Attached files
| file | filename |
|---|---|
| EX-32 - EXHIBIT 32 - Hospitality Investors Trust, Inc. | hit-exhibit32xq32018.htm |
| EX-31.2 - EXHIBIT 31.2 - Hospitality Investors Trust, Inc. | hit-exhibit312xq32018.htm |
| EX-31.1 - EXHIBIT 31.1 - Hospitality Investors Trust, Inc. | hit-exhibit311xq32018.htm |
| EX-10.2 - EXHIBIT 10.2 - Hospitality Investors Trust, Inc. | hit-exhibit102xq32018.htm |
| EX-10.1 - EXHIBIT 10.1 - Hospitality Investors Trust, Inc. | hit-exhibit101xq32018.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2018
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 000-55394
HOSPITALITY INVESTORS TRUST, INC.
(Exact Name of Registrant as Specified in its Charter)
Maryland | 80-0943668 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
Park Avenue Tower, 65 East 55th Street, Suite 801, New York, NY | 10022 | |
(Address of Principal Executive Office) | (Zip Code) | |
(571) 529-6390
(Registrant’s Telephone Number, Including Area Code)
450 Park Avenue, Suite 1400, New York, NY, 10022
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x
No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer x | Smaller reporting company o | |
Emerging growth company x | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. Yes x No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares of the registrant's common stock, $0.01 par value, outstanding as of November 1, 2018 was 39,343,604.
TABLE OF CONTENTS
Page | |
i
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
HOSPITALITY INVESTORS TRUST, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share data)
September 30, 2018 | December 31, 2017 | ||||||
(unaudited) | |||||||
ASSETS | |||||||
Real estate investments: | |||||||
Land | $ | 338,469 | $ | 341,651 | |||
Buildings and improvements | 1,944,814 | 1,921,396 | |||||
Furniture, fixtures and equipment | 251,893 | 226,242 | |||||
Total real estate investments | 2,535,176 | 2,489,289 | |||||
Less: accumulated depreciation and amortization | (324,770 | ) | (257,592 | ) | |||
Total real estate investments, net | 2,210,406 | 2,231,697 | |||||
Cash and cash equivalents | 82,705 | 55,736 | |||||
Assets held for sale | — | 5,586 | |||||
Restricted cash | 27,743 | 63,444 | |||||
Investments in unconsolidated entities | 3,597 | 3,649 | |||||
Below-market lease asset, net | 9,130 | 9,428 | |||||
Prepaid expenses and other assets | 38,938 | 36,705 | |||||
Goodwill | 14,408 | 14,408 | |||||
Total Assets | $ | 2,386,927 | $ | 2,420,653 | |||
LIABILITIES, NON-CONTROLLING INTEREST AND EQUITY | |||||||
Mortgage notes payable, net | 1,504,524 | 1,495,777 | |||||
Promissory notes payable, net | — | 1,000 | |||||
Mandatorily redeemable preferred securities, net | 219,362 | 233,058 | |||||
Accounts payable and accrued expenses | 77,647 | 67,452 | |||||
Total Liabilities | $ | 1,801,533 | $ | 1,797,287 | |||
Commitments and Contingencies | |||||||
Contingently Redeemable Class C Units in operating partnership; 11,619,210 and 9,507,892 units issued and outstanding, respectively ($171,383 and $140,241 liquidation preference, respectively) | $ | 160,336 | 128,044 | ||||
Stockholders' Equity | |||||||
Preferred stock, $0.01 par value, 50,000,000 shares authorized, one share issued and outstanding | — | — | |||||
Common stock, $0.01 par value, 300,000,000 shares authorized, 39,343,604 and 39,505,742 shares issued and outstanding, respectively | 393 | 395 | |||||
Additional paid-in capital | 871,755 | 871,840 | |||||
Deficit | (449,690 | ) | (379,559 | ) | |||
Total equity of Hospitality Investors Trust, Inc. stockholders | 422,458 | 492,676 | |||||
Non-controlling interest - consolidated variable interest entity | 2,600 | 2,646 | |||||
Total Stockholders' Equity | $ | 425,058 | $ | 495,322 | |||
Total Liabilities, Contingently Redeemable Class C Units, and Stockholders' Equity | $ | 2,386,927 | $ | 2,420,653 | |||
1
The accompanying notes are an integral part of these statements.
2
HOSPITALITY INVESTORS TRUST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except for share and per share data)
(Unaudited)
Three Months Ended September 30, 2018 | Three Months Ended September 30, 2017 | Nine Months Ended September 30, 2018 | Nine Months Ended September 30, 2017 | ||||||||||||
Revenues | |||||||||||||||
Rooms | $ | 152,058 | $ | 159,423 | $ | 439,661 | $ | 453,073 | |||||||
Food and beverage | 4,707 | 4,607 | 14,906 | 15,174 | |||||||||||
Other | 3,560 | 3,211 | 10,551 | 9,709 | |||||||||||
Total revenue | 160,325 | 167,241 | 465,118 | 477,956 | |||||||||||
Operating expenses | |||||||||||||||
Rooms | 38,919 | 39,385 | 112,482 | 112,218 | |||||||||||
Food and beverage | 4,080 | 3,981 | 12,414 | 12,206 | |||||||||||
Management fees | 4,331 | 4,606 | 12,718 | 19,649 | |||||||||||
Other property-level operating expenses | 61,798 | 64,787 | 183,010 | 185,210 | |||||||||||
Acquisition and transaction related costs | — | — | 27 | 498 | |||||||||||
General and administrative | 5,193 | 4,389 | 14,874 | 14,230 | |||||||||||
Depreciation and amortization | 28,446 | 26,464 | 83,070 | 78,519 | |||||||||||
Impairment of goodwill and long-lived assets | — | 5,396 | 17,255 | 22,838 | |||||||||||
Rent | 1,701 | 1,625 | 5,038 | 4,906 | |||||||||||
Total operating expenses | 144,468 | 150,633 | 440,888 | 450,274 | |||||||||||
Operating income | $ | 15,857 | $ | 16,608 | $ | 24,230 | $ | 27,682 | |||||||
Interest expense | (27,083 | ) | (24,728 | ) | (78,423 | ) | (74,019 | ) | |||||||
Other income | 134 | 15 | 247 | 52 | |||||||||||
Equity in earnings of unconsolidated entities | 199 | 231 | 101 | 381 | |||||||||||
Total other expenses, net | (26,750 | ) | (24,482 | ) | (78,075 | ) | (73,586 | ) | |||||||
Loss before taxes | $ | (10,893 | ) | $ | (7,874 | ) | $ | (53,845 | ) | $ | (45,904 | ) | |||
Income tax expense (benefit) | (112 | ) | 1,105 | (1,022 | ) | 1,538 | |||||||||
Net loss and comprehensive loss | $ | (10,781 | ) | $ | (8,979 | ) | $ | (52,823 | ) | $ | (47,442 | ) | |||
Less: Net income attributable to non-controlling interest | 44 | 154 | 63 | 237 | |||||||||||
Net loss before dividends and accretion | $ | (10,825 | ) | $ | (9,133 | ) | $ | (52,886 | ) | $ | (47,679 | ) | |||
Deemed dividend related to beneficial conversion feature of Class C Units | — | — | — | (4,535 | ) | ||||||||||
Dividends on Class C Units (cash and PIK) | (5,405 | ) | (4,369 | ) | (15,355 | ) | (8,681 | ) | |||||||
Accretion of Class C Units | (663 | ) | (556 | ) | (1,890 | ) | (1,097 | ) | |||||||
Net loss attributable to common stockholders | $ | (16,893 | ) | $ | (14,058 | ) | $ | (70,131 | ) | $ | (61,992 | ) | |||
Basic and Diluted net loss attributable to common stockholders per common share | $ | (0.43 | ) | $ | (0.35 | ) | $ | (1.78 | ) | $ | (1.58 | ) | |||
Basic and Diluted weighted average shares of common stock outstanding | 39,336,099 | 39,611,261 | 39,444,858 | 39,346,904 | |||||||||||
The accompanying notes are an integral part of these statements.
3
HOSPITALITY INVESTORS TRUST, INC.
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands, except for share data)
(Unaudited)
Common Stock | ||||||||||||||||||||||||||
Number of Shares | Par Value | Additional Paid-in Capital | Deficit | Total Equity of Hospitality Investors Trust, Inc. Stockholders | Non-controlling Interest | Total Non-controlling Interest and Equity | ||||||||||||||||||||
Balance, December 31, 2017 | 39,505,742 | $ | 395 | $ | 871,840 | $ | (379,559 | ) | $ | 492,676 | $ | 2,646 | $ | 495,322 | ||||||||||||
Repurchase and retirement of common stock | (169,348 | ) | (2 | ) | (1,192 | ) | — | (1,194 | ) | — | (1,194 | ) | ||||||||||||||
Net loss before dividends and accretion | — | — | — | (52,886 | ) | (52,886 | ) | — | (52,886 | ) | ||||||||||||||||
Net income attributable to non-controlling interest | — | — | — | — | — | 63 | 63 | |||||||||||||||||||
Dividends paid or declared | — | — | — | — | — | (109 | ) | (109 | ) | |||||||||||||||||
Cash distributions on Class C Units | — | — | — | (9,213 | ) | (9,213 | ) | — | (9,213 | ) | ||||||||||||||||
Accretion on Class C Units | — | — | — | (1,890 | ) | (1,890 | ) | — | (1,890 | ) | ||||||||||||||||
PIK distributions on Class C Units | — | — | — | (6,142 | ) | (6,142 | ) | — | (6,142 | ) | ||||||||||||||||
Share-based payments | 7,210 | — | 1,107 | — | 1,107 | — | 1,107 | |||||||||||||||||||
Balance, September 30, 2018 | 39,343,604 | $ | 393 | $ | 871,755 | $ | (449,690 | ) | $ | 422,458 | $ | 2,600 | $ | 425,058 | ||||||||||||
The accompanying notes are an integral part of these statements.
4
HOSPITALITY INVESTORS TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, 2018 | Nine Months Ended September 30, 2017 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (52,823 | ) | $ | (47,442 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 83,070 | 78,519 | ||||||
Impairment of goodwill and long-lived assets | 17,255 | 22,838 | ||||||
Amortization and write-off of deferred financing costs | 9,421 | 8,194 | ||||||
Other adjustments, net | 1,675 | 284 | ||||||
Changes in assets and liabilities: | ||||||||
Prepaid expenses and other assets | (3,858 | ) | (2,751 | ) | ||||
Due to related parties | — | (2,879 | ) | |||||
Accounts payable and accrued expenses | 16,392 | 17,401 | ||||||
Net cash provided by operating activities | $ | 71,132 | $ | 74,164 | ||||
Cash flows from investing activities: | ||||||||
Payment received on note for sale of hotel | 1,625 | — | ||||||
Acquisition of hotel assets, net of cash received | — | (60,028 | ) | |||||
Real estate investment improvements and purchases of property and equipment | (85,189 | ) | (56,995 | ) | ||||
Payments related to Property Management Transactions | (1,000 | ) | (12,000 | ) | ||||
Other adjustments, net | — | 1,044 | ||||||
Proceeds from sale of hotel, net | 5,461 | — | ||||||
Net cash used in investing activities | $ | (79,103 | ) | $ | (127,979 | ) | ||
Cash flows from financing activities: | ||||||||
Proceeds from Class C Units | 25,000 | 135,000 | ||||||
Repurchase of shares of common stock | (1,194 | ) | — | |||||
Payment of Class C Units issuance costs | (875 | ) | (13,866 | ) | ||||
Dividends/Distributions paid | (9,322 | ) | (5,567 | ) | ||||
Mandatorily redeemable preferred securities redemptions | (14,370 | ) | (47,275 | ) | ||||
Repayment of Contingent Consideration | — | (4,620 | ) | |||||
Proceeds from mortgage notes payable | — | 1,101,000 | ||||||
Deferred financing fees | — | (19,672 | ) | |||||
Repayments of promissory and mortgage notes payable | — | (1,030,622 | ) | |||||
Net cash (used in) provided by financing activities | $ | (761 | ) | $ | 114,378 | |||
Net change in cash and cash equivalents and restricted cash | (8,732 | ) | 60,563 | |||||
Cash and cash equivalents and restricted cash, beginning of period | 119,180 | 77,837 | ||||||
Cash and cash equivalents and restricted cash, end of period | $ | 110,448 | $ | 138,400 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Interest paid | $ | 63,256 | $ | 66,550 | ||||
Income tax paid | $ | 722 | $ | 1,301 | ||||
Non-cash investing and financing activities: | ||||||||
Deemed dividend related to beneficial conversion feature of Class C Units | $ | — | $ | (4,535 | ) | |||
Accretion of Class C Units | $ | (1,890 | ) | $ | (1,097 | ) | ||
PIK Accrual on Class C Units | $ | (6,142 | ) | $ | (3,473 | ) | ||
Waiver of obligation from Former Advisor | $ | — | $ | (5,822 | ) | |||
5
HOSPITALITY INVESTORS TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, 2018 | Nine Months Ended September 30, 2017 | |||||||
Real estate investment improvements and purchases of property and equipment in accounts payable and accrued expenses | $ | 8,205 | $ | 6,571 | ||||
Class B Units in operating partnership converted and redeemed for Common Stock | $ | — | $ | 7,659 | ||||
Note payable to Former Property Manager | $ | — | $ | 2,000 | ||||
Common stock issued to Former Property Manager | $ | — | $ | 4,076 | ||||
The accompanying notes are an integral part of these statements.
