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Table of Contents

 

 

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 September 30, 2014

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 333-186090

 

 

BRE SELECT HOTELS CORP

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   35-2464254

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

c/o Blackstone Real Estate Partners VII L.P.

345 Park Avenue

New York, New York

  10154
(Address of principal executive offices)   (Zip Code)

(212) 583-5000

(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.    Yes  ¨    No  x

(Note: As a voluntary filer, the registrant has not been subject to the filing requirements of Section 13 or 15(d) of the Exchange Act for the past 90 days. The registrant has filed all reports required under Section 13 or 15(d) of the Exchange Act during the preceding 12 months.)

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

Common Stock, $0.01 par value per share

 

100

(Class)   Outstanding at November 1, 2014

 

 

 


Table of Contents

BRE SELECT HOTELS CORP

FORM 10-Q

INDEX

 

         Page  

PART I. FINANCIAL INFORMATION

  

Item 1.

 

Financial Statements:

  
 

Condensed Consolidated Balance Sheets – September 30, 2014 (Unaudited) and December 31, 2013

     3   
 

Condensed Consolidated Statements of Operations (Unaudited) - Three and Nine Months Ended September 30, 2014 and 2013 (Successor) and Period from January 1, 2013 through May 13, 2013 (Predecessor)

     4   
 

Condensed Consolidated Statements of Cash Flows (Unaudited) - Nine Months Ended September 30, 2014 and 2013 (Successor) and Period from January 1, 2013 through May 13, 2013 (Predecessor)

     5   
 

Notes to Condensed Consolidated Financial Statements

     6   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     17   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     23   

Item 4.

 

Controls and Procedures

     23   

PART II. OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

     24   

Item 1A.

 

Risk Factors

     24   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     24   

Item 3.

 

Defaults upon Senior Securities

     24   

Item 4.

 

Mine Safety Disclosures

     24   

Item 5.

 

Other Information

     24   

Item 6.

 

Exhibits

     25   

Signatures

     26   

This Form 10-Q includes references to certain trademarks or service marks. The SpringHill Suites® by Marriott, TownePlace Suites® by Marriott, Fairfield Inn® by Marriott, Courtyard® by Marriott, Residence Inn® by Marriott and Marriott Suites® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Homewood Suites® by Hilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites® trademarks are the property of Hilton Worldwide, Inc. or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted for uses other than in this paragraph but will be deemed to be included wherever the above referenced terms are used.


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

BRE SELECT HOTELS CORP

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

     September 30,
2014
     December 31,
2013
 
     (Unaudited)         

ASSETS

     

Investment in real estate, net of accumulated depreciation of $36,353 and $16,359, respectively

   $ 962,174       $ 959,014   

Hotels held for sale

     0         9,485   

Cash and cash equivalents

     29,772         23,902   

Restricted cash

     35,064         39,179   

Due from third party managers, net

     5,553         4,841   

Prepaid expenses

     2,715         2,352   

Deferred financing costs, net

     8,479         12,575   

Goodwill

     126,377         126,377   

Other assets

     1,569         3,858   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 1,171,703       $ 1,181,583   
  

 

 

    

 

 

 

LIABILITIES

     

Accounts payable and accrued expenses

   $ 15,385       $ 12,453   

Due to third party managers, net

     374         0   

Mortgages payable

     608,945         617,855   

Mezzanine loans

     172,488         175,000   
  

 

 

    

 

 

 

TOTAL LIABILITIES

     797,192         805,308   

Commitments and contingencies (Note 8)

     

7% Series A Cumulative Redeemable Preferred Stock, $1.90 per share initial liquidation preference; 120,000,000 shares authorized, 97,032,848 shares issued and outstanding at both September 30, 2014 and December 31, 2013

     183,825         183,825   

SHAREHOLDERS’ EQUITY

     

Preferred stock, $0.0001 par value; 30,000,000 shares authorized, none issued and outstanding at both September 30, 2014 and December 31, 2013

     0         0   

Common stock, $0.01 par value; 100,000 shares authorized, 100 shares issued and outstanding at both September 30, 2014 and December 31, 2013

     0         0   

Additional paid-in capital

     159,757         192,450   

Retained earnings

     30,929         0   
  

 

 

    

 

 

 

TOTAL SHAREHOLDERS’ EQUITY

     190,686         192,450   
  

 

 

    

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 1,171,703       $ 1,181,583   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


Table of Contents

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(in thousands, except share data)

 

     Successor           Predecessor  
     Three Months
Ended
September 30,
2014
    Nine Months
Ended
September 30,
2014
    Three Months
Ended
September 30,
2013
    Nine Months
Ended
September 30,
2013
          Period from
January 1
through
May 13, 2013
 

REVENUE

               

Room revenue

   $ 74,614      $ 200,260      $ 69,451      $ 104,681          $ 82,063   

Other revenue

     4,598       13,772       4,324       6,655            6,212   

Reimbursed expenses

     0        0        0        0            2,838   
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Total revenue

     79,212       214,032       73,775       111,336            91,113   
 

EXPENSES

               

Operating expense

     17,802       50,209       17,008       25,462            23,167   

Hotel administrative expense

     5,747        16,730        5,700        8,604            7,159   

Sales and marketing

     5,757       15,958       5,474       8,302            7,407   

Utilities

     2,923        7,638        2,792        4,028            3,188   

Repair and maintenance

     2,712       8,084       2,734       4,184            4,081   

Franchise fees

     3,682        9,936        3,478        5,206            3,716   

Management fees

     2,888       7,927       2,443       3,659            3,010   

Taxes, insurance and other

     3,546        10,436        3,292        5,258            4,457   

General and administrative

     777       2,542       832       1,721            2,828   

Merger transaction costs

     0        0        320        21,463            67,633   

Reimbursed expenses

     0       0       0       0            2,838   

Depreciation expense

     6,760        19,994        6,534        9,854            10,651   
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Total expenses

     52,594       149,454       50,607       97,741            140,135   
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Operating income (loss)

     26,618        64,578        23,168        13,595            (49,022
 

Interest expense, net

     (9,666 )     (28,696 )     (9,621 )     (14,908 )          (1,439

Unrealized gain (loss) on derivatives

     22        (397     (208     231            0   
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Income (loss) from continuing operations before income tax expense

     16,974       35,485       13,339       (1,082 )          (50,461
 

Income tax expense

     (3,649     (4,463     (1,964     (3,420 )          (140
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Income (loss) from continuing operations

     13,325       31,022       11,375       (4,502 )          (50,601
 

(Loss) income from discontinued operations, net of tax

     (162     (93     (455     (322 )          18   
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Net income (loss)

     13,163       30,929       10,920       (4,824 )          (50,583
 

Series A Preferred Stock dividends declared

     (3,231     (9,693     (3,231     (6,139 )          0   
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Net income (loss) available for common stockholders

   $ 9,932     $ 21,236     $ 7,689     ($ 10,963 )        ($ 50,583
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Basic and diluted net income (loss) per common share

               
 

From continuing operations, after Series A Preferred Stock dividends

   $ 100,940.00      $ 213,290.00      $ 81,440.00      ($ 106,410.00 )        ($ 0.55

From discontinued operations

     (1,620.00 )     (930.00 )     (4,550.00 )     (3,220.00 )          0.00   
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Total basic and diluted net income (loss) per common share available to common stockholders

   $ 99,320.00      $ 212,360.00      $ 76,890.00      ($ 109,630.00 )        ($ 0.55
  

 

 

   

 

 

   

 

 

   

 

 

        

 

 

 

Dividends per common share

   $ 9,000     $ 23,000     $ 4,100     $ 4,100          $ 0   
 

Weighted average common shares outstanding - basic and diluted

     100        100        100        100            91,270,197   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4


Table of Contents

BRE SELECT HOTELS CORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)

 

     Successor     Predecessor  
     Nine Months
Ended
September 30,
2014
    Nine Months
Ended
September 30,
2013
    Period from
January 1
through
May 13, 2013
 

Cash flows from operating activities:

        

Net income (loss)

   $ 30,929      ($ 4,824 )   ($ 50,583

Adjustments to reconcile net income (loss) to cash provided by operating activities:

        

Depreciation

     19,994        9,895       10,912   

Estimated selling costs on hotels held for sale

     0       435       0   

Loss on sale of hotels held for sale

     150        0       0   

Fair value adjustment of interest rate cap

     397       (231 )     0   

Amortization of deferred financing costs

     4,096        1,986       93   

Other non-cash expenses, net

     (22 )     (11 )     2   

Changes in operating assets and liabilities:

        

Increase in cash restricted for operating expenses

     (3,279 )     (3,792 )     0   

(Increase) decrease in due to/from third party managers, net

     (338     4,718       (1,001

Decrease (increase) in prepaid expenses and other assets

     1,176       (5,058 )     (313

Increase (decrease) in accounts payable and accrued expenses

     3,188        6,446       (1,301
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     56,291       9,564       (42,191
 

Cash flows from investing activities:

        

