Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended June 30, 2019

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 000-55394

HOSPITALITY INVESTORS TRUST, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Maryland	80-0943668
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
Park Avenue Tower, 65 East 55th Street, Suite 801, New York, NY	10022
(Address of Principal Executive Office)	(Zip Code)

 

(571) 529-6390

(Registrant’s Telephone Number, Including Area Code)

 

Not applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Securities registered pursuant to section 12(b) of the Act: None.
Title of each class		Trading Symbol(s)		Name of each exchange on which registered
N/A		N/A		N/A

 

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 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 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 filer ☐	Accelerated filer ☐
Non-accelerated filer ☒	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 7(a)(2)(B) of the Securities Act. Yes ☒   No ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐   No ☒

The number of shares of the registrant's common stock, $0.01 par value, outstanding as of August 1, 2019 was 39,151,201.

 

 

TABLE OF CONTENTS

 

		Page
PART I
Item 1.	Financial Statements	1
	Consolidated Balance Sheets as of June 30, 2019 (Unaudited) and December 31, 2018	1
	Consolidated Statements of Operations and Comprehensive Loss (Unaudited) for the Three Months Ended June 30, 2019 and the Three Months Ended June 30, 2018 and for the Six Months Ended June 30, 2019 and the Six Months Ended June 30, 2018	2
	Consolidated Statement of Changes in Equity (Unaudited) for the Three Months Ended June 30, 2019 and the Three Months Ended June 30, 2018 and for the Six Months Ended June 30, 2019 and the Six Months Ended June 30, 2018	3
	Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2019 and the Six Months Ended June 30, 2018	4
	Notes to Consolidated Financial Statements (Unaudited)	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36
PART II
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults Upon Senior Securities	37
Item 4.	Mine Safety Disclosures	37
Item 5.	Other Information	38
Item 6.	Exhibits	39
Signatures		41

 

 

 

		June 30, 2019				December 31, 2018
		(unaudited)
ASSETS
Real estate investments:
Land		$	319,728			$	337,858
Buildings and improvements			1,823,194				1,947,619
Furniture, fixtures and equipment			244,479				257,314
Total real estate investments			2,387,401				2,542,791
Less: accumulated depreciation and amortization			(363,164	)			(347,929	)
Total real estate investments, net			2,024,237				2,194,862
Cash and cash equivalents			65,561				54,886
Assets held for sale			98,703				—
Restricted cash			38,903				27,959
Investments in unconsolidated entities			3,667				3,684
Right of use assets			59,644				—
Below-market lease asset, net			—				9,030
Prepaid expenses and other assets			44,722				35,836
Goodwill			11,030				11,030
Total Assets		$	2,346,467			$	2,337,287
LIABILITIES, NON-CONTROLLING INTEREST AND EQUITY
Mortgage notes payable, net		$	1,551,541			$	1,507,509
Mandatorily redeemable preferred securities, net			—				219,596
Accounts payable and accrued expenses			65,543				62,965
Lease liabilities			52,720				—
Total Liabilities		$	1,669,804			$	1,790,070
Commitments and Contingencies
Contingently Redeemable Class C Units in operating partnership; 27,220,865 and 11,767,678 units issued and outstanding, respectively ($401,508 and $173,573 liquidation preference, respectively)			385,473				163,148
Stockholders' Equity
Preferred stock, $0.01 par value, 50,000,000 shares authorized, one share issued and outstanding			—				—
Common stock, $0.01 par value, 300,000,000 shares authorized, 39,140,343 and 39,134,628 shares issued and outstanding, respectively			391				391
Additional paid-in capital			870,953				870,251
Deficit			(582,491	)			(489,108	)
Total equity of Hospitality Investors Trust, Inc. stockholders			288,853				381,534
Non-controlling interest - consolidated variable interest entity			2,337				2,535
Total Equity		$	291,190			$	384,069
Total Liabilities, Contingently Redeemable Class C Units, and Stockholders' Equity		$	2,346,467			$	2,337,287

---

 

		Three Months Ended June 30, 2019				Three Months Ended June 30, 2018				Six Months Ended June 30, 2019				Six Months Ended June 30, 2018
Revenues
Rooms		$	155,565			$	155,821			$	289,269			$	287,603
Food and beverage			5,392				5,254				10,331				10,199
Other			4,228				3,760				7,666				6,991
Total revenue			165,185				164,835				307,266				304,793
Operating expenses
Rooms			39,214				38,779				74,341				73,563
Food and beverage			4,434				4,249				8,541				8,334
Management fees			4,576				4,569				8,457				8,387
Other property-level operating expenses			63,279				62,324				123,844				121,212
Transaction related costs			546				27				546				27
General and administrative			4,835				4,824				10,058				9,681
Depreciation and amortization			28,283				28,253				56,768				54,624
Impairment of goodwill and long-lived assets			32,564				17,255				43,491				17,255
Rent			1,672				1,642				3,315				3,337
Total operating expenses			179,403				161,922				329,361				296,420
Operating income (loss)		$	(14,218	)		$	2,913			$	(22,095	)		$	8,373
Interest expense			(24,372	)			(26,234	)			(50,525	)			(51,340	)
Other income			158				126				372				113
Equity in earnings (loss) of unconsolidated entities			222				56				227				(98	)
Total other expenses, net			(23,992	)			(26,052	)			(49,926	)			(51,325	)
Loss before taxes		$	(38,210	)		$	(23,139	)		$	(72,021	)		$	(42,952	)
Income tax expense (benefit)			247				334				(1,144	)			(910	)
Net loss and comprehensive loss		$	(38,457	)		$	(23,473	)		$	(70,877	)		$	(42,042	)
Less: Net income (loss) attributable to non-controlling interest			(19	)			47				(111	)			19
Net loss before dividends and accretion		$	(38,438	)		$	(23,520	)		$	(70,766	)		$	(42,061	)
Dividends on Class C Units (cash and PIK)			(12,528	)			(5,281	)			(20,470	)			(9,950	)
Accretion of Class C Units			(1,264	)			(638	)			(2,147	)			(1,227	)
Net loss attributable to common stockholders		$	(52,230	)		$	(29,439	)		$	(93,383	)		$	(53,238	)
Basic and Diluted net loss attributable to common stockholders per common share		$	(1.33	)		$	(0.75	)		$	(2.39	)		$	(1.35	)
Basic and Diluted weighted average shares of common stock outstanding			39,127,758				39,502,003				39,126,844				39,500,138

---

 

		Three and Six-Month Period Ended June 30, 2019
		Common Stock
		Number of Shares				Par Value				Additional Paid-in Capital				Deficit				Total Equity of Hospitality Investors Trust, Inc. Stockholders				Non-controlling Interest				Total Non-controlling Interest and Equity
December 31, 2018			39,134,628			$	391			$	870,251			$	(489,108	)		$	381,534			$	2,535			$	384,069
Repurchase and retirement of common stock			(2,177	)			—				(20	)			—				(20	)			—				(20	)
Net loss before dividends and accretion			—				—				—				(32,328	)			(32,328	)			—				(32,328	)
Net loss attributable to non-controlling interest			—				—				—				—				—				(92	)			(92	)
Cash distributions on Class C Units			—				—				—				(4,765	)			(4,765	)			—				(4,765	)
Accretion on Class C Units			—				—				—				(883	)			(883	)			—				(883	)
PIK distributions on Class C Units			—				—				—				(3,177	)			(3,177	)			—				(3,177	)
Share-based payments			—				—				448				—				448				—				448
March 31, 2019			39,132,451			$	391			$	870,679			$	(530,261	)		$	340,809			$	2,443			$	343,252
Repurchase and retirement of common stock			—				—				—				—				—				—				—
Net loss before dividends and accretion			—				—				—				(38,438	)			(38,438	)			—				(38,438	)
Net loss attributable to non-controlling interest			—				—				—				—				—				(19	)			(19	)
Dividends paid or declared			—				—				—				—				—				(87	)			(87	)
Cash distributions on Class C Units			—				—				—				(7,517	)			(7,517	)			—				(7,517	)
Accretion on Class C Units			—				—				—				(1,264	)			(1,264	)			—				(1,264	)
PIK distributions on Class C Units			—				—				—				(5,011	)			(5,011	)			—				(5,011	)
Share-based payments			7,892				—				274				—				274				—				274
June 30, 2019			39,140,343			$	391			$	870,953			$	(582,491	)		$	288,853			$	2,337			$	291,190

 