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Note 1 - Organization
Hospitality Investors Trust, Inc. (the "Company") was incorporated on July 25, 2013 as a Maryland corporation and qualified as a real estate investment trust ("REIT") beginning with the taxable year ended December 31, 2014. The Company was formed primarily to acquire lodging properties in the midscale limited service, extended stay, select service, upscale select service, and upper upscale full service segments within the hospitality sector. As of September 30, 2018, the Company had acquired or had an interest in a total of 144 hotels with a total of 17,320 guest rooms located in 33 states. As of September 30, 2018, all but one of these hotels operated under a franchise or license agreement with a national brand owned by one of Hilton Worldwide, Inc., Marriott International, Inc., Hyatt Hotels Corporation, and Intercontinental Hotels Group or one of their respective subsidiaries or affiliates.
As of September 30, 2018, 79 of the hotel assets the Company has acquired were managed by Crestline Hotels & Resorts, LLC ("Crestline") and 65 of the hotel assets the Company has acquired were managed by other property managers. As of September 30, 2018, the Company’s other property managers were Hampton Inns Management LLC and Homewood Suites Management LLC, affiliates of Hilton Worldwide Holdings Inc. (38 hotels), InnVentures IVI, LP (2 hotels), McKibbon Hotel Management, Inc. (21 hotels) and Larry Blumberg & Associates, Inc. (4 hotels).
Following the suspension of the Company’s initial public offering (the “IPO” or the “Offering”) in 2015, the Company’s primary business objective has been a focus on meeting its capital requirements and on maximizing the value of its existing portfolio by continuing to invest in its hotels, primarily through brand-mandated property improvement plans (“PIPs”), and through intensive asset management. In January 2017, the Company suspended paying distributions to its stockholders entirely and suspended its Distribution Reinvestment Program (the “DRIP”) in connection with its entry into a Securities Purchase, Voting and Standstill Agreement (the "SPA") with Brookfield Strategic Real Estate Partners II Hospitality REIT II LLC (the "Brookfield Investor). Currently, under the Brookfield Approval Rights (as defined below), prior approval is required before the Company can declare or pay any distributions or dividends to its common stockholders, except for cash distributions equal to or less than $0.525 per annum per share.
On April 23, 2018, the Company's board of directors approved an updated estimated net asset value per share of common stock ("Estimated Per-Share NAV") equal to $13.87 based on an estimated fair value of the Company’s assets less the estimated fair value of the Company’s liabilities, divided by 39,505,742 shares of common stock outstanding on a fully diluted basis as of December 31, 2017. It is currently anticipated that the Company will publish an updated Estimated Per-Share NAV on at least an annual basis.
On January 7, 2017, the third anniversary of the commencement of the IPO, the IPO terminated in accordance with its terms.
On January 12, 2017, the Company along with its operating partnership, Hospitality Investors Trust Operating Partnership, L.P. (the "OP"), entered into (i) the SPA with the Brookfield Investor, as well as related guarantee agreements with certain affiliates of the Brookfield Investor, and (ii) a Framework Agreement (the “Framework Agreement”) with the Company’s former advisor, American Realty Capital Hospitality Advisors, LLC (the "Former Advisor"), the Company’s former property managers, American Realty Capital Hospitality Properties, LLC and American Realty Capital Hospitality Grace Portfolio, LLC (together, the “Former Property Manager”), Crestline, then an affiliate of the Former Advisor and the Former Property Manager, American Realty Capital Hospitality Special Limited Partnership, LLC (the “Former Special Limited Partner”), another affiliate of the Former Advisor and the Former Property Manager, and, for certain limited purposes, the Brookfield Investor.
On March 31, 2017, the initial closing under the SPA (the “Initial Closing”) occurred and various transactions and agreements contemplated by the SPA were consummated and executed, including but not limited to:
• | the sale by the Company and purchase by the Brookfield Investor of one share of a new series of preferred stock designated as the Redeemable Preferred Share, par value $0.01 per share (the “Redeemable Preferred Share”), for a nominal purchase price; and |
7
• | the sale by the Company and purchase by the Brookfield Investor of 9,152,542.37 units of a new class of units of limited partnership in the OP entitled "Class C Units" (the “Class C Units”), for a purchase price of $14.75 per Class C Unit, or $135.0 million in the aggregate. |
On February 27, 2018, the second closing under the SPA (the “Second Closing”) occurred, pursuant to which the Company sold 1,694,915.25 additional Class C Units to the Brookfield Investor, for a purchase price of $14.75 per Class C Unit, or $25.0 million in the aggregate.
Subject to the terms and conditions of the SPA, the Company has the right to sell, and the Brookfield Investor has agreed to purchase, additional Class C Units in an aggregate amount of up to $240.0 million at subsequent closings (each, a "Subsequent Closing") that may occur through February 2019. The Subsequent Closings are subject to conditions, and there can be no assurance they will be completed on their current terms, or at all.
Without obtaining the prior approval of the majority of the then outstanding Class C Units and/or at least one of the two directors (each, a "Redeemable Preferred Director") elected to the Company’s board of directors by the Brookfield Investor pursuant to its rights as the holder of the Redeemable Preferred Share, the Company is restricted from taking certain operational and governance actions. These restrictions (collectively referred to herein as the “Brookfield Approval Rights”) are subject to certain exceptions and conditions. See Note 3 - Brookfield Investment - Brookfield Approval Rights.
The SPA also contains certain standstill and voting restrictions applicable to the Brookfield Investor and certain of its affiliates.
Prior to the Initial Closing, the Company had no employees, and the Company depended on the Former Advisor to manage certain aspects of its affairs on a day-to-day basis pursuant to the advisory agreement with the Former Advisor (the “Advisory Agreement”). The Framework Agreement provides for the Company’s transition from an externally managed company with no employees of its own that is dependent on the Former Advisor and its affiliates to manage its day-to-day operations, to a self-managed company. The transactions contemplated by the Framework Agreement generally were consummated at, and as a condition to, the Initial Closing. At the Initial Closing, pursuant to the Framework Agreement, the Advisory Agreement was terminated.
Substantially all of the Company’s business is conducted through the OP. Prior to the Initial Closing, the Company was the sole general partner and held substantially all of the units of limited partner interest in the OP entitled “OP Units” ("OP Units"). The Brookfield Investor holds all the issued and outstanding Class C Units which rank senior in payment of distributions and in the distribution of assets to the OP Units held by the Company, and BSREP II Hospitality II Special GP, OP LLC (the “Special General Partner”), an affiliate of the Brookfield Investor, is the special general partner of the OP, with certain non-economic rights that apply if the OP fails to redeem the Class C Units when required to do so, including the ability to commence selling the OP's assets until the Class C Units have been fully redeemed. As of September 30, 2018, the total liquidation preference of the issued and outstanding Class C Units was $171.4 million.
See Note 3 - Brookfield Investment for additional information regarding the Redeemable Preferred Share, the Class C Units, and the Brookfield Approval Rights.
Note 2 - Summary of Significant Accounting Policies
The accompanying consolidated financial statements of the Company included herein were prepared in accordance with United States Generally Accepted Accounting Principles ("GAAP"). The consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. These adjustments are considered to be of a normal, recurring nature.
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. In determining whether the Company has a controlling financial interest in a joint venture and the requirement to consolidate the accounts of that entity, management considers factors such as percentage ownership interest, authority to make decisions and contractual and substantive participating rights of the other partners or members as well as whether the entity is a variable interest entity for which the Company is the primary beneficiary.
8
Use of Estimates
The preparation of the accompanying consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Real Estate Investments
The Company allocates the purchase price of properties acquired in real estate investments to tangible and identifiable intangible assets acquired based on their respective fair values at the date of acquisition. Tangible assets include land, land improvements, buildings and furniture, fixtures and equipment. The Company utilizes various estimates, processes and information to determine the property value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Amounts allocated to land, land improvements, buildings and furniture, fixtures and equipment are based on purchase price allocation studies performed by independent third parties or on the Company’s analysis of comparable properties in the Company’s portfolio. Identifiable intangible assets and liabilities, as applicable, are typically related to contracts, including operating lease agreements, ground lease agreements and hotel management agreements, which are recorded at fair value. The Company also considers information obtained about each property as a result of the Company’s pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.
Prior to January 1, 2018, the Company's acquisitions of hotel properties were accounted for as acquisitions of existing businesses, and all transaction costs associated with the acquisitions, were expensed as incurred. As a result of a change in applicable GAAP guidance, beginning January 1, 2018, the Company's acquisitions of hotel properties are anticipated to be accounted for as acquisitions of groups of assets rather than business combinations, although the determination will be made on a transaction-by-transaction basis. If the Company concludes that an acquisition will be accounted for as a group of assets, the transaction costs associated with the acquisition will be capitalized as part of the assets acquired.
The Company's investments in real estate, including transaction costs, that are not considered to be business combinations under GAAP are recorded at cost. Improvements and replacements are capitalized when they extend the useful life of the asset. Costs of repairs and maintenance are expensed as incurred. Depreciation of the Company's long-lived assets is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, 15 years for land improvements, five years for furniture, fixtures and equipment, and the shorter of the useful life or the remaining lease term for leasehold interests.
The Company is required to make subjective assessments as to the useful lives of the Company’s assets for purposes of determining the amount of depreciation to record on an annual basis with respect to the Company’s investments in real estate. These assessments have a direct impact on the Company’s net income because if the Company were to shorten the expected useful lives of the Company’s investments in real estate, the Company would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
Below-Market Lease
The below-market lease intangible is based on the difference between the market rent and the contractual rent for the Company's ground lease obligations, and is discounted to a present value using an interest rate reflecting the Company's assessment of the risk associated with the leases acquired (See Note 4 - Leases). Acquired lease intangible assets are amortized over the remaining lease term. The amortization of a below-market lease is recorded as an increase to rent expense on the Consolidated Statements of Operations and Comprehensive Loss.
Impairment of Long-Lived Assets
When circumstances indicate the carrying amount of a property may not be recoverable, the Company reviews the asset for impairment. This review is based on a comparison of the carrying amount to an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. The estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of demand, competition and other factors. If impairment exists, due to the inability to recover the carrying amount of a property, an impairment loss will be recorded to the extent that the carrying amount exceeds the estimated fair value of the property. The
9
Company recognized an impairment loss of $5.4 million on the sale of three of the four hotels classified as assets held for sale during the three months ended September 30, 2017. No impairment loss was recognized on the Company's long-lived assets during the three months ended September 30, 2018. During the nine months ended September 30, 2018 and 2017, the Company recognized $17.3 million and $6.8 million in impairment loss on its long-lived assets, respectively. See Note 16 - Impairments.