Capital improvements, net

     (23,433 )     (727 )     (7,735

Proceeds from sale of hotels held for sale, net

     9,380        0       5,866   

Property insurance proceeds

     353       0       0   

Cash paid for business acquisition, net of cash acquired

     0        (881,652 )     0   

Net decrease (increase) in cash restricted for property improvements

     7,394       (27,689 )     113   
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (6,306     (910,068 )     (1,756
 

Cash flows from financing activities:

        

Net payments on credit facility

     0        (30,970 )     (3,500
 

Net proceeds from borrowings on mortgage payable and mezzanine loans

     0       775,000       0   

Payments of mortgage debt

     (8,910     (125 )     (5,869

Payments of mezzanine debt

     (2,512 )     0       0   

Financing fees

     0        (15,884 )     0   

Conversion of Series B convertible preferred stock

     0       0       64,367   

Net capital contribution from Sponsor

     0        214,880       0   

Merger costs related to issuance of Series A Preferred Stock

     0       (1,223 )     0   

Dividends paid to Series A Preferred shareholders

     (9,693     (2,222 )     0   

Dividends paid to common shareholders

     (23,000 )     (4,100 )     0   
  

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (44,115     935,356       54,998   
 

Net increase in cash and cash equivalents

     5,870       34,852       11,051   
 

Cash and cash equivalents, beginning of period

     23,902        0       0   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 29,772     $ 34,852     $ 11,051   
  

 

 

   

 

 

   

 

 

 

Supplemental Cash Flow Information including Non-Cash Activities:

      

Interest paid

   $ 25,066     $ 11,721     $ 933   

Taxes paid

   $ 945      $ 1,247      $ 367   

Accrued capital improvements

   $ 2,007     $ 0     $ 0   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5


Table of Contents

BRE SELECT HOTELS CORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization

BRE Select Hotels Corp, together with its wholly-owned subsidiaries (the “Company”), is a Delaware corporation that made an election, through the filing of Form 1120-REIT for 2012, to qualify as a real estate investment trust, or REIT, for federal income tax purposes. The Company was formed on November 28, 2012 to invest in income-producing real estate in the United States through the acquisition of Apple REIT Six, Inc. (“Apple Six”) on behalf of BRE Select Hotels Holdings LP (“BRE Holdings”), a Delaware limited partnership and an affiliate of the Company. 100% of the common stock of the Company is owned by BRE Holdings, which is an affiliate of Blackstone Real Estate Partners VII L.P. (“Sponsor”). The acquisition of Apple Six was completed on May 14, 2013 (“Acquisition Date”). As of September 30, 2014, the Company owned 62 hotels located in 18 states with an aggregate of 7,347 rooms.

For purposes of this quarterly report on Form 10-Q, references to the Company for periods prior to the Acquisition Date shall be deemed to refer to Apple Six, unless the context indicates otherwise.

2. Summary of Significant Accounting Policies

Principles of Consolidation - The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

Basis of Presentation - The Company was determined to be the acquirer for accounting purposes and, therefore, the merger was accounted for using the acquisition method of accounting. Accordingly, the purchase price of the Merger (as defined below) has been allocated to the Company’s assets and liabilities based upon their estimated fair values at the Acquisition Date. As used herein, the term “Predecessor” refers to the financial position and results of operations of Apple Six prior to the Acquisition Date. The term “Successor” refers to the financial position and results of operations of the Company on or after the Acquisition Date. Certain merger transaction costs incurred prior to May 14, 2013 by the Company are included in the Successor period, as that period represents the commencement of Successor operations. Prior to May 14, 2013, the Company had no revenues, and expenses were comprised solely of merger related costs. For accounting purposes, the purchase price allocation was applied on May 14, 2013.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with standards for the preparation of interim financial statements. In the opinion of management, all adjustments (consisting of normal and recurring adjustments) necessary for a fair presentation have been included. Operating results for the interim periods noted herein are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2014. These unaudited financial statements should be read in conjunction with the audited financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Use of Estimates - The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Cash and Cash Equivalents - Cash and cash equivalents primarily consists of cash in banks. Cash equivalents consist of investments with maturities of three months or less at acquisition. The Company has deposits in excess of $250,000 within single financial institutions that are not insured by the Federal Deposit Insurance Corporation. The Company believes it mitigates this risk by depositing with major financial institutions.

Restricted Cash - Restricted cash consists of deposits held in escrow for the payment of certain required repairs, capital improvements, property taxes, insurance and ground rent pursuant to the terms of the Company’s mortgages payable and mezzanine loans, as well as a repairs and improvements reserve required by the Marriott International Inc. or its affiliates (“Marriott”) management agreements.

Due from Third Party Manager, net - Due from third party managers, net, represents the net working capital advanced to and held by the hotel management companies for operation of the hotels.

Investment in Real Estate and Related Depreciation - Real estate is stated at cost, net of accumulated depreciation. Repair and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements that extend the useful life of the real estate asset are capitalized and depreciated over the estimated useful life of the real estate asset. Depreciation is computed using the straight-line method over the average estimated useful lives of the assets, which are 39 years for buildings, 10 years for major improvements and three to seven years for furniture and equipment.

 

6


Table of Contents

Impairment of Investment in Real Estate - The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include: (1) a property with current or potential losses from operations, (2) when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or (3) when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares a quarterly recoverability analysis to assist with its evaluation of impairment indicators. The analysis compares each property’s current year actual and forecasted occupancy and revenue per available room (“RevPAR”) compared to the prior year. No triggering events have occurred to indicate the asset carrying values will not be recoverable as of September 30, 2014. If events or circumstances change, such as the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and in such instances an impairment loss would be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.

Hotels Held for Sale - The Company classifies assets as held for sale when the criteria specified under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360, Impairment or Disposal of Long-Lived Assets, are met. Specifically, the criteria followed by the Company includes (a) management commits to a plan to sell, (b) the asset is available for immediate sale in its present condition, (c) the Company initiates an active program to locate a buyer, (d) the sale is probable to be completed within one year, and (e) the Company is actively marketing the asset at a reasonable price in relation to its current fair value. The Company discontinues depreciating the assets and estimates the sales price, net of selling costs, of such assets. If, in management’s opinion, the net sales price of the assets that have been identified for sale is less than the net book value of the assets, an impairment charge is recorded.

Goodwill - Goodwill represents the excess of purchase price over fair value of assets acquired and liabilities assumed in business combinations, and is characterized by the intangible assets that do not qualify for separate recognition. In accordance with accounting guidance related to goodwill and other intangible assets, the Company performs its annual testing for impairment of goodwill during the fourth quarter of each year and in certain situations between those annual dates if indicators of impairment are present. No indicators of impairment which would require a test of goodwill during the interim periods presented were identified.

Revenue Recognition - Revenue is recognized as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel’s services. Taxes collected from customers and submitted to taxing authorities are not recorded in revenue.

Sales and Marketing Costs - Sales and marketing costs are expensed when incurred. These costs represent the expense for franchise advertising and reservations systems under the terms of the hotel management and franchise agreements and general and administrative expenses that are directly attributable to advertising and promotion.

Income Taxes - The Company made an election, through the filing of Form 1120-REIT for 2012, to qualify as a REIT under the Internal Revenue Code of 1986, as amended, beginning with the Company’s short taxable year ended December 31, 2012. In order to qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement that it distribute at least 90% of its adjusted taxable income to its shareholders, subject to certain adjustments and excluding any net capital gain. The Company intends to adhere to these requirements to qualify for REIT status, and assuming it does qualify for taxation as a REIT, it will generally not be subject to federal income taxes to the extent it distributes substantially all of its taxable income to the Company’s shareholders. However, the Company’s taxable REIT subsidiaries (“TRS”) will generally be subject to federal, state, and local income taxes and the consolidated income tax provision includes those taxes.

Valuation of Deferred Tax Assets - The Company has approximately $1.7 million of deferred tax assets as of September 30, 2014. Management considered various factors, including tax planning strategies, future reversals of existing taxable temporary differences and future projected taxable income in determining that a valuation allowance for the deferred tax assets of $1.0 million is required at September 30, 2014, and the Company believes that it is more likely than not that it will be able to realize the $0.7 million of net deferred tax assets in the future. If a determination is made that all, or a portion, of the remaining net deferred tax assets may not be realized, an increase in income tax expense would be recorded in that period.

 

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Table of Contents

Income (loss) from Discontinued Operations - Income (loss) from discontinued operations is computed in accordance with ASC 205-20, Discontinued Operations, which requires, among other things, that the primary assets and liabilities and the results of operations of the Company’s real property that has been sold, or otherwise qualifies as held for sale, be classified as discontinued operations and segregated from the Company’s continuing operations in the condensed consolidated statements of operations.

Income (loss) per Common Share (Predecessor) - Basic income (loss) per common share is computed based upon the weighted average number of shares outstanding during the period. Diluted income (loss) per common share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period. Series B convertible preferred shares were converted on May 13, 2013 in connection with the Merger (as defined below) and included in the weighted average common shares calculation for the applicable periods. There were no potential common shares with a dilutive effect during the applicable periods, and as a result, basic and dilutive outstanding shares were the same.

Income (loss) per Common Share (Successor) - Basic income (loss) per common share is computed based upon the weighted average number of shares outstanding during the period, after giving effect to the Series A Preferred Stock dividends declared during the period. There were no potential dilutive shares during the applicable periods, and as a result, basic and dilutive outstanding shares were the same.

