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Section 1: 10-Q (10-Q)

peb-20200930
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM10-Q
 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020
OR
    
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    
For the transition period from              to              .
Commission File Number 001-34571
PEBBLEBROOK HOTEL TRUST
(Exact Name of Registrant as Specified in Its Charter)
Maryland27-1055421
(State of Incorporation
or Organization)
(I.R.S. Employer
Identification No.)
4747 Bethesda AvenueSuite 1100
Bethesda,Maryland20814
(Address of Principal Executive Offices)(Zip Code)
(240)507-1300
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common Shares, $0.01 par value per sharePEBNew York Stock Exchange
6.50% Series C Cumulative Redeemable Preferred Shares PEB-PCNew York Stock Exchange
6.375% Series D Cumulative Redeemable Preferred Shares PEB-PDNew York Stock Exchange
6.375% Series E Cumulative Redeemable Preferred Shares PEB-PENew York Stock Exchange
6.30% Series F Cumulative Redeemable Preferred Shares PEB-PFNew York Stock Exchange
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes      No



Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ☑  Yes     No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filerAccelerated filer
Non-accelerated filer(do not check if a smaller reporting company)Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      Yes      No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
ClassOutstanding at October 26, 2020
Common shares of beneficial interest ($0.01 par value per share)130,917,185




Pebblebrook Hotel Trust
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
PART II. OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
2


PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.


Pebblebrook Hotel Trust
Consolidated Balance Sheets
(In thousands, except share and per-share data)
September 30,
2020
December 31, 2019
 (Unaudited) 
ASSETS
Investment in hotel properties, net$5,980,580 $6,332,587 
Cash and cash equivalents204,553 30,098 
Restricted cash12,422 26,777 
Hotel receivables (net of allowance for doubtful accounts of $388 and $738, respectively)
11,312 49,619 
Prepaid expenses and other assets56,922 59,474 
Total assets$6,265,789 $6,498,555 
LIABILITIES AND EQUITY
Debt$2,354,066 $2,229,220 
Accounts payable, accrued expenses and other liabilities247,623 260,166 
Lease liabilities - operating leases255,177 256,271 
Deferred revenues33,965 57,704 
Accrued interest5,533 4,694 
Distribution payable9,306 58,564 
      Total liabilities2,905,670 2,866,619 
Commitments and contingencies (Note 11)
Shareholders’ equity:
Preferred shares of beneficial interest, $.01 par value (liquidation preference $510,000 at September 30, 2020 and at December 31, 2019), 100,000,000 shares authorized; 20,400,000 shares issued and outstanding at September 30, 2020 and December 31, 2019
204 204 
Common shares of beneficial interest, $.01 par value, 500,000,000 shares authorized; 130,673,300 shares issued and outstanding at September 30, 2020 and 130,484,956 shares issued and outstanding at December 31, 2019
1,307 1,305 
Additional paid-in capital4,092,602 4,069,410 
Accumulated other comprehensive income (loss)(69,663)(24,715)
Distributions in excess of retained earnings(671,667)(424,996)
Total shareholders’ equity3,352,783 3,621,208 
Non-controlling interests7,336 10,728 
      Total equity3,360,119 3,631,936 
      Total liabilities and equity$6,265,789 $6,498,555 
The accompanying notes are an integral part of these financial statements.
3