Assets Held for Sale (Long Lived-Assets)
When the Company initiates the sale of long-lived assets, it assesses whether the assets meet the criteria to be considered assets held for sale. The review is based on whether the following criteria are met:
• | Management and the Company's board of directors have committed to a plan to sell the asset group; |
• | The subject assets are available for immediate sale in their present condition; |
• | The Company is actively locating buyers as well as other initiatives required to complete the sale; |
• | The sale is probable and the transfer is expected to qualify for recognition as a complete sale in one year; |
• | The long-lived asset is being actively marketed for sale at a price that is reasonable in relation to fair value; and |
• | Actions necessary to complete the plan indicate it is unlikely significant changes will be made to the plan or the plan will be withdrawn. |
If all the criteria are met, a long-lived asset held for sale is measured at the lower of its carrying amount or fair value less cost to sell, and the Company will cease recording depreciation. Any adjustment to the carrying amount is recorded as an impairment loss. The Company did not have any hotels that qualified as an asset held for sale at September 30, 2018. The Company had four hotels that were classified as held for sale as of September 30, 2017, three of which were sold during the fourth quarter of 2017 and one of which was sold during the first quarter of 2018.
Goodwill
The Company allocates goodwill to each reporting unit. For the Company’s purposes, each of its wholly-owned hotels is considered a reporting unit. The Company tests goodwill for impairment at least annually, or upon the occurrence of any "triggering events" if sooner. During the three months ended March 31, 2018, the Company changed the date of its annual goodwill impairment testing from June 30 to March 31 of each year. The change was made to align the timing of the Company's annual goodwill impairment test with the determination of Estimated Per-Share NAV, each of which includes a fair value assessment of the Company's hotel properties. Upon the occurrence of any "triggering events," the Company is required to compare the fair value of each reporting unit to which goodwill has been allocated, to the carrying amount of such reporting unit including the allocation of goodwill. If the carrying amount of a reporting unit exceeds its fair value, the Company applies a one-step quantitative test and records the amount of goodwill impairment as the excess of the reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to such reporting unit.
During 2017, as a result of a business combination and consideration transferred in exchange for an in-place workforce, intellectual property and infrastructure assets in connection with the consummation of the transactions contemplated by the Framework Agreement, the Company recognized $31.6 million as goodwill (See Note 3 - Brookfield Investment). The Company did not record any goodwill impairment during the three and nine months ended September 30, 2018, or during the three months ended September 30, 2017. The Company recorded an impairment of its goodwill of $16.1 million during the nine months ended September 30, 2017.
Cash and Cash Equivalents
Cash and cash equivalents include cash in bank accounts as well as investments in highly-liquid money market funds with original maturities of three months or less at purchase.
Restricted Cash
Restricted cash consists of amounts required under mortgage agreements for future capital improvements to owned assets, future interest and property tax payments and cash flow deposits while subject to mortgage agreement restrictions.
Deferred Financing Fees
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Deferred financing fees represent commitment fees, legal fees and other costs associated with obtaining commitments for financing. These fees are amortized as a component of interest expense over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing fees are expensed in full when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financial transactions that do not close are expensed in the period in which it is determined that the financing will not be successful. Deferred financing fees are deducted from their related liabilities on the Company's Consolidated Balance Sheets.
Revenue Recognition
The Company's revenue is primarily from rooms, food and beverage, and other, and is disaggregated on the Company's Consolidated Statement of Operations and Comprehensive Loss.
Room sales are driven by a fixed fee charged to a hotel guest to stay at the hotel property for an agreed-upon period. A majority of the Company's room reservations are cancellable and the Company transfers promised goods and services to the hotel guest as of the date upon which the hotel guest occupies a room and at the same time earns and recognizes revenue. The Company offers advance purchase reservations that are paid for by the hotel guest in advance and the Company recognizes deferred revenue as a result of such reservations. The Company's obligation to the hotel guest is satisfied as of the date upon which the hotel guest occupies a room. The Company's room revenue accounted for 94.8% and 95.3% of the Company's total revenue for the three months ended September 30, 2018 and 2017, respectively. The Company's room revenue accounted for 94.5% and 94.8% of the Company's total revenue for the nine months ended September 30, 2018 and 2017, respectively. Food, beverage, and other revenue are recognized at the point of sale on the date of the transaction as the hotel guest simultaneously obtains control of the good or service.
Income Taxes
The Company elected and qualified to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code") commencing with its tax year ended December 31, 2014. In order to continue to qualify as a REIT, the Company must annually distribute to its stockholders 90% of its REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain, and must comply with various other organizational and operational requirements. As of December 31, 2017, the Company had approximately $152.1 million in net operating loss carry forward that may be used in the future to reduce the amount otherwise required to be distributed by the Company to meet REIT requirements. The Company generally will not be subject to federal corporate income tax on that portion of its REIT taxable income that it distributes to its stockholders. The Company may be subject to certain state and local taxes on its income, property taxes and federal income and excise taxes on its undistributed income. The Company's hotels are leased to taxable REIT subsidiaries, which are owned by the OP. The taxable REIT subsidiaries are subject to federal, state and local income taxes.
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss, capital loss, and tax credit carryovers. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which such amounts are expected to be realized or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including future reversals of existing taxable temporary differences, future projected taxable income and tax planning strategies.
GAAP prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. The Company must determine whether it is "more-likely-than-not" that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement in order to determine the amount of benefit to recognize in the financial statements. This accounting standard applies to all tax positions related to income taxes. As of September 30, 2018, the Company's tax years that remain subject to examination by major tax jurisdictions are 2014, 2015, 2016 and 2017.
Earnings/Loss per Share
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The Company calculates basic income or loss per share by dividing net income or loss attributable to common stockholders for the period by the weighted-average shares of its common stock outstanding for such period. Diluted income per share takes into account the effect of dilutive instruments, such as unvested restricted shares of common stock ("restricted shares") and unvested restricted share units in respect of shares of common stock ("RSUs"), except when doing so would be anti-dilutive.
The Company currently has outstanding restricted shares whose holders are entitled to participate in dividends when and if paid on shares of common stock. The Company also currently has outstanding RSUs whose holders generally are credited with dividend or other distribution equivalents when and if paid on shares of common stock. These dividends or other distribution equivalents will be regarded as having been reinvested in RSUs and will only be paid to the extent the corresponding RSUs vest. To the extent the Company were to have distributions in the future, it would be required to calculate earnings per share using the two-class method with regard to restricted shares, whereby earnings or losses are reduced by distributed earnings as well as any available undistributed earnings allocable to holders of restricted shares.
Fair Value Measurements
In accordance with Accounting Standards Codification section 820 - Fair Value Measurement, certain assets and liabilities are recorded at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability between market participants in an orderly transaction on the measurement date. The market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability is known as the principal market. When no principal market exists, the most advantageous market is used. This is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received or minimizes the amount that would be paid. Fair value is based on assumptions market participants would make in pricing the asset or liability. Generally, fair value is based on observable quoted market prices or derived from observable market data when such market prices or data are available. When such prices or inputs are not available, the reporting entity should use valuation models.
The Company’s financial instruments recorded at fair value on a recurring basis are categorized based on the priority of the inputs used to measure fair value. The inputs used in measuring fair value are categorized into three levels, as follows:
• | Level 1 - Inputs that are based upon quoted prices for identical instruments traded in active markets. |
• | Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar investments in markets that are not active, or models based on valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the investment. |
• | Level 3 - Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. |
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
See Note 11 - Fair Value Measurements for fair value disclosures.
Class C Units
The Company initially measured the Class C Units which were issued to the Brookfield Investor at fair value net of issuance costs. The Company is required to accrete the carrying value of the Class C Units to the liquidation preference using the effective interest method over the five year period prior to the holder's redemption option becoming exercisable (See "Accretion of Class C Units" on the Company's Consolidated Statements of Operations and Comprehensive Loss). However, if it becomes probable that the Class C Units will become redeemable prior to such date, the Company will adjust the carrying value of the Class C Units to the maximum liquidation preference.
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Pursuant to the SPA with the Brookfield Investor, the Company may become obligated to issue additional Class C Units to the Brookfield Investor in the future and this obligation is considered a contingent forward contract under Accounting Standards Codification section 480 - Distinguishing Liabilities from Equity, and accounted for as a liability. The fair value of the contingent forward liability was initially recognized at zero since the contingent forward contract was executed at fair market value. The Company has determined the value of the contingent forward liability was $1.3 million as of September 30, 2018 (See Note 12 - Commitments and Contingencies).
Advertising Costs
The Company expenses advertising costs for hotel operations as incurred. These costs were $4.8 million for the three months ended September 30, 2018, and $5.0 million for the three months ended September 30, 2017. Advertising costs were $13.8 million for the nine months ended September 30, 2018, and $14.2 million for the nine months ended September 30, 2017.
Allowance for Doubtful Accounts
Receivables consist principally of trade receivables from customers and are generally unsecured and are due within 30 to 90 days. The Company records a provision for uncollectible accounts using the allowance method. Expected credit losses associated with trade receivables are recorded as an allowance for doubtful accounts. The allowance for doubtful accounts is estimated based upon historical patterns of credit losses for aged receivables as well as specific provisions for certain identifiable, potentially uncollectible balances. When internal collection efforts on accounts have been exhausted, the accounts are written off and the associated allowance for doubtful accounts is reduced. Trade and note receivable balances, net of the allowance for doubtful accounts, are included in prepaid expenses and other assets in the accompanying Consolidated Balance Sheets, and are as follows (in thousands):
September 30, 2018 | December 31, 2017 | ||||||
Trade receivables | $ | 10,828 | $ | 9,638 | |||
Note receivable from sale of hotel | — | 1,625 | |||||
Allowance for doubtful accounts | (575 | ) | (312 | ) | |||
Trade and Note receivables, net of allowance | $ | 10,253 | $ | 10,951 | |||
Reportable Segments
The Company has determined that it has one reportable segment, with activities related to investing in real estate. The Company’s investments in real estate generate room revenue and other income through the operation of the properties, which comprise 100% of the total consolidated revenues. Management evaluates the operating performance of the Company’s investments in real estate on an individual property level, and therefore each property is considered a reporting unit. Each of the Company's reporting units are also considered to be operating segments, but none of these individual operating segments represents a reportable segment as they meet the criteria in GAAP to aggregate all properties into one reportable segment.
Derivative Transactions
The Company at certain times enters into derivative instruments to hedge exposure to changes in interest rates. The Company’s derivatives as of September 30, 2018, consist of interest rate cap agreements which it believes will help to mitigate its exposure to increasing borrowing costs under floating rate indebtedness. The Company has elected not to designate its interest rate cap agreements as cash flow hedges. The impact of the interest rate caps for the three and nine months ended September 30, 2018 and 2017, was immaterial to the consolidated financial statements.
See disclosures above with respect to Class C Units and contingent forward liability. The contingent forward is considered a derivative transaction under GAAP.
Recently Issued Accounting Pronouncements
As of January 1, 2018, the Company retrospectively adopted the ASU 2016-18, Statement of Cash Flow, Restricted Cash (Topic 230). The impact of retrospective adoption of the ASU 2016-18 resulted in reclassification of prior-period restricted cash balances and activity in the statement of cash flows. The amounts included in restricted cash on the Company's consolidated
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balance sheet are now included with cash and cash equivalents on the statement of cash flows. These amounts totaled $27.7 million and $68.1 million as of September 30, 2018 and 2017, respectively. The adoption of this standard did not change the Company's balance sheet presentation.
