Attached files

file filename
EX-10.3 - EXHIBIT 10.3 - Summit Hotel OP, LPa6829610ex10-3.htm
EX-32.1 - EXHIBIT 32.1 - Summit Hotel OP, LPa6829610ex32-1.htm
EX-10.4 - EXHIBIT 10.4 - Summit Hotel OP, LPa6829610ex10-4.htm
EX-32.2 - EXHIBIT 32.2 - Summit Hotel OP, LPa6829610ex32-2.htm
EX-32.3 - EXHIBIT 32.3 - Summit Hotel OP, LPa6829610ex32-3.htm
EX-10.6 - EXHIBIT 10.6 - Summit Hotel OP, LPa6829610ex10-6.htm
EX-10.5 - EXHIBIT 10.5 - Summit Hotel OP, LPa6829610ex10-5.htm
EX-31.3 - EXHIBIT 31.3 - Summit Hotel OP, LPa6829610ex31-3.htm
EX-32.4 - EXHIBIT 32.4 - Summit Hotel OP, LPa6829610ex32-4.htm
EX-31.4 - EXHIBIT 31.4 - Summit Hotel OP, LPa6829610ex31-4.htm
EX-31.1 - EXHIBIT 31.1 - Summit Hotel OP, LPa6829610ex31-1.htm
EX-10.2 - EXHIBIT 10.2 - Summit Hotel OP, LPa6829610ex10-2.htm
EX-31.2 - EXHIBIT 31.2 - Summit Hotel OP, LPa6829610ex31-2.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________

FORM 10-Q
_________________


[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2011

OR

[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______________ to _______________

Commission File Number:  001-35074 (Summit Hotel Properties, Inc.)
Commission File Number:  001-54273 (Summit Hotel OP, LP)

SUMMIT HOTEL PROPERTIES, INC.
SUMMIT HOTEL OP, LP
(Exact name of registrant as specified in its charter)
_________________
 
Maryland (Summit Hotel Properties, Inc.)
27-2962512 (Summit Hotel Properties, Inc.)
Delaware (Summit Hotel OP, LP)
27-2966616 (Summit Hotel OP, LP)
(State or other jurisdiction
(I.R.S. Employer Identification No.)
of incorporation or organization)
 
 
2701 South Minnesota Avenue, Suite 6
Sioux Falls, SD 57105
(Address of principal executive offices, including zip code)

(605) 361-9566
(Registrant’s telephone number, including area code)
_________________
 
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.
Summit Hotel Properties, Inc.  [x] Yes    [ ]  No
Summit Hotel OP, LP  [x] Yes    [ ]  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405) of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Summit Hotel Properties, Inc.  [ ] Yes    [x]  No
Summit Hotel OP, LP  [ ] Yes    [x]  No
 
 
 

 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company in Rule 12b-2 of the Exchange Act.
 
Summit Hotel Properties, Inc.
 
Large accelerated filer  [ ]  Accelerated filer  [ ]
 Non-accelerated filer [x]  Smaller reporting company  [ ]
   
Summit Hotel OP, LP
 
Large accelerated filer  [ ]    Accelerated filer  [ ]
Non-accelerated filer [x]  Smaller reporting company  [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Summit Hotel Properties, Inc.  [ ] Yes    [x]  No Summit Hotel OP, LP  [ ] Yes    [x]  No
 
As of August 11, 2011, the number of outstanding shares of common stock of Summit Hotel Properties, Inc. was 27,278,000 and the number of outstanding units of partnership interest in Summit Hotel OP, LP designated as “Common Units” was 37,378,000, including Common Units held by Summit Hotel Properties, Inc. and its wholly owned subsidiary which is the general partner of Summit Hotel OP, LP.

 
 

 
 
EXPLANATORY NOTE
 
This report combines the Quarterly Reports on Form 10-Q for the three months ended June 30, 2011 of Summit Hotel Properties, Inc., a Maryland corporation, and Summit Hotel OP, LP, a Delaware limited partnership.
 
Unless stated otherwise or the context otherwise requires, references in this report to:
 
 
·
“Summit REIT” mean Summit Hotel Properties, Inc., a Maryland corporation;
 
 
·
“Summit OP” mean Summit Hotel OP, LP, a Delaware limited partnership, our operating partnership;
 
 
·
“our predecessor” mean Summit Hotel Properties, LLC, a South Dakota limited liability company that was merged into Summit OP on February 4, 2011 and is considered the acquiror for accounting purposes; and
 
 
·
“we,” “our,” “us,” “our company” or “the company” mean Summit REIT, Summit OP and their consolidated subsidiaries taken together as one enterprise. When this report discusses or refers to activities occurring prior to February 14, 2011, the date on which our operations commenced, these references refer to our predecessor.
 
Summit REIT is the sole member of Summit Hotel GP, LLC, a Delaware limited liability company, which is the sole general partner (the “General Partner”) of Summit OP.  Effective as of February 14, 2011, our predecessor merged with and into Summit OP, with the former members of our predecessor exchanging their membership interests in our predecessor for common units of partnership interest of Summit OP (“Common Units”) and Summit OP succeeding to the business and assets of our predecessor.  Also, on February 14, 2011, Summit REIT completed its initial public offering (“IPO”) and a concurrent private placement of its common stock and contributed the net proceeds of the IPO and concurrent private placement to Summit OP in exchange for Common Units.  As of June 30, 2011, Summit REIT owned an approximate 73% partnership interest in Summit OP, including the sole general partnership interest held by the General Partner.  As the sole member of the General Partner, Summit REIT has exclusive control of Summit OP’s day-to-day management.  The remaining interests in Summit OP are owned by third parties, including the former members of our predecessor.
 
We believe combining the Quarterly Reports on Form 10-Q of Summit REIT and Summit OP into this single report provides the following benefits:
 
 
·
it enhances investors’ understanding of Summit REIT and Summit OP by enabling investors to view the business as a whole in the same manner as management views and operates the business;
 
 
·
it eliminates duplicative disclosure and provides a more streamlined and readable presentation since a substantial portion of the disclosure applies to both Summit REIT and Summit OP; and
 
 
·
it creates time and cost efficiencies for both companies through the preparation of one combined report instead of two separate reports.
 
We also believe it is important to understand the few differences between Summit REIT and Summit OP in the context of how Summit REIT and Summit OP operate as a consolidated company.  Summit REIT intends to elect and qualify to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”), for its short taxable year ending December 31, 2011.
 
Summit REIT’s only material assets are its ownership of Common Units of Summit OP and its ownership of the membership interests in the General Partner.  As a result, Summit REIT does not conduct business itself, other than controlling, through the General Partner, Summit OP, raising capital through issuances of equity securities from time to time and guaranteeing certain debt of Summit OP and its subsidiaries.  Summit OP and its subsidiaries hold all the assets of the consolidated company.  Except for net proceeds from securities issuances by Summit REIT, which are contributed to Summit OP in exchange for partnership units of Summit OP, Summit OP and its subsidiaries generate capital from the operation of our business and through borrowings and the issuance of partnership units of Summit OP.
 
 
 

 
 
Stockholders’ equity, partners’ capital and noncontrolling interests are the main areas of difference between the consolidated financial statements of Summit REIT and those of Summit OP.  Summit OP’s capital interests include Common Units representing general and limited partnership interests.  The Common Units owned by limited partners other than Summit REIT and its subsidiaries are accounted for in partners’ capital in Summit OP’s consolidated financial statements and within stockholders’ equity in Summit REIT’s consolidated financial statements as noncontrolling interests.
 
In order to highlight the differences between Summit REIT and Summit OP, there are sections in this report that separately discuss Summit REIT and Summit OP, including separate financial statements and notes thereto and separate Exhibit 31 and Exhibit 32 certifications.  In the sections that combine disclosure for Summit REIT and Summit OP (i.e., where the disclosure refers to the consolidated company), this report refers to actions or holdings as our actions or holdings and, unless otherwise indicated, means the actions or holdings of Summit REIT and Summit OP and their respective subsidiaries, as one consolidated enterprise.
 
As the sole member of the General Partner, Summit REIT consolidates Summit OP for financial reporting purposes, and Summit REIT does not have assets other than its investment in the General Partner and Summit OP.  Therefore, while stockholders’ equity and partners’ capital differ as discussed above, revenues and expenses, and the assets and liabilities of Summit REIT and Summit OP are the same on their respective financial statements.
 
Finally, we refer to a number of other entities in this report as follows.  Unless the context otherwise requires or indicates, references in this report to:
 
 
·
“our predecessor” include Summit Group of Scottsdale, Arizona, LLC (“Summit of Scottsdale”);
 
 
·
“our TRSs” refer to Summit Hotel TRS, Inc., a Delaware corporation, and Summit Hotel TRS II, Inc., a Delaware corporation, and any other taxable REIT subsidiaries (“TRSs”) that we may form in the future;
 
 
·
“our TRS lessees” refer to our TRSs and the wholly owned subsidiaries of our TRSs that lease our hotels from Summit OP or subsidiaries of Summit OP; and
 
 
·
“The Summit Group” refer to The Summit Group, Inc., our predecessor’s hotel management company, Company Manager and Class C Member, which is wholly owned by our Executive Chairman, Kerry W. Boekelheide.
 