Table of Contents

Pebblebrook Hotel Trust
Consolidated Statements of Operations and Comprehensive Income
(In thousands, except share and per-share data)
(Unaudited)
 For the three months ended September 30,For the nine months ended September 30,
 2020201920202019
Revenues:
Room$51,337 $296,622 $239,279 $851,899 
Food and beverage12,454 90,088 82,635 274,803 
Other operating13,189 36,842 46,765 106,102 
Total revenues76,980 423,552 368,679 1,232,804 
Expenses:
Hotel operating expenses:
Room15,835 71,878 75,390 209,707 
Food and beverage10,578 64,690 66,144 194,981 
Other direct and indirect44,538 110,922 171,456 330,617 
Total hotel operating expenses70,951 247,490 312,990 735,305 
Depreciation and amortization56,696 69,775 168,044 177,376 
Real estate taxes, personal property taxes, property insurance, and ground rent27,947 31,588 85,173 94,009 
General and administrative7,466 8,315 38,259 25,753 
Transaction costs10,339 4,035 10,474 7,576 
Impairment loss  20,570  
(Gain) loss on sale of hotel properties47  (117,401) 
(Gain) loss and other operating expenses917 1,529 3,753 6,219 
Total operating expenses174,363 362,732 521,862 1,046,238 
Operating income (loss)(97,383)60,820 (153,183)186,566 
Interest expense(27,514)(26,465)(75,196)(84,512)
Other115 7 442 23 
Income (loss) before income taxes(124,782)34,362 (227,937)102,077 
Income tax (expense) benefit(5,778)(4,382)8,531 (5,924)
Net income (loss)(130,560)29,980 (219,406)96,153 
Net income (loss) attributable to non-controlling interests(253)89 (535)254 
Net income (loss) attributable to the Company(130,307)29,891 (218,871)95,899 
Distributions to preferred shareholders(8,139)(8,139)(24,417)(24,417)
Net income (loss) attributable to common shareholders$(138,446)$21,752 $(243,288)$71,482 
Net income (loss) per share available to common shareholders, basic$(1.06)$0.17 $(1.86)$0.55 
Net income (loss) per share available to common shareholders, diluted$(1.06)$0.17 $(1.86)$0.55 
Weighted-average number of common shares, basic130,645,990 130,484,956 130,588,765 130,467,193 
Weighted-average number of common shares, diluted130,645,990 130,622,130 130,588,765 130,690,342 
4

Table of Contents
Pebblebrook Hotel Trust
Consolidated Statements of Operations and Comprehensive Income - Continued
(In thousands, except share and per-share data)
(Unaudited)
For the three months ended September 30,For the nine months ended September 30,
2020201920202019
Comprehensive Income:
Net income (loss)$(130,560)$29,980 $(219,406)$96,153 
Other comprehensive income (loss):
Unrealized gain (loss) on derivative instruments9,722 (7,874)(44,948)(38,002)
Comprehensive income (loss)(120,838)22,106 (264,354)58,151 
Comprehensive income (loss) attributable to non-controlling interests(187)66 (624)146 
Comprehensive income (loss) attributable to the Company$(120,651)$22,040 $(263,730)$58,005 
The accompanying notes are an integral part of these financial statements.