		Three and Six-Month Period Ended June 30, 2018
		Common Stock
		Number of Shares				Par Value				Additional Paid-in Capital				Deficit				Total Equity of Hospitality Investors Trust, Inc. Stockholders				Non-controlling Interest				Total Non-controlling Interest and Equity
December 31, 2017			39,505,742			$	395			$	871,840			$	(379,559	)		$	492,676			$	2,646			$	495,322
Net loss before dividends and accretion			—				—				—				(18,541	)			(18,541	)			—				(18,541	)
Net loss attributable to non-controlling interest			—				—				—				—				—				(28	)			(28	)
Cash distributions on Class C Units			—				—				—				(2,801	)			(2,801	)			—				(2,801	)
Accretion on Class C Units			—				—				—				(589	)			(589	)			—				(589	)
PIK distributions on Class C Units			—				—				—				(1,868	)			(1,868	)			—				(1,868	)
Share-based payments			—				—				361				—				361				—				361
March 31, 2018			39,505,742			$	395			$	872,201			$	(403,358	)		$	469,238			$	2,618			$	471,856
Repurchase and retirement of common stock			(170,260	)			(2	)			(1,198	)			—				(1,200	)			—				(1,200	)
Net loss before dividends and accretion			—				—				—				(23,520	)			(23,520	)			—				(23,520	)
Net income attributable to non-controlling interest			—				—				—				—				—				47				47
Dividends paid or declared			—				—				—				—				—				(109	)			(109	)
Cash distributions on Class C Units			—				—				—				(3,169	)			(3,169	)			—				(3,169	)
Accretion on Class C Units			—				—				—				(638	)			(638	)			—				(638	)
PIK distributions on Class C Units			—				—				—				(2,112	)			(2,112	)			—				(2,112	)
Share-based payments			—				—				361				—				361				—				361
June 30, 2018			39,335,482			$	393			$	871,364			$	(432,797	)		$	438,960			$	2,556			$	441,516

---

 

		Six Months Ended June 30, 2019				Six Months Ended June 30, 2018
Cash flows from operating activities:
Net loss		$	(70,877	)		$	(42,042	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization			56,768				54,624
Impairment of goodwill and long-lived assets			43,491				17,255
Amortization and write-off of deferred financing costs			5,404				6,225
Other adjustments, net			899				1,188
Changes in assets and liabilities:
Prepaid expenses and other assets			(6,968	)			(4,957	)
Accounts payable and accrued expenses			11,601				5,728
Net cash provided by operating activities		$	40,318			$	38,021
Cash flows from investing activities:
Payment received on note for sale of hotel			—				1,625
Real estate investment improvements and purchases of property and equipment			(35,475	)			(60,614	)
Payments related to Property Management Transactions			—				(1,000	)
Proceeds from sale of hotel, net			—				5,461
Other adjustments, net			61				—
Net cash used in investing activities		$	(35,414	)		$	(54,528	)
Cash flows from financing activities:
Proceeds from Class C Units			219,746				25,000
Payment of Class C Units issuance costs			(7,756	)			(875	)
Dividends/Distributions paid			(12,369	)			(6,079	)
Payments of mortgage notes payable			(1,031,600	)			—
Proceeds from mortgage notes payable			1,086,100				—
Deferred financing fees			(17,640	)			—
Mandatorily redeemable preferred securities redemptions			(219,746	)			(14,370	)
Repurchase of shares of common stock			(20	)			(1,200	)
Net cash provided by financing activities		$	16,715			$	2,476
Net change in cash and cash equivalents and restricted cash			21,619				(14,031	)
Cash and cash equivalents and restricted cash, beginning of period			82,845				119,180
Cash and cash equivalents and restricted cash, end of period		$	104,464			$	105,149

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		Six Months Ended June 30, 2019				Six Months Ended June 30, 2018
Supplemental disclosure of cash flow information:
Interest paid		$	39,547			$	45,603
Income taxes paid		$	625			$	698
Non-cash investing and financing activities:
Accretion of Class C Units		$	(2,147	)		$	(1,227	)
PIK accrual on Class C Units		$	(8,188	)		$	(3,980	)
Real estate investment improvements and purchases of property and equipment in accounts payable and accrued expenses		$	4,732			$	14,133

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Note 1 - Organization

 

Hospitality Investors Trust, Inc. (the "Company"), incorporated on July 25, 2013, is a self-managed real estate investment trust ("REIT") that invests primarily in premium-branded select-service lodging properties in the United States. As of June 30, 2019, the Company owns or has an interest in a total of 144 hotels with a total of 17,324 guest rooms located in 33 states. As of June 30, 2019, all but one of these hotels operated under a franchise or license agreement with a national brand owned by one of Hilton Worldwide, Inc., Marriott International, Inc., Hyatt Hotels Corporation, and Intercontinental Hotels Group or one of their respective subsidiaries or affiliates. The Company's one unbranded hotel has a direct affiliation with a leading university in Atlanta.

 

As part of its investment strategy to continue to pursue the sale of non-core hotels and reallocate capital into more attractive investment opportunities, the Company commenced marketing for sale a total of 26 hotels during the quarter ended June 30, 2019. See Note 13 - Sale of Hotels and Assets Held for Sale for additional information.

 

The Company conducted its initial public offering ("IPO"), from January 2014 until November 2015 without listing shares of its common stock on a national securities exchange, and it has not subsequently listed its shares. There currently is no established trading market for the Company’s shares and there may never be one.

 

The Company is required to annually publish an Estimated Per-Share NAV pursuant to the rules and regulations of the Financial Industry Regulatory Authority. On May 9, 2019, the Company's board of directors unanimously approved an updated estimated net asset value per share of common stock ("Estimated Per-Share NAV") equal to $9.21 based on an estimated fair value of the Company's assets less the estimated fair value of the Company's liabilities, divided by 39,134,628 shares of common stock outstanding on a fully diluted basis as of December 31, 2018 (the "2019 NAV"), and the Company published its 2019 NAV on May 13, 2019. The Company intends to publish an updated Estimated Per-Share NAV on at least an annual basis. 

 

Substantially all of the Company’s business is conducted through its operating partnership, Hospitality Investors Trust Operating Partnership, L.P. (the "OP"). On January 12, 2017, the Company, along with the OP, entered into the Securities Purchase, Voting and Standstill Agreement ("SPA") with Brookfield Strategic Real Estate Partners II Hospitality REIT II LLC (the "Brookfield Investor), to secure a commitment of up to $400 million by the Brookfield Investor to make capital investments in the Company necessary for the Company to meet its short-term and long-term liquidity requirements and obligations by purchasing units of limited partner interest in the OP entitled “Class C Units” (“Class C Units”) through February 2019. Following the final closing pursuant to the SPA on February 27, 2019 (the "Final Closing"), the Brookfield Investor no longer has any obligations or rights to purchase Class C Units pursuant to the SPA or otherwise.

 

The Brookfield Investor holds all the issued and outstanding Class C Units and the sole issued and outstanding Redeemable Preferred Share (as defined herein), and, as a result has significant governance and other rights that could be used to control or influence the Company's decisions or actions. As of June 30, 2019, the total liquidation preference of the issued and outstanding Class C Units was $401.5 million. The Class C Units are convertible into units of limited partner interest in the OP entitled “OP Units” (“OP Units”), which may be redeemed for shares of the Company’s common stock or, at the Company’s option, the cash equivalent. As of the date of this Quarterly Report on Form 10-Q, the Brookfield Investor owns or controls 41.0% of the voting power of the Company’s common stock on an as-converted basis (See Note 3 - Brookfield Investment for additional information).

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

 

Note 2 - Summary of Significant Accounting Policies

 

The accompanying consolidated financial statements of the Company included herein were prepared in accordance with United States Generally Accepted Accounting Principles ("GAAP"). The consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to fairly state the results for the interim periods presented. These adjustments are considered to be of a normal, recurring nature.

 

The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2018, which are included in the Company's Annual Report on Form 10-K filed with the SEC on April 16, 2019.

 

Principles of Consolidation and Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. In determining whether the Company has a controlling financial interest in a joint venture and the requirement to consolidate the accounts of that entity, management considers factors such as percentage ownership interest, authority to make decisions and contractual and substantive participating rights of the other partners or members as well as whether the entity is a variable interest entity for which the Company is the primary beneficiary.

 

Use of Estimates

 

The preparation of the accompanying 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Real Estate Investments

 

The Company allocates the purchase price of properties acquired in real estate investments to tangible and identifiable intangible assets acquired based on their respective fair values at the date of acquisition. Tangible assets include land, land improvements, buildings and furniture, fixtures and equipment. The Company utilizes various estimates, processes and information to determine the property value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Amounts allocated to land, land improvements, buildings and furniture, fixtures and equipment are based on purchase price allocation studies performed by independent third parties or on the Company’s analysis of comparable properties in the Company’s portfolio. Identifiable intangible assets and liabilities, as applicable, are typically related to contracts, including operating lease agreements, ground lease agreements and hotel management agreements, which are recorded at fair value. The Company also considers information obtained about each property as a result of the Company’s pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.

 

The Company's acquisitions of hotel properties are accounted for as acquisitions of groups of assets rather than business combinations, although the determination will be made on a transaction-by-transaction basis. If the Company concludes that an acquisition will be accounted for as a group of assets, the transaction costs associated with the acquisition will be capitalized as part of the assets acquired.

 

The Company's investments in real estate, including transaction costs, that are not considered to be business combinations under GAAP are recorded at cost. Improvements and replacements are capitalized when they extend the useful life of the asset. Costs of repairs and maintenance are expensed as incurred. Depreciation of the Company's long-lived assets is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, 15 years for land improvements, five years for furniture, fixtures and equipment, and the shorter of the useful life or the remaining lease term for leasehold interests.

 

The Company is required to make subjective assessments as to the useful lives of the Company’s assets for purposes of determining the amount of depreciation to record on an annual basis with respect to the Company’s investments in real estate. These assessments have a direct impact on the Company’s net income because if the Company were to shorten the expected useful lives of the Company’s investments in real estate, the Company would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.