New Accounting Pronouncements - In April 2014, the FASB issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Under the update, discontinued operations as defined as either 1) a component of an entity (or group of components) that (i) has been disposed of or meets the criteria to be classified as held-for-sale and (ii) represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, or 2) is a business or nonprofit activity that on acquisition, meets the criteria to be classified as held-for-sale. The accounting update is effective on a prospective basis for disposals or assets meeting the definition as held-for-sale for accounting periods beginning on or after December 15, 2014. Early application is permitted, but only for those disposals that have not been reported in previously issued financial statements.

Historically, the Company has classified and reported disposals of its operating properties for which operations and cash flows are clearly distinguished as discontinued operations. See Note 13. Upon adoption of this standard, we expect that future disposals of operating real estate assets will not qualify for discontinued operations reporting treatment, unless the disposals represent a strategic shift that will have a major effect on the Company’s operations and financial results.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers. The update outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The accounting update is effective for accounting periods beginning on or after December 15, 2016. Early application is not permitted. The Company is currently assessing the impact this new guidance may have on the Company’s operations and financial results.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern. The ASU requires management to evaluate relevant conditions, events and certain management plans that are known or reasonably knowable as of the evaluation date when determining whether substantial doubt about an entity’s ability to continue as a going concern exists. Management will be required to make this evaluation for both annual and interim reporting periods. The standard states substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate this it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The Company will be required to apply the provisions of ASU 2014-15 for accounting periods beginning after December 15, 2016. The Company does not expect the new standard to impact its condensed combined financial statements or require further disclosure.

3. Merger

On May 14, 2013, the Company completed the acquisition of Apple Six, pursuant to the Agreement and Plan of Merger, dated as of November 29, 2012 (the “Merger Agreement”), by and between the Company, BRE Holdings and Apple Six, pursuant to which Apple Six merged with and into the Company (the “Merger”). As a result of the Merger, the Company acquired 100% of the controlling interest of Apple Six. Each issued and outstanding common share and related Series A preferred share of Apple Six were exchanged for (i) $9.20 in cash and (ii) one share of 7% Series A Cumulative Redeemable Preferred Stock (“Series A Preferred Stock”) of the Company with an initial liquidation preference of $1.90 per share. The Merger was funded by a net cash contribution of $214.9 million indirectly made by the Sponsor and its affiliates, Series A Preferred Stock with an aggregate initial liquidation preference of $184.4 million, and $775.0 million of debt. In connection with these activities, the Company incurred $0.3 million and $21.5 million in merger transaction costs for the three and nine months ended September 30, 2013, respectively, and the Predecessor incurred Merger transaction costs of $67.6 million for the period from January 1, 2013 through May 13, 2013. All costs related to the Merger were expensed in the period in which they were incurred and are reflected in Merger transaction costs in the condensed consolidated statements of operations.

The Merger was accounted for using the purchase method of accounting in accordance with ASC 805, Business Combinations, and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values at the Acquisition Date. The Company engaged a third party valuation firm to assist in the determination of the fair values of tangible and intangible assets acquired.

 

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The following is a summary of the amounts (in thousands) assigned to the assets acquired and liabilities assumed by the Company in connection with the Merger:

 

Investment in real estate (including real estate held for sale)

   $ 980,895   

Goodwill

     126,377   

Cash

     11,051   

Restricted cash-furniture, fixtures and other escrows

     1,196   

Due from third party managers, net

     7,186   

Prepaid expenses and other assets

     4,160   

Credit facility

     (30,970

Mortgage debt

     (18,078

Accounts payable and accrued expenses

     (4,452

Ground lease

     (300
  

 

 

 
   $ 1,077,065   
  

 

 

 

Goodwill recognized is deductible for tax purposes.

4. Investment in Real Estate, net

Investment in real estate, net as of September 30, 2014 and December 31, 2013 consisted of the following (in thousands):

 

     September 30,
2014
    December 31,
2013
 

Land

   $ 154,303     $ 153,968   

Building and Improvements

     795,920        793,900   

Furniture, Fixtures and Equipment

     29,158       25,408   

Construction in Progress

     19,146        2,097   
  

 

 

   

 

 

 
     998,527       975,373   

Less: Accumulated Depreciation

     (36,353     (16,359
  

 

 

   

 

 

 

Investment in Real Estate, net

   $ 962,174     $ 959,014   
  

 

 

   

 

 

 

5. Deferred Financing Costs

Deferred financing costs consist of amounts paid for direct and indirect costs associated with the origination of the mortgage and mezzanine loan agreements entered into at the time of the Merger and further discussed in Note 6. Such costs are amortized on a straight-line basis (which approximates the effective interest method) over the term of the related debt. Amortization of deferred financing costs totaled $1.4 million and $4.1 million for the three and nine months ended September 30, 2014, respectively, and is included in interest expense in the condensed consolidated statements of operations.

6. Mortgages Payable and Mezzanine Loans

On May 14, 2013, in connection with the acquisition of Apple Six pursuant to the Merger Agreement, certain indirect, wholly-owned subsidiaries of the Company (the “Mortgage Borrowers”) obtained a $600.0 million mortgage loan (the “Mortgage Loan”) from Citigroup Global Markets Realty Corp. and Bank of America, N.A. (collectively, the “Lenders”). The Mortgage Loan is secured by first-priority, cross-collateralized mortgage liens on 61 of the 62 properties owned or ground-leased by certain subsidiaries of the Company, all related personal property, reserves, a pledge of all income received by the Mortgage Borrowers with respect to the properties and a security interest in a cash management account.

Certain indirect, wholly-owned subsidiaries of the Company that own direct ownership interests in the Mortgage Borrowers (the “Mezzanine A Borrowers”) obtained a $100.0 million loan (the “Mezzanine A Loan”) from the Lenders. Certain other indirect, wholly-owned subsidiaries of the Company that own direct or indirect ownership interests in the Mortgage Borrowers (the “Mezzanine B Borrowers” and, together with the Mezzanine A Borrowers, the “Mezzanine Borrowers” and, together with the Mortgage Borrowers, the “Borrowers”) obtained a $75.0 million loan (the “Mezzanine B Loan” and, together with the Mezzanine A Loan, the “Mezzanine Loans” and, together with the Mortgage Loan, the “Loans”) from the Lenders. Each of the Mezzanine Loans is secured by first-priority, cross-collateralized pledges of the direct or indirect ownership interests of each of the Mezzanine Borrowers in the Mortgage Borrowers, all related personal property, reserves, a pledge of all income received by each of the Mezzanine Borrowers with respect to its direct or indirect ownership interests in the Mortgage Borrowers and a security interest in a cash management account.

 

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Each portion of the collateral security of the Mezzanine Loans is cross-defaulted with the Mortgage Loan and each portion of the collateral security of the Mezzanine B Loan is cross-defaulted with the Mezzanine A Loan. In addition to the payment of the cash consideration in the Merger, the proceeds from the Loans were used to repay Apple Six’s credit facility with Wells Fargo Bank, N.A., to repay or defease certain of Apple Six’s mortgage debt, for other costs and expenses relating to the transactions in connection with the Merger Agreement and to establish reserves, including certain reserves required to be established under the terms of the Loans.

The initial interest rate of the Mortgage Loan is equal to the one-month London interbank offered rate for deposits, or LIBOR, plus a margin rate of approximately 3.34%. By amendments executed on July 8, 2013 and July 22, 2013, respectively, the Mortgage Borrowers and the Lenders assigned the principal balance of the Mortgage Loan among each of the six components of the Mortgage Loan and the Mortgage Borrowers and the Lenders assigned each of the six components of the Mortgage Loan with varying floating interest rates with an initial collective weighted average interest rate equal to LIBOR plus a margin of approximately 3.34%. The initial interest rate of the Mezzanine A Loan is equal to the one-month LIBOR plus a margin rate of 5.75%. The initial interest rate of the Mezzanine B Loan is equal to the one-month LIBOR plus a margin rate of 6.95%. The Loans are scheduled to mature on May 9, 2016, with an option for the Borrowers to extend the initial term for two one-year extension terms, subject to certain conditions. In the event the Borrowers exercise the second one-year extension option, there will be a one-time increase in the applicable interest rate by 25 basis points for the last one-year extension period. The Loans are not subject to any mandatory amortization. The Company’s effective interest rate for the Loans was 4.15% for the three and nine months ended September 30, 2014.

The Loans contain various representations and warranties, as well as certain financial, operating and other covenants that will, among other things, limit the Company’s ability to:

 

    incur additional secured or unsecured indebtedness;

 

    make cash distributions at any time that the debt yield, representing the quotient (expressed as a percentage) calculated by dividing the annualized net operating income of the properties subject to the Loans by the outstanding principal amount of the indebtedness under the Loans, is less than 8.75% or if there is a default continuing under any Mezzanine Loan (including the failure to make regularly scheduled debt service payments thereunder) until such time as the debt yield is equal to or greater than 9.00% or the Mezzanine Loan default has been cured;

 

    make investments or acquisitions;

 

    use assets as security in other transactions;

 

    sell assets (except that the Borrowers are permitted to sell assets so long as the debt yield is not reduced, subject to payment of applicable prepayment premiums and other property release requirements);

 

    guarantee other indebtedness; and

 

    consolidate, merge or transfer all or substantially all of the Company’s assets.