5

Table of Contents

Pebblebrook Hotel Trust
Consolidated Statements of Equity
(In thousands, except share data)
(Unaudited)
Three Months Ended September 30, 2020
Preferred SharesCommon SharesAdditional Paid-In CapitalAccumulated Other Comprehensive Income (Loss) Distributions in Excess of Retained Earnings Total Shareholders' EquityNon-Controlling InterestsTotal Equity
SharesAmountSharesAmount
Balance at June 30, 202020,400,000 $204 130,564,060 $1,306 $4,077,497 $(79,385)$(531,914)$3,467,708 $21,038 $3,488,746 
Share-based compensation— —  — 1,660 — — 1,660 — 1,660 
Distributions on common shares/units— — — — — — (1,307)(1,307)(3)(1,310)
Distributions on preferred shares— — — — — — (8,139)(8,139)— (8,139)
Redemption of non-controlling interest LTIP units— — 109,240 1 13,445 — — 13,446 (13,446)— 
Other comprehensive income (loss):
Unrealized gain (loss) on derivative instruments— — — — — 9,722 — 9,722 — 9,722 
Net income (loss)— — — — — — (130,307)(130,307)(253)(130,560)
Balance at September 30, 202020,400,000 $204 130,673,300 $1,307 $4,092,602 $(69,663)$(671,667)$3,352,783 $7,336 $3,360,119 
Three Months Ended September 30, 2019
Preferred SharesCommon SharesAdditional Paid-In CapitalAccumulated Other Comprehensive Income (Loss)Distributions in Excess of Retained EarningsTotal Shareholders' EquityNon-Controlling InterestsTotal Equity
SharesAmountSharesAmount
Balance at June 30, 201920,400,000 $204 130,484,956 $1,305 $4,065,672 $(28,798)$(358,615)$3,679,768 $10,506 $3,690,274 
Share-based compensation— — — — 1,857 — — 1,857 277 2,134 
Distributions on common shares/units— — — — — — (49,768)(49,768)(141)(49,909)
Distributions on preferred shares— — — — — — (8,139)(8,139)— (8,139)
Other comprehensive income (loss):
Unrealized gain (loss) on derivative instruments— — — — — (7,874)— (7,874)— (7,874)
Net income (loss)— — — — — — 29,891 29,891 89 29,980 
Balance at September 30, 201920,400,000 $204 130,484,956$1,305 $4,067,529$(36,672)$(386,631)$3,645,735 $10,731 $3,656,466 
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Pebblebrook Hotel Trust
Consolidated Statements of Equity - Continued
(In thousands, except share data)
(Unaudited)
Nine Months Ended September 30, 2020
Preferred SharesCommon SharesAdditional Paid-In CapitalAccumulated Other Comprehensive Income (Loss) Distributions in Excess of Retained Earnings Total Shareholders' EquityNon-Controlling InterestsTotal Equity
SharesAmountSharesAmount
Balance at December 31, 201920,400,000 $204 130,484,956 $1,305 $4,069,410 $(24,715)$(424,996)$3,621,208 $10,728 $3,631,936 
Issuance of shares, net of offering costs— — — — (94)— — (94)— (94)
Issuance of common shares for Board of Trustees compensation— — 23,528 1 636 — — 637 — 637 
Repurchase of common shares— — (47,507)(1)(1,254)— — (1,255)— (1,255)
Share-based compensation— — 103,083 1 10,459 — — 10,460 10,616 21,076 
Distributions on common shares/units— — — — — — (3,383)(3,383)(27)(3,410)
Distributions on preferred shares— — — — — — (24,417)(24,417)— (24,417)
Redemption of non-controlling interest LTIP units— — 109,240 1 13,445 — — 13,446 (13,446)— 
Other comprehensive income (loss):
Unrealized gain (loss) on derivative instruments— — — — — (44,948)— (44,948)— (44,948)
Net income (loss)— — — — — — (218,871)(218,871)(535)(219,406)
Balance at September 30, 202020,400,000 $204 130,673,300 $1,307 $4,092,602 $(69,663)$(671,667)$3,352,783 $7,336 $3,360,119 
Nine Months Ended September 30, 2019
Preferred SharesCommon SharesAdditional Paid-In CapitalAccumulated Other Comprehensive Income (Loss)Distributions in Excess of Retained EarningsTotal Shareholders' EquityNon-Controlling InterestsTotal Equity
SharesAmountSharesAmount
Balance at December 31, 201820,400,000 $204 130,311,289 $1,303 $4,065,804 $1,330 $(308,806)$3,759,835 $10,095 $3,769,930 
Issuance of shares, net of offering costs— — — — (275)— — (275)— (275)
Issuance of common shares for Board of Trustees compensation— — 25,282 1 739 — — 740 — 740 
Repurchase of common shares— — (126,681)(1)(4,008)— — (4,009)— (4,009)
Share-based compensation— — 275,066 2 5,269 — — 5,271 829 6,100 
Distributions on common shares/units— — — — — — (149,307)(149,307)(447)(149,754)
Distributions on preferred shares— — — — — — (24,417)(24,417)— (24,417)
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Other comprehensive income (loss):
Unrealized gain (loss) on derivative instruments— — — — — (38,002)— (38,002)— (38,002)
Net income (loss)— — — — — — 95,899 95,899 254 96,153 
Balance at September 30, 201920,400,000 $204 130,484,956 $1,305 $4,067,529 $(36,672)$(386,631)$3,645,735 $10,731 $3,656,466 