 

Impairment of Long-Lived Assets

 

Upon the occurrence of certain “triggering events” under the provisions of the Accounting Standards Codification ("ASC") section 360-Property, Plant and Equipment, the Company reviews its hotel investments which are considered to be long-lived assets under GAAP for impairment.  These triggering events include significant declines in market value of the asset, significant declines in operating performance, significant adverse changes in economic conditions and potential sales of hotel properties which result in shorter holding periods. If a triggering event occurs and circumstances indicate the carrying amount of the property may not be recoverable, the Company performs a recoverability test which compares the carrying amount to an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. The estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of demand, competition and other factors. If the Company determines it is unable to recover the carrying amount of the asset over the useful life, impairment is deemed to exist, and an impairment loss will be recorded to the extent that the carrying amount exceeds the estimated fair value of the property. See Note 14 - Impairments for impairment disclosures.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Assets Held for Sale (Long Lived-Assets)

 

When the Company initiates the sale of long-lived assets, it assesses whether the assets meet the criteria to be considered assets held for sale. The review is based on whether the following criteria are met:

 

•

Management and the Company's board of directors have committed to a plan to sell the asset group;

 

•

The subject assets are available for immediate sale in their present condition;

 

•

The Company is actively locating buyers as well as other initiatives required to complete the sale;

 

•

The sale is probable and the transfer is expected to qualify for recognition as a complete sale in one year;

 

•

The long-lived asset is being actively marketed for sale at a price that is reasonable in relation to fair value; and

 

•

Actions necessary to complete the plan indicate it is unlikely significant changes will be made to the plan or the plan will be withdrawn.

 

If all the criteria are met, a long-lived asset held for sale is measured at the lower of its carrying amount or fair value less cost to sell, and the Company will cease recording depreciation. Any adjustment to the carrying amount is recorded as an impairment loss. See Note 13 - Sale of Hotels and Assets Held for Sale for assets held for sale disclosures.

 

Goodwill

 

The Company allocates goodwill to each reporting unit. For the Company’s purposes, each of its wholly-owned hotels is considered a reporting unit. The Company tests goodwill for impairment at least annually, as of March 31, or upon the occurrence of any "triggering events" under ASC section 360, if sooner. Upon the occurrence of any "triggering events," the Company is required to compare the fair value of each reporting unit to which goodwill has been allocated, to the carrying amount of such reporting unit including the allocation of goodwill. If the carrying amount of a reporting unit exceeds its fair value, the Company applies a one-step quantitative test and records the amount of goodwill impairment as the excess of the reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to such reporting unit.

 

During 2018, the Company recorded impairments to goodwill of $3.4 million resulting in a goodwill balance of $11.0 million as of December 31, 2018. There was no goodwill impairment recognized during the three or six months ended June 30, 2019, resulting in no change to the goodwill balance for the three or six months ended June 30, 2019.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash in bank accounts as well as investments in highly-liquid money market funds with original maturities of three months or less at purchase.

 

Restricted Cash

 

Restricted cash consists of amounts required under mortgage agreements for future capital improvements to owned assets, future interest and property tax payments and cash flow deposits while subject to mortgage agreement restrictions.

 

Deferred Financing Fees

 

Deferred financing fees represent commitment fees, legal fees and other costs associated with obtaining commitments for financing. These fees are amortized as a component of interest expense over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing fees are expensed in full when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financial transactions that do not close are expensed in the period in which it is determined that the financing will not be successful. Deferred financing fees are deducted from their related liabilities on the Company's Consolidated Balance Sheets.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Revenue Recognition

 

The Company's revenue is primarily from rooms, food and beverage, and other, and is disaggregated on the Company's Consolidated Statement of Operations and Comprehensive Loss.

 

Room sales are driven by a fixed fee charged to a hotel guest to stay at the hotel property for an agreed-upon period. A majority of the Company's room reservations are cancellable and the Company transfers promised goods and services to the hotel guest as of the date upon which the hotel guest occupies a room and at the same time earns and recognizes revenue. The Company offers advance purchase reservations that are paid for by the hotel guest in advance and the Company recognizes deferred revenue as a result of such reservations. The Company's obligation to the hotel guest is satisfied as of the date upon which the hotel guest occupies a room. The Company's room revenue accounted for 94.2% and 94.5% of the Company's total revenue for the three months ended June 30, 2019 and 2018, respectively. The Company's room revenue accounted for 94.1% and 94.4% of the Company's total revenue for the six months ended June 30, 2019 and 2018, respectively. Food, beverage, and other revenue are recognized at the point of sale on the date of the transaction as the hotel guest simultaneously obtains control of the good or service.

 

Income Taxes

 

The Company elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code") commencing with its tax year ended December 31, 2014. In order to continue to qualify as a REIT, the Company must annually distribute to its stockholders 90% of its REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain, and must comply with various other organizational and operational requirements. The Company generally will not be subject to federal corporate income tax on that portion of its REIT taxable income that it distributes to its stockholders. The Company may be subject to certain state and local taxes on its income, property taxes and federal income and excise taxes on its undistributed income. The Company's hotels are leased to taxable REIT subsidiaries, which are owned by the OP. The taxable REIT subsidiaries are subject to federal, state and local income taxes.

 

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss, capital loss, and tax credit carryovers. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which such amounts are expected to be realized or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including future reversals of existing taxable temporary differences, future projected taxable income and tax planning strategies.

 

GAAP prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. The Company must determine whether it is "more-likely-than-not" that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement in order to determine the amount of benefit to recognize in the financial statements. This accounting standard applies to all tax positions related to income taxes. As of June 30, 2019, the Company's tax years that remain subject to examination by major tax jurisdictions are 2014, 2015, 2016, 2017 and 2018.

 

Earnings/Loss per Share

 

The Company calculates basic income or loss per share by dividing net income or loss attributable to common stockholders for the period by the weighted-average shares of its common stock outstanding for such period. Diluted income per share takes into account the effect of dilutive instruments, such as unvested restricted shares of common stock ("restricted shares") and unvested restricted share units in respect of shares of common stock ("RSUs"), except when doing so would be anti-dilutive.

 

The Company currently has outstanding restricted shares whose holders are entitled to participate in dividends when and if paid on shares of common stock. The Company also currently has outstanding RSUs whose holders generally are credited with dividend or other distribution equivalents when and if paid on shares of common stock. These dividends or other distribution equivalents will be regarded as having been reinvested in RSUs and will only be paid to the extent the corresponding RSUs vest. To the extent the Company were to have distributions in the future, it would be required to calculate earnings per share using the two-class method with regard to restricted shares, whereby earnings or losses are reduced by distributed earnings as well as any available undistributed earnings allocable to holders of restricted shares.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Fair Value Measurements

 

In accordance with ASC section 820 - Fair Value Measurement, certain assets and liabilities are recorded at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability between market participants in an orderly transaction on the measurement date. The market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability is known as the principal market. When no principal market exists, the most advantageous market is used. This is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received or minimizes the amount that would be paid. Fair value is based on assumptions market participants would make in pricing the asset or liability. Generally, fair value is based on observable quoted market prices or derived from observable market data when such market prices or data are available. When such prices or inputs are not available, the reporting entity should use valuation models.

 

The Company’s financial instruments recorded at fair value on a recurring basis are categorized based on the priority of the inputs used to measure fair value. The inputs used in measuring fair value are categorized into three levels, as follows:

 

•

Level 1 - Inputs that are based upon quoted prices for identical instruments traded in active markets.

 

•

Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar investments in markets that are not active, or models based on valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the investment.

 

•

Level 3 - Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

 

The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.

 

See Note 10 - Fair Value Measurements for fair value disclosures.

 

Class C Units

 

The Company initially measured the Class C Units which were issued to the Brookfield Investor at fair value net of issuance costs. The Company is required to accrete the carrying value of the Class C Units to the liquidation preference using the effective interest method over the five year period prior to the holder's redemption option becoming exercisable (See "Accretion of Class C Units" on the Company's Consolidated Statements of Operations and Comprehensive Loss). However, if it becomes probable that the Class C Units will become redeemable prior to such date, the Company will adjust the carrying value of the Class C Units to the maximum liquidation preference.

 

Until the Final Closing, the Company could have become obligated pursuant to the SPA with the Brookfield Investor to issue additional Class C Units. This obligation was considered a contingent forward contract under ASC section 480 - Distinguishing Liabilities from Equity, and the Company accounted for it as a liability. The fair value of the contingent forward liability was recognized through current earnings at December 31, 2018, and the Company had no contingent forward liability as of either December 31, 2018 or June 30, 2019 and will not have such liability in the future (See Note 11 - Commitments and Contingencies).

 

Leases

 

Effective January 1, 2019, the Company adopted ASU 2016-02 Leases, which requires companies to recognize operating leases under GAAP as “right of use assets” (“ROU assets”) and lease liabilities on the balance sheet. The Company has $59.6 million of ROU assets and $52.7 million of lease liabilities as of June 30, 2019 for its operating leases. The Company's below-market lease intangible, net, of $8.2 million is also included in the ROU assets on the Company's Consolidated Balance Sheets. 

