and base-rate plus an applicable margin in the case of each base rate loan whereby the applicable margins are dependent on the ratio of consolidated debt to gross asset value (Leverage Ratio) as follows:
Leverage Ratio
Applicable Margin of
each LIBOR Loan
(% per annum)
 
Applicable Margin of
each Base Rate Loan
(% per annum)
Greater than or equal to 60%
2.40
%
 
1.40
%
Greater than or equal to 55% but less than 60%
2.15
%
 
1.15
%
Greater than or equal to 50% but less than 55%
2.00
%
 
1.00
%
Greater than or equal to 45% but less than 50%
1.85
%
 
0.85
%
Less than 45%
1.65
%
 
0.65
%
interest on the unsecured term loan is payable monthly at LIBOR plus an applicable margin in the case of each LIBOR loan and base-rate plus an applicable margin in the case of each base rate loan whereby the applicable margins are dependent on the Leverage Ratio as follows:
Leverage Ratio
Applicable Margin of
each LIBOR Loan
(% per annum)
 
Applicable Margin of
each Base Rate Loan
(% per annum)
Greater than or equal to 60%
2.35
%
 
1.35
%
Greater than or equal to 55% but less than 60%
2.10
%
 
1.10
%
Greater than or equal to 50% but less than 55%
1.95
%
 
0.95
%
Greater than or equal to 45% but less than 50%
1.80
%
 
0.80
%
Less than 45%
1.60
%
 
0.60
%
an unused commitment fee is payable monthly under the unsecured revolving facility based on the unused revolver balance at a rate of 0.30% per annum in the event that the unsecured revolving facility usage is less than 50% and a rate of 0.20% per annum in the event that the unsecured revolving facility usage is equal to or greater than 50%;
the maturity date of both the unsecured revolving facility and the unsecured term loan is May 27, 2020;
the unsecured credit facility requires that SH Funding own, at all times, a minimum of five unencumbered assets, exclusive of assets located in Mexico, and is initially supported by a pool of unencumbered assets that currently consists of the Fairmont Chicago hotel, the Fairmont Scottsdale Princess hotel, the Four Seasons Hotel Austin, the Four Seasons Jackson Hole hotel, the Four Seasons Resort Scottsdale at Troon North, the Four Seasons Silicon Valley hotel, the Marriott Lincolnshire Resort (which we entered into an agreement to sell), the Ritz-Carlton Laguna Niguel hotel, and the Westin St. Francis hotel;
the borrowing capacity under the unsecured revolving facility is reduced by any amounts previously borrowed and not repaid and any outstanding letters of credit;

52


financial covenants include: (a) minimum corporate fixed charge coverage of 1.50, (b) maximum corporate leverage of 60%, (c) maximum secured leverage of 50%; (d) maximum secured recourse leverage of 10%, (e) maximum unsecured leverage of 60%, (f) minimum unsecured interest coverage of 2.00, and (g) minimum tangible net worth of approximately $1.8 billion, excluding goodwill and currency translation adjustments, plus an amount equal to 75% of the net proceeds of any new issuances of our common stock, which is not used to reduce indebtedness or used in a transaction or series of transactions to redeem outstanding capital stock; and
certain restrictions on SHR and SH Funding’s ability to pay dividends.
Other terms and conditions exist including a limitation on mortgaging the unencumbered assets and limitations on the Company's ability to incur costs for discretionary capital programs and to redeem, retire or repurchase common stock.
Mortgages payable, net of discount. The following table summarizes our outstanding debt and scheduled maturities related to mortgages payable, net of discount, as of September 30, 2015 (in thousands):
 
Balance as of September 30, 2015
 
Remainder
of 2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
Mortgages payable
 
 
 
 
 
 
 
 
 
 
 
 
 
Hotel del Coronado, LIBOR plus 3.65%
$
475,000

 
$

 
$
475,000

 
$

 
$

 
$

 
$

Four Seasons Washington, D.C., LIBOR plus 2.25%
120,000

 

 

 
120,000

 

 

 

Loews Santa Monica Beach Hotel, LIBOR plus 2.55%
120,000

 

 

 
120,000

 

 

 

JW Marriott Essex House Hotel, LIBOR plus 2.95%
225,000

 

 

 

 
225,000

 

 

Ritz-Carlton Half Moon Bay, LIBOR plus 2.40%
115,000

 

 

 

 

 

 
115,000

InterContinental Miami, 3.99%
115,000

 

 

 

 

 

 
115,000

Montage Laguna Beach, 3.90%
150,000

 

 

 
884

 
2,723

 
2,831

 
143,562

InterContinental Chicago, 5.61%
141,147

 
655

 
2,040

 
2,182

 
2,310

 
2,445

 
131,515

Total mortgages payable(1)
1,461,147

 
$
655

 
$
477,040

 
$
243,066

 
$
230,033

 
$
5,276

 
$
505,077

Unamortized discount
(941
)
 
 
 
 
 
 
 
 
 
 
 
 
Total mortgages payable, net of discount
$
1,460,206

 


 


 


 


 


 