In February 2016, the FASB issued ASU 2016-02 Leases ("ASU 2016-02"), which requires an entity to separate lease components from nonlease components in a contract. ASU 2016-02 provides more guidance on how to identify and separate components than did previous GAAP. ASU 2016-02 requires lessees to recognize assets and liabilities arising from operating leases on the balance sheet. This amendment has not fundamentally changed lessor accounting, however some changes have been made to align and conform to the lessee guidance. The standard requires a modified retrospective approach, with an option to use certain transition relief. In July 2018, the FASB issued ASU 2018-10, Codification Improvements ("ASU 2018-10") and ASU 2018-11 (“ASU 2018-11”), Targeted Improvements to Topic 842, Leases. The amendments in ASU 2018-10 affect narrow aspects of the guidance issued earlier, remove certain inconsistencies and provide additional clarification related to the guidance issued earlier. ASU 2018-11 provides entities with an additional optional transition method to adopt ASU 2016-02 by recognizing a cumulative-effect adjustment to opening balance of retained earnings in the period of adoption. The adoption of ASU 2016-02 becomes effective for the Company for the fiscal year beginning after December 15, 2018, and all subsequent annual and interim periods. Early adoption is permitted. The Company continues to evaluate the impact of this standard and anticipates this standard will have a material impact on the Company's Consolidated Balance Sheet as, following adoption, the Company will be required to recognize its operating leases, which are primarily comprised of one operating lease with respect to the Georgia Tech Hotel & Conference Center and nine ground leases, under which it is the lessee, as right of use assets and liabilities in the Consolidated Balance Sheet. However, the Company does not expect this standard to have a material impact on the Company's Consolidated Statement of Operations and Comprehensive Loss.
In August 2018, the FASB issued ASU 2018-13 Fair Value Measurements (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). Among other changes, ASU 2018-13 addresses changes in disclosures related to unrealized gains and losses and transfers between levels in the fair value hierarchy. ASU 2018-13 is effective for the Company for fiscal years beginning after December 15, 2019. The Company does not anticipate that the adoption of ASU 2018-13 will have any impact on the Company's consolidated financial statements.
Note 3 - Brookfield Investment
The Redeemable Preferred Share
The Redeemable Preferred Share held by the Brookfield Investor has been classified as permanent equity on the Consolidated Balance Sheets.
The Redeemable Preferred Share ranks on parity with the Company’s common stock, with the same rights with respect to preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, terms and conditions of redemption and other terms and conditions as the Company’s common stock, with certain exceptions.
For so long as the Brookfield Investor holds the Redeemable Preferred Share, the Brookfield Investor has certain rights with respect to the election of members of the Company's board of directors and its committees, including the right to elect two Redeemable Preferred Directors to the Company’s board of directors and to approve two additional independent directors (each, an "Approved Independent Director") to be recommended and nominated by the Company's board of directors for election by the stockholders at each annual meeting. In addition, each committee of the Company's board of directors, subject to limited exceptions, must include at least one of the Redeemable Preferred Directors.
The holder of the Redeemable Preferred Share has certain rights in the event the OP fails to redeem Class C Units when required to do so, including the right to increase the size of the Company's board of directors by a number of directors that would result in the holder of the Redeemable Preferred Share being entitled to nominate and elect a majority of the Company's board of directors, subject to compliance with the provisions of the Company's charter requiring at least a majority of the Company's directors to be Independent Directors (as defined in the Company's charter).
Class C Units
As of September 30, 2018, the Class C Units are reflected on the Consolidated Balance Sheets at $160.3 million. The value of the Class C Units as of September 30, 2018, is derived by reducing the $160.0 million in gross proceeds by the $14.7 million
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in costs directly attributable to the issuance of Class C Units, including $6.0 million paid directly to the Brookfield Investor at the Initial Closing in the form of expense reimbursements and a commitment fee, and increased by $11.4 million in quarterly distributions payable to holders of Class C Units in the form of additional Class C Units, $3.5 million in the accretion of the carrying value to the liquidation preference through September 30, 2018, and $0.1 million resulting from a change in value of the contingent forward liability.
The Class C Units have been classified as temporary equity due to the contingent redemption features described in more detail below. At the Initial Closing, the Class C Units were deemed to have a “beneficial conversion feature” as the effective conversion price of the Class C Units under GAAP as of March 31, 2017 was less than the fair value of the Company's common stock on such date. As a result, the Company recognized the beneficial conversion feature as a deemed dividend of $4.5 million during the three months ended March 31, 2017, thereby reducing income available to common stockholders for purposes of calculating earnings per share.
Rank
The Class C Units rank senior to the OP Units and all other equity interests in the OP with respect to priority in payment of distributions and in the distribution of assets in the event of the liquidation, dissolution or winding-up of the OP, whether voluntary or involuntary, or any other distribution of the assets of the OP among its equity holders for the purpose of winding up its affairs.
Distributions
Commencing on June 30, 2017, holders of Class C Units are entitled to receive, with respect to each Class C Unit, fixed, quarterly cumulative cash distributions at a rate of 7.50% per annum from legally available funds. If the Company fails to pay these cash distributions when due, the per annum rate will increase to 10% until all accrued and unpaid distributions required to be paid in cash are reduced to zero.
Commencing on June 30, 2017, holders of Class C Units are also entitled to receive, with respect to each Class C Unit, a fixed, quarterly, cumulative PIK Distribution at a rate of 5% per annum ("PIK Distributions"). If the Company fails to redeem the Brookfield Investor when required to do so pursuant to the amendment and restatement of the OP's existing agreement of limited partnership (the "A&R LPA"), the 5% per annum PIK Distribution rate will increase to a per annum rate of 7.50%, and would further increase by 1.25% per annum for the next four quarterly periods thereafter, up to a maximum per annum rate of 12.5%.
The number of Class C Units delivered in respect of the PIK Distributions on any distribution payment date will be equal to the number obtained by dividing the amount of PIK Distribution by $14.75.
The Brookfield Investor is also entitled to receive tax distributions under certain limited circumstances. As of September 30, 2018, no tax distributions have been paid.
For the three months ended September 30, 2018, the Company paid cash distributions of $3.2 million and PIK Distributions of 146,594.53 Class C Units to the Brookfield Investor, as the sole holder of the Class C Units. For the nine months ended September 30, 2018, the Company paid cash distributions of $9.2 million and PIK Distributions of 416,402.88 Class C Units to the Brookfield Investor, as the sole holder of the Class C Units.
Conversion Rights
The Class C Units are generally convertible into OP Units at any time at the option of the holder thereof at an initial conversion price of $14.75 (the "Conversion Price"). The Conversion Price is subject to anti-dilution and other adjustments upon the occurrence of certain events and transactions.
Liquidation Preference
The liquidation preference with respect to each Class C Unit as of a particular date is the original purchase price paid under the SPA or the value upon issuance of any Class C Unit received as a PIK Distribution, plus, with respect to such Class C Unit up to but not including such date, (i) any accrued and unpaid cash distributions and (ii) any accrued and unpaid PIK Distributions.
Mandatory Redemption
The Class C Units are generally subject to mandatory redemption at a premium to liquidation preference if the OP consummates any liquidation, sale of all or substantially all of the assets, dissolution or winding-up, whether voluntary or involuntary, sale, merger, reorganization, reclassification or recapitalization or other similar event (a “Fundamental Sale Transaction”) prior to March 31, 2022. The amount of the premium, which may be substantial, varies based on the timing of consummation of the Fundamental Sale Transaction.
Holder Redemptions
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The holders of the Class C Units may redeem such Class C Units at any time on or after March 31, 2022 for a redemption price in cash equal to the liquidation preference and also have certain other redemption rights in connection with the Company’s failure to maintain REIT status or material breaches of the A&R LPA.
Remedies Upon Failure to Redeem
If the OP fails to redeem Class C Units when required to do so pursuant to the terms of the A&R LPA, beginning three months after such failure the Special General Partner has the exclusive right, power and authority to sell the assets or properties of the OP for cash at such time or times as the Special General Partner may determine, upon engaging a reputable, national third party sales broker or investment bank reasonably acceptable to holders of a majority of the then outstanding Class C Units to conduct an auction or similar process designed to maximize the sales price. The proceeds from sales of assets or properties by the Special General Partner must be used first to make any and all payments or distributions due or past due with respect to the Class C Units, regardless of the impact of such payments or distributions on the Company or the OP.
The foregoing rights of the Special General Partner are in addition to the other rights described herein if the OP fails to redeem Class C Units when required to do so pursuant to the terms of the A&R LPA.
Company Redemption After Five Years
At any time and from time to time on or after March 31, 2022, the Company has the right to elect to redeem all or any part of the issued and outstanding Class C Units for an amount in cash equal to the liquidation preference.
Transfer Restrictions
The Brookfield Investor is generally permitted to make transfers of Class C Units without the prior consent of the Company, provided that any transferee must customarily invest in these types of securities or real estate investments of any type or have in excess of $100.0 million of assets.
Preemptive Rights
If the Company or the OP proposes to issue additional equity securities, subject to certain exceptions and in accordance with the procedures in the A&R LPA, any holder of Class C Units that owns Class C Units representing more than 5% of the outstanding shares of the Company’s common stock on an as-converted basis has certain preemptive rights.
Brookfield Approval Rights
The Articles Supplementary with respect to the Redeemable Preferred Share restrict the Company from taking certain actions without the prior approval of at least one of the Redeemable Preferred Directors, and the A&R LPA restricts the OP from taking certain actions without the prior approval of the majority of the then outstanding Class C Units.
In general, subject to certain exceptions, prior approval is required before the Company or its subsidiaries (including the OP) are permitted to take any of the following actions: equity issuances; organizational document amendments; debt incurrences; affiliate transactions; sale of all or substantially all assets; bankruptcy or insolvency declarations; declarations or payments of dividends or other distributions; redemptions or repurchases of securities; adoption of, and amendments to, the annual business plan (including the annual operating and capital budget) required under the terms of the Redeemable Preferred Share; hiring and compensation decisions related to certain key personnel (including executive officers); property acquisitions and property sales and dispositions that do not meet transaction-size limits and other defined criteria and would be outside of the OP’s normal course of business; entry into new lines of business; settlement of material litigation; changes to material agreements; increasing or decreasing the number of directors on the Company’s board of directors; nominating or appointing a director (other than a Redeemable Preferred Director) who is not independent; nominating or appointing the chairperson of the Company’s board of directors; and certain other matters.
Note 4 - Leases
In connection with its hotel acquisitions the Company has assumed various lease agreements. These lease agreements primarily comprise one operating lease with respect to the Georgia Tech Hotel & Conference Center and nine ground leases which are also classified as operating leases under GAAP. The following table summarizes the Company's future minimum rental commitments under these leases (in thousands):
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Minimum Rental Commitments | Amortization of Above and Below Market Lease Intangibles to Rent Expense | |||||||
For the three months ending December 31, 2018 | $ | 1,305 | $ | 100 | ||||
Year ending December 31, 2019 | 5,227 | 398 | ||||||
Year ending December 31, 2020 | 5,265 | 398 | ||||||
Year ending December 31, 2021 | 5,271 | 398 | ||||||
Year ending December 31, 2022 | 5,292 | 398 | ||||||
Thereafter | 76,451 | 7,438 | ||||||
Total | $ | 98,811 | $ | 9,130 | ||||
The Company has allocated values to certain above and below-market lease intangibles based on the difference between market rents and rental commitments under the leases. During the three months ended September 30, 2018 and September 30, 2017 and the nine months ended September 30, 2018 and September 30, 2017, amortization of below-market lease intangibles, net, to rent expense was $0.1 million and $0.1 million, and $0.3 million and $0.3 million, respectively. Rent expense for the three months ended September 30, 2018 and September 30, 2017 and the nine months ended September 30, 2018 and September 30, 2017 was $1.6 million and $1.5 million and $4.7 million and $4.6 million, respectively.