 

The Company's leases are primarily comprised of: ground or operating leases of certain of its hotel properties; one corporate office lease; and leases of vans, copiers and other miscellaneous equipment. All of the foregoing are classified as operating leases under GAAP. The Company determines if an agreement is considered a lease under GAAP at commencement of the agreement. The Company determines the lease term by assuming the exercise of all renewal options that are reasonably certain.

 

The Company includes leases of its hotel properties, and its corporate office space lease, in ROU assets and lease liabilities on the Company’s Consolidated Balance Sheet.  The Company's below-market lease intangible, net, which is attributed to its ground leases is also included in the ROU assets on the Company's Consolidated Balance Sheet. The Company determined that its vans, copiers, and other miscellaneous equipment were immaterial to the Company’s financial statements and therefore they have been excluded from the Company's ROU assets and lease liabilities. 

 

Operating lease ROU assets and lease liabilities are recognized at the commencement date and are calculated using the present value of future lease payments over the lease term. The discount rate used in the present value calculation is the Company's estimate of its incremental borrowing rate based on the information available at the lease commencement date. ASU 2016-02 did not result in any changes to how operating lease payments are expensed under GAAP, and therefore, the Company's total operating lease payments continue to be expensed on a straight-line basis over the life of the lease commencing upon possession of the property. The below-market lease intangible is based on the difference between the market rent and the contractual rent for the Company’s ground lease obligations and is discounted to a present value using an interest rate reflecting the Company’s assessment of the risk associated with the leases acquired. Acquired lease intangible assets are amortized over the remaining lease term. See Note 4 - Leases for lease disclosures.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Advertising Costs

 

The Company expenses advertising costs for hotel operations as incurred. These costs were $5.9 million for the three months ended June 30, 2019, and $4.9 million for the three months ended June 30, 2018. Advertising costs were $10.9 million for the six months ended June 30, 2019, and $9.0 million for the six months ended June 30, 2018. 

 

Allowance for Doubtful Accounts

 

Receivables consist principally of trade receivables from customers and are generally unsecured and are due within 30 to 90 days. The Company records a provision for uncollectible accounts using the allowance method. Expected credit losses associated with trade receivables are recorded as an allowance for doubtful accounts. The allowance for doubtful accounts is estimated based upon historical patterns of credit losses for aged receivables as well as specific provisions for certain identifiable, potentially uncollectible balances. When internal collection efforts on accounts have been exhausted, the accounts are written off and the associated allowance for doubtful accounts is reduced. Trade and note receivable balances, net of the allowance for doubtful accounts, are included in prepaid expenses and other assets in the accompanying Consolidated Balance Sheets, and are as follows (in thousands):

 

 

Reportable Segments

 

The Company has determined that it has one reportable segment, with activities related to investing in real estate. The Company’s investments in real estate generate room revenue and other income through the operation of the properties, which comprise 100% of the total consolidated revenues. Management evaluates the operating performance of the Company’s investments in real estate on an individual property level, and therefore each property is considered a reporting unit. Each of the Company's reporting units are also considered to be operating segments, but none of these individual operating segments represents a reportable segment as they meet the criteria in GAAP to aggregate all properties into one reportable segment.

 

Derivative Transactions

 

The Company at certain times enters into derivative instruments to hedge exposure to changes in interest rates. The Company’s derivatives as of June 30, 2019, consist of interest rate cap agreements which it believes will help to mitigate its exposure to increasing borrowing costs under floating rate indebtedness, and a variable interest-only bond which it has acquired in connection with the securitization of one of its mortgage loans to effectively reduce its borrowing costs. The Company has elected not to designate its interest rate cap agreements and the variable interest-only bond as cash flow hedges. The impact of the interest rate caps for the three and six months ended June 30, 2019 and June 30, 2018, was immaterial to the consolidated financial statements. See Note 5 - Mortgage Notes Payable and Note 10 - Fair Value Measurements for variable interest-only bond disclosures.

 

Recently Issued Accounting Pronouncements 

 

In August 2018, the FASB issued ASU 2018-13 Fair Value Measurements (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). Among other changes, ASU 2018-13 addresses changes in disclosures related to unrealized gains and losses and transfers between levels in the fair value hierarchy. ASU 2018-13 is effective for the Company for fiscal years beginning after December 15, 2019. The Company does not anticipate that the adoption of ASU 2018-13 will have any impact on the Company's consolidated financial statements.

 

In March 2019, the FASB issued ASU 2019-01 Leases (Topic 842): Codification Improvements ("ASU 2019-01").  The amendments in ASU 2019-01 clarifies the existing codification as well as corrects unintended application of the existing guidance. The amendment provides additional guidance on determining the fair value of underlying assets by lessors that are not manufacturers or dealers, how to present sales-type and direct financing leases on the cash flow statement and transition disclosures related to topic 250, Accounting Changes and Error Corrections. ASU 2019-01 is effective for the Company for fiscal years beginning after December 15, 2019, with the transition disclosures related to Topic 250 effective for the fiscal year beginning on January 1, 2019. Transition disclosures related to Topic 250 were adopted by the Company on January 1, 2019, did not have a material impact on the Company's consolidated financial statements. The Company does not anticipate that the adoption of other additional guidance from ASU 2019-01 will have any impact on the Company's consolidated financial statements.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

 

Note 3 - Brookfield Investment

 

On March 31, 2017, the initial closing under the SPA (the “Initial Closing”) occurred and various transactions and agreements contemplated by the SPA were consummated and executed, including but not limited to:

 

•

the sale by the Company and purchase by the Brookfield Investor of one share of a new series of preferred stock designated as the Redeemable Preferred Share, par value $0.01 per share (the “Redeemable Preferred Share”), for a nominal purchase price; and

 

•

the sale by the Company and purchase by the Brookfield Investor of 9,152,542.37 Class C Units for a purchase price of $14.75 per Class C Unit, or $135.0 million in the aggregate.

 

On February 27, 2018, the second closing under the SPA (the “Second Closing”) occurred, pursuant to which the Company sold 1,694,915.25 additional Class C Units to the Brookfield Investor, for a purchase price of $14.75 per Class C Unit, or $25.0 million in the aggregate.

 

On February 27, 2019, the Final Closing occurred, pursuant to which we sold 14,898,060.78 additional Class C Units to the Brookfield Investor, for a purchase price of $14.75 per Class C Unit, or $219.7 million in the aggregate. Following the Final Closing, the Brookfield Investor no longer has any obligations or rights to purchase additional Class C Units pursuant to the SPA or otherwise.

 

Without obtaining the prior approval of the majority of the then outstanding Class C Units and/or at least one of the two directors (each, a "Redeemable Preferred Director") elected to the Company’s board of directors by the Brookfield Investor pursuant to its rights as the holder of the Redeemable Preferred Share, the Company is restricted from taking certain operational and governance actions. These restrictions (collectively referred to herein as the “Brookfield Approval Rights”) are subject to certain exceptions and conditions. See “Brookfield Approval Rights” below.

 

The Redeemable Preferred Share

 

The Redeemable Preferred Share held by the Brookfield Investor has been classified as permanent equity on the Consolidated Balance Sheets.

 

The Redeemable Preferred Share ranks on parity with the Company’s common stock, with the same rights with respect to preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, terms and conditions of redemption and other terms and conditions as the Company’s common stock, with certain exceptions.

 

For so long as the Brookfield Investor holds the Redeemable Preferred Share, the Brookfield Investor has certain rights with respect to the election of members of the Company's board of directors and its committees, including the right to elect two Redeemable Preferred Directors to the Company’s board of directors and to approve two additional independent directors (each, an "Approved Independent Director") to be recommended and nominated by the Company's board of directors for election by the stockholders at each annual meeting. In addition, each committee of the Company's board of directors, subject to limited exceptions, must include at least one of the Redeemable Preferred Directors.

 

The holder of the Redeemable Preferred Share has certain rights in the event the OP fails to redeem Class C Units when required to do so, including the right to increase the size of the Company's board of directors by a number of directors that would result in the holder of the Redeemable Preferred Share being entitled to nominate and elect a majority of the Company's board of directors, subject to compliance with the provisions of the Company's charter requiring at least a majority of the Company's directors to be Independent Directors (as defined in the Company's charter).

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Class C Units

 

As of June 30, 2019, the Class C Units reflected on the Consolidated Balance Sheets is reconciled in the following table (in millions):

 

                                            

 

The Class C Units have been classified as temporary equity due to the contingent redemption features described in more detail below. At the Initial Closing, the Class C Units were deemed to have a “beneficial conversion feature” as the effective conversion price of the Class C Units under GAAP as of March 31, 2017 was less than the fair value of the Company's common stock on such date. As a result, the Company recognized the beneficial conversion feature as a deemed dividend of $4.5 million during the three months ended March 31, 2017, thereby reducing income available to common stockholders for purposes of calculating earnings per share.

 

Rank

 

The Class C Units rank senior to the OP Units and all other equity interests in the OP with respect to priority in payment of distributions and in the distribution of assets in the event of the liquidation, dissolution or winding-up of the OP, whether voluntary or involuntary, or any other distribution of the assets of the OP among its equity holders for the purpose of winding up its affairs.

 

Distributions

 

Commencing on June 30, 2017, holders of Class C Units are entitled to receive, with respect to each Class C Unit, fixed, quarterly cumulative cash distributions at a rate of 7.50% per annum from legally available funds. If the Company fails to pay these cash distributions when due, the per annum rate will increase to 10% until all accrued and unpaid distributions required to be paid in cash are reduced to zero.