The accompanying notes are an integral part of these financial statements.
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Pebblebrook Hotel Trust
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 For the nine months ended September 30,
 20202019
Operating activities:
Net income (loss)$(219,406)$96,153 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization168,044 177,376 
Share-based compensation21,076 6,100 
Amortization of deferred financing costs, non-cash interest and mortgage loan premiums11,199 13,547 
(Gain) loss on sale of hotel properties(117,401) 
Impairment loss20,570  
Non-cash ground rent4,669 4,921 
Other(289)2,301 
Changes in assets and liabilities:
Hotel receivables37,217 (12,504)
Prepaid expenses and other assets(3,933)1,147 
Accounts payable and accrued expenses(47,896)23,791 
Deferred revenues(20,708)3,269 
Net cash provided by (used in) operating activities(146,858)316,101 
Investing activities:
Improvements and additions to hotel properties(110,443)(117,989)
Proceeds from sales of hotel properties375,131 437,871 
Purchase of corporate office equipment, software, and furniture (560)
Net cash provided by (used in) investing activities264,688 319,322 
Financing activities:
Payment of offering costs — common and preferred shares(94)(275)
Payment of deferred financing costs(3,618)(318)
Borrowings under revolving credit facilities760,115 211,893 
Repayments under revolving credit facilities(635,115)(281,893)
Proceeds from debt12,965  
Repayments of debt(12,965)(451,831)
Repurchases of common shares(1,255)(4,009)
Distributions — common shares/units(52,649)(135,054)
Distributions — preferred shares(24,417)(24,417)
Repayments of refundable membership deposits(697)(524)
Net cash provided by (used in) financing activities42,270 (686,428)
Net change in cash and cash equivalents and restricted cash160,100 (51,005)
Cash and cash equivalents and restricted cash, beginning of year56,875 107,811 
Cash and cash equivalents and restricted cash, end of period$216,975 $56,806 
The accompanying notes are an integral part of these financial statements.
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PEBBLEBROOK HOTEL TRUST
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Organization
Pebblebrook Hotel Trust (the "Company") was formed as a Maryland real estate investment trust in October 2009 to opportunistically acquire and invest in hotel properties located primarily in major United States cities, with an emphasis on major gateway coastal markets.
As of September 30, 2020, the Company owned 53 hotels with a total of 13,236 guest rooms. The hotels are located in the following markets: Boston, Massachusetts; Chicago, Illinois; Key West, Florida; Miami (Coral Gables), Florida; Los Angeles, California (Beverly Hills, Santa Monica, and West Hollywood); Naples, Florida; New York, New York; Philadelphia, Pennsylvania; Portland, Oregon; San Diego, California; San Francisco, California; Seattle, Washington; Stevenson, Washington; and Washington, D.C.
Substantially all of the Company’s assets are held by, and all of the Company's operations are conducted through, Pebblebrook Hotel, L.P. (the "Operating Partnership"). The Company is the sole general partner of the Operating Partnership. At September 30, 2020, the Company owned 99.8% of the common limited partnership units issued by the Operating Partnership ("common units"). The remaining 0.2% of the common units are owned by the other limited partners of the Operating Partnership. For the Company to qualify as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"), it cannot operate the hotels it owns. Therefore, the Operating Partnership and its subsidiaries lease the hotel properties to subsidiaries of Pebblebrook Hotel Lessee, Inc. (collectively with its subsidiaries, "PHL"), a taxable REIT subsidiary ("TRS"), which in turn engage third-party eligible independent contractors to manage the hotels. PHL is consolidated into the Company’s financial statements.