 
 

 

TABLE OF CONTENTS
 
Page 
 
PART I — FINANCIAL INFORMATION
 
         
Item 1.
Financial Statements.
    1  
           
 
Summit Hotel Properties, Inc. and Summit Hotel Properties, LLC (Predecessor)
       
 
Condensed Consolidated Balance Sheets (unaudited) — June 30, 2011 and December 31, 2010
    1  
 
Condensed Consolidated Statements of Operations (unaudited) — Three and Six Months Ended
       
 
June 30, 2011 and 2010
    2  
 
Condensed Consolidated Statements of Changes in Equity (unaudited) — Six Months Ended
       
 
June 30, 2011
    3  
 
Condensed Consolidated Statements of Cash Flows (unaudited) — Six Months Ended
       
 
June 30, 2011 and 2010
    4  
           
 
Summit Hotel OP, LP and Summit Hotel Properties, LLC (Predecessor)
       
 
Condensed Consolidated Balance Sheets (unaudited) — June 30, 2011 and December 31, 2010
    6  
 
Condensed Consolidated Statements of Operations (unaudited) — Three and Six Months Ended
       
 
June 30, 2011 and 2010
    7  
 
Condensed Consolidated Statements of Changes in Equity (unaudited) — Six Months Ended
       
 
June 30, 2011
    8  
 
Condensed Consolidated Statements of Cash Flows (unaudited) — Six Months Ended
       
 
June 30, 2011 and 2010
    9  
           
 
Notes to Condensed Consolidated Financial Statements
    11  
           
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
    22  
           
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
    46  
           
Item 4.
Controls and Procedures.
    46  
   
PART II — OTHER INFORMATION
 
           
Item 1.
Legal Proceedings.
    47  
           
Item 1A.
Risk Factors.
    47  
           
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
    47  
           
Item 3.
Defaults Upon Senior Securities.
    48  
           
Item 4.
[Removed and Reserved.]
    48  
           
Item 5.
Other Information.
    48  
           
Item 6.
Exhibits.
    48  
 

 
 

 
 
PART I — FINANCIAL INFORMATION
 
Item 1.               Financial Statements
 
SUMMIT HOTEL PROPERTIES, INC. AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 2011 AND DECEMBER 31, 2010 

 
   
Summit Hotel Properties, Inc.
 
Summit Hotel Properties, LLC (Predecessor)
   
2011
 
2010
ASSETS
           
             
             
  Cash and cash equivalents
  $ 29,589,139     $ 7,977,418  
  Restricted cash
    1,024,109       1,933,268  
  Trade receivables
    4,484,399       2,665,076  
  Receivable due from affiliate
    -       4,620,059  
  Prepaid expenses and other
    3,118,765       1,738,645  
  Land held for development
    20,294,973       20,294,973  
  Property and equipment, net
    478,633,469       445,715,804  
  Deferred charges and other assets, net
    9,944,564       4,051,295  
  Other assets
    3,594,787       4,011,992  
          TOTAL ASSETS
  $ 550,684,205     $ 493,008,530  
                 
                 
LIABILITIES AND EQUITY
               
                 
LIABILITIES
               
  Accounts payable
  $ 940,827     $ 864,560  
  Related party accounts payable
    -       771,066  
  Accrued expenses
    14,623,459       11,092,131  
  Mortgages and notes payable
    251,720,675       420,437,207  
          TOTAL LIABILITIES
    267,284,961       433,164,964  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
EQUITY
               
  Members' equity
    -       61,468,029  
  Common stock, $.01 par value per share,  450,000,000 shares authorized,
               
            27,278,000 issued and oustanding as of June 30, 2011
    272,780       -  
  Additional paid-in capital
    240,885,162       -  
  Accumulated deficit and distributions
    (2,272,324 )     -  
  Total stockholders' equity
    238,885,618       61,468,029  
  Noncontrolling interest
    44,513,626       (1,624,463 )
          TOTAL EQUITY
    283,399,244       59,843,566  
                 
          TOTAL LIABILITIES AND EQUITY
  $ 550,684,205     $ 493,008,530  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
1

 
 
SUMMIT HOTEL PROPERTIES, INC. AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010 

 
   
Summit Hotel Properties, Inc.
 
Summit Hotel Properties, LLC (Predecessor)
 
Summit Hotel Properties, Inc.
 
Summit Hotel Properties, LLC
(Predecessor)
   
Three Months Ended 6/30/11
 
Three Months Ended 6/30/10
 
Period 2/14/11
through 6/30/11
 
Period 1/1/11
through 2/13/11
 
Six Months Ended 6/30/10
                               
REVENUES
                             
  Room revenues
  $ 37,824,945     $ 35,258,817     $ 56,271,795     $ 14,268,042     $ 65,938,663  
  Other hotel operations revenues
    763,619       590,909       1,125,918       330,251       1,273,783  
Total Revenue
    38,588,564       35,849,726       57,397,713       14,598,293       67,212,446  
                                         
EXPENSES
                                       
Hotel operating expenses
                                       
  Rooms
    11,727,100       10,505,996       16,643,700       4,960,450       20,048,040  
  Other direct
    5,031,210       4,158,337       7,152,417       2,657,760       8,286,682  
  Other indirect
    9,179,041       9,244,765       14,113,569       4,686,274       17,681,096  
  Other
    201,047       152,108       274,085       73,038       302,361  
Total hotel operating expenses
    26,138,398       24,061,206       38,183,771       12,377,522       46,318,179  
  Depreciation and amortization
    6,819,608       6,671,258       10,248,823       3,429,216       13,521,822  
  Corporate general and administrative:
                                       
     Salaries and other compensation
    699,014       -       1,066,032       -       -  
     Other
    774,459       -       1,549,811       -       -  
     Equity based compensation
    175,656       -       302,484       -       -  
  Hotel property acquisition costs
    -       (9,173 )     -       -       56,519  
Total Expenses
    34,607,135       30,723,291       51,350,921       15,806,738       59,896,520  
                                         
INCOME (LOSS) FROM OPERATIONS
    3,981,429       5,126,435       6,046,792       (1,208,445 )     7,315,926  
                                         
OTHER INCOME (EXPENSE)
                                       
  Interest income
    10,280       11,474       14,227       7,139       23,559  
  Interest expense
    (3,007,640 )     (7,133,904 )     (6,518,769 )     (4,666,216 )     (12,701,101 )
  Gain (loss) on disposal of assets
    (36,031 )     (1,938 )     (36,031 )     -       (39,389 )
Total Other Income (Expense)
    (3,033,391 )     (7,124,368 )     (6,540,573 )     (4,659,077 )     (12,716,931 )
                                         
INCOME (LOSS) FROM CONTINUING OPERATIONS
    948,038       (1,997,933 )     (493,781 )     (5,867,522 )     (5,401,005 )
                                         
INCOME TAX EXPENSE
    (344,177 )     (75,702 )     (516,479 )     (339,034 )     (228,185 )
                                         
NET INCOME (LOSS)
    603,861       (2,073,635 )     (1,010,260 )     (6,206,556 )     (5,629,190 )
                                         
NET INCOME (LOSS) ALLOCATED TO
                                       
    NONCONTROLLING INTEREST
    163,042       -       (272,770 )     -       -  
                                         
NET INCOME (LOSS) ALLOCATED TO COMMON
  $ 440,819     $ (2,073,635 )   $ (737,490 )   $ (6,206,556 )   $ (5,629,190 )
   STOCKHOLDERS
                                       
                                         
Net income (loss) per share:
                                       
  Basic and diluted
  $ 0.02             $ (0.03 )                
Weighted-average common shares outstanding:
                                       
  Basic and diluted
    27,278,000               27,278,000                  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
2

 
 
SUMMIT HOTEL PROPERTIES, INC. AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2011 

 
                           
Total
           
   
# of Shares
             
Accumulated
 
Stockholders'/
           
   
of Common
 
Common
 
Additional
 
Deficit and
  Members'  
Noncontrolling
 
Total
   
Stock
 
Stock
 
Paid-In Capital
 
Distributions
 
Equity
 
Interest
 
Equity
Predecessor
                                         
BALANCES, JANUARY 1, 2011
  -     $ -     $ -     $ -     $ 61,468,029     $ (1,624,463 )   $ 59,843,566  
                                                       
Net income (loss)
  -       -       -       -       (6,206,556 )     -       (6,206,556 )
                                                       
Distributions to members
  -       -       -       -       (8,282,935 )     -       (8,282,935 )
                                                       
BALANCES, FEBRUARY 13, 2011
  -     $ -     $ -     $ -     $ 46,978,538     $ (1,624,463 )   $ 45,354,075  
                                                       
Summit Hotel Properties, Inc.
                                                     