 

Commencing on June 30, 2017, holders of Class C Units are also entitled to receive, with respect to each Class C Unit, a fixed, quarterly, cumulative PIK Distribution at a rate of 5% per annum ("PIK Distributions"). If the Company fails to redeem the Brookfield Investor when required to do so pursuant to the amendment and restatement of the OP's existing agreement of limited partnership (the "A&R LPA"), the 5% per annum PIK Distribution rate will increase to a per annum rate of 7.50%, and would further increase by 1.25% per annum for the next four quarterly periods thereafter, up to a maximum per annum rate of 12.5%.

 

The number of Class C Units delivered in respect of the PIK Distributions on any distribution payment date will be equal to the number obtained by dividing the amount of PIK Distribution by $14.75.

 

The Brookfield Investor is also entitled to receive tax distributions under certain limited circumstances. As of March 31, 2019, no tax distributions have been paid.

 

For the three months ended June 30, 2019 and June 30, 2018, the Company paid cash distributions of $7.5 million and $3.2 million and PIK Distributions of 339,747.46 and 143,191.33 Class C Units, respectively, to the Brookfield Investor, as the sole holder of the Class C Units.  For the six months ended June 30, 2019 and June 30, 2018, the Company paid cash distributions of $12.3 million and $6.0 million and PIK Distributions of 555,126.21 and 269,808.34 Class C Units, respectively, to the Brookfield Investor, as the sole holder of the Class C Units. 

 

Conversion Rights

 

The Class C Units are generally convertible into OP Units at any time at the option of the holder thereof at an initial conversion price of $14.75 (the "Conversion Price"). The Conversion Price is subject to anti-dilution and other adjustments upon the occurrence of certain events and transactions.

 

Liquidation Preference

 

The liquidation preference with respect to each Class C Unit as of a particular date is the original purchase price paid under the SPA or the value upon issuance of any Class C Unit received as a PIK Distribution, plus, with respect to such Class C Unit up to but not including such date, (i) any accrued and unpaid cash distributions and (ii) any accrued and unpaid PIK Distributions.

 

Mandatory Redemption

 

The Class C Units are generally subject to mandatory redemption at a premium to liquidation preference if the OP consummates any liquidation, sale of all or substantially all of the assets, dissolution or winding-up, whether voluntary or involuntary, sale, merger, reorganization, reclassification or recapitalization or other similar event (a “Fundamental Sale Transaction”) prior to March 31, 2022. The amount of the premium, which may be substantial, varies based on the timing of consummation of the Fundamental Sale Transaction.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Holder Redemptions

 

The holders of the Class C Units may redeem such Class C Units at any time on or after March 31, 2022 for a redemption price in cash equal to the liquidation preference and also have certain other redemption rights in connection with the Company’s failure to maintain REIT status or material breaches of the A&R LPA.

 

Remedies Upon Failure to Redeem

 

If the OP fails to redeem Class C Units when required to do so pursuant to the terms of the A&R LPA, beginning three months after such failure BSREP II Hospitality II Special GP OP LLC (the "Special General Partner"), an affiliate of the Brookfield Investor, has the exclusive right, power and authority to sell the assets or properties of the OP for cash at such time or times as the Special General Partner may determine, upon engaging a reputable, national third party sales broker or investment bank reasonably acceptable to holders of a majority of the then outstanding Class C Units to conduct an auction or similar process designed to maximize the sales price. The proceeds from sales of assets or properties by the Special General Partner must be used first to make any and all payments or distributions due or past due with respect to the Class C Units, regardless of the impact of such payments or distributions on the Company or the OP.

 

The foregoing rights of the Special General Partner are in addition to the other rights described herein if the OP fails to redeem Class C Units when required to do so pursuant to the terms of the A&R LPA.

 

Company Redemption After Five Years

 

At any time and from time to time on or after March 31, 2022, the Company has the right to elect to redeem all or any part of the issued and outstanding Class C Units for an amount in cash equal to the liquidation preference.

 

Transfer Restrictions

 

The Brookfield Investor is generally permitted to make transfers of Class C Units without the prior consent of the Company, provided that any transferee must customarily invest in these types of securities or real estate investments of any type or have in excess of $100.0 million of assets.

 

Preemptive Rights

 

If the Company or the OP proposes to issue additional equity securities, subject to certain exceptions and in accordance with the procedures in the A&R LPA, any holder of Class C Units that owns Class C Units representing more than 5% of the outstanding shares of the Company’s common stock on an as-converted basis has certain preemptive rights.

 

Brookfield Approval Rights

 

The articles supplementary with respect to the Redeemable Preferred Share restrict the Company from taking certain actions without the prior approval of at least one of the Redeemable Preferred Directors, and the A&R LPA restricts the OP from taking certain actions without the prior approval of the majority of the then outstanding Class C Units.

 

In general, subject to certain exceptions, prior approval is required before the Company or its subsidiaries (including the OP) are permitted to take any of the following actions: equity issuances; organizational document amendments; debt incurrences; affiliate transactions; sale of all or substantially all assets; bankruptcy or insolvency declarations; declarations or payments of dividends or other distributions; redemptions or repurchases of securities; adoption of, and amendments to, the annual business plan (including the annual operating and capital budget) required under the terms of the Redeemable Preferred Share; hiring and compensation decisions related to certain key personnel (including executive officers); property acquisitions and property sales and dispositions that do not meet transaction-size limits and other defined criteria and would be outside of the OP’s normal course of business; entry into new lines of business; settlement of material litigation; changes to material agreements; increasing or decreasing the number of directors on the Company’s board of directors; nominating or appointing a director (other than a Redeemable Preferred Director) who is not independent; nominating or appointing the chairperson of the Company’s board of directors; and certain other matters.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

 

Note 4 - Leases

 

As of June 30, 2019, the Company recorded leases of its hotel properties and its corporate office space lease in ROU assets and lease liabilities on the Company’s Consolidated Balance Sheet. The Company's below-market lease intangible, net, which is attributed to its ground leases is also included in the Company's ROU assets. The Company’s leases have remaining lease terms of five to 47 years. Most leases include one or more options to renew, with renewal terms that can extend the lease term from five to 50 years. One Company lease includes a purchase option. Lease extension and termination options require written notice by the Company in accordance with specific parameters addressed in each individual lease. Certain of the leases require variable lease payments typically based on a percentage of hotel revenue but no less than a minimum base rent. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants.

 

During the six months ended June 30, 2019, the Company paid rental obligations of $2.7 million,  which was included in the measurement of lease liabilities and ROU assets. The cash paid is included in operating cash flows on the Company Statement of Cash Flows.

 

Supplemental balance sheet information related to the Company's leases was as follows:

 

 

Supplemental income statement information related to the Company's leases was as follows:

 

Maturity of Lease Liabilities Analysis as of June 30, 2019 for the Company's operating leases of hotel properties and corporate office space were as follows (in thousands):

 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

The following table summarizes future minimum rental commitments for the Company's operating leases comprised of leases of certain of the Company's hotel properties as of December 31, 2018 (in thousands):

 

 

The Company has allocated values to certain above and below-market lease intangibles based on the difference between market rents and rental commitments under the leases. During the three and six months ended June 30, 2018, amortization of below-market lease intangibles, net, to rent expense was $0.1 million and $0.2 million, respectively. Rent expense for the three months and six months ended June 30, 2018 was $1.5 million and $3.1 million, respectively.

 

Note 5 - Mortgage Notes Payable

 

The Company’s mortgage notes payable as of June 30, 2019 and December 31, 2018 consist of the following, respectively (in thousands):

 

 

 

 

Interest expense related to the Company's mortgage notes payable for the three months ended June 30, 2019 and for the three months ended June 30, 2018, was $21.9 million and $18.8 million, respectively. Interest expense related to the Company's mortgage notes payable for the six months ended June 30, 2019 and for the six months ended June 30, 2018, was $42.3 million and $36.5 million, respectively.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Baltimore Courtyard and Providence Courtyard    

 

On April 5, 2019, the Company refinanced mortgage debt on two of its hotel properties: the Courtyard Baltimore Downtown/Inner Harbor, a 205-key select service hotel located in Baltimore, MD (the “Baltimore Courtyard”), and the Courtyard Providence Downtown, a 219-key select service hotel located in downtown Providence, RI (the “Providence Courtyard”).  The new mortgage and mezzanine loans were in an aggregate principal amount of $46.1 million (such loans, the “Baltimore Courtyard and Providence Courtyard Bridge Loans”).

 

At the closing of the Baltimore Courtyard and Providence Courtyard Bridge Loans, the net proceeds after accrued interest and certain closing costs were used to repay the $45.5 million principal amount then outstanding under the Company’s existing mortgage indebtedness on the Baltimore Courtyard and the Providence Courtyard properties.

 

The new loan dated April 5, 2019 was then refinanced and prepaid in full at par in accordance with its terms on May 1, 2019, with proceeds from the 92-Pack Loans.

 

Hilton Garden Inn Blacksburg Joint Venture    

 

The Hilton Garden Inn Blacksburg Joint Venture Loan matures June 6, 2020. On July 6, 2015 and each month thereafter, the Company is required to make an interest only payment based on the outstanding principal and a fixed annual interest rate of 4.31%. The entire principal amount is due at maturity.