Defaults under the Loans include, among other things, the failure to pay interest or principal when due, material misrepresentations, transfers of the underlying security for the Loans without any required consent from the applicable Lender, defaults under material agreements relating to the properties, including franchise and management agreements, bankruptcy of a Borrower or the Company, failure to maintain required insurance and a failure to observe other covenants under the Loans, in each case subject to any applicable cure rights.

The Borrowers may prepay the Loans, in whole or in part, at any time after the twelfth month of the initial term of the Loans, except that, if a prepayment is made at any time during the period from the thirteenth month through the eighteenth month of the initial term of the Loans and such prepayment, when aggregated with all other prepayments made by a Borrower of the applicable Loan, exceeds 15% of the amount of the Loans funded to such Borrower, then such Borrower will pay to the Lenders an amount equal to the present value of the interest payable on the principal being prepaid for the period from the date of the prepayment through the eighteenth month of the initial term of the Loans. Any prepayment made after the eighteenth month of the initial term of the Loans may be made without any prepayment penalty or fee. Notwithstanding the foregoing, any prepayment of the Loans with casualty or condemnation proceeds or any prepayment to enable the Borrowers to remove a ground leased property as collateral security due to a default by a Borrower under the applicable ground lease will not be subject to any limitation on prepayment or any prepayment fee or penalty.

In addition, the applicable Borrowers for each Loan and the Company will have recourse liability under the Loans for certain matters typical of a transaction of this type, including, without limitation, relating to losses arising out of actions by the Borrowers, the Company, the Sponsor or their respective affiliates which constitute fraud, intentional misrepresentation, misappropriation of funds (including insurance proceeds), removal or disposal of any property after an event of default under the Loans, a material violation of the due on sale/encumbrance covenants set forth in the loan agreements, willful misconduct that results in waste to any property and any material modification or voluntary termination of a ground lease without the Lenders’ prior written consent if required under the loan agreements. The applicable Borrowers for each Loan and the Company will also have recourse liability for the Loans in the event any security instrument or loan agreement is deemed a fraudulent conveyance or

 

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a preference, in the event of a voluntary or collusive involuntary bankruptcy of any Borrower or any operating lessee of the properties, in the event Borrower, the Company, the Sponsor or their respective affiliates consent to or join in the application for the appointment of a custodian, receiver, trustee or examiner of any Borrower, or the operating lessee of any of the properties or any property or any Borrower or any operating lessee of the properties making an assignment for the benefit of creditors.

The Company sold three hotels during the second quarter of 2014 and one hotel during the third quarter of 2014, as further discussed in Note 13. As part of the sales, the Company repaid $8.6 million of the Mortgage Loan and $2.5 million of the Mezzanine Loans.

As part of the Merger, the Company assumed an existing loan with a commercial lender secured by the Company’s Fort Worth, Texas Residence Inn property. The loan matures on October 6, 2022 and carries a fixed interest rate of 4.73%. The Company repaid $0.3 million of principal during the nine months ended September 30, 2014, and the outstanding principal balance as of September 30, 2014 was $17.6 million and is included in mortgages payable in the condensed consolidated balance sheets. In addition, in conjunction with the Merger, Apple Six’s unsecured credit facility of $31.0 million was paid in full and extinguished and the mortgage loan of $5.6 million on the Hillsboro, Oregon Courtyard property was defeased. Interest expense, excluding deferred financing costs discussed in Note 5, was $8.3 million and $24.7 million for the three and nine months ended September 30, 2014, respectively, and is included in interest expense, net in the condensed consolidated statements of operations.

Future scheduled principal payments of debt obligations (assuming no exercise of extension options) as of September 30, 2014 are as follows (in thousands):

 

     Mortgages
Payable
     Mezzanine
Loans
     Total  

2014 (remaining months)

   $ 103      $ 0       $ 103   

2015

     421         0         421   

2016

     591,829        172,488         764,317   

2017

     464         0         464   

2018

     487        0         487   

Thereafter

     15,641         0         15,641   
  

 

 

    

 

 

    

 

 

 

Total

   $ 608,945      $ 172,488       $ 781,433   
  

 

 

    

 

 

    

 

 

 

7. Fair Value of Financial Instruments

In accordance with the authoritative guidance on fair value measurements and disclosures, the Company measures nonfinancial assets and liabilities subject to nonrecurring measurement and financial assets and liabilities subject to recurring measurement based on a hierarchy that prioritizes inputs to valuation techniques used to measure the fair value. Inputs used in determining fair value should be from the highest level available in the following hierarchy:

Level 1 — Inputs based on quoted market prices in active markets for identical assets or liabilities that the reporting entity has the ability to access.

Level 2 — Inputs based on quoted prices for similar assets or liabilities, quoted market prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.

Level 3 — Inputs are unobservable for the asset or liability and typically based on an entity’s own assumptions as there is little, if any, related market activity.

Determining estimated fair values of the Company’s financial instruments such as mortgages payable and mezzanine loans requires considerable judgment to interpret market data. The market assumptions and/or estimation methodologies used may have a material effect on estimated fair value amounts. Accordingly, the estimates presented are not necessarily indicative of the amounts by which these instruments could be purchased, sold, or settled. Carrying amounts and estimated fair values of financial instruments, for periods indicated, were as follows (in thousands):

 

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     September 30, 2014      December 31, 2013  
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
 

Financial assets and liabilities measured at fair value on a recurring basis:

           

Interest rate caps

   $ 68       $ 68       $ 465       $ 465   

Financial assets not measured at fair value:

           

Cash and cash equivalents

   $ 29,772       $ 29,772       $ 23,902       $ 23,902   

Restricted cash

   $ 35,064      $ 35,064      $ 39,179      $ 39,179   

Due from third party managers, net

   $ 5,553       $ 5,553       $ 4,841       $ 4,841   

Financial liabilities not measured at fair value:

           

Accounts payable and accrued expenses

   $ 15,385       $ 15,385       $ 12,453       $ 12,453   

Due to third party managers, net

   $ 374      $ 374      $ 0      $ 0   

Mortgages payable

   $ 608,945       $ 608,069       $ 617,855       $ 616,425   

Mezzanine loans

   $ 172,488      $ 172,488      $ 175,000      $ 175,000   

Interest rate caps - The Company acquired three interest rate cap agreements, as required by the terms of its Loans, considered to be derivative financial instruments. Each agreement caps the interest rate on its mortgages payable and mezzanine loans obtained in connection with the Merger. The Company did not designate the derivative as hedges for accounting purposes and, accordingly, accounts for the interest rate caps at fair value in the accompanying consolidated balance sheet in other assets with adjustments to fair value recorded in unrealized gain (loss) on derivatives in the condensed consolidated statements of operations. The interest rate caps were acquired at a cost of $431,210. Fair value is determined by using prevailing market data and incorporating proprietary models based on well recognized financial principals and reasonable estimates where applicable from a third party source. This is considered a Level 2 valuation technique.

Cash, cash equivalents and restricted cash - These financial assets bear interest at market rates and have maturities of less than 90 days. The carrying value approximates fair value due to the short-term nature of these assets. This is considered a Level 1 valuation technique.

Due from/to third party managers, accounts payable and accrued expenses - The carrying value of these financial instruments approximates their fair value due to the short-term nature of these financial instruments. This is considered a Level 1 valuation technique.

Mortgages payable and mezzanine loans - For the fixed rate mortgage payable, fair value is calculated by discounting the future cash flows of each instrument at estimated market rates of debt obligations with similar maturities and credit profiles or quality. This is considered a Level 3 valuation technique. The fair value of the variable rate mortgage payable and mezzanine loans cannot be reasonably estimated because it is not readily determinable without undue cost.

8. Commitments and Contingencies

Legal Fees – In connection with the Merger, on November 29, 2012 Apple Six entered into a litigation cost sharing agreement with Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (the “other Apple REIT companies”). Pursuant to the litigation cost sharing agreement:

 

  The Company, as successor to Apple Six, will pay 20%, and the other parties to the litigation cost sharing agreement will pay 80%, of the fees and expenses of specified counsel or any other counsel, consultant or service provider jointly retained in connection with the Apple REIT class action litigation, incurred after November 29, 2012 in connection with the Apple REIT class action litigation.

The following is a description of the class action litigation:

On December 13, 2011, the United States District Court for the Eastern District of New York (the “District Court”) ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. Apple Six was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc. et al. class action lawsuit, which was filed on June 20, 2011.

On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against Apple Six, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. (“David Lerner Associates”) and David Lerner. Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. are collectively referred to as “other Apple REIT companies.” The consolidated complaint, purportedly brought on behalf of all purchasers of units in Apple Six and the other Apple REIT companies, or those who otherwise acquired these units that were

 

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offered and sold to them by David Lerner Associates or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.