(1)
All of these loan agreements require maintenance of financial covenants, all of which we were in compliance with at September 30, 2015.
Our long-term liquidity requirements consist primarily of funds necessary to pay for scheduled debt maturities, debt refinancings, renovations, expansions and other non-recurring capital expenditures that need to be made periodically to our properties and the costs associated with acquisitions of properties. In addition, we may use cash to buy back outstanding debt or common securities from time to time when market conditions are favorable through open market purchases, privately negotiated transactions, or a tender offer, although the terms of our unsecured credit facility and Merger Agreement may impose certain conditions or restrictions in connection therewith.
Historically, we have satisfied our long-term liquidity requirements through various sources of capital, including our existing working capital, cash provided by operations, sales of properties, long-term property mortgage indebtedness, credit facility arrangements, issuance of senior unsecured debt instruments and through the issuance of additional equity securities. Credit markets have improved and access to mortgage and corporate level debt is more readily available. However, the capital markets can be volatile and there are no guarantees our maturing debt will be readily refinanced. Our ability to raise funds through the issuance of equity securities is dependent upon, among other things, general market conditions for both REITs in general and us specifically, including market perceptions regarding the Company. Additionally, we are subject to various restrictions on raising additional capital, issuing additional equity or debt, repurchasing equity or debt, and entering into certain acquisition and disposition transactions under the Merger Agreement.

53


Equity Securities
As of September 30, 2015, we had 2,781,074 RSUs and performance-based RSUs outstanding, of which 1,001,550 were vested. The following table presents the changes in our issued and outstanding shares of common stock and SH Funding operating partnership units (OP Units) from December 31, 2014 to September 30, 2015 (excluding RSUs):
 
Shares of Common Stock
 
OP Units Represented
by Noncontrolling
Interests
 
Total
Outstanding at December 31, 2014
267,435,799

 
793,618

 
268,229,417

RSUs and performance-based RSUs redeemed for shares of our common stock
711,369

 

 
711,369

Common stock issued
13,942,988

 

 
13,942,988

Outstanding at September 30, 2015
282,090,156

 
793,618

 
282,883,774

Cash Flows
Operating Activities. Net cash provided by operating activities was $171.4 million for the nine months ended September 30, 2015 compared to net cash provided by operating activities of $109.4 million for the nine months ended September 30, 2014. Cash flows from operations increased from 2014 to 2015 primarily due to increased operating income at many of our Same Store Assets, operating income generated by newly acquired hotels, a reduction in income taxes paid, which was significantly higher in the prior year due to income taxes paid attributable to the sale of the Four Seasons Punta Mita Resort and adjacent La Solana land parcel, and a reduction in cash interest paid.
Investing Activities. Net cash used in investing activities was $246.7 million for the nine months ended September 30, 2015 and net cash provided by investing activities was $58.8 million for the nine months ended September 30, 2014. The significant investing activities during these periods are summarized below:
We acquired the Four Seasons Hotel Austin for a cash payment of $196.3 million and partially funded the acquisition of the Montage Laguna Beach resort with a cash payment of $110.3 million during the nine months ended September 30, 2015. We acquired the 50% equity interests in the Fairmont Scottsdale Princess Venture and the 63.6% equity interests in the Hotel del Coronado Venture not previously owned by us for aggregate cash payments of $300.6 million during the nine months ended September 30, 2014.
We sold the Hyatt Regency La Jolla hotel for sales proceeds of $118.3 million during the nine months ended September 30, 2015. The proceeds received from the sale of the Hyatt Regency La Jolla hotel includes amounts used to repay the related mortgage loan balance. We sold the Four Seasons Punta Mita Resort and the adjacent La Solana land parcel for sales proceeds of $206.9 million during the nine months ended September 30, 2014, and we sold the Marriott London Grosvenor Square hotel for sales proceeds of $209.4 million, of which $209.2 million was received during the nine months ended September 30, 2014. The proceeds received from the sale of the Marriott London Grosvenor Square hotel includes amounts used to repay the related outstanding mortgage loan balance.
We received cash from unconsolidated affiliates of $1.8 million and $2.2 million during the nine months ended September 30, 2015 and 2014, respectively.
We sold unrestricted cash of $2.2 million through the disposition of the Hyatt Regency La Jolla hotel during the nine months ended September 30, 2015. We sold unrestricted cash of $15.6 million through dispositions of the Four Seasons Punta Mita Resort and the Marriott London Grosvenor Square hotel during the nine months ended September 30, 2014.
We acquired unrestricted cash of $9.0 million through our acquisitions of the Four Seasons Hotel Austin and the Montage Laguna Beach resort during the nine months ended September 30, 2015 and acquired unrestricted cash of $22.2 million through our acquisitions of the 50% equity interests in the Fairmont Scottsdale Princess Venture and the 63.6% equity interests in the Hotel del Coronado Venture during the nine months ended September 30, 2014.
We disbursed $68.1 million and $55.2 million during the nine months ended September 30, 2015 and 2014, respectively, for capital expenditures primarily related to room renovations.
Restricted cash and cash equivalents decreased by $1.1 million during the nine months ended September 30, 2015 and increased by $5.4 million during the nine months ended September 30, 2014.