Note 5 - Mortgage Notes Payable
The Company’s mortgage notes payable as of September 30, 2018 and December 31, 2017 consist of the following, respectively (in thousands):
Outstanding Mortgage Notes Payable | ||||||||||||||
Encumbered Properties | September 30, 2018 | December 31, 2017 | Interest Rate | Payment | Maturity | |||||||||
Baltimore Courtyard & Providence Courtyard | $ | 45,500 | $ | 45,500 | 4.30% | Interest Only, Principal paid at Maturity | April 2019 | |||||||
Hilton Garden Inn Blacksburg Joint Venture | 10,500 | 10,500 | 4.31% | Interest Only, Principal paid at Maturity | June 2020 | |||||||||
87-Pack Mortgage Loan - 87 properties in Grace Portfolio | 805,000 | 805,000 | One-month LIBOR plus 2.56% | Interest Only, Principal paid at Maturity | May 2019, subject to three, one year extension rights | |||||||||
87-Pack Mezzanine Loan - 87 properties in Grace Portfolio | 110,000 | 110,000 | One-month LIBOR plus 6.50% | Interest Only, Principal paid at Maturity | May 2019, subject to three, one year extension rights | |||||||||
Additional Grace Mortgage Loan - 20 properties in Grace Portfolio and one additional property | 232,000 | 232,000 | 4.96% | Interest Only, Principal paid at Maturity | October 2020 | |||||||||
Term Loan - 28 properties | 310,000 | 310,000 | One-month LIBOR plus 3.00% | Interest Only, Principal paid at Maturity | May 2019, subject to three, one year extension rights | |||||||||
Total Mortgage Notes Payable | $ | 1,513,000 | $ | 1,513,000 | ||||||||||
Less: Deferred Financing Fees, Net | $ | 8,476 | $ | 17,223 | ||||||||||
Total Mortgage Notes Payable, Net | $ | 1,504,524 | $ | 1,495,777 | ||||||||||
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Interest expense related to the Company's mortgage notes payable for the three months ended September 30, 2018 and for the three months ended September 30, 2017, was $19.6 million and $16.8 million, respectively. Interest expense related to the Company's mortgage notes payable for the nine months ended September 30, 2018 and for the nine months ended September 30, 2017, was $56.0 million and $49.8 million, respectively.
Baltimore Courtyard and Providence Courtyard
The Baltimore Courtyard and Providence Courtyard Loan matures on April 6, 2019. On May 6, 2014 and each month thereafter, the Company is required to make an interest only payment based on the outstanding principal and a fixed annual interest rate of 4.30%. The entire principal amount is due at maturity.
Hilton Garden Inn Blacksburg Joint Venture
The Hilton Garden Inn Blacksburg Joint Venture Loan matures June 6, 2020. On July 6, 2015 and each month thereafter, the Company is required to make an interest only payment based on the outstanding principal and a fixed annual interest rate of 4.31%. The entire principal amount is due at maturity.
87-Pack Loans
A total of 87 of the Company’s hotels, all of which were originally acquired in February 2015 as part of a portfolio currently comprising 111 hotel properties (the “Grace Portfolio”), have been financed pursuant to a mortgage loan agreement (the “87-Pack Mortgage Loan”) and a mezzanine loan agreement (the “87-Pack Mezzanine Loan” and, collectively with the 87-Pack Mortgage Loan, the “87-Pack Loans”), with an aggregate principal balance of $915.0 million. The principal amount of the 87-Pack Mortgage Loan is $805.0 million and the 87-Pack Mortgage Loan is secured by the 87 Company hotel properties (each, a “87-Pack Collateral Property”). The principal amount of the 87-Pack Mezzanine Loan is $110.0 million and the 87-Pack Mezzanine Loan is secured by the ownership interest in the entities which own the 87-Pack Collateral Properties and the related operating lessees.
The 87-Pack Loans mature on May 1, 2019, subject to three one-year extension rights at the Company's option which, if all three extension rights are exercised, would result in a fully extended maturity date of May 1, 2022. The 87-Pack Loans are prepayable in whole or in part without any prepayment fee or any other fee or penalty. Prepayments under the 87-Pack Mortgage Loan are generally conditioned on a pro-rata prepayment being made under the 87-Pack Mezzanine Loan.
The 87-Pack Mortgage Loan requires monthly interest payments at a variable rate equal to one-month LIBOR plus 2.56%, and the 87-Pack Mezzanine Loan requires monthly interest payments at a variable rate equal to one-month LIBOR plus 6.50%, for a combined weighted average interest rate of LIBOR plus 3.03%. Pursuant to an interest rate cap agreement, the LIBOR portions of the interest rates due under the 87-Pack Loans are effectively capped at the greater of (i) 4.0% and (ii) a rate that would result in a debt service coverage ratio specified in the loan documents.
In connection with a sale or disposition to a third party of an individual 87-Pack Collateral Property, such 87-Pack Collateral Property may be released from the 87-Pack Loans, subject to certain conditions and limitations, by prepayment of a portion of the 87-Pack Loans at a release price calculated in accordance with the terms of the 87-Pack Loans.
The 87-Pack Loans also provides for certain amounts to be deposited into reserve accounts, including with respect to a portion of the costs associated with the PIPs required pursuant to the franchise agreements related to the 87-Pack Collateral Properties.
For the term of the 87-Pack Loans, the Company and the OP are required to maintain, on a consolidated basis, a net worth of $250.0 million (excluding accumulated depreciation and amortization). As of September 30, 2018, the Company was in compliance with this financial covenant.
Additional Grace Mortgage Loan
A portion of the purchase price of the Grace Portfolio was financed through additional mortgage financing which loan was refinanced during October 2015 (the “Additional Grace Mortgage Loan”). The Additional Grace Mortgage Loan carries a fixed annual interest rate of 4.96% per annum with a maturity date on October 6, 2020. Pursuant to the Additional Grace Mortgage Loan, the Company agreed to make periodic payments into an escrow account for the PIPs required by the franchisors, and the Company made the final PIP reserve payment during June 2018. The Additional Grace Mortgage Loan includes the following financial covenants: minimum consolidated net worth and minimum consolidated liquidity. As of September 30, 2018, the Company was in compliance with these financial covenants.
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Term Loan
On April 27, 2017, the Company and the OP, as guarantors, and certain wholly-owned subsidiaries of the OP, as borrowers, entered into a Second Amended and Restated Term Loan Agreement (the “Term Loan”) in an aggregate principal amount of $310.0 million. The Term Loan is collateralized by 28 of the Company’s hotel properties (each, a “Term Loan Collateral Property”).
The Term Loan matures on May 1, 2019, subject to three one-year extension rights at the Company's option which, if all three extension rights are exercised, would result in an outside maturity date of May 1, 2022. The Term Loan is prepayable in whole or in part at any time, subject to payment of LIBOR breakage, if any.
The Term Loan requires monthly interest payments at a variable rate of one-month LIBOR plus 3.00%. Pursuant to an interest rate cap agreement, the LIBOR portions of the interest rates due under the Term Loan is capped at 4.00% during the initial term, and a rate based on a debt service coverage ratio during any extension term.
In connection with a sale or disposition to a third party of an individual Term Loan Collateral Property, such Term Loan Collateral Property may be released from the Term Loan, subject to certain conditions and limitations, by prepayment of a portion of the Term Loan at a release price calculated in accordance with the terms of the Term Loan.
The Term Loan also provides for certain amounts to be deposited into reserve accounts, including with respect to all costs associated with the PIPs required pursuant to the franchise agreements related to the Term Loan Collateral Properties.
For the term of the Term Loan, the Company and the OP are required to maintain, on a consolidated basis, a net worth of $250.0 million (excluding accumulated depreciation and amortization). As of September 30, 2018, the Company was in compliance with this financial covenant.
Note 6 - Promissory Notes Payable
Note Payable to Former Property Manager
As part of the consideration for the Property Management Transactions (as defined in Note 13 below), the Company and the OP agreed pursuant to the Framework Agreement to make certain cash payments to the Former Property Manager, which agreement was classified under GAAP as a short-term note payable with the Former Property Manager. The note payable which was non-interest bearing and required twelve monthly installments of $333,333.33, was repaid in full during March 2018. See Note 13 - Related Party Transactions and Arrangements for additional information.
Note 7 - Mandatorily Redeemable Preferred Securities
In February 2015, a portion of the contract purchase price for the Grace Portfolio was satisfied by the issuance to the sellers of the Grace Portfolio of approximately $447.1 million of liquidation value of preferred equity interests (the "Grace Preferred Equity Interests") in two newly-formed Delaware limited liability companies, HIT Portfolio I Holdco, LLC and HIT Portfolio II Holdco, LLC (together, the "Holdco entities"). Each of the Holdco entities is an indirect subsidiary of the Company and an indirect owner of the 111 hotels currently comprising the Grace Portfolio. The two Holdco entities correspond, respectively, to the pool of hotels encumbered by the 87-Pack Loan (plus four additional otherwise unencumbered hotels) and the pool of hotels encumbered by the Additional Grace Mortgage Loan.
The holders of the Grace Preferred Equity Interests were entitled to monthly distributions at a rate of 7.50% per annum for the first 18 months following closing, through August 2016, and are entitled to 8.00% per annum thereafter. The Company was required to reduce the liquidation value of the Grace Preferred Equity Interest to 50.0% of the $447.1 million originally issued by February 27, 2018, and is required to redeem the Grace Preferred Equity Interests in full by February 27, 2019. Beginning in April 2015, the Company became obligated to use 35% of any IPO and other equity issuance proceeds to redeem the Grace Preferred Equity Interests at par, up to a maximum of $350.0 million in redemptions for any 12-month period. Accordingly, the Company has used a portion of the proceeds from its prior equity issuances to redeem a portion of the Grace Preferred Equity Interests.
On February 27, 2018, the Company used $10.6 million of proceeds from the Second Closing to reduce the liquidation value of the Grace Preferred Equity Interests to $223.5 million, and thereby satisfied its obligation to redeem 50.0% of the Grace Preferred Equity Interests originally issued by such date. During the nine months ended September 30, 2018, the Company also used $3.8 million of proceeds from the sale of one of its hotels to further reduce the liquidation value of the Grace Preferred Equity Interests to $219.7 million as of September 30, 2018.
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In connection with a sale or disposition of an individual property in the Grace Portfolio, the holders of the Grace Preferred Equity Interests are entitled to prepayment of a portion of the Grace Preferred Equity Interests at a release price calculated in accordance with the terms of the Grace Preferred Equity Interests. The Company is also required, in certain circumstances, to apply debt proceeds from the Grace Portfolio to redeem the Grace Preferred Equity Interests at par. In addition, the Company has the right, at its option, to redeem the Grace Preferred Equity Interests, in whole or in part, at any time at par. In the event of liquidation of the Holdco entities, the holders of the Grace Preferred Equity Interests would be entitled to receive their original value (as reduced by redemptions) prior to any distributions being made to the Company or the Company's stockholders. The holders of the Grace Preferred Equity Interests have certain consent rights over major actions by the Company relating to the Grace Portfolio. In connection with the issuance of the Grace Preferred Equity Interests, the Company and the OP have made certain guarantees and indemnities to the sellers and their affiliates or indemnifying the sellers and their affiliates related to the Grace Portfolio. If the Company is unable to satisfy the redemption, distribution or other requirements of the Grace Preferred Equity Interests (including if there is a default under the related guarantees provided by the Company and the OP), the holders of the Grace Preferred Equity Interests have certain rights, including the ability to assume control of the operations of the Grace Portfolio through the assumption of control of the Holdco entities. Due to the fact that the Grace Preferred Equity Interests are mandatorily redeemable and certain of their other characteristics, the Grace Preferred Equity Interests are treated as debt in accordance with GAAP.
Note 8 - Accounts Payable and Accrued Expenses
The following is a summary of the components of accounts payable and accrued expenses (in thousands):
September 30, 2018 | December 31, 2017 | ||||||
Trade accounts payable | $ | 17,605 | $ | 24,261 | |||
Accrued expenses | 60,042 | 43,191 | |||||
Total | $ | 77,647 | $ | 67,452 | |||
Note 9 - Common Stock
The Company had 39,343,604 and 39,505,742 shares of common stock outstanding as of each of September 30, 2018 and December 31, 2017.
Common Stock Issuances
At the Initial Closing the Company issued 279,329 shares of the Company’s common stock to the Former Property Manager, and converted all 524,956 Class B Units held by the Former Advisor into 524,956 OP Units, and, immediately following such conversion, redeemed such 524,956 OP Units for 524,956 shares of the Company’s common stock.
The Company determined the fair value on the date of the above issuance of the Company's common stock to be $14.59 per share. The Company determined this value by utilizing income and market based approaches further adjusted for fair value of debt and the Class C Units, and applied a discount for lack of marketability. As part of the process, the Company made the determination after consulting with a nationally recognized third party advisor.