Equity from Predecessor
  -     $ -     $ -     $ -     $ -     $ 45,354,075     $ 45,354,075  
Net proceeds from sale of common stock
  27,278,000       272,780       240,582,678       -       240,855,458       -       240,855,458  
Dividends paid
  -       -       -       (1,534,834 )     (1,534,834 )     (567,679 )     (2,102,513 )
Equity-based compensation
  -       -       302,484       -       302,484       -       302,484  
Net income (loss)
  -       -       -       (737,490 )     (737,490 )     (272,770 )     (1,010,260 )
                                                       
BALANCES, JUNE 30, 2011
  27,278,000     $ 272,780     $ 240,885,162     $ (2,272,324 )   $ 238,885,618     $ 44,513,626     $ 283,399,244  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
3

 
 
SUMMIT HOTEL PROPERTIES, INC. AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 

 
   
2011
 
2010
             
OPERATING ACTIVITIES
           
  Net income (loss)
  $ (7,216,816 )   $ (5,629,190 )
  Adjustments to reconcile net income to
               
   net cash from operating activities:
               
    Depreciation and amortization
    13,678,039       13,521,822  
    Amortization of prepaid lease
    23,700       23,700  
    Equity-based compensation
    302,484       -  
    (Gain) loss on disposal of assets
    36,031       39,389  
  Changes in operating assets and liabilities:
               
    Trade receivables
    (1,819,323 )     (1,807,872 )
    Prepaid expenses and other
    3,239,939       341,479  
    Accounts payable and related party accounts payable
    (694,799 )     (64,614 )
    Accrued expenses
    3,531,328       1,277,181  
    Restricted cash released (funded)
    909,159       85,210  
                 
NET CASH PROVIDED BY (USED IN)
    11,989,742       7,787,105  
  OPERATING ACTIVITIES
               
                 
INVESTING ACTIVITIES
               
  Land and hotel acquisitions and construction in progress
    (37,700,000 )     (604,232 )
  Purchases of other property and equipment
    (11,147,843 )     (1,018,274 )
  Proceeds from asset dispositions, net of closing costs
    357,843       7,246  
                 
NET CASH PROVIDED BY (USED IN)
    (48,490,000 )     (1,615,260 )
  INVESTING ACTIVITIES
               
                 
FINANCING ACTIVITIES
               
  Proceeds from issuance of debt
    57,882,528       3,348,350  
  Principal payments on debt
    (226,599,060 )     (4,934,721 )
  Financing fees on debt
    (3,641,499 )     (963,060 )
  Proceeds from sale of common stock, net of offering costs
    240,855,458       -  
  Distributions to members
    (10,385,448 )     (535,261 )
                 
NET CASH PROVIDED BY (USED IN)
    58,111,979       (3,084,692 )
  FINANCING ACTIVITIES
               
                 
NET CHANGE IN CASH AND CASH EQUIVALENTS
    21,611,721       3,087,153  
                 
CASH AND CASH EQUIVALENTS
               
  BEGINNING OF PERIOD
    7,977,418       8,239,225  
 
               
  END OF PERIOD
  $ 29,589,139     $ 11,326,378  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
4

 
 
SUMMIT HOTEL PROPERTIES, INC. AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 

 
   
2011
 
2010
             
SUPPLEMENTAL DISCLOSURE OF
           
  CASH FLOW INFORMATION:
           
    Cash payments for interest
  $ 12,122,358     $ 12,357,600  
                 
    Cash payments for state income taxes
  $ 568,967     $ 51,386  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
5

 
 
SUMMIT HOTEL OP, LP AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 2011 AND DECEMBER 31, 2010 

 
   
Summit Hotel
OP, LP
 
Summit Hotel Properties, LLC (Predecessor)
   
2011
 
2010
ASSETS
           
             
             
  Cash and cash equivalents
  $ 29,589,139     $ 7,977,418  
  Restricted cash
    1,024,109       1,933,268  
  Trade receivables
    4,484,399       2,665,076  
  Receivable due from affiliate
    -       4,620,059  
  Prepaid expenses and other
    3,118,765       1,738,645  
  Land held for development
    20,294,973       20,294,973  
  Property and equipment, net
    478,633,469       445,715,804  
  Deferred charges and other assets, net
    9,944,564       4,051,295  
  Other assets
    3,594,787       4,011,992  
          TOTAL ASSETS
  $ 550,684,205     $ 493,008,530  
                 
                 
LIABILITIES AND EQUITY
               
                 
LIABILITIES
               
  Accounts payable
  $ 940,827     $ 864,560  
  Related party accounts payable
    -       771,066  
  Accrued expenses
    14,623,459       11,092,131  
  Mortgages and notes payable
    251,720,675       420,437,207  
          TOTAL LIABILITIES
    267,284,961       433,164,964  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
EQUITY
               
  Members' equity
    -       61,468,029  
  Partners' equity:
               
     Summit Hotel Properties Inc., 27,278,000 units outstanding
    238,885,618       -  
     Unaffiliated Limited partners, 10,100,000 units outstanding
    44,513,626       -  
  Total members'/partners' equity
    283,399,244       61,468,029  
  Noncontrolling interest
    -       (1,624,463 )
          TOTAL EQUITY
    283,399,244       59,843,566  
                 
          TOTAL LIABILITIES AND EQUITY
  $ 550,684,205     $ 493,008,530  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
6

 
 
SUMMIT HOTEL OP, LP AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 

 
   
Summit Hotel OP, LP
 
Summit Hotel Properties, LLC (Predecessor)
 
Summit Hotel OP, LP
 
Summit Hotel Properties, LLC
(Predecessor)
   
Three Months Ended 6/30/11
 
Three Months Ended 6/30/10
 
Period 2/14/11
through 6/30/11
 
Period 1/1/11
through 2/13/11
 
Six Months Ended 6/30/10
                               
REVENUES
                             
  Room revenues
  $ 37,824,945     $ 35,258,817     $ 56,271,795     $ 14,268,042     $ 65,938,663  
  Other hotel operations revenues
    763,619       590,909       1,125,918       330,251       1,273,783  
Total Revenue
    38,588,564       35,849,726       57,397,713       14,598,293       67,212,446  
                                         
EXPENSES
                                       
Hotel operating expenses
                                       
  Rooms
    11,727,100       10,505,996       16,643,700       4,960,450       20,048,040  
  Other direct
    5,031,210       4,158,337       7,152,417       2,657,760       8,286,682  
  Other indirect
    9,179,041       9,244,765       14,113,569       4,686,274       17,681,096  
  Other
    201,047       152,108       274,085       73,038       302,361  
Total hotel operating expenses
    26,138,398       24,061,206       38,183,771       12,377,522       46,318,179  
  Depreciation and amortization
    6,819,608       6,671,258       10,248,823       3,429,216       13,521,822  
  Corporate general and administrative:
                                       
     Salaries and other compensation
    699,014       -       1,066,032       -       -  
     Other
    774,459       -       1,549,811       -       -  
     Equity based compensation
    175,656       -       302,484       -       -  
  Hotel property acquisition costs
    -       (9,173 )     -       -       56,519  
Total Expenses
    34,607,135       30,723,291       51,350,921       15,806,738       59,896,520  
                                         
INCOME (LOSS) FROM OPERATIONS
    3,981,429       5,126,435       6,046,792       (1,208,445 )     7,315,926  
                                         
OTHER INCOME (EXPENSE)
                                       
  Interest income
    10,280       11,474       14,227       7,139       23,559  
  Interest expense
    (3,007,640 )     (7,133,904 )     (6,518,769 )     (4,666,216 )     (12,701,101 )
  Gain (loss) on disposal of assets
    (36,031 )     (1,938 )     (36,031 )     -       (39,389 )
Total Other Income (Expense)
    (3,033,391 )     (7,124,368 )     (6,540,573 )     (4,659,077 )     (12,716,931 )
                                         
INCOME (LOSS) FROM CONTINUING OPERATIONS
    948,038       (1,997,933 )     (493,781 )     (5,867,522 )     (5,401,005 )
                                         
INCOME TAX EXPENSE
    (344,177 )     (75,702 )     (516,479 )     (339,034 )     (228,185 )
                                         
NET INCOME (LOSS)
    603,861       (2,073,635 )     (1,010,260 )     (6,206,556 )     (5,629,190 )
                                         
                                         
Net income (loss) per unit:
                                       
  Basic and diluted
  $ 0.02             $ (0.03 )                
Weighted-average units outstanding:
                                       
  Basic and diluted
    37,378,000               37,378,000                  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
7

 
 
SUMMIT HOTEL OP, LP AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2011

 
         
Total
           
   
Summit Hotel
 
Members'/Unaffiliated
Limited
 
Noncontrolling
 
Total
   
Properties Inc.
 