COVID-19 Operations and Liquidity Update
In March 2020, the World Health Organization declared the novel coronavirus ("COVID-19") to be a global pandemic and the virus has continued to spread throughout the United States and the world. As a result of this pandemic and subsequent government mandates and health official recommendations, hotel demand was nearly eliminated. Following the government mandates and health official recommendations, the Company temporarily suspended operations at a majority of its hotels and resorts and dramatically reduced staffing and expenses at the hotels that remained operational. Travel restrictions have slowly eased in a few markets and leisure demand began to recover late in the second quarter. As of September 30, 2020, 35 of the Company's hotels, listed below, were open, while the operations at the remaining 18 hotels were still temporarily suspended.
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PropertyLocation
1.L'Auberge Del MarDel Mar, CA
2.Hotel Palomar Los Angeles Beverly HillsLos Angeles, CA
3.W Los Angeles - West Beverly HillsLos Angeles, CA
4.Mondrian Los AngelesWest Hollywood, CA
5.Le Meridien Delfina Santa MonicaSanta Monica, CA
6.Viceroy Santa Monica HotelSanta Monica, CA
7.Le Parc Suite HotelWest Hollywood, CA
8.Montrose West HollywoodWest Hollywood, CA
9.Chamberlain West Hollywood HotelWest Hollywood, CA
10.Grafton on SunsetWest Hollywood, CA
11.Embassy Suites San Diego Bay - DowntownSan Diego, CA
12.Paradise Point Resort & SpaSan Diego, CA
13.San Diego Mission Bay ResortSan Diego, CA
14.The Westin San Diego Gaslamp QuarterSan Diego, CA
15.Hilton San Diego Gaslamp QuarterSan Diego, CA
16.Solamar HotelSan Diego, CA
17.Hotel SperoSan Francisco, CA
18.Hotel Zetta San FranciscoSan Francisco, CA
19.Chaminade Resort & SpaSanta Cruz, CA
20.Southernmost Beach ResortKey West, FL
21.The Marker Key West Harbor ResortKey West, FL
22.LaPlaya Beach Resort and ClubNaples, FL
23.Hotel Colonnade Coral Gables, Autograph CollectionMiami, FL
24.The Liberty, A Luxury Collection Hotel, BostonBoston, MA
25.Revere Hotel Boston CommonBoston, MA
26.Hyatt Regency Boston HarborBoston, MA
27.W BostonBoston, MA
28.The Westin Copley Place, BostonBoston, MA
29.George HotelWashington, DC
30.Viceroy Washington DCWashington, DC
31.Skamania LodgeStevenson, WA
32.Hotel Monaco SeattleSeattle, WA
33.The Nines, a Luxury Collection Hotel, PortlandPortland, OR
34.Hotel Chicago Downtown, Autograph CollectionChicago, IL
35.Sofitel Philadelphia at Rittenhouse SquarePhiladelphia, PA
Subsequent to September 30, 2020, the Company re-opened 4 additional hotels and anticipates re-opening additional hotels when demand recovers.
COVID-19 has had a significant negative impact on the Company's operations and financial results to date and the Company expects that the COVID-19 pandemic will continue to have a significant negative impact on the Company's results of operations, financial position and cash flow for the remainder of 2020 and into 2021. The Company cannot estimate when travel demand will recover. As a result of this uncertainty, in March 2020, the Company fully drew down on its $650.0 million unsecured revolving credit facility, reduced the quarterly cash dividend on its common shares to one penny, reduced planned capital expenditures, reduced the compensation of its executive officers, board of trustees and employees, and, working closely with its hotel operating partners, significantly reduced its hotels' operating expenses. On June 29, 2020, the Company amended its existing credit facilities, term loan facilities and senior notes. Among other things, the amendments extended the maturity of
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a significant portion of a $300.0 million term loan from November 2021 to November 2022, waived existing financial covenants through the end of the first quarter of 2021 and provided substantially less restrictive financial covenants through the end of the second quarter of 2022. Refer to "Note 5. Debt" for additional information regarding the amendments. Based on these amendments and the expense and cash flow reductions, the Company believes that it will have sufficient liquidity to meet its obligations for the next twelve months. The negative impact will result in a significant income tax loss in PHL. Given the continued negative impact of the COVID-19 pandemic on the Company's financial results and uncertainties about the Company's ability to utilize its net operating loss in future years, the Company recognized a valuation allowance of $10.0 million during the third quarter of 2020. As of September 30, 2020, the Company has a tax asset of $11.7 million attributable to the net operating loss carryback, which is included in prepaid expenses and other assets in the accompanying consolidated balance sheets.
The Company also adopted an optional remote-work policy and other physical distancing policies at its corporate office and the Company does not anticipate these policies to have any adverse impact on its ability to continue to operate its business.  Transitioning to a remote-work environment has not had a material adverse impact on the Company's financial reporting system, internal controls or disclosure controls and procedures.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim consolidated financial statements and related notes have been prepared in accordance with U.S. GAAP and in conformity with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) applicable to interim financial information. As such, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with the rules and regulations of the SEC. These unaudited consolidated financial statements include all adjustments considered necessary for a fair presentation of the consolidated balance sheets, consolidated statements of operations and comprehensive income, consolidated statements of equity and consolidated statements of cash flows for the periods presented. Interim results are not necessarily indicative of full-year performance, as a result of the impact of seasonal and other short-term variations and the acquisitions and or dispositions of hotel properties. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
The Company and its subsidiaries are separate legal entities and maintain records and books of account separate and apart from each other. The consolidated financial statements include all of the accounts of the Company and its subsidiaries and are presented in accordance with U.S. GAAP. All significant intercompany balances and transactions have been eliminated in consolidation.
Certain reclassifications have been made to the prior period's financial statements to conform to the current year presentation, including separate presentation of the Company's operating lease liabilities on the Company's consolidated balance sheets.
Use of Estimates
The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and revenues and expenses. These estimates are prepared using management’s best judgment, after considering past, current and expected events and economic conditions. Actual results could differ from these estimates.
Fair Value Measurements
A fair value measurement is based on the assumptions that market participants would use in pricing an asset or liability in an orderly transaction. The hierarchy for inputs used in measuring fair value are as follows:

1.Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
2.Level 2 – Inputs include quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, and model-derived valuations whose inputs are observable.
3.Level 3 – Model-derived valuations with unobservable inputs.

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In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
The Company's financial instruments include cash and cash equivalents, restricted cash, accounts payable and accrued expenses. Due to their short maturities, the carrying amounts of these assets and liabilities approximate fair value. See Note 5 to the accompanying consolidated financial statements for disclosures on the fair value of debt and derivative instruments.
Investment in Hotel Properties
Upon acquisition of a hotel property, the Company measures and recognizes the fair value of the acquired land, land improvements, building, furniture, fixtures and equipment, identifiable intangible assets or liabilities, other assets and assumed liabilities. Identifiable intangible assets or liabilities typically arise from contractual arrangements in connection with the transaction, including terms that are above or below market compared to an estimated market agreement at the acquisition date. Acquisition-date fair values of assets and assumed liabilities are determined based on replacement costs, appraised values, and estimated fair values using methods similar to those used by independent appraisers and that use appropriate discount and/or capitalization rates and available market information. Hotel acquisitions are generally considered to be asset acquisitions defined by ASU 2017-01 and transaction costs related to asset acquisitions are capitalized. Transaction costs related to business combinations are expensed as incurred and included in the consolidated statements of operations and comprehensive income.
Hotel renovations and replacements of assets that improve or extend the life of an asset are recorded at cost and depreciated over their estimated useful lives. Assets under capital leases are recorded at the present value of the minimum lease payments. Repair and maintenance costs are expensed as incurred.
Hotel properties are recorded at cost and depreciated using the straight-line method over an estimated useful life of 10 to 40 years for buildings, land improvements, and building improvements and 1 to 10 years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets. Intangible assets arising from contractual arrangements are typically amortized over the life of the contract. The Company is required to make subjective assessments as to the useful lives and classification of properties for purposes of determining the amount of depreciation expense to reflect each year with respect to the assets. These assessments may impact the Company’s results of operations.
The Company reviews its investments in hotel properties for impairment whenever events or changes in circumstances indicate that the carrying value of the hotel properties may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, when a hotel property experiences a current or projected loss from operations, when it becomes more likely than not that a hotel property will be sold before the end of its useful life, adverse changes in the demand for lodging at the properties due to declining national or local economic conditions and/or new hotel construction in markets where the hotels are located. When such conditions exist, the Company performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from the ultimate disposition of a hotel exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying value of the asset, an adjustment to reduce the carrying value to the related hotel’s estimated fair market value is recorded and an impairment loss is recognized. In the evaluation of impairment of its hotel properties, the Company makes many assumptions and estimates including projected cash flows both from operations and eventual disposition, expected useful life and holding period, future required capital expenditures, and fair values, including consideration of capitalization rates, discount rates, and comparable selling prices. The Company will adjust its assumptions with respect to the remaining useful life of the hotel property when circumstances change or it is more likely than not that the hotel property will be sold prior to its previously expected useful life.
The Company will classify a hotel as held for sale and will cease recording depreciation expense when a binding agreement to sell the property has been signed under which the buyer has committed a significant amount of nonrefundable cash, approval of the Board of Trustees has been obtained, no significant financing contingencies exist, and the sale is expected to close within one year. If the fair value less costs to sell is lower than the carrying value of the hotel, the Company will record an impairment loss. The Company will classify the loss, together with the related operating results, as continuing or discontinuing operations on the consolidated statements of operations and comprehensive income and classify the assets and related liabilities as held for sale on the consolidated balance sheets.