54


Financing Activities. Net cash used in financing activities was $237.2 million for the nine months ended September 30, 2015 and net cash used in financing activities was $16.4 million for the nine months ended September 30, 2014. The significant financing activities during these periods are summarized below:
We received proceeds from an underwritten public offering of common stock, net of offering costs, of approximately $416.6 million during the nine months ended September 30, 2014.
We paid $90.4 million to redeem all of the issued and outstanding shares of our Series B Preferred Stock during the nine months ended September 30, 2015, and we paid $199.5 million to redeem all of the issued and outstanding shares of our Series A Preferred Stock and our Series C Preferred Stock during the nine months ended September 30, 2014.
We distributed $0.1 million and $11.9 million to our preferred shareholders during the nine months ended September 30, 2015 and 2014, respectively.
We had net borrowings of $302.0 million under our credit facility arrangements during the nine months ended September 30, 2015. We made net payments of $110.0 million on our credit facility arrangements during the nine months ended September 30, 2014.
We made net payments of $395.3 million and $88.6 million on mortgages during the nine months ended September 30, 2015 and 2014, respectively.
We paid distributions of $43.7 million to holders of noncontrolling interests in consolidated affiliates during the nine months ended September 30, 2015.
We paid $6.5 million and $5.4 million in financing costs that were deferred during the nine months ended September 30, 2015 and 2014, respectively.
We paid $22.3 million to terminate interest rate swaps during the nine months ended September 30, 2014.
We received contributions of $5.7 million from holders of noncontrolling interests in consolidated affiliates related to the Essex House Hotel Venture during the nine months ended September 30, 2014.
Dividend Policy
We generally intend to distribute each year substantially all of our taxable income (which does not necessarily equal net income as calculated in accordance with GAAP) to our shareholders so as to comply with REIT provisions of the Tax Code. If necessary for REIT qualification purposes, we may need to distribute any taxable income in cash or by a special dividend. Under the terms of the Merger Agreement, we may not declare or pay any other dividends to holders of SHR common stock (unless such distribution is of a minimum amount necessary for SHR to maintain REIT status or to avoid the incurrence of certain taxes) without the prior written consent of BRE Holdings.
Contractual Obligations
The following table summarizes our future payment obligations and commitments as of September 30, 2015 (in thousands):
 
Payments Due by Period
 
Total
 
Less than
1 year (1)
 
1 to 3
years
 
4 to 5
years
 
More than
5 years
Long-term debt obligations (2)
$
1,763,147

 
$
655

 
$
720,106

 
$
235,309

 
$
807,077

Interest on long-term debt obligations (3)
194,617

 
14,615

 
81,213

 
52,644

 
46,145

Operating lease obligations—ground leases and office space
130,650

 
837

 
6,563

 
5,500

 
117,750

Purchase commitments (4)
35,651

 
14,411

 
21,240

 

 

Total
$
2,124,065

 
$
30,518

 
$
829,122

 
$
293,453

 
$
970,972

(1)
These amounts represent obligations that are due within fiscal year 2015.
(2)
Long-term debt obligations include our credit facility arrangements and mortgages and exclude the unamortized discount. Maturity dates do not include extension options.
(3)
Interest on variable-rate debt obligations is calculated based on the variable rates at September 30, 2015.

55


(4)
Amounts include executed construction contracts.
Reserve Funds for Capital Expenditures
We maintain each of our hotels in excellent condition and in conformity with applicable laws and regulations and in accordance with the agreed upon requirements in our management agreements with our hotel operators.
We are obligated to maintain reserve funds for capital expenditures at the majority of our hotels (including the periodic replacement or refurbishment of furniture, fixtures and equipment) as determined pursuant to the management agreements with our hotel operators. As of September 30, 2015, $48.4 million was in restricted cash reserves for future capital expenditures. Generally, our agreements with hotel operators require us to reserve funds at amounts ranging between 4.0% and 5.0% of the individual hotel’s annual revenues and require the funds to be set aside in restricted cash. Expenditures are capitalized as incurred and depreciation begins when the related asset is placed in service. Any unexpended amounts will remain our property upon termination of the management and operating contracts.
Off-Balance Sheet Arrangements
Fairmont Scottsdale Princess Venture
We had a 50% ownership interest in FMT Scottsdale Holdings, L.L.C. and Walton/SHR FPH Holdings, L.L.C. (together, the Fairmont Scottsdale Princess Venture), which owns the Fairmont Scottsdale Princess hotel, and accounted for our investment under the equity method of accounting. On March 31, 2014, we acquired the remaining 50% interest in the Fairmont Scottsdale Princess Venture that was previously owned by our joint venture partner.
Our equity in earnings of the Fairmont Scottsdale Princess Venture was $4.8 million for the nine months ended September 30, 2014.
Hotel del Coronado Venture
We had a 36.4% ownership interest in BSK Del Partners, L.P. (the Hotel del Coronado Venture), which owns the Hotel del Coronado, and accounted for our investment under the equity method of accounting. On June 11, 2014, we acquired the remaining 63.6% interest in the Hotel del Coronado Venture that was previously owned by our joint venture partner.
Our equity in earnings of the Hotel del Coronado Venture was $0.6 million for the nine months ended September 30, 2014.
Four Seasons RCPM
We own a 31.0% interest in and act as asset manager for a venture with two unaffiliated parties that developed the Four Seasons Residence Club Punta Mita, a luxury vacation home product sold in fractional and whole ownership interests on the property adjacent to the Four Seasons Punta Mita Resort in Mexico. We account for this investment under the equity method of accounting. At September 30, 2015 and December 31, 2014, our investment in the unconsolidated affiliate amounted to $1.6 million and $3.4 million, respectively. Our equity in losses of the unconsolidated affiliate was $0.2 million for the nine months ended September 30, 2014.
Lot H5 Venture