On February 16, 2012, one shareholder of Apple Six and Apple REIT Seven, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against Apple Six, Apple REIT Seven, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, and certain executives of David Lerner Associates. The complaint, purportedly brought on behalf of all purchasers of units of Apple Six and Apple REIT Seven, Inc., or those who otherwise acquired these units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.

On April 18, 2012, Apple Six and the other Apple REIT companies served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. Apple Six and the other Apple REIT companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint.

On April 3, 2013, the motion to dismiss the consolidated complaint in the In re Apple REITs Litigation was granted in full with prejudice. On April 12, 2013, plaintiffs filed a notice of appeal in the Apple REIT class action litigation, appealing the decision to the United States Court of Appeals for the Second Circuit. On July 26, 2013, plaintiffs filed a brief in support of their appeal. On October 25, 2013, defendants filed a brief opposing plaintiffs’ appeal. On November 15, 2013, plaintiffs filed a reply brief in further support of their appeal. Oral argument on plaintiffs’ appeal was held on March 31, 2014.

On April 23, 2014, the United States Court of Appeals for the Second Circuit (the “Second Circuit”) entered a summary order in the In re Apple REITs Litigation. In the summary order, the Second Circuit affirmed the dismissal by the District Court of the federal securities claims and state securities law claims and affirmed the dismissal of the unjust enrichment claim. However, the Second Circuit vacated the District Court’s dismissal of the plaintiffs’ state law breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, and negligence claims and remanded for further proceedings.

After remand, on June 6, 2014, defendants filed a brief in support of their motion to dismiss. On July 9, 2014, plaintiffs filed an opposition brief. Defendants’ reply brief was filed on August 8, 2014.

The Company believes that any claims against it are without merit, and it intends to continue to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of this proceeding or provide a reasonable estimate of the possible loss or range of loss due to this proceeding.

 

    The Company, as successor to Apple Six, will pay 25%, and the other parties to the litigation cost sharing agreement will pay 75%, of the fees and expenses of specified counsel or any other counsel, consultant or service provider jointly retained in connection with the SEC investigation, incurred after November 29, 2012 in connection with the SEC investigation. On February 12, 2014, the SEC entered into a settlement with the Company, the Other Apple REIT Companies and Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc. and Apple Nine Advisors, Inc. (collectively the “Advisory Companies”) and Glade M. Knight, Apple Six’s former Chief Executive Officer, and Bryan F. Peery, Apple Six’s former Chief Financial Officer. The settlement related to the previously announced SEC investigation focused principally on the adequacy of certain disclosures in the filings of Apple Six beginning in 2008, as well as the review of certain transactions involving Apple Six and certain of the other Apple REIT companies with which the Company is not affiliated. Following completion of the Company’s acquisition of Apple Six on May 14, 2013, the Company, as the surviving corporation in the Merger, became involved in the SEC investigation. The settlement requires the Company to, without admitting or denying any allegations, consent to the issuance of an administrative order alleging various disclosure deficiencies that occurred at the Apple REITs prior to the Company’s acquisition of Apple Six and to cease and desist from committing or causing violations of specified securities laws, but does not require the Company to pay any financial penalties. Certain of the other parties to the settlement agreement with which the Company is not affiliated, however, also agreed to pay financial penalties and made certain undertakings that are not applicable to the Company. The settlement and the allegations have no impact on the financial statements of the Company.

Franchise Agreements - As of September 30, 2014, the Company’s hotel properties, other than the Courtyard in Myrtle Beach, South Carolina, the SpringHill Suites in Fort Worth, Texas and the Marriott in Redmond, Washington, (the “Marriott Managed Properties”) are operated under franchise agreements between the Company’s TRS and Marriott International, Inc. (“Marriott”) or Hilton Hotels Corporation (“Hilton”) or one of their respective affiliates. The franchise agreements for these hotels allow the properties to operate under the brand identified in the applicable franchise agreements. The management agreements for each of the Marriott Managed Properties allow the Marriott Managed Properties to operate under the brand identified therein. Pursuant to the franchise agreements, the Company pays a royalty fee, generally between 4.5% and 6.0% of room revenue, which is included in Franchise fees in the condensed consolidated statements of operations. Program fees, which include additional fees for marketing, are included in Sales and marketing expense, and central reservation system and other franchisor costs are included in Operating expense in the condensed consolidated statements of operations.

Management Agreements - As of September 30, 2014, each of the Company’s 62 hotels are operated and managed, under separate management agreements, by affiliates of the following companies: Marriott, Stonebridge Realty Advisors, Inc. (“Stonebridge”), Western International (“Western”), Larry Blumberg & Associates (“LBA”), White Lodging Services Corporation (“White”), Inn Ventures, Inc. (“Inn Ventures”), or Interstate Hotels & Resorts, Inc. (“Interstate”). In connection with the Merger, the five hotels previously managed by affiliates of Hilton Worldwide, Inc. and the one hotel previously managed by Newport Hospitality Group, Inc. were converted to management by Interstate on May 14, 2013. The management agreements require the Company to pay a monthly fee calculated as a percentage of revenues, generally between 2.5% - 7.0%, as well as annual incentive fees, if applicable, and are included in Management fees in the condensed consolidated statements of operations. If the Company terminates a management agreement prior to its expiration, it may be liable for estimated management fees through the remaining term and liquidated damages. Additionally, the Company, from time to time, enters into management agreements to manage retail premises ancillary to its hotels.

TRS Lease Agreements - The Company’s lease agreements are intercompany agreements between the TRS lessees and our property-owning subsidiaries. These agreements generally contain terms which are customary for third-party lease agreements, including terms for rent payments and other expenses. All related rental income and expense related to the TRS lease agreements net to zero and have no impact on the condensed consolidated financial statements.

 

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Ground Leases – As of September 30, 2014, four of the Company’s hotel properties had ground leases with remaining terms ranging from two to 20 years. Two properties, the Courtyard in Tuscaloosa, Alabama and the Fairfield Inn in Tuscaloosa, Alabama, are leased to the Company pursuant to a single ground lease. The ground lease for the Residence Inn in Pittsburgh, Pennsylvania originated at the time of the Merger and has a term of 20 years. Payments under this lease are payable to a subsidiary of the Company and, therefore eliminated in consolidation and excluded from the table below. Each of the remaining three leases has the option for the Company to extend the lease. The Residence Inn in Portland, Oregon has a lease for parking space which is included in the table below. Ground lease expenses totaled $0.1 million and $0.2 million for each of the three and nine months ended September 30, 2014, respectively, and are included in taxes, insurance and other in the condensed consolidated statements of operations. The aggregate amounts of minimum lease payments under these lease agreements for the five years subsequent to September 30, 2014 and thereafter are as follows (in thousands):

 

     Amount  

2014 (remaining months)

   $ 66   

2015

     267   

2016

     209   

2017

     132   

2018

     99   

Thereafter

     479   
  

 

 

 

Total

   $ 1,252   
  

 

 

 

9. 7% Series A Cumulative Redeemable Preferred Stock

In connection with the Merger, the Company issued 97,032,848 shares of Series A Preferred Stock. The terms of these shares provide the Company with the right to redeem such shares at any time for an amount equal to the liquidation preference, plus any accumulated and unpaid dividends. In addition, the terms of these shares include an option for a holder of such shares to require the Company to redeem all or a portion of such holder’s shares on or after November 14, 2020 for an amount equal to the liquidation preference, plus any accumulated and unpaid dividends. The initial dividend rate on these shares is 7% per annum. The dividend rate will increase to 9% per annum if dividends are not paid in cash for more than six quarters, and to 11% per annum if they are not redeemed after the earlier of certain change of control events and May 14, 2018. Due to the option provided to the holders of these shares, such shares have been classified outside permanent shareholders’ equity.

On September 30, 2013, BRE Holdings purchased approximately 2.0 million shares of the Series A Preferred Stock for $1.30 per share as part of a tender offer extended to all shareholders. The shares are currently held by BRE Holdings.

The initial liquidation preference of $1.90 per share will be subject to downward adjustment should net costs and payments relating to certain legacy litigation and regulatory matters exceed $3.5 million from the date of the Merger Agreement (November 29, 2012). The Company recognizes changes in the redemption value immediately as they occur and adjusts the carrying amount of the Series A Preferred Stock to equal the redemption value at the end of each reporting period. As of September 30, 2014, the initial liquidation preference has not been adjusted.

On March 31, 2014, the Board of Directors of the Company declared a dividend for the Series A Preferred Stock of $0.0333 per share, which was paid on April 15, 2014 to shareholders of record on April 1, 2014. On June 18, 2014, the Board of Directors of the Company declared a dividend for the Series A Preferred Stock of $0.0333 per share, which was paid on July 15, 2014 to shareholders of record on July 1, 2014. On September 15, 2014, the Board of Directors of the Company declared a dividend for the Series A Preferred Stock of $0.0333 per share, which was paid on October 15, 2014 to shareholders of record on October 1, 2014. Refer to the Condensed Consolidated Statements of Cash Flows for dividends paid to Series A Preferred shareholders for the nine months ended September 30, 2014.

10. Shareholders’ Equity

The Company is authorized to issue 150,100,000 shares of capital stock pursuant to its Amended and Restated Certificate of Incorporation, consisting of (i) 100,000 shares of common stock, par value $0.01 per share, and (ii) 150,000,000 shares of preferred stock, par value $0.0001 per share.