Distributions
On January 13, 2017, in connection with its approval of the Company’s entry into the SPA, the Company’s board of directors suspended paying distributions to the Company's stockholders entirely. Currently, under the Brookfield Approval Rights, prior approval is required before the Company can declare or pay any distributions or dividends to its common stockholders, except for cash distributions equal to or less than $0.525 per annum per share.
Share Repurchase Program
On September 24, 2018, the Company announced that its board of directors had adopted a new share repurchase program (the "SRP"), effective as of October 1, 2018. Pursuant to the SRP, any stockholder of the Company’s common stock may request that the Company repurchase all or a portion of their shares of common stock at a price established by the board of directors (the “Repurchase Price”). The Repurchase Price is initially $9.00 per share and may be changed by the board of directors from time to time in its sole discretion. Repurchases will be made quarterly at the Repurchase Price effective on the last day of the quarter.
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Repurchases under the SRP will be limited to a maximum number of shares of common stock for any quarter equal to the lower of 1,000,000 shares of common stock or 5% of the number of shares of common stock outstanding as of the last day of the previous quarter. The board of directors may modify, suspend, reactivate or terminate the SRP at any time and has the power, in its sole discretion, to repurchase fewer shares than have been requested in any particular quarter, or none at all. The Company did not make any share repurchases in 2017, or during the nine months ended September 30, 2018, except pursuant to the tender offers discussed below.
Company Tender Offers
On May 14, 2018, the Company commenced a self-tender offer (the “Company Offer”) for up to 1,000,000 shares of common stock at a price of $7.05 per share. The Company Offer was made in response to an unsolicited offer to stockholders commenced on May 7, 2018 by a third party. The Company Offer expired at 5:00 p.m., New York City time, on June 29, 2018. On June 29, 2018, a total of 170,260 shares were tendered in the Company Offer and purchased and subsequently retired by the Company, for an aggregate purchase price of $1.2 million. On August 2, 2018, the Company was advised that, due to an error by the Depositary for the Company Offer, a total of 912 shares were improperly accepted in the Company Offer. Upon correction of this error, the total shares purchased and retired by the Company was 169,348 shares.
During the three months ended December 31, 2017, the Company completed a self-tender offer in response to an unsolicited offer to stockholders by a third party. A total of 113,091 shares were tendered in the offer and purchased and subsequently retired by the Company, for an aggregate purchase price of $763,366.
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Note 10 - Share-Based Payments
The Company has adopted an employee and director incentive restricted share plan (as amended and/or restated, the “RSP”), which provides it with the ability to grant awards of restricted shares and, following an amendment and restatement in connection with the Initial Closing, RSUs to the Company’s directors, officers and employees, as well as the directors and employees of entities that provide services to the Company. The total number of shares of common stock that may be granted under the RSP may not exceed 5% of the authorized shares of common stock at any time and in any event may not exceed 4,000,000 shares (as such number may be adjusted for stock splits, stock dividends, combinations and similar events).
Restricted share awards entitle the recipient to receive shares of common stock from the Company under terms that provide for vesting over a specified period of time or upon attainment of pre-established performance objectives. Such awards would typically be forfeited with respect to the unvested shares upon the termination of the recipient’s employment or other relationship with the Company. Restricted shares may not, in general, be sold or otherwise transferred until restrictions are removed and the shares have vested. Holders of restricted shares may receive cash or stock distributions when and if paid prior to the time that the restrictions on the restricted shares have lapsed. Any distributions payable in shares of common stock are generally subject to the same restrictions as the underlying restricted shares. The fair value of the restricted shares is expensed over the applicable vesting period. The Company recognizes the impact of forfeited restricted share awards as they occur.
RSUs represent a contingent right to receive shares of common stock at a future settlement date, subject to satisfaction of applicable vesting conditions and/or other restrictions, as set forth in the RSP and an award agreement evidencing the grant of RSUs. RSUs may not, in general, be sold or otherwise transferred until restrictions are removed and the rights to the shares of common stock have vested. Holders of RSUs do not have or receive any voting rights with respect to the RSUs or any shares underlying any award of RSUs, but such holders generally are credited with dividend or other distribution equivalents that are regarded as having been reinvested in RSUs which are subject to the same vesting conditions and/or other restrictions as the underlying RSUs. The fair value of the RSUs is expensed over the applicable vesting period. The Company recognizes the impact of forfeited RSUs as they occur.
Restricted Share Awards
A summary of the Company's restricted share awards for the nine months ended September 30, 2018 is presented below.
Number of Shares | Weighted Average Grant Date Fair Value (per share) | Aggregate Intrinsic Value (in thousands) | |||||||||
Non-vested December 31, 2017 | 7,576 | $ | 14.59 | $ | 111 | ||||||
Granted | 7,210 | $ | 14.18 | $ | 102 | ||||||
Vested | 7,576 | $ | 14.59 | $ | 111 | ||||||
Forfeitures | — | $ | — | $ | — | ||||||
Non-vested September 30, 2018 | 7,210 | $ | 14.18 | $ | 102 | ||||||
Prior to the Initial Closing, the Company made annual restricted share awards to its independent directors that vested annually over a five-year period following the date of grant, subject to continued service. In connection with the Initial Closing, the Company implemented a new director compensation program. Following the Initial Closing and pursuant to a compensation payment agreement, restricted share awards are generally made to an affiliate of the Brookfield Investor in respect of the Redeemable Preferred Directors’ service on the board of directors and vest on the earlier of the first anniversary of the date of grant or the date of the next annual meeting of the board of directors following the date of grant, subject to the continued service of the applicable Redeemable Preferred Director.
There was less than $0.1 million compensation expense related to restricted shares for the three months ended September 30, 2018 and September 30, 2017. The compensation expense for the nine months ended September 30, 2018 and September 30, 2017 was less than $0.1 million and $0.1 million, respectively. As of September 30, 2018, there was less than $0.1 million remaining unrecognized compensation expense.
RSU Awards
A summary of the Company's RSU awards for the nine months ended September 30, 2018 is presented below:
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Number of Shares | Weighted Average Grant Date Fair Value (per share) | Aggregate Intrinsic Value (in thousands) | |||||||||
Non-vested December 31, 2017 | 99,840 | $ | 15.04 | $ | 1,502 | ||||||
Granted | 275,709 | $ | 14.18 | $ | 3,910 | ||||||
Vested | 42,507 | $ | 14.98 | $ | 637 | ||||||
Forfeited | 678 | $ | 14.59 | $ | 10 | ||||||
Non-vested September 30, 2018 | 332,364 | $ | 14.34 | $ | 4,765 | ||||||
RSU awards to the Company’s executive officers and other employees generally vest annually over a four-year vesting period following the date of grant, subject to continued service. RSU awards to directors other than Redeemable Preferred Directors vest on the earlier of the first anniversary of the date of grant or the date of the next annual meeting of the board of directors following the date of grant, subject to the continued service of the applicable director. In addition, during 2017, certain RSU awards to directors other than Redeemable Preferred Directors were issued in connection with the simultaneous forfeiture of an equal number of restricted shares. These RSU awards have the same vesting terms as the restricted shares which were forfeited (i.e., annually over a five-year period following the date of grant of the original restricted share award). Vested RSUs may only be settled in shares of common stock and such settlement generally will be on the earliest of (i) in the calendar year in which the third anniversary of each applicable vesting date occurs, (ii) termination of the recipient’s services to the Company and (iii) a change in control event. As of September 30, 2018, the Company anticipates that all unvested RSUs will vest in accordance with their terms.
The compensation expense related to RSUs for the three and nine months ended September 30, 2018 was approximately $0.4 million and $1.0 million, respectively. The compensation expense related to RSUs for the three and nine months ended September 30, 2017 was approximately $0.2 million in both periods. As of September 30, 2018, there was $4.0 million of unrecognized compensation expense remaining.
Note 11 - Fair Value Measurements
The Company is required to disclose the fair value of financial instruments which it is practicable to estimate. The fair value of cash and cash equivalents, accounts receivable and accounts payable and accrued expenses approximate their carrying amounts due to the relatively short maturity of these items. The following table shows the carrying amounts and the fair values of material liabilities, excluding deferred financing fees, that qualify as financial instruments (in thousands):
September 30, 2018 | |||||||
Carrying Amount | Fair Value | ||||||
Mortgage notes payable | $ | 1,513,000 | $ | 1,511,217 | |||
Mandatorily redeemable preferred securities | 219,746 | 214,228 | |||||
Contingent forward liability(1) | $ | 1,302 | $ | 1,302 | |||
Total | $ | 1,734,048 | $ | 1,726,747 | |||
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(1) See Note 12 - Commitments and Contingencies
The fair value of the mortgage notes payable and mandatorily redeemable preferred securities were determined using the discounted cash flow method and applying current market rates and is classified as level 3 under the fair value hierarchy. Market rates take into consideration general market conditions and maturity.
The contingent forward liability represents the fair value of the Company's obligation to issue Class C Units to the Brookfield Investor in the future (See Note 12 - Commitments and Contingencies), and is estimated by using option pricing analysis and discounting the estimated value of Class C Units to account for uncertainty and lack of marketability. The contingent forward liability is classified as level 3 under the fair value hierarchy.
During the three months ended June 30, 2018, the Company recorded an impairment loss of $17.3 million on its hotel properties (See Note 16 - Impairments). The fair value of these hotel properties was based on the observable market data which is considered level 2 input under the fair value hierarchy and unobservable inputs that reflect the Company's internal assumptions, which are considered level 3 input under the fair value hierarchy. There were no impairment losses recorded for the three months ended September 30, 2018.
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Note 12 - Commitments and Contingencies
Litigation
In the ordinary course of business, the Company may become subject to litigation, claims and regulatory matters. There are no material legal or regulatory proceedings pending or known to be contemplated against the Company at the date of this filing, other than as set forth below.
In February 2018, a stockholder of the Company, Tom Milliken, filed a derivative complaint (the “Complaint”) on behalf of the Company and against the Company, as well as the Former Advisor, the Former Property Manager, various affiliates of those entities (together, the “Former Advisor Defendants”), and certain current and former directors and officers of the Company (the “Director Defendants”). The Complaint was filed in the District Court for the Southern District of New York on February 26, 2018. The Complaint alleges, among other things, that the Former Advisor and the Director Defendants breached their fiduciary duties to the Company and its stockholders by putting their own interests above those of the Company, which breach was aided and abetted by certain of the Former Advisor Defendants. The Complaint also asserts claims of breach of contract against the Director Defendants, corporate waste against the Former Advisor and certain of the Director Defendants, and unjust enrichment against certain of the Director Defendants and Former Advisor Defendants. The Company had been investigating the above claims and others made by the stockholder since receipt of a shareholder demand letter from Mr. Milliken's attorneys in July 2017 and a supplemental demand letter in December 2017. In March 2018, the Company received a new demand letter from a different stockholder making substantially similar claims to those contemplated by the Complaint. The claims made in the Complaint and the new demand letter do not seek recovery of losses from or damages against the Company, but instead allege that the Company has sustained damages as a result of actions by the Former Advisor Defendants and the Director Defendants, and therefore no accrual of any potential liability was necessary as of September 30, 2018, other than for incurred out-of-pocket legal fees and expenses. The Company has consulted with its outside legal counsel and established a special litigation committee comprised solely of independent directors, which is investigating the claims made by both stockholders and evaluating the next steps that will be taken. In May 2018, the Company filed a motion to stay the Complaint pending the outcome of the investigation, and, in August 2018, the District Court granted the Company's motion.
Environmental Matters
In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. The Company has not been notified by any governmental authority of any non-compliance, liability or other claim and is not aware of any other environmental condition that it believes will have a material adverse effect on the results of operations.
Contingent Forward Liability
Pursuant to the SPA with the Brookfield Investor, the Company may become obligated to issue additional Class C Units to the Brookfield Investor and this obligation is considered a contingent forward contract under Accounting Standards Codification section 480 - Distinguishing Liabilities from Equity, and accounted for as a liability. The fair value of the contingent forward liability was initially recognized at zero since the contingent forward contract was executed at fair market value. The Company has determined the fair value of the contingent forward liability was $1.3 million as of September 30, 2018, which is included in the Consolidated Balance Sheets in accounts payable and accrued expenses. The Company will measure the contingent forward liability on a recurring basis until the Company is no longer obligated to issue additional Class C Units and any changes in fair value will be recognized through earnings. At the time that the Company is no longer obligated to issue additional Class C Units, the corresponding liability will be extinguished.