On June 14, 2013, we entered into an amended and restated venture agreement with an unaffiliated third party, forming the Lot H5 Venture. The Lot H5 Venture owns the Lot H5 land parcel, an undeveloped, oceanfront land parcel in Punta Mita, Nayarit, Mexico. We have a preferred position in the Lot H5 Venture that entitles us to receive the first $12.0 million of distributions generated from the Lot H5 Venture, with any excess distributions split equally between the partners. We jointly control the Lot H5 Venture with our partner and account for our interest in the Lot H5 Venture as an equity method investment. At September 30, 2015 and December 31, 2014, our investment in the unconsolidated affiliate amounted to $19.4 million. Our equity in earnings of the unconsolidated affiliate was $0.02 million for the nine months ended September 30, 2014.
Related Party Transactions
We have in the past engaged in transactions with related parties. See "Item 1. Financial Statements - 13. Related Party Transactions" for a discussion of our transactions with related parties.
Critical Accounting Policies
Our discussion and analysis of financial condition and results of operations is based on our condensed consolidated interim financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in

56


conformity with GAAP requires management to make estimates and assumptions that affect the financial statements and disclosures. Some of these estimates and assumptions require application of difficult, subjective, and/or complex judgment about the effect of matters that are inherently uncertain and that may change in subsequent periods. We evaluate our estimates and assumptions on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
A disclosure of our critical accounting policies which affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements is included in our Annual Report on Form 10-K for the year ended December 31, 2014 in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Seasonality
The lodging business is seasonal in nature, and we experience some seasonality in our business. Revenues for hotels in tourist areas, those with significant group business, and in areas driven by greater climate changes are generally seasonal. Quarterly revenues also may be adversely affected by events beyond our control, such as extreme weather conditions and other acts of nature, terror attacks or alerts, airline strikes, economic factors and other considerations affecting travel.
To the extent that cash flows from operations are insufficient during any quarter, due to temporary or seasonal fluctuations in revenues, we may have to enter into short-term borrowings to pay operating expenses and make distributions to our stockholders.
New Accounting Guidance

See "Item1. Financial Statements—2. Summary of Significant Accounting Policies—New Accounting Guidance."
Non-GAAP Financial Measures
We present five non-GAAP financial measures that we believe are useful to management and investors as key measures of our operating performance: FFO attributable to SHR common shareholders; FFO—Fully Diluted; Comparable FFO; EBITDA; and Comparable EBITDA. Amounts presented in accordance with our definitions of FFO attributable to SHR common shareholders, FFO—Fully Diluted, Comparable FFO, EBITDA, and Comparable EBITDA may not be comparable to similar measures disclosed by other companies, since not all companies calculate these non-GAAP measures in the same manner. FFO attributable to SHR common shareholders, FFO—Fully Diluted, Comparable FFO, EBITDA, and Comparable EBITDA should not be considered as an alternative measure of our net income (loss) or operating performance. FFO attributable to SHR common shareholders, FFO—Fully Diluted, Comparable FFO, EBITDA, and Comparable EBITDA may include funds that may not be available for our discretionary use due to functional requirements to conserve funds for capital expenditures and property acquisitions and other commitments and uncertainties. Although we believe that FFO attributable to SHR common shareholders, FFO—Fully Diluted, Comparable FFO, EBITDA, and Comparable EBITDA can enhance the understanding of our financial condition and results of operations, these non-GAAP financial measures, when viewed individually, are not necessarily better indicators of any trend as compared to comparable GAAP measures such as net income (loss) attributable to SHR common shareholders. In addition, adverse economic and market conditions might negatively impact our cash flow. We have provided a quantitative reconciliation of FFO attributable to SHR common shareholders, FFO—Fully Diluted, Comparable FFO, EBITDA, and Comparable EBITDA to the most directly comparable GAAP financial performance measure, which is net income (loss) attributable to SHR common shareholders.
EBITDA and Comparable EBITDA
EBITDA represents net income (loss) attributable to SHR common shareholders excluding: (i) interest expense, (ii) income taxes, including deferred income tax benefits and expenses applicable to our foreign subsidiaries and income taxes applicable to sale of assets; (iii) depreciation and amortization; and (iv) preferred stock dividends. EBITDA also excludes interest expense, income taxes and depreciation and amortization of our unconsolidated affiliates. EBITDA is presented on a full participation basis, which means we have assumed conversion of all redeemable noncontrolling interests of our operating partnership into our common stock. We believe this treatment of noncontrolling interests provides useful information for management and our investors and appropriately considers our current capital structure. We also present Comparable EBITDA, which eliminates the effect of realizing deferred gains on our sale leasebacks, as well as the effect of gains or losses on sales of assets, early extinguishment of debt, impairment losses, foreign currency exchange gains or losses and certain other charges that are highly variable from year to year.