 

87-Pack Loans

 

During the quarter ended March 31, 2019 and the year ended December 31, 2018, a total of 87 of the Company’s hotels, all of which were originally acquired in February 2015 as part of a portfolio currently comprising 111 hotel properties (the “Grace Portfolio”), were financed pursuant to a mortgage loan agreement (the “87-Pack Mortgage Loan”) and a mezzanine loan agreement (the “87-Pack Mezzanine Loan” and, collectively with the 87-Pack Mortgage Loan, the “87-Pack Loans”), with an aggregate principal balance of $915.0 million. The principal amount of the 87-Pack Mortgage Loan was $805.0 million and the 87-Pack Mortgage Loan was secured by the 87 Company hotel properties (each, a “87-Pack Collateral Property”). The principal amount of the 87-Pack Mezzanine Loan was $110.0 million and the 87-Pack Mezzanine Loan was secured by the ownership interest in the entities which own the 87-Pack Collateral Properties and the related operating lessees.

 

On May 1, 2019, the 87-Pack Loans matured and were refinanced as part of the 92-Pack Loans. 

 

The 87-Pack Mortgage Loan required monthly interest payments at a variable rate equal to one-month LIBOR plus 2.56%, and the 87-Pack Mezzanine Loan required monthly interest payments at a variable rate equal to one-month LIBOR plus 6.50%, for a combined weighted average interest rate of LIBOR plus 3.03%. Pursuant to an interest rate cap agreement, the LIBOR portions of the interest rates due under the 87-Pack Loans were effectively capped at the greater of (i) 4.0% and (ii) a rate that would result in a debt service coverage ratio specified in the loan documents.

 

In connection with a sale or disposition to a third party of an individual 87-Pack Collateral Property, such 87-Pack Collateral Property was entitled to be released from the 87-Pack Loans, subject to certain conditions and limitations, by prepayment of a portion of the 87-Pack Loans at a release price calculated in accordance with the terms of the 87-Pack Loans.

 

The 87-Pack Loans also provided for certain amounts to be deposited into reserve accounts, including with respect to a portion of the costs associated with the PIPs required pursuant to the franchise agreements related to the 87-Pack Collateral Properties.

 

For the term of the 87-Pack Loans, the Company and the OP were required to maintain, on a consolidated basis, a net worth of $250.0 million (excluding accumulated depreciation and amortization). The Company was in compliance with the financial covenants during the life of the loan. 

 

92-Pack Loans

 

On May 1, 2019, the Company refinanced the 87-Pack Loans and the Baltimore Courtyard and Providence Courtyard Bridge Loans with new mortgage and mezzanine indebtedness of $1,040 million on 92 of the Company’s hotel properties (the “92-Pack Loans”). 

 

At closing, the Company used the net proceeds from the 92-Pack Loans after accrued interest and closing costs to repay $961.1 million outstanding under the 87-Pack Loans and the Baltimore Courtyard and Providence Courtyard Bridge Loans.  The Company also used $10.0 million of proceeds to fund a reserve with the lenders that the Company can utilize to fund expenditures for work required to be performed under property improvement plans (“PIPs”) required by franchisors of the 92 hotel properties. During the term of the 92-Pack Loans, the Company will be required to periodically deposit additional reserves with the lenders that the Company can utilize to fund a portion of future PIP work and other capital improvements.

 

The 92-Pack Loans are fully prepayable with certain prepayment fees applicable on or prior to May 7, 2020, provided, however, that the first 25% of each of the 92-Pack Loans is prepayable at par. Following May 7, 2020, each of the 92-Pack Loans may be prepaid without payment of any prepayment fee or any other fee or penalty.  Prepayments under the mortgage loan are generally conditioned on a pro-rata prepayment being made under the mezzanine loans.

 

The 92-Pack Mortgage Loan requires monthly interest payments at a variable rate equal to one-month LIBOR plus 2.14%, the 92-Pack Senior Mezzanine Loan required monthly interest payments at a variable rate equal to one-month LIBOR plus 5.60%, and the 92-Pack Junior Mezzanine Loan requires monthly interest payments at a variable rate equal to one-month LIBOR plus 8.50% for a combined weighted average interest rate of LIBOR plus 2.90%. Pursuant to an interest rate cap agreement, the LIBOR portions of the interest rates due under the 92-Pack Loans were effectively capped at 4.0%.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

 In connection with a sale or disposition to a third party of any of the 92 hotel properties serving as collateral, such property may be released from the 92-Pack Loans, subject to certain conditions and limitations, by prepayment of a portion of the 92-Pack Loans at a release price calculated in accordance with the terms of the 92-Pack Loans.

 

For the term of the 92-Pack Loans, the Company and the OP are required to maintain, on a consolidated basis, a net worth of (i) $250.0 million (excluding their interest in the 92 hotel properties serving as collateral and excluding accumulated depreciation and amortization) and (ii) $500.0 million (including their interest in the 92 hotel properties serving as collateral but excluding accumulated depreciation and amortization). As of June 30, 2019, the Company was in compliance with this financial covenant.

 

Variable Interest-Only Bond 

 

During the three months ended June 30, 2019, the Company recorded a derivative asset associated with a variable interest-only bond issued as part of the lenders' securitization of the 92-Pack Mortgage Loan and acquired by the Company in connection with such securitization. The interest-only bond was acquired to effectively reduce the Company’s borrowing cost on the 92-Pack Loans. The Company values the variable interest-only bond at fair value (See Note 10 - Fair Value Measurements).

 

Additional Grace Mortgage Loan

 

A portion of the purchase price of the Grace Portfolio was financed through additional mortgage financing which loan was refinanced during October 2015 (the “Additional Grace Mortgage Loan”). The Additional Grace Mortgage Loan carries a fixed annual interest rate of 4.96% per annum with a maturity date on October 6, 2020. Pursuant to the Additional Grace Mortgage Loan, the Company agreed to make periodic payments into an escrow account for the PIPs required by the franchisors, and the Company made the final PIP reserve payment during June 2018. The Additional Grace Mortgage Loan includes the following financial covenants: minimum consolidated net worth and minimum consolidated liquidity. As of June 30, 2019, the Company was in compliance with these financial covenants.

 

Term Loan

 

On April 27, 2017, the Company and the OP, as guarantors, and certain wholly-owned subsidiaries of the OP, as borrowers, entered into a Second Amended and Restated Term Loan Agreement (as amended, the “Term Loan”) in an aggregate principal amount of $310.0 million. The Term Loan is collateralized by 28 of the Company’s hotel properties (each, a “Term Loan Collateral Property”).

 

Prior to the closing of the 92-Pack Loans, the Term Loan was scheduled to mature on May 1, 2019, subject to three one-year extension rights at the Company's option which, if all three extension rights were exercised, would have resulted in an outside maturity date of May 1, 2022. At the closing of the 92-Pack Loans, $25.0 million of the net proceeds were used to prepay principal under the Term Loan. This prepayment reduced the amount outstanding under the Term Loan to $285.0 million, and concurrently, the Company extended the maturity of the Term Loan in accordance with its terms to May 1, 2020. On May 22, 2019, the Company entered into an amendment to the Term Loan which reduced the commitment under the Term Loan from $310.0 million to $285.0 million and added one additional extension term of one-year to the term of the Term Loan, such that if the Company exercises all extension rights, the maturity date of the Term Loan would be May 1, 2023.

 

The Term Loan is prepayable in whole or in part at any time, subject to payment of LIBOR breakage, if any.

 

The Term Loan requires monthly interest payments at a variable rate of one-month LIBOR plus 3.00%. Pursuant to an interest rate cap agreement, the LIBOR portions of the interest rates due under the Term Loan is capped at 4.00% during the initial term, and a rate based on a debt service coverage ratio during any extension term.

 

In connection with a sale or disposition to a third party of an individual Term Loan Collateral Property, such Term Loan Collateral Property may be released from the Term Loan, subject to certain conditions and limitations, by prepayment of a portion of the Term Loan at a release price calculated in accordance with the terms of the Term Loan.

 

The Term Loan also provides for certain amounts to be deposited into reserve accounts, including with respect to all costs associated with the PIPs required pursuant to the franchise agreements related to the Term Loan Collateral Properties.

 

For the term of the Term Loan, the Company and the OP are required to maintain, on a consolidated basis, a net worth of $250.0 million (excluding accumulated depreciation and amortization). As of June 30, 2019, the Company was in compliance with this financial covenant.

 

 

Note 6 - Mandatorily Redeemable Preferred Securities

 

In February 2015, a portion of the contract purchase price for the Grace Portfolio was satisfied by the issuance to the sellers of the Grace Portfolio of approximately $447.1 million of liquidation value of preferred equity interests (the "Grace Preferred Equity Interests") in two newly-formed Delaware limited liability companies, HIT Portfolio I Holdco, LLC and HIT Portfolio II Holdco, LLC (together, the "Holdco entities"). Each of the Holdco entities is an indirect subsidiary of the Company and an indirect owner of the 111 hotels currently comprising the Grace Portfolio. The two Holdco entities correspond, respectively, to the pool of hotels encumbered by the 87-Pack Loan (plus four additional otherwise unencumbered hotels) and the pool of hotels encumbered by the Additional Grace Mortgage Loan subsidiaries of the Company.