Partners' Equity
 
Interest
 
Equity
Predecessor
                       
BALANCES, JANUARY 1, 2011
  $ -     $ 61,468,029     $ (1,624,463 )   $ 59,843,566  
                                 
Net income (loss)
    -       (6,206,556 )     -       (6,206,556 )
                                 
Distributions to members
    -       (8,282,935 )     -       (8,282,935 )
                                 
BALANCES, FEBRUARY 13, 2011
  $ -     $ 46,978,538     $ (1,624,463 )   $ 45,354,075  
                                 
Summit Hotel OP, LP
                               
Equity from predecessor/limited partners
  $ -     $ 45,354,075     $ -     $ 45,354,075  
Contributions
    240,855,458       -       -       240,855,458  
Dividends paid
    (1,534,834 )     (567,679 )     -       (2,102,513 )
Equity-based compensation
    302,484       -       -       302,484  
Net income (loss)
    (737,490 )     (272,770 )     -       (1,010,260 )
                                 
BALANCES, JUNE 30, 2011
  $ 238,885,618     $ 44,513,626     $ -     $ 283,399,244  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
8

 
 
SUMMIT HOTEL OP, LP AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010 

 
   
2011
 
2010
             
OPERATING ACTIVITIES
           
  Net income (loss)
  $ (7,216,816 )   $ (5,629,190 )
  Adjustments to reconcile net income to
               
   net cash from operating activities:
               
    Depreciation and amortization
    13,678,039       13,521,822  
    Amortization of prepaid lease
    23,700       23,700  
    Equity-based compensation
    302,484       -  
    (Gain) loss on disposal of assets
    36,031       39,389  
  Changes in operating assets and liabilities:
               
    Trade receivables
    (1,819,323 )     (1,807,872 )
    Prepaid expenses and other
    3,239,939       341,479  
    Accounts payable and related party accounts payable
    (694,799 )     (64,614 )
    Accrued expenses
    3,531,328       1,277,181  
    Restricted cash released (funded)
    909,159       85,210  
                 
NET CASH PROVIDED BY (USED IN)
    11,989,742       7,787,105  
  OPERATING ACTIVITIES
               
                 
INVESTING ACTIVITIES
               
  Land and hotel acquisitions and construction in progress
    (37,700,000 )     (604,232 )
  Purchases of other property and equipment
    (11,147,843 )     (1,018,274 )
  Proceeds from asset dispositions, net of closing costs
    357,843       7,246  
                 
NET CASH PROVIDED BY (USED IN)
    (48,490,000 )     (1,615,260 )
  INVESTING ACTIVITIES
               
                 
FINANCING ACTIVITIES
               
  Proceeds from issuance of debt
    57,882,528       3,348,350  
  Principal payments on debt
    (226,599,060 )     (4,934,721 )
  Financing fees on debt
    (3,641,499 )     (963,060 )
  Proceeds from sale of common stock, net of offering costs
    240,855,458       -  
  Distributions to members
    (10,385,448 )     (535,261 )
                 
NET CASH PROVIDED BY (USED IN)
    58,111,979       (3,084,692 )
  FINANCING ACTIVITIES
               
                 
NET CHANGE IN CASH AND CASH EQUIVALENTS
    21,611,721       3,087,153  
                 
CASH AND CASH EQUIVALENTS
               
  BEGINNING OF PERIOD
    7,977,418       8,239,225  
 
               
  END OF PERIOD
  $ 29,589,139     $ 11,326,378  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
9

 
 
SUMMIT HOTEL OP, LP AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010

 
   
2011
 
2010
             
SUPPLEMENTAL DISCLOSURE OF
           
  CASH FLOW INFORMATION:
           
    Cash payments for interest
  $ 12,122,358     $ 12,357,600  
                 
    Cash payments for state income taxes
  $ 568,967     $ 51,386  
 
 
(See Notes to Condensed Consolidated Financial Statements)
 
 
10

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
NOTE 1 -     SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS

Basis of Presentation

Summit Hotel Properties, Inc. (the “Company”) is a self-advised hotel investment company that was organized on June 30, 2010 as a Maryland corporation.  The Company holds both general and limited partner interests in Summit Hotel OP, LP (the “Operating Partnership”), a Delaware limited partnership also organized on June 30, 2010.  On February 14, 2011, the Company closed on its initial public offering (“IPO”) of 26,000,000 shares of common stock and a concurrent private placement of 1,274,000 shares of common stock.  Effective February 14, 2011, the Operating Partnership and Summit Hotel Properties, LLC, (the Predecessor”) completed the merger of the Predecessor with and into the Operating Partnership (the “Merger”). At the effective time of the Merger, the outstanding Class A, Class A-1, Class B and Class C membership interests in the Predecessor were converted into, and cancelled in exchange for, a total of 9,993,992 common units of partnership interest in the Operating Partnership (“Common Units”), and the members of the Predecessor were admitted as limited partners of the Operating Partnership. Also effective February 14, 2011, The Summit Group, Inc., the parent company of the Predecessor (“The Summit Group”), contributed its 36% Class B membership interest in Summit Group of Scottsdale, AZ LLC (“Summit of Scottsdale”) to the Operating Partnership in exchange for 74,829 Common Units and an unaffiliated third-party investor contributed its 15% Class C membership interest in Summit of Scottsdale to the Operating Partnership in exchange for 31,179 Common Units.  Effective February 14, 2011, the Company contributed the net proceeds of the IPO and the concurrent private placement to the Operating Partnership in exchange for an aggregate of 27,274,000 Common Units.  A wholly owned subsidiary of the Company is the sole general partner of the Operating Partnership.  Unless the context otherwise requires, “we” and “our” refer to the Company and the Operating Partnership collectively.
 
For accounting and financial reporting purposes, the Predecessor is considered the acquiror in the Merger. As a result, the historical consolidated financial statements of the Predecessor are presented as the historical consolidated financial statements of the Company and the Operating Partnership after completion of the Merger and the contributions of the Class B and C membership interests in Summit of Scottsdale to the Operating Partnership (collectively, the “Reorganization Transaction”).
 
As a result of the Reorganization Transaction, the Operating Partnership and its subsidiaries acquired sole ownership of the 65 hotels in its initial portfolio. In addition, the Operating Partnership and its subsidiaries assumed the liabilities, including indebtedness, of the Predecessor and its subsidiaries.

As of June 30, 2011, our real estate investment portfolio consists of 69 upscale, upper midscale and midscale hotels with a total of 7,010 guestrooms located in small, mid-sized and suburban markets in 19 states.  (see Note 8 for new acquisitions)  The hotels are leased to subsidiaries (“TRS Lessees”) of the Company’s taxable REIT subsidiaries (“TRSs”).  The Company indirectly owns 100% of the outstanding equity interests in the TRS Lessees.

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for reporting on interim periods.  Accordingly, certain information and footnotes required by Generally Accepted Accounting Principles (“GAAP”) for complete financial statements have been condensed or omitted.  Interim results may not be indicative of fiscal year performance because of seasonal and other factors.  These interim statements should be read in conjunction with the financial statements and notes thereto included in our combined Annual Report on Form 10-K filing for the year ended December 31, 2010.  In management’s opinion, all adjustments made were normal and recurring in nature, and were necessary for a fair statement of the results of the interim period.  The December 31, 2010 balance sheet has been derived from the Predecessor’s audited financial statements included in our combined Annual Report on Form 10-K for the year ended December 31, 2010.
 
 
11

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
Use of Estimates

The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Consolidation

The accompanying consolidated financial statements of the Company include the accounts of the Company, the Operating Partnership, and the Operating Partnership’s subsidiaries.  The accompanying consolidated financial statements of the Operating Partnership include the accounts of the Operating Partnership and its subsidiaries. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.

Reclassifications

Certain reclassifications have been made to the prior-year financial information of the Predecessor to conform to our current-year presentation as follows for the six months ended June 30:
 
to reclassify (a) $20.0 million of direct hotel operations expense (wages, payroll taxes and benefits, linens, cleaning and guestroom supplies and complimentary breakfast) as rooms expense; and (b) $3.0 million of direct hotel operations expense (franchise royalties) as other indirect expense;
   
to reclassify (a) $4.1 million of other hotel operating expense (utilities and telephone) as other direct expense; and (b) $5.1 million of other hotel operating expense (property taxes, insurance and cable) as other indirect expense;
   
to reclassify (a) $2.1 million of general, selling and administrative expense (office supplies, advertising, miscellaneous operating expenses and bad debt expense) as other direct expenses; (b) $9.7 million of general, selling and administrative expense (credit card/travel agent commissions, management company expense, management company legal and accounting fees and franchise fees) as other indirect expenses; and (c) $302,000 of general, selling and administrative expense (ground rent and other expense) as other expense;
   
to reclassify $2.1 million of repairs and maintenance expense as other direct expenses; and
   
to reclassify $57,000 of other indirect expense (hotel startup costs) as hotel property acquisition costs.
 