57


We believe EBITDA and Comparable EBITDA are useful to management and investors in evaluating our operating performance because they provide management and investors with an indication of our ability to incur and service debt, to satisfy general operating expenses, to make capital expenditures and to fund other cash needs or reinvest cash into our business. We also believe they help management and investors meaningfully evaluate and compare the results of our operations from period to period by removing the impact of our asset base (primarily depreciation and amortization) from our operating results. Our management also uses EBITDA and Comparable EBITDA as measures in determining the value of acquisitions and dispositions.

58


The following table provides a reconciliation of net income attributable to SHR common shareholders to Comparable EBITDA (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Net income attributable to SHR common shareholders
$
23,261

 
$
20,988

 
$
45,770

 
$
318,986

Depreciation and amortization—continuing operations
39,633

 
32,932

 
117,628

 
83,195

Depreciation and amortization—discontinued operations

 

 

 
1,275

Interest expense—continuing operations
18,575

 
21,844

 
62,069

 
59,705

Interest expense—discontinued operations

 

 

 
1,326

Income taxes—continuing operations
3,857

 
370

 
6,528

 
616

Income taxes—discontinued operations

 

 

 
833

Income taxes—sale of assets

 

 

 
20,451

Net income attributable to noncontrolling interests in SHR's operating partnership (1)
65

 
67

 
169

 
1,197

Adjustments attributable to noncontrolling interests in consolidated affiliates (2)
(732
)
 
(4,070
)
 
(7,778
)
 
(11,684
)
Adjustments attributable to unconsolidated affiliates (3)

 
(11
)
 

 
8,432

Preferred shareholder dividends

 
1,802

 

 
18,795

EBITDA
84,659

 
73,922

 
224,386

 
503,127

Realized portion of deferred gain on sale leaseback
(29
)
 
(52
)
 
(116
)
 
(159
)
(Gain) loss on sale of assets—continuing operations
(2,661
)
 
38

 
(43,274
)
 
(729
)
Gain on sale of assets—discontinued operations

 
(63
)
 

 
(176,943
)
Loss (gain) on consolidation of affiliates

 
15

 

 
(143,451
)
Impairment losses
2,325

 

 
12,726

 

Loss on early extinguishment of debt—continuing operations

 
609

 
34,211

 
609

Loss on early extinguishment of debt—discontinued operations

 

 

 
272

Foreign currency exchange (gain) loss—continuing operations
(4
)
 
69

 
72

 
75

Foreign currency exchange gain—discontinued operations

 

 

 
(32
)
Hotel acquisition costs
343

 

 
1,409

 

Costs related to the Mergers
4,018

 

 
4,018

 

Non-cash interest rate derivative activity
6

 
127

 
152

 
127

Amortization of below market hotel management agreement
513

 
513

 
1,539

 
621

Activist shareholder costs

 

 

 
1,637

Adjustments attributable to noncontrolling interests in consolidated affiliates (4)
(8
)
 
(5
)
 
16,551

 
104

Comparable EBITDA
$
89,162

 
$
75,173

 
$
251,674

 
$
185,258

(1)
EBITDA is presented on a full participation basis, which means we have assumed conversion of all redeemable noncontrolling interests in SHR's operating partnership into shares of SHR's common stock. This adjustment reverses the net income that was allocated to the noncontrolling interests in SHR's operating partnership.
(2)
This adjustment represents the portion of interest expense, income taxes and depreciation and amortization attributable to the noncontrolling interests in affiliates that are consolidated but not wholly owned by us.
(3)
This adjustment represents our portion of interest expense, income taxes and depreciation and amortization related to affiliates that are not consolidated.
(4)
This adjustment represents the portion of gains or losses from sales of depreciable property and the portion of loss on early extinguishment of debt attributable to the noncontrolling interests in affiliates that are consolidated but not wholly owned by us.


59


FFO Attributable to SHR Common Shareholders, FFO-Fully Diluted, and Comparable FFO
We compute FFO attributable to SHR common shareholders in accordance with standards established by the National Association of Real Estate Investment Trusts, or NAREIT. NAREIT adopted a definition of FFO in order to promote an industry-wide standard measure of REIT operating performance. NAREIT defines FFO as net income (loss) (computed in accordance with GAAP) excluding losses or gains from sales of depreciable property, impairment of depreciable real estate, real estate-related depreciation and amortization, and our portion of these items related to unconsolidated affiliates. We also present FFO—Fully Diluted, which is FFO attributable to SHR common shareholders plus income or loss on income attributable to redeemable noncontrolling interests of our operating partnership. We also present Comparable FFO, which is FFO—Fully Diluted excluding the impact of any gains or losses on early extinguishment of debt, impairment losses on non-depreciable assets, foreign currency exchange gains or losses and certain other charges that are highly variable from year to year.
We believe that the presentation of FFO attributable to common shareholders, FFO—Fully Diluted and Comparable FFO provides useful information to management and investors regarding our results of operations because they are measures of our ability to fund capital expenditures and expand our business. In addition, FFO is widely used in the real estate industry to measure operating performance without regard to items such as depreciation and amortization.