 

The holders of the Grace Preferred Equity Interests were entitled to monthly distributions at a rate of 7.50% per annum for the first 18 months following closing, through August 2016, and entitled to 8.00% per annum thereafter. The Company was required to reduce the liquidation value of the Grace Preferred Equity Interests to 50.0% of the $447.1 million originally issued by February 27, 2018, and to redeem the Grace Preferred Equity Interests in full by February 27, 2019.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Interest expense related to the Grace Preferred Equity Interests for the three months ended June 30, 2019 and June 30, 2018 was zero and $4.3 million, respectively. Interest expense related to the Grace Preferred Equity Interests for the six months ended June 30, 2019 and June 30, 2018 was $2.7 million and $8.7 million, respectively.

 

On February 27, 2019, the Company used proceeds from the concurrent sale of Class C Units to the Brookfield Investor at the Final Closing to redeem the remaining $219.7 million in liquidation value of Grace Preferred Equity Interests.

 

Due to the fact that the Grace Preferred Equity Interests were mandatorily redeemable and certain of their other characteristics, the Grace Preferred Equity Interests were treated as debt in accordance with GAAP.

 

Note 7 - Accounts Payable and Accrued Expenses

 

The following is a summary of the components of accounts payable and accrued expenses (in thousands):

 

 

 

Note 8 - Common Stock

 

The Company had 39,140,343 and 39,134,628 shares of common stock outstanding as of each of June 30, 2019 and December 31, 2018, respectively.

 

Share Repurchase Program

 

On September 24, 2018, the Company announced that its board of directors had adopted a new share repurchase program (the "SRP"), effective as of October 1, 2018, pursuant to which the Company was offering, subject to certain terms and conditions, liquidity to stockholders by offering to make quarterly repurchases of common stock at a price to be established by the board of directors. In February 2019, the board of directors suspended the SRP. The suspension will remain in effect unless and until the board takes further action to reactivate the SRP. There can be no assurance the SRP will be reactivated on its current terms, different terms or at all. Prior to such suspension, the Company repurchased a total of 211,154 shares of common stock pursuant to the SRP for a total purchase price of $1.9 million, including 208,977 shares for a total purchase price of $1.9 million during the quarter and year ended December 31, 2018. 

 

 

Note 9 - Share-Based Payments

 

The Company has an employee and director incentive restricted share plan (as amended and/or restated, the “RSP”), which provides it with the ability to grant awards of restricted shares and RSUs to the Company’s directors, officers and employees, as well as the directors and employees of entities that provide services to the Company. The total number of shares of common stock that may be granted under the RSP may not exceed 5% of the authorized shares of common stock at any time and in any event may not exceed 4,000,000 shares (as such number may be adjusted for stock splits, stock dividends, combinations and similar events).

 

Restricted share awards entitle the recipient to receive shares of common stock from the Company under terms that provide for vesting over a specified period of time or upon attainment of pre-established performance objectives. Such awards would typically be forfeited with respect to the unvested shares upon the termination of the recipient’s employment or other relationship with the Company. Restricted shares may not, in general, be sold or otherwise transferred until restrictions are removed and the shares have vested. Holders of restricted shares may receive cash or stock distributions when and if paid prior to the time that the restrictions on the restricted shares have lapsed. Any distributions payable in shares of common stock are generally subject to the same restrictions as the underlying restricted shares. The restricted shares are measured at fair value and expensed over the applicable vesting period. The Company recognizes the impact of forfeited restricted share awards as they occur.

 

RSUs represent a contingent right to receive shares of common stock at a future settlement date, subject to satisfaction of applicable vesting conditions and/or other restrictions, as set forth in the RSP and an award agreement evidencing the grant of RSUs. RSUs may not, in general, be sold or otherwise transferred until restrictions are removed and the rights to the shares of common stock have vested. Holders of RSUs do not have or receive any voting rights with respect to the RSUs or any shares underlying any award of RSUs, but such holders generally are credited with dividend or other distribution equivalents that are regarded as having been reinvested in RSUs which are subject to the same vesting conditions and/or other restrictions as the underlying RSUs. The RSUs are measured at fair value and  expensed over the applicable vesting period. The Company recognizes the impact of forfeited RSUs as they occur.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

Restricted Share Awards

 

A summary of the Company's restricted share awards for the six months ended June 30, 2019 is presented below.

 

 

Prior to the Initial Closing, the Company made annual restricted share awards to its independent directors that vested annually over a five-year period following the date of grant, subject to continued service. In connection with the Initial Closing, the Company implemented a new director compensation program. Following the Initial Closing and pursuant to a compensation payment agreement, restricted share awards are made to an affiliate of the Brookfield Investor in respect of the Redeemable Preferred Directors’ service on the board of directors and vest on the earlier of the first anniversary of the date of grant or the date of the next annual meeting of the board of directors following the date of grant, subject to the continued service of the applicable Redeemable Preferred Director. As of June 30, 2019, the Company anticipates that all unvested restricted share awards will vest in accordance with their terms.

 

The compensation expense related to restricted shares for the three months ended June 30, 2019 was less than $0.1 million.  There was no compensation expense related to restricted shares for three months ended June 30, 2018. The compensation expense related to restricted shares for the six months ended June 30, 2019 and the six months ended June 30, 2018 was less than $0.1 million. As of June 30, 2019, there were no remaining unrecognized compensation expense.

 

RSU Awards

 

A summary of the Company's RSU awards for the six months ended June 30, 2019 is presented below:

 

 

RSU awards to the Company’s executive officers and other employees generally vest annually over a four-year vesting period following the date of grant, subject to continued service. RSU awards to directors vest on the earlier of the first anniversary of the date of grant or the date of the next annual meeting of the board of directors following the date of grant, subject to the continued service of the applicable director. Vested RSUs may only be settled in shares of common stock and such settlement generally will be on the earliest of (i) in the calendar year in which the third anniversary of each applicable vesting date occurs, (ii) termination of the recipient’s services to the Company and (iii) a change in control event. As of June 30, 2019, the Company anticipated that all unvested RSUs would vest in accordance with their terms.

 

The compensation expense related to RSUs for the three months ended June 30, 2019 and the three months ended June 30, 2018 was approximately $0.3 million and $0.4 million, respectively. The compensation expense related to RSUs for the six months ended June 30, 2019 and the six months ended June 30, 2018 was approximately $0.7 million and $0.7 million, respectively. As of June 30, 2019, there was $3.5 million of unrecognized compensation expense remaining.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

 

Note 10 - Fair Value Measurements

 

The Company is required to disclose the fair value of financial instruments which it is practicable to estimate. The fair value of cash and cash equivalents, accounts receivable and accounts payable and accrued expenses approximate their carrying amounts due to the relatively short maturity of these items. The following table shows the carrying amounts and the fair values of material liabilities, excluding deferred financing fees, that qualify as financial instruments (in thousands):

 

 

The fair value of the mortgage notes payable was determined using the discounted cash flow method and applying current market rates and is classified as level 3 under the fair value hierarchy. Market rates take into consideration general market conditions and maturity.

 

During the three and six months ended June 30, 2019, the Company recorded impairment losses on its hotel properties (See Note 14 - Impairments). The fair value of these hotel properties was based on the observable market data which is considered level 2 input under the fair value hierarchy and unobservable inputs that reflect the Company's internal assumptions, which are considered level 3 input under the fair value hierarchy.

 

During the three months ended June 30, 2019, the Company recorded a derivative asset associated with a variable interest-only bond that the Company acquired in connection with the lenders' securitization of the 92-Pack Mortgage Loan (See Note 5 - Mortgage Notes Payable). The fair value of the variable interest-only bond of $1.9 million was based on the observable market data which is considered level 2 input under the fair value hierarchy.

 

 

Note 11 - Commitments and Contingencies

 

Litigation

 

In the ordinary course of business, the Company may become subject to litigation, claims and regulatory matters. There are no material legal or regulatory proceedings pending or known to be contemplated against the Company at the date of this filing, other than as set forth below.

 

A special litigation committee (the “SLC”) of the Company’s board of directors (the “Board”) has been empowered to investigate claims asserted in shareholder demand letters sent to the Board by counsel for two of the Company’s stockholders, Tom Milliken and Stuart Wollman, as well as the allegations contained in an Amended Complaint filed by Mr. Milliken in the United States District Court for the Southern District of New York (the “Federal Court Action”). The SLC also has been empowered to determine whether to pursue actions by the Company against the defendants in the Federal Court Action. The SLC, which is represented by independent counsel, has substantially completed its investigation of the claims contained in the demand letters and Federal Court Action (collectively “the Claims”).

 

The SLC has determined it appropriate to pursue some but not all of the Claims. As previously disclosed, the SLC has been in discussion with the Company’s current Chief Executive Officer, Jonathan P. Mehlman, and his counsel regarding resolution of certain Claims against him in the Federal Court Action. Subject to signing a definitive settlement agreement and receiving court approval, the SLC, on behalf of the Company, and Mr. Mehlman have agreed in principle to resolve the Claims against Mr. Mehlman whereby he will pay back to the Company a portion of certain fees he received.