 
12

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
Certain reclassifications have been made to the prior-year financial information of the Predecessor to conform to our current-year presentation as follows for the three months ended June 30:
 
to reclassify (a) $10.5 million of direct hotel operations expense (wages, payroll taxes and benefits, linens, cleaning and guestroom supplies and complimentary breakfast) as rooms expense; and (b) $1.6 million of direct hotel operations expense (franchise royalties) as other indirect expense;
   
to reclassify (a) $2.0 million of other hotel operating expense (utilities and telephone) as other direct expense; and (b) $2.6 million of other hotel operating expense (property taxes, insurance and cable) as other indirect expense;
   
to reclassify (a) $1.0 million of general, selling and administrative expense (office supplies, advertising, miscellaneous operating expenses and bad debt expense) as other direct expenses; (b) $5.1 million of general, selling and administrative expense (credit card/travel agent commissions, management company expense, management company legal and accounting fees and franchise fees) as other indirect expenses; and (c) $152,000 of general, selling and administrative expense (ground rent and other expense) as other expense;
   
to reclassify $1.2 million of repairs and maintenance expense as other direct expenses; and
   
to reclassify ($9,000) of other indirect expense (hotel startup costs) as hotel property acquisition costs.
 
New Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued an update (ASU No. 2010-06) to Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, to improve disclosure requirements regarding transfers, classes of assets and liabilities, and inputs and valuation techniques.  Certain provisions of ASU No. 2010-06 to ASC 820 related to separate line items for all purchases, sales, issuances, and settlements of financial instruments valued using Level 3 are effective for fiscal years beginning after December 15, 2010.  The adoption of this ASC update on January 1, 2011 had no material impact on the consolidated financial statements or disclosures of the Company, the Operating Partnership or the Predecessor.

In May 2011, FASB issued an update (ASU No. 2011-04) to ASC 820, Fair Value Measurements and Disclosures, to develop common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and IFRS.  This update is effective for interim and fiscal years beginning after December 15, 2011.  The Company does not feel that this will have a material impact on the consolidated financial statements.

In June 2011, FASB issued ASU 2011-05, Presentation of comprehensive Income.  ASU 2011-05 requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in equity.  ASU 2011-05 is effective for interim and fiscal years beginning after December 15, 2011.  The Company does not feel that this will have a material impact on the consolidated financial statements.
 
 
13

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
Revenue Recognition

Revenue is recognized when rooms are occupied and services have been rendered.

Fair Value

FASB ASC 820 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements.   Fair value is defined under generally accepted accounting principles as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Valuation techniques used to measure fair value, as required by Topic 820 of the FASB ASC, must maximize the use of observable inputs and minimize the use of unobservable inputs.

Our estimates of the fair value of financial instruments as of June 30, 2011 were determined using available market information and appropriate valuation methods.  Considerable judgment is necessary to interpret market data and develop estimated fair value.  The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.

The carrying amounts of cash and cash equivalents, restricted cash, receivables, accounts payable and other liabilities approximate fair value due to the short-term nature of these instruments.

As of June 30, 2011, the aggregate fair value of our consolidated mortgages and notes payable is approximately $253.5 million, compared to the aggregate carrying value of approximately $251.7 million on our consolidated balance sheet.  As of December 31, 2010, the aggregate fair value was approximately $401.2 million compared to the aggregate carrying value of approximately $400.8 million.

FASB ASC 820 also requires that non-financial assets and non-financial liabilities be disclosed at fair value in the financial statements if these items are measured at fair value on a non-recurring basis, such as in determining impairment loss or the value of assets held for sale as described below.

Depreciation and Amortization of Hotels

Hotels are carried at cost and depreciated using the straight-line method over an estimated useful life of 27 to 40 years for buildings and two to 15 years for furniture, fixtures and equipment. We are required to make subjective assessments as to the useful lives and classification of our properties for purposes of determining the amount of depreciation expense to reflect each year with respect to the assets.

Long-Lived Assets and Impairment

We apply the provisions of FASB ASC 360, Property Plant and Equipment, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets.

We monitor events and changes in circumstances for indicators that the carrying value of a hotel and related assets may be impaired. Factors that could trigger an impairment analysis include, among others: (1) significant underperformance relative to historical or projected operating results, (2) significant changes in the manner of use of a hotel or the strategy of our overall business, (3) a significant increase in competition, (4) a significant adverse change in legal factors or regulations or (5) significant negative industry or economic trends. When such factors are identified, we prepare an estimate of the undiscounted future cash flows, without interest charges, of the specific hotel and determine if the investment in such hotel is recoverable based on the undiscounted future cash flows. If impairment is indicated, an adjustment is made to the carrying value of the hotel to reflect the hotel at fair value.
 
 
14

 

SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
Assets Held for Sale

FASB ASC 360 requires a long-lived asset to be sold to be classified as “held for sale” in the period in which certain criteria are met, including that the sale of the asset within one year is probable.  FASB ASC 360 also requires that the results of operations of a component of an entity that either has been disposed of or is classified as held for sale be reported in discontinued operations if the operations and cash flows of the component have been or will be eliminated from our ongoing operations.

As a part of regular policy, we periodically review hotels based on established criteria such as age of hotel property, type of franchise associated with hotel property, and adverse economic and competitive conditions in the region surrounding the property.  During the period, we completed a comprehensive review of our investment strategy and of our existing hotel portfolio to identify properties which we believe is either non-core or no longer complement the business as required by FASB ASC 360.  We do not believe that any properties meet this criteria at this time.

Acquisitions

We allocate the purchase price of acquisitions based on the fair value of the acquired land, building, furniture, fixtures and equipment, goodwill, other assets and assumed liabilities. We determine the acquisition-date fair values of all assets and assumed liabilities using methods similar to those used by independent appraisers, for example, using a discounted cash flow analysis that utilizes appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. Acquisition costs are expensed as incurred.

Equity-Based Compensation

We have adopted the 2011 Equity Incentive Plan, which provides for the grants of stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights and other stock-based awards, or any combination of the foregoing. Equity-based compensation is recognized as an expense in the financial statements over the vesting period and measured at the fair value of the award on the date of grant. The amount of the expense may be subject to adjustment in future periods depending on the specific characteristics of the equity-based award and the application of accounting guidance.

Income Taxes

We have elected to be taxed as a REIT under the Code. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute annually to our stockholders at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains, which does not necessarily equal net income as calculated in accordance with GAAP. As a REIT, we generally will not be subject to federal income tax (other than taxes paid by our TRSs) to the extent we currently distribute 100% of our REIT taxable income to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for the four taxable years following the year during which qualification is lost unless we satisfy certain relief provisions.
 
 
15

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
We accounted for federal and state income taxes with respect to our TRSs using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statements’ carrying amounts of existing assets and liabilities and respective tax bases and operating losses and tax-credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

NOTE 2 -     INITIAL PUBLIC OFFERING

As noted above, on February 14, 2011, the Company closed its IPO of 26,000,000 shares of common stock and its concurrent private placement of 1,274,000 shares of common stock. Net proceeds received by the Company and the Operating Partnership from the IPO and the concurrent private placement were $240.9 million, after deducting the underwriting discount related to the IPO of $17.7 million and the payment of offering expenses of approximately $7.3 million.  The Company contributed the net proceeds of the IPO and the concurrent private placement to the Operating Partnership in exchange for Common Units.

NOTE 3 -     ACQUISITIONS

We have made four acquisitions during the second quarter of 2011. We purchased the Homewood Suites in Ridgeland, MS on April 15, 2011 for approximately $7.3 million, the Staybridge Suites in Glendale, CO on April 27, 2011 for approximately $10.0 million, the Holiday Inn in Duluth, GA on April 27, 2011 for approximately $7.0 million, and the Hilton Garden Inn in Duluth, GA for approximately $13.4 million on May 25, 2011.  The purchases were financed with borrowings under our unsecured revolving credit facility.  We did not acquire any intangibles or assume any debt related to these four acquisitions.

The following table illustrates the allocation of the aggregated purchase prices for the purchases discussed above during 2011:
 
 
    2011
       
       
Land     5,614  
Hotel buildings and improvements     31,054  
Furniture, fixtures and equipment     1,032  
Current assets     310  
Total assets acquired     38,010  
Current liabilities     296  
Net assets acquired     37,714  
 
 
16

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
NOTE 4 -     DEBT OBLIGATIONS

A detail of mortgage loans and notes payable at June 30, 2011 and December 31, 2010, are comprised of the following:
 
   
2011
 
2010
             
Fixed-rate mortgage loans
  $ 112.1     $ 170.1  
Variable-rate mortgage loans
    139.6       250.3  
    $ 251.7     $ 420.4  
 
We utilized a portion of the IPO proceeds to pay down outstanding mortgage indebtedness. During the three months ended March 31, 2011, we utilized approximately $227.2 million to reduce outstanding mortgage indebtedness and pay associated costs, as follows:
 
approximately $89.3 million to repay in full a loan from Fortress Credit Corp., including approximately $2.1 million of exit fees, interest and legal fees;
   
approximately $78.2 million to repay in full a loan originally made by Lehman Brothers Bank, including approximately $1.4 million to pay an extinguishment premium and other transaction costs;
   
approximately $21.4 million to repay in full two loans from Marshall & Isley Bank; and
   
approximately $38.3 million to repay in full two loans from First National Bank of Omaha.