60


The following table provides a reconciliation of net income attributable to SHR common shareholders to Comparable FFO (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Net income attributable to SHR common shareholders
$
23,261

 
$
20,988

 
$
45,770

 
$
318,986

Depreciation and amortization—continuing operations
39,633

 
32,932

 
117,628

 
83,195

Depreciation and amortization—discontinued operations

 

 

 
1,275

Corporate depreciation
(126
)
 
(124
)
 
(381
)
 
(370
)
(Gain) loss on sale of assets—continuing operations
(2,661
)
 
38

 
(43,274
)
 
(729
)
Gain on sale of assets, net of tax—discontinued operations

 
(63
)
 

 
(156,492
)
Loss (gain) on consolidation of affiliates

 
15

 

 
(143,451
)
Impairment losses
2,325

 

 
12,726

 

Realized portion of deferred gain on sale leaseback
(29
)
 
(52
)
 
(116
)
 
(159
)
Adjustments attributable to noncontrolling interests in SHR's operating partnership (1)
(113
)
 
(105
)
 
(339
)
 
(298
)
Adjustments attributable to noncontrolling interests in consolidated affiliates (2)
(436
)
 
(2,166
)
 
12,122

 
(5,972
)
Adjustments attributable to unconsolidated affiliates (3)

 

 

 
5,077

FFO attributable to SHR common shareholders
61,854

 
51,463

 
144,136

 
101,062

Adjustments attributable to noncontrolling interests in SHR's operating partnership - other (4)
178

 
172

 
508

 
1,495

FFO – Fully Diluted
62,032

 
51,635

 
144,644

 
102,557

Non-cash interest rate derivative activity
2,465

 
3,241

 
8,183

 
3,131

Loss on early extinguishment of debt—continuing operations

 
609

 
34,211

 
609

Loss on early extinguishment of debt—discontinued operations

 

 

 
272

Foreign currency exchange (gain) loss—continuing operations
(4
)
 
69

 
72

 
75

Foreign currency exchange gain—discontinued operations

 

 

 
(32
)
Amortization of debt discount
40

 
623

 
730

 
1,246

Amortization of below market hotel management agreement
513

 
513

 
1,539

 
621

Hotel acquisition costs
343

 

 
1,409

 

Costs related to the Mergers
4,018

 

 
4,018

 

Activist shareholder costs

 

 

 
1,637

Excess of redemption price over carrying amount of redeemed preferred stock

 

 

 
6,912

Adjustments attributable to noncontrolling interests in consolidated affiliates (5)

 

 
(90
)
 

Comparable FFO
$
69,407

 
$
56,690

 
$
194,716

 
$
117,028

(1)
This adjustment represents the portion of depreciation and amortization attributable to the redeemable noncontrolling interests in our operating partnership.
(2)
This adjustment represents the portion of depreciation and amortization and gains or losses from sales of depreciable property that are attributable to the noncontrolling interests in affiliates that are consolidated but not wholly owned by us.
(3)
This adjustment represents our portion of the depreciation and amortization related to affiliates that are not consolidated.
(4)
This adjustment represents amounts other than depreciation and amortization that are attributable to the redeemable noncontrolling interests in our operating partnership.
(5)
This adjustment represents the portion of loss on early extinguishment of debt that is attributable to the noncontrolling interests in affiliates that are consolidated but not wholly owned by us.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk
Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. We use derivative financial instruments to manage, or hedge, interest rate risks related to our borrowings. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. We use methods which incorporate standard market conventions and techniques such as discounted cash flow analysis and option pricing models to determine fair value. All methods of estimating fair value result in general approximation of value and such value may or may not actually be realized.
See “Item 1. Financial Statements 11. Derivatives” for information on our interest rate cap agreements outstanding as of September 30, 2015.
As of September 30, 2015, our total outstanding mortgages and indebtedness under the unsecured credit facility totaled approximately $1.8 billion, of which approximately 23.0% was fixed-rate debt. If market rates of interest on our variable rate debt increase by 20%, the increase in interest expense on the variable rate debt would decrease future earnings and cash flows by approximately $0.5 million annually.
Interest risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of the reduced level of overall economic activity that could exist in that environment. Furthermore, in the event of a 20% increase in the market rates of interest on our variable rate debt as discussed above, we may take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.
Currency Exchange Risk
Effective September 1, 2015, we transferred our leasehold interest in the Marriott Hamburg hotel to an unaffiliated third party. As of the transfer date, we were released from all of its obligations under the lease arrangements. As a result, currency exchange risk no longer arises as a normal part of our business.
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this quarterly report on Form 10-Q was made under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer. Based upon this evaluation, as of September 30, 2015, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that information required to be disclosed by us in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.
We are not involved in any material litigation nor, to our knowledge, is any material litigation threatened against us, other than routine litigation arising in the ordinary course of business or which is expected to be covered by insurance.