Revenue Recognition
Revenue consists of amounts derived from hotel operations, including the sales of rooms, food and beverage, and other ancillary services. Room revenue is recognized over the length of a customer's hotel stay. Revenue from food and beverage and other ancillary services is generated when a customer chooses to purchase goods or services separately from a hotel room and revenue is recognized on these distinct goods and services at the point in time or over the time period that goods or services
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are provided to the customer. Certain ancillary services are provided by third parties and the Company assesses whether it is the principal or agent in these arrangements. If the Company is the agent, revenue is recognized based upon the commission earned from the third party. If the Company is the principal, the Company recognizes revenue based upon the gross sales price. Some contracts for rooms or food and beverage services require an upfront deposit which is recorded as deferred revenues (or contract liabilities) and recognized once the performance obligations are satisfied.
The Company recognizes revenue related to nonrefundable membership initiation fees and refundable membership initiation deposits over the expected life of an active membership. For refundable membership initiation deposits, the difference between the amount paid by the member and the present value of the refund obligation is deferred and recognized as other operating revenues on the consolidated statements of operations and comprehensive income over the expected life of an active membership. The present value of the refund obligation is recorded as a membership initiation deposit liability in the consolidated balance sheets and accretes over the nonrefundable term using the effective interest method using the Company's incremental borrowing rate. The accretion is included in interest expense.
Certain of the Company's hotels have retail spaces, restaurants or other spaces which the Company leases to third parties. When collection of substantially all lease payments during the lease term is considered probable, lease revenue is recognized on a straight-line basis over the life of the lease. When collection of substantially all lease payments during the lease term is not considered probable, revenue is recognized as the lesser of the amount under straight-line basis or cash received. Lease revenue is included in other operating revenues in the Company's consolidated statements of operations and comprehensive income.
The Company collects sales, use, occupancy and similar taxes at its hotels which are presented on a net basis on the consolidated statements of operations and comprehensive income. Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize hotel services. The Company maintains an allowance for doubtful accounts sufficient to cover estimated potential credit losses.
Income Taxes
To qualify as a REIT for federal income tax purposes, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 90 percent of its adjusted taxable income to its shareholders. As a REIT, the Company generally is not subject to federal corporate income tax on that portion of its taxable income that is currently distributed to shareholders. The Company is subject to certain state and local taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. In addition, PHL, whose subsidiaries lease the Company’s hotels from the Operating Partnership, is subject to federal and state income taxes. The Company accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Valuation allowances are provided if, based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
Share-based Compensation
The Company has adopted an equity incentive plan that provides for the grant of common share options, share awards, share appreciation rights, performance units and other equity-based awards. Equity-based compensation is measured at the fair value of the award on the date of grant and recognized as an expense on a straight-line basis over the vesting period. Share-based compensation awards that contain a performance condition are reviewed at least quarterly to assess the achievement of the performance condition. Compensation expense will be adjusted when a change in the assessment of achievement of the specific performance condition level is determined to be probable. The determination of fair value of these awards is subjective and involves significant estimates and assumptions including expected volatility of the Company's shares, expected dividend yield, expected term and assumptions of whether these awards will achieve parity with other operating partnership units or achieve performance thresholds.
Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing the net income (loss) available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income (loss) available to common shareholders, as adjusted for dilutive securities, by the weighted-average number of common shares outstanding plus dilutive securities. Any anti-dilutive securities are excluded from the diluted per-share calculation.
Recent Accounting Standards