Holders of the Company’s common stock are entitled to one vote for each share of common stock held. At September 30, 2014 and December 31, 2013, there were 100 shares of common stock issued and outstanding.

On February 14, 2014, the Board of Directors of the Company declared a dividend for common stock of $50,000 per share, which was paid on February 19, 2014. On May 14, 2014, the Board of Directors of the Company declared a dividend for common stock of $90,000 per share, which was paid on May 16, 2014. On August 11, 2014, the Board of Directors of the Company declared a dividend for common stock of $90,000 per share, which was paid on August 15, 2014. Refer to the Condensed Consolidated Statements of Cash Flows for dividends paid to common shareholders for the nine months ended September 30, 2014.

 

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Under the prior Amended and Restated Certificate of Incorporation, the authorized preferred stock of the Company included a series designated Series B Redeemable Preferred Stock (“Series B Preferred Stock”), of which 125 shares were authorized. The Company, at its option, was able to redeem shares of the Series B Preferred Stock, in whole or in part, at any time or from time to time, for cash at a redemption price equal to $1,000 per share plus an amount equal to all accrued and unpaid dividends thereon to and including the dated fixed for redemption. Dividends on the Series B Preferred Stock were payable at the rate of 12% per annum of the total $1,000 per share. 113 shares of Series B Preferred Stock were issued on January 18, 2013 and were redeemed on May 10, 2013.

11. Income Taxes

The Company accounts for TRS income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The analysis utilized by the Company in determining the deferred tax valuation allowance involves considerable management judgment and assumptions. For the three and nine months ended September 30, 2014, the Company recorded $3.6 million and $4.5 million of income tax expense, respectively. Tax expense for the three and nine months ended September 30, 2014 is comprised of federal and state income taxes.

12. Related Party Transactions

The Sponsor and its affiliates are in the business of making investments in companies and real estate assets and currently own, and may, from time to time acquire and hold, in each case, interests in businesses or assets that compete directly or indirectly with the Company. In addition, certain affiliates of the Sponsor control Hilton Worldwide Holdings Inc., which indirectly owns the entities that serve as franchisors and receive franchise fees for 27 of the hotels owned by the Company. In connection with the Sponsor’s and its affiliates’ business activities, the Sponsor, BRE Holdings or any of their affiliates, including, without limitation, Hilton Worldwide Holdings Inc. or its subsidiaries (“Hilton”), may from time to time enter into arrangements with the Company or its subsidiaries. These arrangements may be subject to restrictions on affiliate transactions contained in agreements entered into in connection with the debt financing arranged to complete the Merger. The Company incurred $5.0 million and $12.9 million of franchise fees, marketing fees, and other expenses in the three and nine months ended September 30, 2014, respectively, payable to Hilton.

13. Hotels Held for Sale and Dispositions

Based on the performance, location and capital requirements, the Company committed to a plan to sell the four properties identified below:

 

    Fairfield Inn - Birmingham, Alabama

 

    SpringHill Suites - Montgomery, Alabama

 

    Fairfield Inn - Orange Park, Florida

 

    SpringHill Suites - Savannah, Georgia

All four of the hotels were sold during the second and third quarter of 2014 as summarized below (in thousands):

 

Hotel

   Sale Date    Net Proceeds      Gain/(Loss)  

Fairfield Inn - Orange Park, Florida

   April 23, 2014    $ 2,978       ($ 67

Fairfield Inn - Birmingham, Alabama

   May 8, 2014      1,509         223   

SpringHill Suites - Savannah, Georgia

   June 2, 2014      3,405         (285

SpringHill Suites - Montgomery, Alabama

   September 4, 2014      1,488         (21
     

 

 

    

 

 

 

Total

      $ 9,380      ($ 150
     

 

 

    

 

 

 

The results of operations for all four of these properties are classified as income from discontinued operations.

The following table sets forth the operating results from discontinued operations for the Successor and Predecessor periods (in thousands).

 

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Table of Contents
     Successor     Predecessor  
     Three Months
Ended
September 30,
2014
    Nine Months
Ended
September 30,
2014
    Three Months
Ended
September 30,
2013
    Nine Months
Ended
September 30,
2013
    Period from
January 1
through
May 13, 2013
 

Total revenue

   $ 254      $ 2,479      $ 1,313      $ 2,112      $ 1,856   

Hotel operating expenses

     220        1,936        1,048        1,598        1,408   

Taxes, insurance and other

     23        155        54        83        168   

General and administrative

     9        67        39        65        0   

Depreciation expense

     0        0        0        42        262   

Interest expense

     27        328        192        192        0   

Income tax (benefit) expense

     (94     (64     0        19        0   

Estimated selling costs

     0        0        435        435     

Gain (loss) from hotel dispositions

     (231     (150     0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from discontinued operations

   ($ 162   ($ 93   ($ 455   ($ 322   $ 18   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company allocates interest expense to discontinued operations and has included such interest expense in computing income (loss) from discontinued operations. Interest expense was allocated by taking the loan release amounts for the discontinued operations, as a percentage of the total outstanding principal, multiplied by the interest expense for the period.

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In this report, the terms “the Company,” “we” or “our” refer to BRE Select Hotels Corp, together with its wholly-owned subsidiaries, and refer to Apple REIT Six, Inc. (“Apple Six”) for the periods prior to the Merger (as defined below), unless the context indicates otherwise.

Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential,” “forecast” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; risks associated with the Company’s indebtedness; financing risks; regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; competition within the hotel and real estate industry; risks associated with the Company’s legal proceedings; and the factors discussed in the sections entitled “Risk Factors” in the Company’s Annual Report on Form 10-K filed on March 28, 2014 (the “Form 10-K”) and in this report. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust (“REIT”) involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the SEC. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statements or cautionary factors as a result of new information, future events or otherwise, except as required by law.

Overview

Certain merger transaction costs incurred prior to May 14, 2013 by the Company are included in the Successor period, as that period represents the commencement of Successor operations. Prior to May 14, 2013, the Company had no revenues, and expenses were comprised solely of merger related costs. Information presented as of September 30, 2014 and December 31, 2013, and for the three and nine months ended September 30, 2014 and 2013, represents that of the Successor. Information for the period from January 1, 2013 through May 13, 2013 is presented for the Predecessor operations.

The Company was formed to invest in income-producing real estate in the United States through the acquisition of Apple Six. The Company intends to be treated as a REIT for federal income tax purposes. On May 14, 2013, the Company completed its previously announced acquisition of Apple Six pursuant to the Agreement and Plan of Merger, dated as of November 29, 2012 (the “Merger Agreement”), by and between the Company, BRE Holdings and Apple Six, pursuant to which Apple Six merged with and into the Company (the “Merger”). As of September 30, 2014, the Company owned 62 hotels located in 18 states with an aggregate of 7,347 rooms.

Hotel Operations

Along with the industry as a whole, we continue to experience improvements in both revenues and operating income as compared to the prior year. Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of our hotels as compared to other hotels within their respective local markets, in general, continues to meet our expectations. We believe the remainder of 2014 will offer attractive growth for both the hotel industry and our Company because of the expected increased demand versus available supply. The Company sold three hotels during the second quarter of 2014 and one during the third quarter of 2014. See Note 13 to the condensed consolidated financial statements.

In evaluating financial condition and operating performance, the most important indicators that we focus on are: (1) revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”), and RevPAR Index, which compares an individual hotel’s results to others in its local market, and (2) expenses, such as hotel operating expenses, general and administrative and other expenses described below.

 

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Table of Contents

The Company previously committed to a plan to sell the Birmingham, Alabama Fairfield Inn, Montgomery, Alabama SpringHill Suites, Orange Park, Florida Fairfield Inn, and Savannah, Georgia SpringHill Suites, as it was determined that these properties no longer fit the Company’s long-term strategic plan. The Birmingham, Alabama Fairfield Inn, Orange Park, Florida Fairfield Inn, and Savannah, Georgia SpringHill Suites were sold during the second quarter of 2014, and the Montgomery, Alabama SpringHill Suites was sold during the third quarter of 2014. The results of these properties have been included in discontinued operations and are not included in the summary below. The following is a summary of the Company’s results from continuing operations:

 

     Successor  
(in thousands, except statistical data)    Three Months
Ended
September 30,
2014
    Percent of
Revenue
    Three Months
Ended
September 30,
2013
    Percent of
Revenue
 

Total hotel revenue

   $ 79,212        100 %   $ 73,775        100

Hotel operating expenses

     41,511        52     39,629        54

Taxes, insurance and other expense

     3,546        4 %     3,292        4

General and administrative expense

     777        1     832        1

Merger transaction costs

     0          320     

Depreciation

     6,760          6,534     

Interest expense, net

     9,666          9,621     

Unrealized loss (gain) on derivatives

     (22       208     

Income tax expense

     3,649          1,964     

Number of hotels

     62          62     

ADR

   $ 135        $ 129     

Occupancy

     82       80  

RevPAR

   $ 110        $ 103     

RevPAR Index (1)

     118          119     

Total rooms sold (2)