Between September 10, 2015 and November 4, 2015, eight putative class action lawsuits (Solak v. Raymond L. Gellein, Jr., et al., Case No. 24-C-15-004678; Snell v. Strategic Hotels & Resorts, Inc. et al., Case No. 24-C-15-004668 (the "Snell Action"); Taylor v. Strategic Hotels & Resorts, Inc. et al., Case No. 24-C-15-004771 (the “Taylor Action No. 4771”); Parshall v. Strategic Hotels & Resorts, Inc. et al., Case No. 24-C-15-004772 (the “Parshall Action”); Burr v. Strategic Hotels & Resorts, Inc., et al., Case No. 24-C-15-004792; Mussman v. Strategic Hotels & Resorts, Inc., et al., Case No. 24-C-004840 (the “Mussman Action”); Taylor v. The Blackstone Group L.P., et al.,Case No. 24-C-15-005056 (the “Taylor Action No. 5056”); and Dahr v. Strategic Hotels & Resorts, Inc., et al., Case No. 24-C-15-005057 (all such actions, collectively, the “Lawsuits”)) purportedly on behalf of holders of SHR common stock were filed in the Circuit Court for Baltimore City, Maryland against members of our board of directors as well as BRE Holdings, Merger Sub, and Merger Opco in connection with the merger. Certain of the Lawsuits also name SH Funding, BRE Partnership VIII, Blackstone and/or SHR as defendants (BRE Holdings, Merger Sub, Merger Opco, BRE Partnership VIII and Blackstone are collectively referred to as the “Blackstone Defendants”). The Taylor Action No. 5056 also purports to bring a derivative claim on behalf of SHR. The Lawsuits generally allege that members of our board of directors breached their fiduciary duties to holders of SHR common stock by, among other things: (i) failing to undertake an adequate sales process; (ii) failing to maximize stockholder value and agreeing to a sales price that undervalues SHR; (iii) implementing preclusive or coercive deal protection devices; (iv) engaging in self-dealing and failing to act in the best interests of holders of SHR common stock; and (v) failing to act with good faith, due care and loyalty. The Lawsuits also allege that SHR, SH Funding, and/or certain of the Blackstone Defendants aided and abetted the members of the board of directors in allegedly breaching their fiduciary duties. The Taylor Action No. 4771, the Parshall Action and the Mussman Action also include a claim against all of the defendants for declaratory relief pursuant to Courts and Judicial Proceedings Article of the Annotated Code of Maryland § 3-401, et seq. The Lawsuits seek, among other things, declaration of the action as a proper class action, equitable relief that would enjoin the consummation of the merger, rescinding, to the extent already implemented, the merger agreement and the terms thereof and fees and costs associated with the litigation. On October 26, 2015, defendants filed an Unopposed Motion to Consolidate Actions and Designate the Consolidated Action to the Business and Technology Case Management Program and to Stay Defendants’ Obligation to Answer or Otherwise Plead.  Also on October 26, 2015, plaintiffs in the Snell, Burr, and Mussman Actions filed a Motion for Consolidation and Appointment of Interim Co-Lead Counsel and Interim Liaison Counsel.  Plaintiff in the Snell Action also filed a Motion for Expedited Discovery as well as a First Amended Class Action Complaint (“Amended Complaint”).  The Amended Complaint includes the same claims set forth in the initial Snell Action complaint and includes additional allegations for breach of fiduciary duty with respect to the definitive proxy statement that SHR filed with the Securities and Exchange Commission on October 20, 2015.  On October 28, 2015, the court issued an order which, inter alia, consolidated the eight pending actions under the caption In re Strategic Hotels & Resorts, Incorporated Shareholder Litigation, Case No. 24-C-15-004668. 
ITEM 1A. RISK FACTORS.
Other than as set forth below, there were no material changes from the risk factors previously disclosed in our annual report on Form 10-K for the year ended December 31, 2014.
The risk factors previously disclosed in our annual report on Form 10-K for the year ended December 31, 2014 are updated by adding the risk factors below which we are including in this quarterly report on Form 10-Q as a result of our entering into the Merger Agreement on September 4, 2015, as further described above:

Risks Related to the Mergers
There may be unexpected delays in the completion of the Mergers, or the Mergers may not be completed at all.
The Mergers are currently expected to close during December 2015, assuming that all of the conditions in the Merger Agreement are satisfied or waived. The Merger Agreement provides that either we or BRE Holdings, may terminate the Merger Agreement if the Mergers have not occurred by March 2, 2016. Certain events may delay the completion of the Mergers or result in a termination of the Merger Agreement. Some of these events are outside the control of either party. In particular, completion of the Company Merger requires the affirmative vote of a majority of our outstanding common stock as of the record date for the special meeting of stockholders. If the required vote is not obtained at a special meeting (including any adjournment or postponement thereof) at which the Company Merger has been voted upon, either we or BRE Holdings,