In connection with the March 23, 2011 termination of franchise agreements with Choice, we executed agreements with ING Investment Management and with GECC in connection with the termination of the franchise agreements with respect to the hotels securing loans from these lenders.
 
We entered into agreement with ING Investment Management (“ING”) pursuant to which ING agreed to forbear, for a period of 120 days, from declaring any default relating to the termination of the Choice franchise agreements.  On July 27, 2011, ING agreed to substitute the SpringHill Suites, Flagstaff, AZ, and the Staybridge Suites, Ridgeland, MS, and release the AmericInn, Fort Smith, AR (formerly Comfort Inn) and AmericInn, Missoula, MT (formerly Comfort Inn), and otherwise waive any defaults related to the termination and change of franchise.  The collateral substitution is anticipated to close on or before September 10, 2011, and is subject to satisfaction of typical due diligence and documentation.
 
GECC agreed to waive any default relating to the termination of the Choice franchise agreements, provided that an event of default would be declared if a replacement franchise agreement is not entered into by August 15, 2011.  On July 25, 2011, we entered into a non-binding letter of intent pursuant to which we and GECC agreed to modify the loans as follows:  (a) decrease the interest rate to 90-day LIBOR plus 3.50%; (b) certain fixed charge coverage ratios will be modified to reflect the stabilization of revenues of the former Choice hotels after their conversion to other nationally-recognized brands and (c) we will pledge additional collateral to the loans, including the Aloft, Jacksonville, Florida, the Hyatt Place, Las Colinas, Texas, and the Fairfield Inn, Boise, Idaho, which liens on these three additional hotels may be released upon satisfaction of certain fixed charge coverage ratio tests on the collateralized hotels as well as on our entire hotel portfolio.  The modification cures any potential default under the GECC loans related to the change in franchise, and was closed August 15, 2011.
 
 
17

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
On March 31, 2011, the Operating Partnership, as borrower, and the Company, as guarantor, entered into a $30.0 million unsecured revolving credit facility with Deutsche Bank AG New York Branch.  The purpose of the revolving credit facility was to fund hotel acquisitions, to fund capital expenditures, to refinance debt and for general working capital purposes.  

On April 29, 2011, we terminated the $30.0 million unsecured revolving credit facility and the Operating Partnership, as borrower, and the Company, as guarantor, entered into a $100.0 million, three-year (with an option to extend for one additional year if we meet certain requirements) senior secured revolving credit facility with Deutsche Bank AG New York Branch, as administrative agent, Deutsche Bank Securities Inc., as lead arranger, and a syndicate of lenders including Deutsche Bank AG New York Branch, Royal Bank of Canada, KeyBank National Association and Regions Bank.  We will pay interest on the periodic advances under the senior secured revolving credit facility at varying rates, based upon, at our option, either (i) 1-, 2-, 3- or 6-month LIBOR, subject to a floor of 0.50%, plus a LIBOR margin between 2.50% - 3.50%, depending upon the ratio of our outstanding consolidated total indebtedness to EBITDA (as defined in the loan documentation), or (ii) the applicable base rate, which is the greatest of the administrative agent’s prime rate, 0.50% plus the federal funds effective rate, and 1-month LIBOR (incorporating the floor of 0.50%) plus 1.00%, plus a margin between 1.50% - 2.50% depending upon the ratio of outstanding consolidated total indebtedness to EBITDA (as defined in the loan documentation). Borrowing availability under the facility is subject to a borrowing base of properties pledged as collateral for borrowings under the facility and other conditions.

On May 13, 2011, the Operating Partnership entered into an agreement with Deutsche Bank AG New York Branch and U.S. Bank National Association that increased the maximum aggregate amount of the credit facility from $100.00 million to $125.0 million.   As of June 30, 2011, the outstanding principal balance on this secured credit facility was approximately $42.7 million.  Our borrowing capacity as of June 30, 2011 was $59.8 million and $17.1 million was available for future use.

On June 28, 2011, we entered into a loan agreement with Goldman Sachs Commercial Mortgage Capital, LP for a loan in the principal amount of $14.75 million secured by a first mortgage lien on real estate, improvements, and personal property related to the SpringHill Suites hotel in Bloomington, MN and the Hampton Inn & Suites hotel in Bloomington, MN.  The interest rate is fixed at 5.67%.  The loan matures July 6, 2016, and principal and interest payments are amortized over a 25 year period.  The loan may not be prepaid before the earlier of the second anniversary of the date on which the loan has been securitized or June 28, 2014, and after such time is subject to prepayment based upon standard defeasance.  The loan is non-recourse, except to Summit OP in the event of standard recourse carve-out provisions.  The borrower must maintain a net operating income at the hotels of at least 80% of net operating income on the date of closing, or excess cash flow from the hotels will be reserved and subject to lender control.
 
NOTE 5 -     NONCONTROLLING INTERESTS

As of June 30, 2011, limited partners of the Operating Partnership other than the Company owned 10,100,000 Common Units representing an approximate 27% limited partnership interest in the Operating Partnership.  Pursuant to the limited partnership agreement, limited partners other than the Company have redemption rights that will enable them to cause the Operating Partnership to redeem their Common Units in exchange for cash, or at the Operating Partnership’s option, shares of the Company’s common stock on a one-for-one basis.  The number of shares of the Company’s common stock issuable upon redemption of Common Units may be adjusted upon the occurrence of certain events such as share dividends, share subdivisions or combinations.
 
 
18

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
The holders of Common Units have the right to require the Operating Partnership to redeem part or all of the Common Units for cash based upon the fair market value of an equivalent number of shares of the Company’s common stock at the time of redemption. However, the Company may, in its sole discretion, elect to acquire the Common Units in exchange for its common stock on a one-for-one basis beginning on the first anniversary of completion of the IPO. Based on this assessment, which includes the evaluation of terms in the agreements related to redemption provisions, the Company has classified these Common units as noncontrolling interests as a component of permanent equity on the June 30, 2011 consolidated balance sheet. The share of net loss allocated to these OP units is reported on the accompanying consolidated statement of operations for the period February 14, 2011 through June 30, 2011 as net loss attributable to noncontrolling interests. For the period from February 14, 2011 through June 30, 2011, no OP units were redeemed.

NOTE 6 -     EQUITY-BASED COMPENSATION

The Company measures and recognizes compensation expense for all equity-based payments.  The compensation expense is recognized based on the grant-date fair value of those awards.  All of the Company’s existing stock option awards have been determined to be equity-classified awards.

The Company’s 2011 Equity Incentive Plan provides for the granting of options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights, and other equity-based award or incentive award up to an aggregate of 2,318,290 shares of the Company’s common stock.  Options granted may be either incentive stock options or nonqualified stock options.  Vesting terms may vary with each grant, and option terms are generally five to ten years.

Concurrent with the completion of the IPO, the Company granted options to purchase 940,000 shares of the Company’s common stock.  Options to purchase shares of common stock were granted with exercise prices equal to $9.75 per share, the fair value of the common stock on the date of grant.  Options vest on a ratable basis over a five year period following the date of grant and options terms are generally five to ten years following the date of grant. The fair value of stock options granted was estimated using a Black-Scholes valuation model with the following assumptions:
 
     
2011
         
 
Expected dividend yield at date of grant
    5.09 %
 
Expected stock price volatility
    56.6 %
 
Risk-free interest rate
    2.57 %
 
Expected life of options (in years)
    6.5  
 
The risk-free interest rate assumptions were based on the U.S. Treasury yield curve in effect at the time of the grant.  The expected volatility was based on historical monthly price changes of a peer group of comparable entities based on the expected life of the options at the date of grant.  The expected life of options is the average number of years the Company estimates that options will be outstanding.  The Company considers groups of associates that have similar historical exercise behavior separately for valuation purposes.
 
 
19

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
The following table summarizes stock option activity under the Company’s 2011 Equity Incentive Plan for the six months ended June 30, 2011:
 
   
Number of
Options
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Terms (years)
 
Aggregate
Intrinsic Value
 (in thousands)
                         
Outstanding at December 31, 2010
    -     $ -       -     $ -  
Granted
    940,000     $ 9.75       -     $ -  
Exercised
    -     $ -       -     $ -  
Cancelled
    -     $ -       -     $ -  
Outstanding at June 30, 2011
    940,000     $ 9.75       9.6     $ 1,504  
Exercisable at June 30, 2011
    -     $ -       -     $ -  
 
Concurrent with the completion of the IPO, the Company granted 4,000 shares of stock to directors of the Company under the 2011 Equity Incentive Plan and recognized $39,000 of compensation expense. These shares vested concurrent with the grant.