     552,782          540,101     

Total rooms available (3)

     675,924          675,924     

 

     Successor     Predecessor  
(in thousands, except statistical data)    Nine Months
Ended
September 30,
2014
    Percent of
Revenue
    Nine Months
Ended
September 30,
2013
    Percent of
Revenue
    Period from
January 1
through
May 13, 2013
    Percent of
Revenue
 

Total hotel revenue

   $ 214,032        100 %   $ 111,336        100 %     $ 88,275        100

Hotel operating expenses

     116,482        54     59,445        53 %       51,728        59

Taxes, insurance and other expense

     10,436        5 %     5,258        5 %       4,457        5

General and administrative expense

     2,542        1     1,721        2 %       2,828        3

Merger transaction costs

     0          21,463            67,633     

Depreciation

     19,994          9,854            10,651     

Interest expense, net

     28,696          14,908            1,439     

Unrealized loss (gain) on derivatives

     397          (231         0     

Income tax expense

     4,463          3,420            140     
 

Number of hotels

     62          62            62     

ADR

   $ 127        $ 127          $ 116     

Occupancy

     78       80         73  

RevPAR

   $ 100        $ 102          $ 84     

RevPAR Index (1)

     119          119            121     

Total rooms sold (2)

     1,570,692          825,971            709,621     

Total rooms available (3)

     2,005,731          1,028,580            978,777     

 

(1) Calculated from data provided by Smith Travel Research, Inc.®
(2) Represents the number of room nights sold during the period.
(3) Represents the number of rooms owned by the Company multiplied by the number of nights in the period.

 

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Table of Contents

Hotels Owned

The following table summarizes the location, brand, manager and number of rooms for each of the 62 hotels the Company owned at September 30, 2014, all of which were acquired on May 14, 2013 in connection with the Merger described in Note 3 of the condensed consolidated financial statements.

 

City

      

State

       

Name

       

Manager

       

Rooms

Dothan

     Alabama       Courtyard       LBA       78

Dothan

     Alabama       Hampton Inn & Suites       LBA       85

Huntsville

     Alabama       Fairfield Inn       LBA       79

Huntsville

     Alabama       Residence Inn       LBA       78

Tuscaloosa

     Alabama       Courtyard       LBA       78

Tuscaloosa

     Alabama       Fairfield Inn       LBA       63

Anchorage

     Alaska       Hampton Inn       Stonebridge       101

Anchorage

     Alaska       Hilton Garden Inn       Stonebridge       125

Anchorage

     Alaska       Homewood Suites       Stonebridge       122

Phoenix

     Arizona       Hampton Inn       Stonebridge       99

Arcadia

     California       Hilton Garden Inn       Stonebridge       124

Arcadia

     California       SpringHill Suites       Stonebridge       86

Bakersfield

     California       Hilton Garden Inn       Interstate       120

Folsom

     California       Hilton Garden Inn       Inn Ventures       100

Foothill Ranch

     California       Hampton Inn       Stonebridge       84

Lake Forest

     California       Hilton Garden Inn       Stonebridge       103

Milpitas

     California       Hilton Garden Inn       Inn Ventures       161

Roseville

     California       Hilton Garden Inn       Inn Ventures       131

San Francisco

     California       Hilton Garden Inn       White       169

Boulder

     Colorado       Marriott       White       157

Glendale

     Colorado       Hampton Inn & Suites       Stonebridge       133

Lakewood

     Colorado       Hampton Inn       Stonebridge       170

Farmington

     Connecticut       Courtyard       White       119

Rocky Hill

     Connecticut       Residence Inn       White       96

Wallingford

     Connecticut       Homewood Suites       White       104

Clearwater

     Florida       SpringHill Suites       LBA       79

Lake Mary

     Florida       Courtyard       LBA       83

Lakeland

     Florida       Residence Inn       LBA       78

Panama City

     Florida       Courtyard       LBA       84

Pensacola

     Florida       Courtyard       LBA       90

Pensacola

     Florida       Fairfield Inn       LBA       63

Pensacola

     Florida       Hampton Inn & Suites       LBA       85

Tallahassee

     Florida       Hilton Garden Inn       Interstate       99

Albany

     Georgia       Courtyard       LBA       84

Columbus

     Georgia       Residence Inn       LBA       78

Valdosta

     Georgia       Courtyard       LBA       84

Mt. Olive

     New Jersey       Residence Inn       White       123

Somerset

     New Jersey       Homewood Suites       White       123

Saratoga Springs

     New York       Hilton Garden Inn       White       112

Roanoke Rapids

     North Carolina       Hilton Garden Inn       Interstate       147

Hillsboro

     Oregon       Courtyard       Inn Ventures       155

Hillsboro

     Oregon       Residence Inn       Inn Ventures       122

Hillsboro

     Oregon       TownePlace Suites       Inn Ventures       136

Portland

     Oregon       Residence Inn       Inn Ventures       258

Pittsburgh

     Pennsylvania       Residence Inn       White       156

Myrtle Beach

     South Carolina       Courtyard       Marriott       135

Nashville

     Tennessee       Homewood Suites       Interstate       121

Arlington

     Texas       SpringHill Suites       Western       121

Arlington

     Texas       TownePlace Suites       Western       94

Dallas

     Texas       SpringHill Suites       Western       148

 

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Table of Contents

Fort Worth

     Texas       Homewood Suites       Interstate       137

Fort Worth

     Texas       Residence Inn       Western       149

Fort Worth

     Texas       SpringHill Suites       Marriott       145

Laredo

     Texas       Homewood Suites       Western       105

Laredo

     Texas       Residence Inn       Western       109

Las Colinas

     Texas       TownePlace Suites       Western       135

McAllen

     Texas       Hilton Garden Inn       Western       104

Fredericksburg

     Virginia       Hilton Garden Inn       Interstate       148

Kent

     Washington       TownePlace Suites       Inn Ventures       152

Mukilteo

     Washington       TownePlace Suites       Inn Ventures       128

Redmond

     Washington       Marriott       Marriott       262

Renton

     Washington       Hilton Garden Inn       Inn Ventures       150
                      

 

                       7,347
                      

 

Results of Operations

As of September 30, 2014, the Company owned 62 hotels located in 18 states with an aggregate of 7,347 rooms. Hotel performance is impacted by many factors, including the economic conditions in the areas we operate as well as the United States, generally. Although hampered by uncertainty regarding government spending, economic indicators in the United States have shown evidence of an economic recovery, which is currently having a positive impact on the lodging industry, including the Company. As a result, the Company’s revenue and operating income improved in the three and nine months ended September 30, 2014 compared to the comparable periods in 2013, and the Company expects continued improvement in revenue and operating income during the remainder of the year.

Revenues

The Company’s principal source of revenue is hotel revenue, consisting of room and other related revenue. For the three months ended September 30, 2014 and 2013, the Company had total hotel revenue from continuing operations of $79.2 million and $73.8 million, respectively. For the nine months ended September 30, 2014, total hotel revenue from continuing operations was $214.0 million, compared to $111.3 million and $88.3 million for the periods from May 14, 2013 through September 30, 2013 and January 1, 2013 through May 13, 2013, respectively. For the three months ended September 30, 2014, the hotels achieved average occupancy of 82% and 80%, ADR of $135 and $129, and RevPAR of $110 and $103, respectively. For the nine months ended September 30, 2014, the hotels achieved average occupancy of 78%, ADR of $127 and RevPAR of $100, compared to occupancy of 80% and 73%, ADR of $127 and $116 and RevPAR of $102 and $84 for the period from May 14, 2013 through September 30, 2013 and January 1, 2013 through May 13, 2013, respectively. ADR is calculated as room revenue divided by number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.

Increases in demand and continued room rate improvements led to the improved results in the current year compared to 2013. Our hotels continue to be leaders in their respective markets, with higher occupancy percentage and ADR compared to our competitors, as evidenced by our consistently high RevPAR Index scores over the baseline of 100.

Expenses

Hotel operating expenses consist of direct room expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the three months ended September 30, 2014 and 2013, hotel operating expenses from continuing operations totaled $41.5 million and $39.6 million, respectively, representing 52% and 54% of total hotel revenue. For the nine months ended September 30, 2014, hotel operating expenses from continuing operations totaled $116.5 million, representing 54% of total hotel revenue. This compares to hotel operating expenses of $59.4 million and $51.7 million, representing 53% and 59% of total hotel revenue for the periods from May 14, 2013 through September 30, 2013 and January 1, 2013 through May 13, 2013, respectively. Results for the three and nine months ended September 30, 2014 reflect the impact of the increases in revenues and the Company’s efforts to control costs. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utilities by monitoring and sharing utilization data across its hotels and management companies. Although operating expenses will increase as occupancy and revenue increases, the Company has and expects to continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality service levels at each property.