63


may terminate the Merger Agreement. We may incur significant additional costs in connection with any delay in completing the Mergers or termination of the Merger Agreement, in addition to significant transaction costs, including legal, financial advisory, accounting, and other costs we have already incurred. We can neither assure you that the conditions to the completion of the Mergers will be satisfied or waived or that any adverse change, effect, event, circumstance, occurrence or state of facts that could give rise to the termination of the Merger Agreement will not occur, and we cannot provide any assurances as to whether or when the Mergers will be completed.
Failure to complete the Mergers in a timely manner or at all could negatively affect our stock price and future business and financial results.
Delays in completing the Mergers or the failure to complete the Mergers at all could negatively affect our future business and financial results, and, in that event, the market price of our common stock may decline significantly, particularly to the extent that the current market price reflects a market assumption that the Mergers will be completed. If the Mergers are not completed for any reason, we will not achieve the expected benefits thereof and will be subject to several risks, including the diversion of management focus and resources from operational matters and other strategic opportunities while working to implement the Mergers, any of which could materially adversely affect our business, financial condition, results of operations and the value of our stock price.
The pendency of the Mergers could adversely affect our business and operations.
In connection with the pending Mergers, some of our current or prospective hotel management companies or lenders may delay or defer decisions, which could negatively impact our revenues, earnings, cash flows and expenses, regardless of whether the Mergers are completed. In addition, under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the Mergers. These restrictions may prevent us from pursuing certain strategic transactions, acquiring and disposing assets, undertaking certain capital projects, undertaking certain financing transactions and otherwise pursuing other actions that are not in the ordinary course of business, even if such actions could prove beneficial. These restrictions may impede our growth which could negatively impact our revenue, earnings and cash flows. Additionally, the pendency of the Mergers may make it more difficult for us to effectively retain and incentivize key personnel.
An adverse judgment in a lawsuit challenging the Mergers may prevent the Mergers from becoming effective or from becoming effective within the expected timeframe.
The Company, SH Funding, the Blackstone Defendants and the members of our board of directors have been named as defendants in a consolidated class action lawsuit challenging the Mergers and seeking, among other things, to enjoin the consummation of the Mergers. Our stockholders may file additional lawsuits challenging the Mergers or the other transactions contemplated by the Merger Agreement, which may name us and/or our board of directors as defendants. We cannot assure you as to the outcome of such lawsuits, including the amount of costs associated with defending these claims or any other liabilities that may be incurred in connection with the litigation of these claims. If plaintiffs are successful in obtaining an injunction prohibiting the parties from completing the Mergers on the agreed-upon terms, such an injunction may delay the consummation of the Mergers in the expected timeframe, or may prevent the Mergers from being consummated altogether. Whether or not any plaintiff’s claim is successful, this type of litigation may result in significant costs and diverts management’s attention and resources, which could adversely affect the operation of our business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.
The information in the Exhibit Index appearing after the signature page of this Form 10-Q is incorporated by reference.


64


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
STRATEGIC HOTELS & RESORTS, INC.
November 5, 2015
 
 
By:
 
/s/ Raymond L. Gellein, Jr.
 
 
 
Raymond L. Gellein, Jr.
President, Chief Executive Officer and Chairman of the Board
(principal executive officer)
November 5, 2015
 
 
By:
 
/s/ Diane M. Morefield
 
 
 
Diane M. Morefield
Executive Vice President and Chief Financial Officer
(principal financial officer and principal accounting officer)

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Exhibit Index
 
 
Exhibit No.
 
Description of Exhibit
 
 
 
 
2.1
 
Agreement and Plan of Merger, dated as of September 4, 2015, by and among BRE Diamond Hotel Holdings LLC, BRE Diamond Hotel LLC, BRE Diamond Hotel Acquisition LLC, Strategic Hotels & Resorts, Inc. and Strategic Hotel Funding, L.L.C. (filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K (File No. 001-32223), filed with the SEC on September 8, 2015 and incorporated herein by reference).
 
 
 
 
 
3.1.a
 
Articles of Amendment and Restatement of the Company (filed as Exhibit 3.1 to the Company’s Amendment No. 3 to the Registration Statement on Form S-11 (File No. 333-112846), filed with the SEC on June 8, 2004 and incorporated herein by reference).
 
 
 
 
3.1.b
 
Articles of Amendment relating to the Company’s name change to Strategic Hotels & Resorts, Inc. (filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 001-32223), filed with the SEC on March 15, 2006 and incorporated herein by reference).
 
 
 
 
3.1.c
 
Articles of Amendment (filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 001-32223), filed with the SEC on May 19, 2010 and incorporated herein by reference).
 
 
 
 
3.1.d
 
Articles of Amendment (filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 001-32223), filed with the SEC on April 19, 2012 and incorporated herein by reference).
 
 
 
 
3.2
 
Amended and Restated ByLaws of the Company (filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 001-32223), filed with the SEC on September 8, 2015 and incorporated herein by reference).
 
 
 
 
 
10.1
 
Strategic Hotels & Resorts, Inc. Supplemental Severance Program (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 001-32223), filed with the SEC on September 8, 2015 and incorporated herein by reference).
 
 
 
 
 
10.2
 
Amendment No. 2 to Employment Agreement, dated as of October 2, 2015, by and between Raymond L. Gellein, Jr. and the Company (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 001-32223), filed with the SEC on October 2, 2015 and incorporated herein by reference).
 
 
 
 
*
31.1
 
Certification of Raymond L. Gellein, Jr., Chief Executive Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
*
31.2
 
Certification of Diane M. Morefield, Chief Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
**
32.1
 
Certification of Raymond L. Gellein, Jr., Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
**
32.2
 
Certification of Diane M. Morefield, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
*
101.INS
 
XBRL Instance Document***
 
 
 
 
*
101.SCH
 
XBRL Taxonomy Extension Schema Document***
 
 
 
 
*
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document***
 
 
 
 
*
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document***
 
 
 
 
*
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document***
 
 
 
 
*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document***
*
Filed herewith.
**
This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liability of that Section. Such exhibit shall not be deemed incorporated into any filing under the Securities Act of 1933, as amended, or the Exchange Act.

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***
Attached as Exhibit 101 to this Quarterly Report on Form 10-Q are the following materials, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at September 30, 2015 and December 31, 2014; (ii) the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2015 and 2014; (iii) the Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and 2014; (iv) the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014; and (v) Notes to the Condensed Consolidated Financial Statements that have been detail tagged.


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