 

Preliminary settlement discussions also have commenced with other parties to the Federal Court Action, including the plaintiff, Mr. Milliken, and certain defendants, including Nicholas Schorsch, William Kahane, the Company’s former external advisor and former property managers, and the parent of the former sponsor of the Company, along with individuals associated with the parent (collectively, the “AR Capital Defendants”).  The SLC is participating in those settlement discussions.  The AR Capital Defendants, Mr. Milliken, the SLC, and the insurance carriers under the Company’s directors and officers policies and a second set of directors and officers policies issued to AR Capital, LLC are now attempting to schedule a mediation session.  At this time, the Company cannot predict whether a mediation will occur or, if it does, what the outcome of such a mediation will be.  In view of the settlement and mediation discussions, the parties in the Federal Court action, with consent of the SLC, sought and were granted an extension of the deadline for the SLC to submit its report in the Federal Court Action through and including September 16, 2019.

 

The Claims do not seek recovery of losses from or damages against the Company, but instead allege that the Company has sustained damages as a result of actions by the defendants, and therefore no accrual of any potential liability was necessary as of June 30, 2019, other than for incurred out-of-pocket legal fees and expenses.

 

Environmental Matters

 

In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. The Company has not been notified by any governmental authority of any non-compliance, liability or other claim and is not aware of any other environmental condition that it believes will have a material adverse effect on the results of operations.

 

Contingent Forward Liability

 

Until the Final Closing, the Company could have become obligated pursuant to the SPA with the Brookfield Investor to issue additional Class C Units. This obligation was considered a contingent forward contract under ASC section 480 - Distinguishing Liabilities from Equity, and the Company accounted for it as a liability.  On February 27, 2019, the Company used the proceeds from the concurrent sale of Class C Units to the Brookfield Investor to redeem the remaining $219.7 million in liquidation value of Grace Preferred Equity Interests, and the Brookfield Investor no longer has any obligations or rights to purchase additional Class C Units. Accordingly, at December 31, 2018, the Company recognized the fair value of the liability as income through current earnings, and thereby extinguished the contingent forward liability of $1.3 million. The Company had no contingent forward liability as of June 30, 2019.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

 

Note 12 - Related Party Transactions and Arrangements

 

Relationships with the Brookfield Investor and its Affiliates

 

As described in Note 3 - Brookfield Investment, on January 12, 2017, the Company and the OP entered into the SPA and the Framework Agreement. On March 31, 2017, the Initial Closing occurred and a variety of transactions contemplated by the SPA and the Framework Agreement were consummated, including the issuance and sale of the Redeemable Preferred Share and 9,152,542.37 Class C Units and the execution or taking of various agreements and actions required to effectuate the Company's transition to self-management. On February 27, 2018, the Second Closing occurred, pursuant to which the Company sold 1,694,915.25 additional Class C Units to the Brookfield Investor, for a purchase price of $14.75 per Class C Unit, or $25.0 million in the aggregate. On February 27, 2019, the Final Closing occurred, pursuant to which the Company sold 14,898,060.78 additional Class C Units to the Brookfield Investor, for a purchase price of $14.75 per Class C Unit, or $219.7 million in the aggregate. Following the Final Closing, the Brookfield Investor no longer has any obligations or rights to purchase additional Class C Units pursuant to the SPA or otherwise.

 

Holders of Class C Units are entitled to receive, with respect to each Class C Unit, fixed, quarterly cumulative cash distributions at a rate of 7.50% per annum from legally available funds. Holders of Class C Units are also entitled to receive, with respect to each Class C Unit, fixed, quarterly, cumulative PIK Distributions payable in Class C Units at a rate of 5% per annum. For the three months ended June 30, 2019 and June 30, 2018, the Company paid cash distributions of $7.5 million and $3.2 million and PIK Distributions of 339,747.46 and 143,191.33 Class C Units, respectively, to the Brookfield Investor, as the sole holder of the Class C Units.  For the six months ended June 30, 2019 and June 30, 2018, the Company paid cash distributions of $12.3 million and $6.0 million and PIK Distributions of 555,126.21 and 269,808.34 Class C Units, respectively, to the Brookfield Investor, as the sole holder of the Class C Units. 

 

Two of the Company’s directors, Bruce G. Wiles, who also serves as Chairman of the Board, and Lowell G. Baron, have been elected to the Company’s board of directors as the Redeemable Preferred Directors pursuant to the Brookfield Investor’s rights as the holder of the Redeemable Preferred Share and pursuant to the SPA. Messrs. Wiles and Baron are Managing Partners of Brookfield Asset Management Inc., an affiliate of the Brookfield Investor.

 

 

Note 13 - Sale of Hotels and Assets Held for Sale

 

Sale of Hotels

 

During the six months ended June 30, 2018, the Company completed the sale of one hotel for a sales price of $5.7 million, resulting in a net loss of approximately $0.1 million, which is reflected in other income (expense) on the Company’s Consolidated Statement of Operations and Comprehensive Loss. The Company used the proceeds from the sale of the hotel to redeem $3.8 million in Grace Preferred Equity Interests in accordance with their terms and for other general corporate purposes.

 

No hotels were sold during the six months ended June 30, 2019.

 

Assets Held for Sale 

 

As part of its investment strategy to continue to pursue the sale of non-core hotels and reallocate capital into more attractive investment opportunities, the Company commenced marketing for sale a total of 26 hotels during the quarter ended June 30, 2019.

 

As of June 30, 2019, 16 of these hotels were subject to definitive sale agreements where the buyer has made a non-refundable deposit and have been classified as held for sale. As of June 30, 2019, the Company recognized an impairment loss on 12 of these 16 hotels, totaling $32.6 million, which includes the estimated costs to sell those assets (See Note 14 - Impairments). The aggregate contract purchase price of these sales is $107.4 million, and the sales are expected to generate net proceeds to the Company of approximately $26.2 million, after prepayment of approximately $74.0 million of related mortgage debt obligations and estimated closing costs. 

 

The Company expects to close on the sale of the above 16 hotels during the third and fourth quarters of 2019. These sales are subject to customary closing conditions, and there can be no assurance they will be completed on their current terms, or at all. The sale of these hotels does not represent a strategic shift of the Company’s operations, and therefore the Company has included the operating results for these properties in income from continuing operations for the three months ended and six months ended June 30, 2019.

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(Unaudited)

 

 

 

Note 14 - Impairments

 

Impairments of Long-Lived Assets

 

During the three months ended June 30, 2019, the Company identified a total of 12 hotel properties where the carrying value of the properties exceeded their fair value and management determined the excess carrying value was unrecoverable. These hotels were among the 16 hotels as of June 30, 2019 that were subject to definitive sale agreements where the buyer has made a non-refundable deposit and have been classified as held for sale. (See Note 13-Sale of Hotels and Assets Held for Sale). The Company recorded cumulative impairment losses of $32.6 million during the three months ended June 30, 2019. The goodwill previously allocated to these properties by the Company had been fully written off as part of impairment of goodwill in prior periods and therefore no further impairment of goodwill was recorded. These hotels were identified for impairment review based on their potential sale, resulting in shorter holding periods. The Company determined the fair value of each hotel was equal to the purchase price in the applicable definitive sales agreement. During the six months ended June 30, 2019 the Company recorded cumulative impairment losses on 13 hotel properties of $43.5 million. All but one of these 13 hotel properties were subject to definitive sale agreements as of June 30, 2019.

 

During the three and six months ended June 30, 2018, the Company identified four hotel properties where the carrying value of the properties exceeded their fair value and management determined the excess carrying value was unrecoverable. The Company recorded an aggregate impairment loss of $17.3 million on the four hotel properties during the three months ended June 30, 2018. These four hotels were identified for impairment review because of a long-term change in market conditions and the potential future sale of such properties. The Company determined the fair value of each hotel using a market and income-based approach. 

 

Note 15 - Subsequent Events

 

The Company has evaluated subsequent events through the filing of this Quarterly Report on Form 10-Q, and determined that there have not been any events that have occurred that would require adjustments to disclosures in the accompanying consolidated financial statements.

 

 

 

 

 

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The hotel business is capital-intensive and renovations are a regular part of the business. We have been undertaking a large-scale PIP program across a significant portion of the hotels in our portfolio. As of June 30, 2019, we have substantially completed work on 99 of the 141 hotels that are part of our PIP program, including six hotels that are among the 26 hotels we commenced marketing for sale during the quarter ended June 30, 2019. We completed PIP work on 13 hotels in 2017, 36 hotels in 2018 and 16 hotels to date in 2019. Due to the progress we have made in our PIP program and the commencement of increased disposition activity, going forward, we expect the number of hotels that undergo PIP renovations to moderate to less than ten hotels annually as we target for sale many of the remaining unrenovated hotels in our PIP program and we continue to selectively defer capital expenditures. We expect to substantially complete our PIP program over the next two to three years.

 

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A large-scale capital project that would cause a hotel to be considered to be under renovation is an extensive renovation of core aspects of the hotel, such as rooms, meeting space, lobby, bars, restaurants, and other public spaces. Both quantitative and qualitative factors are taken into consideration in determining if a particular renovation would cause a hotel to be considered to be under renovation for these purposes, including unusual or exceptional circumstances such as a reduction or increase in room count, a significant alteration of the business operations, or the closing of material portions of the hotel during the renovation. 

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