NOTE 7 -     EARNINGS (LOSS) PER SHARE

Diluted loss per share was the same as basic loss per share for the three and six months ended June 30, 2011 because all outstanding stock option awards were anti-dilutive.

NOTE 8 -     COMMITMENTS AND CONTINGENCIES

We are involved from time to time in litigation arising in the ordinary course of business, however, we are not currently aware of any actions against us that we believe would materially adversely affect our business, financial condition or results of operations.
 
On March 23, 2011, Choice Hotels International terminated the franchise agreements for the following hotels effective that date:
 
Cambria Suites, San Antonio, TX;
   
Cambria Suites, Baton Rouge, LA;
   
Cambria Suites, Boise, ID;
   
Comfort Inn, Ft. Smith, AR;
   
Comfort Inn, Salina, KS;
   
Comfort Inn, Missoula, MT;
   
Comfort Suites, Golden, CO;
   
Comfort Inn & Suites, Twin Falls, ID;
   
Comfort Suites, Charleston, WV; and
   
Comfort Suites, Ft. Worth, TX
 
 
20

 
 
SUMMIT HOTEL PROPERTIES, INC., SUMMIT HOTEL OP, LP, AND SUMMIT HOTEL PROPERTIES, LLC (PREDECESSOR)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2011 

 
Choice also terminated the franchise agreement for the Cambria Suites, Bloomington, MN effective June 23, 2011.  We filed an arbitration action against Choice claiming wrongful termination of our franchise agreements.  Choice filed suit in United States District Court claiming trademark infringement and breach of contract.  In addition, in response to our arbitration action, Choice responded with counterclaims of fraudulent inducement, negligent misrepresentation, breach of contract and trademark infringement.  The parties have agreed to litigate all claims in the arbitration action.  The Company vehemently denies all asserted claims and is vigorously defending the claims.

Following the termination of the 11 franchise agreements with Choice, we entered into new license or franchise agreements for nine hotels.  On April 6, 2011, we entered into a license agreement with Holiday Hospitality Franchising, Inc. for the Holiday Inn in Boise, ID.  On April 15, 2011, we entered into franchise agreements with AmericInn International, LLC for five hotels in Salina, KS; Missoula, MT; Golden, CO; Twin Falls, ID; and Ft. Smith, AR.  On May 17, 2011, we entered into a license agreement with Carlson Inc. for the Country Inn & Suites in San Antonio, TX.  On June 24, 2011, we entered into a franchise agreement with Marriott International, Inc. for the SpringHill Suites in Bloomington, MN.  On August 5, 2011, we entered into a franchise agreement with Hilton Worldwide for the DoubleTree in Baton Rouge, LA.  We anticipate entering into new franchise agreements with respect to our 70 room hotel in Ft. Worth, TX and our 67 room hotel in Charleston, WV, in the third quarter of 2011.  However, we can give no assurance that we will be able to enter into new franchise agreements for these hotels.

NOTE 9 -     RECENT DEVELOPMENTS

On April 27, 2011, we entered into a contract with IHG Management (Maryland) LLC to manage the Holiday Inn hotel in Gwinnett, GA pursuant to a hotel management agreement with a 20-year term, which is extendable at IHG’s option, upon written notice and if not then in default on the agreement, by up to two five-year terms.
 
On May 25, 2011, we entered into a contract with Noble Management Group, LLC to manage the Hilton Garden Inn hotel in Gwinnett, GA pursuant to a hotel management agreement with a 3-year term, which is extendable at Noble’s option, upon written notice and if not then in default on the agreement, by up to two three-year terms.  In conjunction with this contract, the Company has agreed to enter into additional hotel management agreements with Noble up to a capped amount, which left unfulfilled could lead to the assessment of future fees under the agreement.
 
We amended the Interstate hotel management agreement, effective as of June 30, 2011, to reduce the base management fee paid to Interstate from 3% to 1.33% of total revenues for 55 of our hotels for all periods from April 1, 2011 through June 30, 2011. We and Interstate entered into the amendment to address operational challenges experienced at the hotels during the second quarter of 2011.
 
In addition, we have entered into purchase agreements for the acquisition of three existing hotels, and are currently engaged in performing due dilligence investigations for all such properties. We are not contractually obligated to purchase these properties at this time, and may terminate the purchase agreements without penalty during the due dilligence period if we are not satisfied with the results of our due dilligence investigation.
 
NOTE 10 -   SUBSEQUENT EVENTS

The Company purchased the Courtyard by Marriott in El Paso, TX on July 28, 2011 for approximately $12.4 million.  The purchase was financed with borrowings under our revolving credit facility.
 
 
21

 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report.
 
Forward-Looking Statements
 
This report, together with other statements and information publicly disseminated by us, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. Forward-looking statements in this report include, among others, statements about our business strategy, including acquisition and development strategies, industry trends, estimated revenue and expenses, ability to realize deferred tax assets and expected liquidity needs and sources (including capital expenditures and the ability to obtain financing or raise capital). You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond our control and which could materially affect actual results, performances or achievements. Factors that may cause actual results to differ materially from current expectations include, but are not limited to:
 
the state of the economy generally and in specific geographic regions in which our hotels are located and the effect of general economic conditions on the U.S. lodging industry;
 
the timing and availability of potential hotel acquisitions and our ability to identify and complete hotel acquisitions in accordance with our business strategy;
 
risks associated with the hotel industry, including competition, market trends, increases in employment costs, energy costs and other operating costs, or decreases in demand caused by actual or threatened terrorist attacks, any type of flu or disease-related pandemic, or downturns in general and local economic conditions;
 
the availability and terms of financing and capital and the general volatility of securities markets;
 
our ability to maintain our relationships with our franchisors and enter into new franchise agreements;
 
the termination of franchise agreements and the payment of termination fees;
 
our dependence on third-party managers of our hotels, and our inability to implement strategic business decisions directly;
 
risks associated with the real estate industry, including environmental contamination and costs of complying with the Americans with Disabilities Act and similar laws;
 
interest rate increases;
 
our ability to satisfy the requirements for qualification as a REIT and the impact of changes in tax laws and government regulations affecting REITs;
 
the possibility of uninsured losses;
 
risks associated with redevelopment and repositioning projects, including delays and cost overruns; and
 
the other factors discussed under the heading “Risk Factors” in our combined Annual Report on Form 10-K for the year ended December 31, 2010, other filings we make from time to time with the Securities and Exchange Commission (the “SEC”) and elsewhere in this report.
 
 
22

 
 
Accordingly, there is no assurance that our expectations will be realized. Except as otherwise required by the federal securities laws, we disclaim any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
 
Overview
 
We are a self-managed hotel investment company that was organized in June 2010 to continue and expand the existing hotel investment business of our predecessor, Summit Hotel Properties, LLC, a leading U.S. hotel owner. We focus exclusively on acquiring and owning premium-branded select-service hotels in the upper midscale and upscale segments of the U.S. lodging industry, as these segments are currently defined by Smith Travel Research (“STR”). We completed our initial public offering (the “IPO”), a concurrent private placement of our common stock and our formation transactions on February 14, 2011, netting approximately $241.3 million from the IPO and concurrent private placement, after underwriting discounts and the payment by us of offering-related costs.
 
We had no business activities prior to completion of the IPO and the formation transactions.  Effective February 14, 2011, our predecessor merged with and into Summit OP (the “Merger”), with Summit OP surviving the Merger and succeeding to the business and assets of our predecessor. At the effective time of the Merger, the outstanding membership interests in our predecessor were converted into, and cancelled in exchange for, a total of 9,993,992 Common Units, and the members of our predecessor were admitted as limited partners of Summit OP. Also effective February 14, 2011, The Summit Group contributed its 36% Class B membership interest in Summit of Scottsdale, which owns two hotels in Scottsdale, Arizona, to Summit OP in exchange for 74,829 Common Units, and an unaffiliated third-party investor contributed its 15% Class C membership interest in Summit of Scottsdale to Summit OP in exchange for 31,179 Common Units. As a result of these reorganization transactions, which we refer to as the “formation transactions,” we acquired sole ownership of the 65 hotels in our predecessor’s portfolio. In addition, we assumed the indebtedness of our predecessor and its subsidiaries.  Although Summit OP was the surviving entity in the Merger, our predecessor is considered the acquiror for accounting purposes and its financial statements became our financial statements upon completion of the Merger.
 
As of June 30, 2011, our hotel portfolio consisted of 69 hotels with a total of 7,010 guestrooms located in 19 states. Except for five hotels, which are subject to ground leases, we own our hotels in fee simple.  As the hotel industry’s segments are currently defined by STR, 30 of our hotels are upper midscale, 28 of our hotels are upscale and 11 of our hotels are midscale (which reflects our classification of our independently operated hotels as midscale, regardless of amenity level). As of June 30, 2011, 52 of our hotels were encumbered by a total of $251.7 million of mortgage debt. As of June 30, 2011, our hotels, with the exception of our four independently operated hotels, were operated under nationally recognized brands, including brands owned by Marriott International, Inc. (“Marriott”), Hilton Worldwide (“Hilton”), InterContinental Hotels Group (“IHG”) and an affiliate of Hyatt Hotels Corporation (“Hyatt”), among others.
 