Note 13 - Related Party Transactions and Arrangements
Relationships with the Brookfield Investor and its Affiliates
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As described in Note 3 - Brookfield Investment, on January 12, 2017, the Company and the OP entered into the SPA and the Framework Agreement. On March 31, 2017, the Initial Closing occurred and a variety of transactions contemplated by the SPA and the Framework Agreement were consummated, including the issuance and sale of the Redeemable Preferred Share and 9,152,542.37 Class C Units and the execution or taking of various agreements and actions required to effectuate the Company's transition to self-management. On February 27, 2018, the Second Closing occurred, pursuant to which the Company sold 1,694,915.25 additional Class C Units to the Brookfield Investor, for a purchase price of $14.75 per Class C Unit, or $25.0 million in the aggregate. Holders of Class C Units are entitled to receive, with respect to each Class C Unit, fixed, quarterly cumulative cash distributions at a rate of 7.50% per annum from legally available funds. Holders of Class C Units are also entitled to receive, with respect to each Class C Unit, fixed, quarterly, cumulative PIK Distributions payable in Class C Units at a rate of 5% per annum. For the three and nine months ended September 30, 2018, the Company paid cash distributions of $3.2 million and $9.2 million and PIK Distributions of 146,594.53 and 416,402.88, respectively, Class C Units to the Brookfield Investor, as the sole holder of the Class C Units.
Two of the Company’s directors, Bruce G. Wiles, who also serves as Chairman of the Board, and Lowell G. Baron, have been elected to the Company’s board of directors as the Redeemable Preferred Directors pursuant to the Brookfield Investor’s rights as the holder of the Redeemable Preferred Share and pursuant to the SPA. Messrs. Wiles and Baron are Managing Partners of Brookfield Asset Management Inc., an affiliate of the Brookfield Investor.
Relationships with AR Capital, AR Global and their Affiliates
As of March 31, 2017, the Former Advisor, the Former Property Manager and Crestline were under common control with AR Capital, LLC (“AR Capital”) and AR Global Investments, LLC (“AR Global”), the successor to certain of AR Capital's businesses. AR Capital is the parent company of the Company’s former sponsor, American Realty Capital IX, LLC. Following the sale of AR Global’s membership interest in Crestline in April 2017, Crestline is no longer under common control with AR Global and AR Capital.
At the Initial Closing, the Company terminated the Advisory Agreement and entered into a transition services agreement with the Former Advisor. In the second quarter of 2017, the transition services agreement with the Former Advisor expired by its terms.
During the three and nine months ended September 30, 2017, the Company incurred zero and $4.6 million in asset management fees, respectively and zero and $0.9 million in general and administrative expense reimbursements, respectively, charged by and due to the Former Advisor, and zero and $2.0 million in property management fees to the Former Property Manager. As all of the Company's arrangements with the Former Advisor and the Former Property Manager (as described in more detail below) have been terminated, there were no fees or reimbursements to these parties incurred by the Company during the three and nine months ended September 30, 2018. Except for the short-term note payable due to the Former Property Manager described below which was repaid in full during March 2018, there were no fees or reimbursements payable due to the Former Advisor and its affiliates as of September 30, 2018 and December 31, 2017, respectively.
Property Management Transactions
At the Initial Closing, as contemplated by and pursuant to the Framework Agreement, the Company entered into a series of amendments, assignments and terminations with respect to its then existing property management arrangements (collectively, the "Property Management Transactions"), the primary effect of which was to terminate the Former Property Manager as the Company's property manager, and enter into direct property management agreements with the Company's then existing sub-managers, which included Crestline.
As consideration for the Property Management Transactions, the Company and the OP:
• | paid a one-time cash amount equal to $10.0 million to the Former Property Manager; |
• | made a monthly cash payment in the amount of $333,333.33, $4.0 million in the aggregate, to the Former Property Manager on the 15th day of each month for the 12 months following the Initial Closing (See Note 6 - Promissory Notes Payable), all of which have been completed as of March 31, 2018; |
• | issued 279,329 shares of the Company's common stock to the Former Property Manager, for which the fair value on the date of grant has been determined to be $14.59 per share (See Note 9 - Common Stock); |
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• | waived any and all obligations of the Former Advisor to refund or otherwise repay any Organization or Offering Expenses (as defined in the Advisory Agreement) to the Company in an amount acknowledged to be $5,821,988, which amount had been reflected as a reduction in offering proceeds due to it being directly related to issuing shares of common stock in prior periods; and |
• | converted all 524,956 units of limited partnership in the OP entitled “Class B Units” (“Class B Units") held by the Former Advisor into 524,956 OP Units, and, immediately following such conversion, redeemed such 524,956 OP Units for 524,956 shares of the Company’s common stock. |
The foregoing consideration aggregated to $31.6 million and was recorded as goodwill on the Company’s Consolidated Balance Sheets. During 2017, the Company recorded impairments to the goodwill (See Note 2 - Summary of Significant Accounting Policies).
Note 14 - Economic Dependency
Prior to the Initial Closing, the Company was dependent on the Former Advisor and its affiliates. Going forward, the Company intends to continue pursuing its investment strategies, subject to the Brookfield Approval Rights. The Company expects to generate additional liquidity through the sale of Class C Units to the Brookfield Investor at Subsequent Closings (See Note 3 - Brookfield Investment). As a result of these relationships, the Company is dependent upon the Brookfield Investor and its affiliates.
Note 15 - Sale of Hotels
During the nine months ended September 30, 2018, the Company completed the sale of one hotel for a sales price of $5.7 million, resulting in a net loss of approximately $0.1 million, which is reflected in other income on the Company’s Consolidated Statement of Operations and Comprehensive Loss. The Company used the proceeds from the sale of the hotel to redeem $3.8 million in Grace Preferred Equity Interests in accordance with their terms and for other general corporate purposes. No other hotel sales have occurred in 2018. No hotels were sold during the three and nine months ended September 30, 2017.
Note 16 - Impairments
Impairments of Long-Lived Assets
During the three months ended June 30, 2018, the Company identified four hotel properties where the carrying value of the properties exceeded their fair value and management determined the excess carrying value was unrecoverable. The Company determined the fair value of each hotel using a market and income based approach. The market approach estimates value based on what other purchasers and sellers in the market have agreed to as price for comparable properties. The income approach utilizes assumptions such as discount rates, future cash flow, and capitalization rates.
These four hotels were identified for impairment review because of a long-term change in market conditions and the potential future sale of such properties. The Company recorded an aggregate impairment loss of $17.3 million on the four hotel properties during the three months ended June 30, 2018. There was no impairment loss during the three months ended September 30, 2018. The Company recorded $1.4 million of impairment loss on its hotel properties during the three months ended June 30, 2017 and an additional impairment loss of $5.4 million during the three months ended September 30, 2017, which includes the cost to sell the assets, on the sale of three of four hotels classified as assets held for sale as of September 30, 2017.
Note 17 - Subsequent Events
The Company has evaluated subsequent events through the filing of this Quarterly Report on Form 10-Q, and determined that there have not been any events that have occurred that would require adjustments to disclosures in the accompanying consolidated financial statements.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements of Hospitality Investors Trust, Inc. and the notes thereto. As used herein, the terms "Company," "we," "our," "our company" or "us" refer to Hospitality Investors Trust, Inc., a Maryland corporation, including, as required by context, to Hospitality Investors Trust Operating Partnership, L.P. (the "OP"), the Company’s operating partnership and a Delaware limited partnership, and to its subsidiaries.
Forward-Looking Statements
Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Those statements include statements regarding the intent, belief or current expectations of our company and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as "may," "will," "seeks," "anticipates," "believes," "estimates," "expects," "plans," "intends," "should" or similar expressions. Actual results may differ materially from those contemplated by such forward-looking statements. Further, forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law.
The following are some of the risks and uncertainties, although not all risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:
• | We have entered into agreements with Brookfield Strategic Real Estate Partners II Hospitality REIT II LLC (the “Brookfield Investor”), pursuant to which, among other things, the Brookfield Investor has purchased $160.0 million in units of a class of limited partner interests in our operating partnership entitled "Class C Units" (the “Class C Units”), and the Brookfield Investor has agreed to purchase additional Class C Units in an aggregate amount of up to $240.0 million at subsequent closings (“Subsequent Closings”). We may require funds, which may not be available on favorable terms or at all, in addition to our operating cash flow, cash on hand and the proceeds that may be available from sales of Class C Units at Subsequent Closings, which are subject to conditions, to meet our capital requirements. |
• | The interests of the Brookfield Investor may conflict with our interests and the interests of our stockholders, and the Brookfield Investor has significant governance and other rights that could be used to control or influence our decisions or actions. |
• | The prior approval rights of the Brookfield Investor will restrict our operational and financial flexibility and could prevent us from taking actions that we believe would be in the best interest of our business. |
• | We no longer pay distributions and there can be no assurance we will resume paying distributions in the future. |
• | We may not be able to make additional investments unless we are able to identify an additional source of capital on favorable terms and obtain prior approval from the Brookfield Investor. |
• | We have a history of operating losses and there can be no assurance that we will ever achieve profitability. |
• | We have terminated our advisory agreement with our former advisor, American Realty Capital Hospitality Advisors, LLC (the “Former Advisor”), and other agreements with its affiliates as part of our transition from external management to self-management. As part of this transition, our business may be disrupted and we may become exposed to risks to which we have not historically been exposed. |
• | No public market currently exists, or may ever exist, for shares of our common stock, and our shares are, and may continue to be, illiquid. |
• | All of the properties we own are hotels, and we are subject to risks inherent in the hospitality industry. |
• | Increases in interest rates could increase the amount of our debt payments. |
• | We have incurred substantial indebtedness, which may limit our future operational and financial flexibility. |
• | We depend on our operating partnership and its subsidiaries for cash flow and are effectively structurally subordinated in right of payment to their obligations, which include distribution and redemption obligations to holders of Class C Units and the preferred equity interests issued by two of our subsidiaries that indirectly own 111 of our hotels (the “Grace Preferred Equity Interests”). |
• | The amount we would be required to pay holders of Class C Units in a fundamental sale transaction may discourage a third party from acquiring us in a manner that might otherwise result in a premium price to our stockholders. |
• | We may fail to realize the expected benefits of our acquisitions of hotels within the anticipated timeframe or at all and we may incur unexpected costs. |
• | We are subject to a variety of risks related to our PIP program, such as we may spend more than budgeted amounts to make necessary renovations and the renovations we make may not have the desired effect of improving the competitive position and enhancing the performance of the hotels renovated. |
• | Increases in labor costs could adversely affect the profitability of our hotels. |
• | Our operating results will be affected by economic and regulatory changes that have an adverse impact on the real estate market in general, and we may not be profitable or realize growth in the value of our real estate properties. |
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• | A prolonged economic slowdown, a lengthy or severe recession or declining real estate values could harm our investments. |
• | Our real estate investments are relatively illiquid and subject to some restrictions on sale, and therefore we may not be able to dispose of properties at the time of our choosing or on favorable terms. |
• | Our failure to continue to qualify to be treated as a real estate investment trust for U.S. federal income tax purposes ("REIT") could have a material adverse effect on us. |
All forward-looking statements should also be read in light of the risks identified in Item 1A of our Annual Report on Form 10-K.
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Overview
We were incorporated on July 25, 2013 as a Maryland corporation and qualified as a REIT beginning with the taxable year ended December 31, 2014. We were formed primarily to acquire lodging properties in the midscale limited service, extended stay, select service, upscale select service, and upper upscale full service segments within the hospitality sector. As of September 30, 2018, we had acquired or had an interest in a total of 144 hotels with a total of 17,320 guest rooms located in 33 states. As of September 30, 2018, all but one of our hotels operated under a franchise or license agreement with a national brand owned by one of Hilton Worldwide, Inc., Marriott International, Inc., Hyatt Hotels Corporation and Intercontinental Hotels Group or one of their respective subsidiaries or affiliates.