Taxes, insurance, and other expenses from continuing operations for the three months ended September 30, 2014 and 2013 were $3.5 million and $3.3 million, respectively, or 4% and 4% of total hotel revenue. Taxes, insurance, and other expenses from continuing operations for the nine months ended September 30, 2014 were $10.4 million, or 5% of total hotel revenue. This compares to taxes, insurance, and other operating expenses from continuing operations of $5.3 million and $4.5 million, or 5% and 5% of total hotel revenue for the periods from May 14, 2013 through September 30, 2013 and January 1, 2013 through

 

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May 13, 2013, respectively. Property taxes have continued to increase in 2014 as the economy has continued to improve and localities reassessed property values accordingly. Also, 2014 insurance rates have increased modestly, largely because of overall insurance industry losses following world-wide catastrophic acts of mother nature.

General and administrative expense from continuing operations for the three months ended September 30, 2014 and 2013 was $0.8 million and $0.8 million, respectively, or 1% and 1% of total hotel revenue. General and administrative expense from continuing operations for the nine months ended September 30, 2014 was $2.5 million, or 1% of total hotel revenue. This compares to general and administrative expense from continuing operations of $1.7 million and $2.8 million, or 2% and 3% of total hotel revenue for the periods from May 14, 2013 through September 30, 2013 and January 1, 2013 through May 13, 2013, respectively. The principal components of general and administrative expense are advisory fees and expenses, legal fees, accounting fees, and reporting expenses. Legal fees primarily relate to legacy matters of the Predecessor and its litigation cost sharing agreement with the other Apple REITs. See Part II, Item 1 Legal Proceedings for further details. General and administrative expense has trended downward since the Merger due to lower overhead costs for the Successor as compared to the Predecessor.

Merger transaction costs were $0 and $0.3 million for the three months ended September 30, 2014 and 2013, respectively. Merger transaction costs were $0 for the nine months ended September 30, 2014. This compares to merger transaction costs of $21.5 million and $67.6 million for the nine month Successor period ended September 30, 2013 and the Predecessor period January 1, 2013 through May 13, 2013, respectively. Costs incurred during 2013 were in connection with the Merger discussed herein, and comprised primarily of legal and other professional services fees.

Depreciation expense from continuing operations for the three months ended September 30, 2014 and 2013 was $6.8 million and $6.5 million, respectively. Depreciation expense from continuing operations for the nine months ended September 30, 2014 was $20.0 million. This compares to depreciation expense from continuing operations of $9.9 million and $10.7 million for the periods from May 14, 2013 through September 30, 2013 and January 1, 2013 through May 13, 2013, respectively. The 2014 expense is lower due to a higher percentage of investment in real estate allocated to building post-Merger compared to 2013, resulting in depreciation expense being spread over a longer period of time.

Interest expense, net for the three months ended September 30, 2014 and 2013 was $9.7 million and $9.6 million, respectively. Interest expense, net for the nine months ended September 30, 2014 was $28.7 million. This compares to interest expense, net of $14.9 million and $1.4 million for the periods from May 14, 2013 through September 30, 2013 and January 1, 2013 through May 13, 2013, respectively. Interest expense increased due to the mortgage and mezzanine loans obtained in connection with the Merger, partly offset by the payoff of the line of credit and the mortgage payable on the Hillsboro Courtyard. As of September 30, 2014, the Company had total debt outstanding of $781.4 million compared to $793.0 million at September 30, 2013. The Company capitalized interest of approximately $0 for the three and nine months ended September 30, 2014 compared to $0 and $0.2 million for the period from May 14, 2013 through September 30, 2013 and January 1, 2013 through May 13, 2013, respectively, in conjunction with hotel renovations.

Liquidity and Capital Resources

Operating cash flow from the properties owned is the Company’s principal source of liquidity. The Company anticipates that cash flow from operations will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, and dividends on the 7% Series A Cumulative Redeemable Preferred Shares.

For the nine months ended September 30, 2014, net cash flows from operating activities were $56.3 million; net cash flows used in investing activities were $6.3 million, including $23.4 million for capital improvements offset by $9.4 million from asset sales and $7.4 million from restricted cash used for property improvements; net cash flows used in financing activities were $44.1 million, due to $11.4 million in mortgage and mezzanine debt payments and $32.7 million in dividends paid to common and Series A Preferred shareholders.

To qualify as a REIT, the Company is required to distribute at least 90% of its ordinary income. Prior to the execution of the Merger Agreement, distributions were paid by the Predecessor at a monthly rate of $0.066 per common share. No distributions were made by the Predecessor in the period from January 1, 2013 through May 13, 2013 per the terms of the Merger Agreement.

On January 15, 2014, the Company paid a dividend for the Series A Preferred Stock of $0.0333 per share to shareholders of record on January 1, 2014. On April 15, 2014, the Company paid a dividend for the Series A Preferred Stock of $0.0333 per share to shareholders of record on April 1, 2014. On July 15, 2014, the Company paid a dividend for the Series A Preferred Stock of $0.0333 per share to shareholders of record on July 1, 2014. On October 15, 2014, the Company paid a dividend for the Series A Preferred Stock of $0.0333 per share to shareholders of record on October 1, 2014.

On February 19, 2014, the Company paid a dividend for the common stock of $50,000 per share. On May 16, 2014, the Company paid a dividend for the common stock of $90,000 per share. On August 15, 2014, the Company paid a dividend for the common stock of $90,000 per share.

The Company has ongoing capital commitments to fund its capital improvements. The Company is required, under all of the hotel franchise agreements and under its loan agreements, to make available for the repair, replacement and refurbishing of furniture, fixtures, and equipment a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. Pursuant to the loan agreement described in Note 6 to the condensed consolidated

 

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financial statements, at closing the Company was required to deposit $15.0 million into a restricted cash account to fund required capital improvements. In addition, for a thirty-six month period thereafter, the Company must deposit in a lender escrow an amount equal to the sum of: (i) $0.4 million and (ii) 4% of total revenue, excluding revenue from the Marriott managed hotels. These funds can then be used for capital enhancements to the properties. Based on current projections of revenue for the remainder of 2014, the total funds reserved and/or expected to be used for capital expenditures for 2014 is approximately $30.0 million.

Contractual Commitments

Our contractual obligations have not changed significantly from those disclosed in “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Contractual Commitments” of our Annual Report on Form 10-K for the year ended December 31, 2013.

Impact of Inflation

Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation. Competitive pressures may, however, limit the operators’ ability to raise room rates. Currently the Company is not experiencing any material impact from inflation.

Business Interruption

Being in the real estate industry, the Company’s financial position and results of operation are exposed to natural disasters. Although management believes there is adequate insurance to cover this exposure, there can be no assurance that such events will not have a material adverse effect on the Company’s financial position or results of operations.

Seasonality

The hotel industry historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.

Critical Accounting Policies

There have been no significant changes in our critical accounting policies or estimates from those disclosed in our Annual Report on Form10-K for the year ended December 31, 2013.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

For the Company’s disclosures about market risk, please see “Quantitative and Qualitative Disclosures about Market Risk” in Part II, Item 7A of the Company’s 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 28, 2014. There have been no material changes to the Company’s disclosures about market risk in Part II, Item 7A of the Company’s 2013 Annual Report on Form 10-K.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company’s management, with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this Form 10-Q. Based upon that evaluation, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer concluded that, as of September 30, 2014, the Company’s disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Apple Six was party to certain legal matters at the time of its acquisition by the Company. Following completion of its acquisition of Apple Six, the Company as the surviving corporation in the Merger, became involved in these legacy matters. The initial liquidation preference of $1.90 per share of Series A Preferred Stock is subject to downward adjustment should net costs and payments relating to certain litigation and regulatory legacy matters exceed $3.5 million, including the litigation and the SEC investigation described in note 8 of the Notes to the Condensed Consolidated Financial Statements. As of September 30, 2014, the initial liquidation preference has not been adjusted. The information regarding these legacy matters can be found under “Commitments and Contingencies” in note 8 of the notes to the Condensed Consolidated Financial Statements contained in this quarterly report and is incorporated by reference into this Item 1.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the section entitled “Risk Factors” in the Company’s 2013 Annual Report on Form 10-K, which could materially adversely affect the Company’s business, financial condition, results of operations (including revenues and profitability), operating cash flow and value. The risks described in the Company’s 2013 Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial also could materially adversely affect its business, financial condition, results of operations (including revenues and profitability), operating cash flow and value. There have been no material changes from the risk factors previously disclosed in the Company’s 2013 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) of the Exchange Act, the Company hereby incorporates by reference herein Exhibit 99.1 of this report, which includes disclosures publicly filed and/or provided to The Blackstone Group L.P., an affiliate of the Company’s Sponsor, by Travelport Worldwide Limited, which may be considered the Company’s affiliate.

 

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Item 6. Exhibits

 

Exhibit

Number

  

Description of Documents

31.1    Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
31.2    Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
32.1
   Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **
99.1    Section 13(r) Disclosure. *
101    The following materials from BRE Select Hotels Corp’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text and in detail. *

 

* Filed herewith
** Furnished herewith

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    BRE SELECT HOTELS CORP
Date: November 12, 2014     By:  

/s/    WILLIAM J. STEIN

   

William J. Stein

Chief Executive Officer and Senior Managing Director

(Principal Executive Officer)

   
   
Date: November 12, 2014     By:  

/s/    BRIAN KIM

   

Brian Kim

Chief Financial Officer, Vice President

and Managing Director

(Principal Financial Officer and Principal Accounting Officer)

   
   
   

 

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