Substantially all of our assets are held by, and all of our operations are conducted through, our operating partnership, Summit Hotel OP, LP, Delaware limited partnership formed in June 2010. Through a wholly owned subsidiary, we are the sole general partner of Summit OP. As of June 30, 2011, Summit REIT owns an approximate 73.0% interest in Summit OP, including general and limited partnership interests. The other limited partners of Summit OP, including The Summit Group and the other former members of our predecessor, own the remaining approximate 27.0% interest in Summit OP as of June 30, 2011. Pursuant to the partnership agreement of Summit OP, through our General Partner we have full, exclusive and complete responsibility and discretion in the management and control of Summit OP, including the ability to cause Summit OP to enter into certain major transactions including acquisitions, dispositions and refinancings, make distributions to partners and to cause changes in Summit OP’s business activities.
 
 
23

 
 
Summit REIT intends to elect to be taxed as a REIT for federal income tax purposes beginning with its short taxable year ending December 31, 2011. To qualify as a REIT, we cannot operate or manage our hotels. Instead, we lease our hotels to our TRS lessees, which are wholly owned, directly or indirectly, by Summit OP. Our TRS lessees engage third-party hotel management companies to operate and manage our hotels pursuant to hotel management agreements. Substantially all of our hotels (67 of our 69 hotels as of June 30, 2011) are managed by Interstate Management Company, LLC (“Interstate”) pursuant to a hotel management agreement between Interstate and certain of our TRS lessees.  In addition, our TRS lessees have entered into hotel management agreements with Noble Management Group, LLC (“Noble”), pursuant to which Noble manages one hotel, and with IHG Management (Maryland) LLC (“IHG Management”), an affiliate of IHG, pursuant to which IHG Management manages one hotel.  Our TRS lessees may also employ other hotel managers in the future. We believe each of Interstate, Noble and IHG Management qualifies as an “eligible independent contractor” for federal income tax purposes. We have, and will have, no ownership or economic interest in any of the hotel management companies engaged by our TRS lessees. Our TRS lessees will be disregarded as separate from our TRSs for federal income tax purposes and their operations consolidated into our financial statements for accounting purposes. Our TRSs will be taxed as “C” corporations, and, unlike our predecessor’s income, our TRSs’ income will be subject to federal, state and local income tax, which will reduce our funds from operations and the cash otherwise available for distribution to our stockholders.
 
Revenues and Expenses
 
Our revenue is derived from hotel operations and consists of room revenue and other hotel operations revenue. As a result of our focus on select-service hotels in the upper midscale and upscale segments of the U.S. lodging industry, substantially all of our revenue is room revenue generated from sales of hotel rooms. We also generate, to a much lesser extent, other hotel operations revenue, which consists of ancillary revenue related to meeting rooms and other guest services provided at our hotels.
 
Our hotel operating expenses consist primarily of expenses incurred in the day-to-day operation of our hotels. Many of our expenses are fixed, such as essential hotel staff, real estate taxes, insurance, depreciation and certain types of franchise fees, and these expenses do not decrease even if the revenue at our hotels decreases. As reclassified, our hotel operating expenses consist of room expenses (wages, payroll taxes and benefits, linens, cleaning and guestroom supplies and complimentary breakfast), other direct expenses (office supplies, utilities, telephone, advertising and bad debts), other indirect expenses (real and personal property taxes, insurance, travel agent and credit card commissions, hotel management fees and franchise fees), and other expenses (ground rent and other items of miscellaneous expense).
 
Reclassification of Certain Prior Period Financial Information
 
Certain reclassifications have been made to the prior-year financial information of our predecessor to conform to our current-year presentation for the three and six month periods ended June 30, 2011 as follows:
 
 
to reclassify (a) $10.5 million and $20.0 million of direct hotel operations expense (wages, payroll taxes and benefits, linens, cleaning and guestroom supplies and complimentary breakfast) as rooms expense for the three and six month periods ended June 30, 2011, respectively; and (b) $1.6 million and $3.0 million of direct hotel operations expense (franchise royalties) as other indirect expense for the three and six month periods ended June 30, 2011, respectively;
 
 
to reclassify (a) $2.0 million and $4.1 million of other hotel operating expense (utilities and telephone) as other direct expense for the three and six month periods ended June 30, 2011, respectively; and (b) $2.6 million and $5.1 million of other hotel operating expense (property taxes, insurance and cable) as other indirect expense for the three and six month periods ended June 30, 2011, respectively;
 
 
to reclassify (a) $1.0 million and $2.1 million of general, selling and administrative expense (office supplies, advertising, miscellaneous operating expenses and bad debt expense) as other direct expenses for the three and six month periods ended June 30, 2011, respectively; (b) $5.1 million and $9.7 million of general, selling and administrative expense (credit card/travel agent commissions, management company expense, management company legal and accounting fees and franchise fees) as other indirect expenses for the three and six month periods ended June 30, 2011, respectively; and (c) $152,000 and $302,000 of general, selling and administrative expense (ground rent and other expense) as other expense for the three and six month periods ended June 30, 2011, respectively;
 
 
24

 
 
 
to reclassify $1.2 million and $2.1 million of repairs and maintenance expense as other direct expenses for the three and six month periods ended June 30, 2011, respectively; and
 
 
to reclassify ($9,000) and $57,000 of other indirect expense (hotel startup costs) as hotel property acquisition costs for the three and six month periods ended June 30, 2011, respectively.
 
Industry Trends and Outlook
 
In mid-2008, U.S. lodging demand started to decline as a result of the economic recession, which caused industry-wide RevPAR to decline for the year, as reported by STR. Throughout 2009, the decrease in lodging demand accelerated, with RevPAR down 16.7% for the year according to STR. Beginning in the first quarter of 2010, we saw trends of improved fundamentals in the U.S. lodging industry, with demand for rooms showing signs of stabilization, and even growth in many of the major markets, as general economic indicators began to experience positive improvement.  Improved fundamentals in the hotel industry continued throughout 2010, although the industry recovery has been modest.  The supply of available rooms is expected to rise at a significantly slower pace over the next several years than during 2006 through 2008.  Demand for rooms is expected to increase at a moderate pace during 2011 and 2012.  Thus, we expect growth in industry-wide RevPAR to continue for the remainder of 2011 and for several years thereafter.
 
While we believe the trends in room demand and supply growth will result in improvement in lodging industry fundamentals, we can provide no assurances that the U.S. economy will strengthen at projected levels and within the expected time periods. If the economy does not improve or if any improvements do not continue for any number of reasons, including, among others, an economic slowdown and other events outside of our control, such as terrorism or significantly increased gasoline prices, lodging industry fundamentals may not improve as expected. In the past, similar events have adversely affected the lodging industry and if these events recur, they may adversely affect the lodging industry in the future.
 
Operating Performance Metrics
 
We use a variety of operating and other information to evaluate the financial condition and operating performance of our business. These key indicators include financial information that is prepared in accordance with generally accepted accounting principles (“GAAP”), as well as other financial information that is not prepared in accordance with GAAP. In addition, we use other information that may not be financial in nature, including statistical information and comparative data. We use this information to measure the performance of individual hotels, groups of hotels and our business as a whole. We periodically compare historical information to our internal budgets as well as industry-wide information. These key indicators include:
 
 
Occupancy rates (“occupancy”);
 
 
Average daily rates (“ADR”); and
 
 
Revenue per available room (“RevPAR”).
 
Occupancy, ADR and RevPAR are commonly used measures within the hotel industry to evaluate operating performance. RevPAR, which is calculated as the product of ADR and occupancy, is an important statistic for monitoring operating performance at the individual hotel level and across our business as a whole. We evaluate individual hotel RevPAR performance on an absolute basis with comparisons to budget and prior periods, as well as on a company-wide and regional basis, and in comparison to a competitive set of hotels. ADR and RevPAR include only room revenue. Our ADR, occupancy and RevPAR performance may be impacted by, among other things, macroeconomic factors such as regional and local employment growth, personal income and corporate earnings, office vacancy rates and business relocation decisions, airport and other business and leisure travel, new hotel construction and the pricing strategies of competitors. In addition, our ADR, occupancy and RevPAR performance are dependent on the continued success of our franchisors and their brands.
 
 
25

 
 
Our Portfolio
 
As of June 30, 2011, our portfolio consists of an aggregate of 69 hotels with a total of 7,010 guestrooms.  Of these hotels, according to STR’s current chain segments, 28 hotels containing 3,148 guestrooms are “upscale,” 30 hotels containing 2,977 guestrooms are “upper midscale” and 11 hotels containing 885 guestrooms are “midscale.”  The hotels operate under the franchise brands shown below:
 
Franchisor/Brand
 
No. of Hotels
 
No. of Rooms
           <