As of September 30, 2018, 79 of the hotel assets we have acquired were managed by Crestline Hotels & Resorts, LLC ("Crestline) and 65 of the hotel assets we have acquired were managed by other property managers. As of September 30, 2018, our other property managers were Hampton Inns Management LLC and Homewood Suites Management LLC, affiliates of Hilton Worldwide Holdings Inc. (38 hotels), InnVentures IVI, LP (2 hotels), McKibbon Hotel Management, Inc. (21 hotels) and Larry Blumberg & Associates, Inc. (4 hotels).
Following the suspension of our initial public offering (the “IPO” or the “Offering”) in 2015, our primary business objective has been a focus on meeting our capital requirements and on maximizing the value of our existing portfolio by continuing to invest in our hotels, primarily through brand-mandated property improvement plans (“PIPs”), and through intensive asset management. In January 2017, we suspended paying distributions to our stockholders entirely and suspended our Distribution Reinvestment Program (the “DRIP”) in connection with our entry into a Securities Purchase, Voting and Standstill Agreement (the “SPA”) with the Brookfield Investor. Currently, under the Brookfield Approval Rights (as defined below), prior approval is required before we can declare or pay any distributions or dividends to our common stockholders, except for cash distributions equal to or less than $0.525 per annum per share.
On April 23, 2018, our board of directors approved an updated estimated net asset value per share of common stock ("Estimated Per-Share NAV") equal to $13.87 based on an estimated fair value of our assets less the estimated fair value of our liabilities, divided by 39,505,742 shares of common stock outstanding on a fully diluted basis as of December 31, 2017. We anticipate that we will publish an updated Estimated Per-Share NAV on at least an annual basis.
On January 7, 2017, the third anniversary of the commencement of our IPO, the IPO terminated in accordance with its terms.
On January 12, 2017, we, along with our operating partnership, Hospitality Investors Trust Operating Partnership, L.P. (the “OP”), entered into (i) the SPA with the Brookfield Investor, as well as related guarantee agreements with certain affiliates of the Brookfield Investor, and (ii) a Framework Agreement (the “Framework Agreement”) with the Former Advisor, our former property managers, American Realty Capital Hospitality Properties, LLC and American Realty Capital Hospitality Grace Portfolio, LLC (together, the “Former Property Manager”), Crestline, then an affiliate of the Former Advisor and the Former Property Manager, American Realty Capital Hospitality Special Limited Partnership, LLC (the “Former Special Limited Partner”), another affiliate of the Former Advisor and the Former Property Manager, and, for certain limited purposes, the Brookfield Investor.
On March 31, 2017, the initial closing under the SPA (the “Initial Closing”) occurred and various transactions and agreements contemplated by the SPA were consummated and executed, including but not limited to:
• | the sale by us and purchase by the Brookfield Investor of one share of a new series of preferred stock designated as the Redeemable Preferred Share, par value $0.01 per share (the “Redeemable Preferred Share”), for a nominal purchase price; and |
• | the sale by us and purchase by the Brookfield Investor of 9,152,542.37 Class C Units, for a purchase price of $14.75 per Class C Unit, or $135.0 million in the aggregate. |
On February 27, 2018, the second closing under the SPA (the “Second Closing”) occurred, pursuant to which we sold 1,694,915.25 additional Class C Units to the Brookfield Investor, for a purchase price of $14.75 per Class C Unit, or $25.0 million in the aggregate.
Subject to the terms and conditions of the SPA, we also have the right to sell, and the Brookfield Investor has agreed to purchase, additional Class C Units in an aggregate amount of up to $240.0 million at subsequent closings (each, a "Subsequent
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Closing") that may occur through February 2019. The Subsequent Closings are subject to conditions, and there can be no assurance they will be completed on their current terms, or at all.
Without obtaining the prior approval of the majority of the then outstanding Class C Units and/or at least one of the two directors elected to our board of directors by the Brookfield Investor pursuant to its rights as the holder of the Redeemable Preferred Share, we are restricted from taking certain operational and governance actions. These restrictions (collectively referred to herein as the “Brookfield Approval Rights”) are subject to certain exceptions and conditions.
The SPA also contains certain standstill and voting restrictions applicable to the Brookfield Investor and certain of its affiliates.
Prior to the Initial Closing, we had no employees, and we depended on the Former Advisor to manage certain aspects of our affairs on a day-to-day basis pursuant to the advisory agreement with the Former Advisor (the “Advisory Agreement”). The Framework Agreement provides for our transition from an externally managed company with no employees of our own that is dependent on the Former Advisor and its affiliates to manage our day-to-day operations, to a self-managed company. The transactions contemplated by the Framework Agreement generally were consummated at, and as a condition to, the Initial Closing. At the Initial Closing, pursuant to the Framework Agreement, the Advisory Agreement was terminated.
Substantially all of our business is conducted through the OP. Prior to the Initial Closing, we were the sole general partner and held substantially all of the units of limited partner interest in the OP entitled “OP Units” ("OP Units"). The Brookfield Investor holds all the issued and outstanding Class C Units which rank senior in payment of distributions and in the distribution of assets to the OP Units held by us, and BSREP II Hospitality II Special GP, OP LLC (the “Special General Partner”), an affiliate of the Brookfield Investor, is the special general partner of the OP, with certain non-economic rights that apply if we fail to redeem the Class C Units when required to do so, including the ability to commence selling the OP's assets until the Class C Units have been fully redeemed. As of September 30, 2018, the total liquidation preference of the issued and outstanding Class C Units was $171.4 million.
Our customers fall into three broad groups: transient business, group business and contract business. Transient business broadly represents individual business or leisure travelers. Business travelers make up the majority of transient demand at our hotels.
Our revenues are comprised of rooms revenue, food and beverage revenue and other revenue which accounted for approximately 94.8%, 2.9%, and 2.2%, respectively, of our total revenues during the three months ended September 30, 2018. Hotel operating expenses (which exclude acquisition and transaction costs, general and administrative, depreciation and amortization and impairment of goodwill and long-lived assets) represented approximately 76.7% of our total operating expenses during the three months ended September 30, 2018.
Critical Accounting Policies and Estimates
Real Estate Investments
We allocate the purchase price of properties acquired in real estate investments to tangible and identifiable intangible assets acquired based on their respective fair values at the date of acquisition. Tangible assets include land, land improvements, buildings and furniture, fixtures and equipment. We utilize various estimates, processes and information to determine the property value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Amounts allocated to land, land improvements, buildings and furniture, fixtures and equipment are based on purchase price allocation studies performed by independent third parties or our analysis of comparable properties in our portfolio. Identifiable intangible assets and liabilities, as applicable, are typically related to contracts, including operating lease agreements, ground lease agreements and hotel management agreements, which are recorded at fair value. We also consider information obtained about each property as a result of our pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.
Prior to January 1, 2018, our acquisitions of hotel properties were accounted for as acquisitions of existing businesses, and all transaction costs associated with the acquisitions, were expensed as incurred. As a result of a change in applicable GAAP guidance, beginning January 1, 2018, our acquisitions of hotel properties are anticipated to be accounted for as acquisitions of groups of assets rather than business combinations, although the determination will be made on a transaction-by-transaction basis. If we conclude that an acquisition will be accounted for as a group of assets, the transaction costs associated with the acquisition will be capitalized as part of the assets acquired.
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Our investments in real estate, including transaction costs, that are not considered to be business combinations under GAAP are recorded at cost. Improvements and replacements are capitalized when they extend the useful life of the asset. Costs of repairs and maintenance are expensed as incurred. Depreciation of our assets is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, 15 years for land improvements, five years for furniture, fixtures and equipment, and the shorter of the useful life or the remaining lease term for leasehold interests.
We are required to make subjective assessments as to the useful lives of our assets for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact our net income because if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
Impairment of Long-Lived Assets
When circumstances indicate the carrying amount of a property may not be recoverable, we review the asset for impairment. This review is based on a comparison of the carrying amount to an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. The estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of demand, competition and other factors. If an impairment exists due to the inability to recover the carrying amount of a property, an impairment loss will be recorded to the extent that the carrying amount exceeds the estimated fair value of the property which results in an immediate charge to net income.
Revenue Recognition
Our revenue is primarily from rooms, food and beverage, and other, and is disaggregated on our Consolidated Statement of Operations and Comprehensive Loss.
Room sales are driven by fixed fee charged to a hotel guest to stay at the hotel property for an agreed-upon period. A majority of our room reservations are cancellable and we transfer promised goods and services to the hotel guest as of the date upon which the hotel guest occupies a room and at the same time earns and recognizes revenue. We offer advance purchase reservations that are paid for by the hotel guest in advance and we recognize deferred revenue as a result of such reservations. Our obligation to the hotel guest is satisfied as of the date upon which the hotel guest occupies a room. Our room revenue accounted for 94.8% and 95.3% of our total revenue for the three months ended September 30, 2018 and 2017 respectively. Our room revenue accounted for 94.5% and 94.8% of our total revenue for the nine months ended September 30, 2018 and 2017 respectively. Food, beverage, and other revenue are recognized at the point of sale on the date of the transaction as the hotel guest simultaneously obtains control of the good or service.
Class C Units
We initially measured the Class C Units at fair value net of issuance costs. We are required to accrete the carrying value of the Class C Units to the liquidation preference using the effective interest method over the five year period prior to the holder's redemption option becoming exercisable. However, if it becomes probable that the Class C Units will become redeemable prior to such date, we will adjust the carrying value of the Class C Units to the maximum liquidation preference.
Pursuant to the SPA with the Brookfield Investor, we may become obligated to issue additional Class C Units to the Brookfield Investor in the future and this obligation is considered a contingent forward contract under Accounting Standards Codification section 480 - Distinguishing Liabilities from Equity and accounted for as a liability. The fair value of the contingent forward liability was initially recognized at zero since the contingent forward contract was executed at fair market value. We determined the value of the contingent forward liability was $1.3 million as of September 30, 2018 (See Note 12 - Commitments and Contingencies). We will measure the contingent forward liability on a recurring basis until the underlying Class C Units are issued and any changes in fair value will be recognized through earnings. At the time that the underlying Class C Units are issued, the corresponding liability will be extinguished.
Revenue Performance Metrics
We measure hotel revenue performance by evaluating revenue metrics such as:
• | Occupancy percentage (“Occ”) - Occ represents the total number of hotel rooms sold in a given period divided by the total number of rooms available. Occ measures the utilization of our hotels' available capacity. |
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• | Average Daily Rate (“ADR”) - ADR represents total hotel room revenues divided by the total number of rooms sold in a given period. |
• | Revenue per Available room (“RevPAR”) - RevPAR is the product of ADR and Occ. |
Occ, ADR, and RevPAR are commonly used measures within the hotel industry to evaluate hotel operating performance. ADR and RevPAR do not include food and beverage or other revenues generated by the hotels. We evaluate individual hotel RevPAR performance on an absolute basis with comparisons to budget, to prior periods and to the hotel competitive set in the market, as well as on a company-wide and regional basis. Our hotel competitive sets generally include branded hotels of similar size, location, age and chain scale (as defined by Smith Travel Research).
Our Occ, ADR and RevPAR performance may be affected by macroeconomic factors such as regional and local employment growth, personal income and corporate earnings, office vacancy rates and business relocation decisions, airport and other business and leisure travel, new hotel property construction, and the pricing strategies of competitors. In addition, our Occ, ADR and RevPAR performance is dependent on the continued success of our franchisors and brands.
We generally expect that room revenues will make up a significant majority of our total revenues, and our revenue results will therefore be highly dependent on maintaining and improving Occ and ADR, which drive RevPAR.
Results of Operations
Prior to the suspension of our IPO in November 2015, we depended, and expected to continue to depend, in substantial part on proceeds from our IPO to meet our major capital requirements. Following the suspension of our IPO in 2015, our primary business objective has been meeting our capital requirements and maximizing the value of our existing portfolio by continuing to invest in our hotels, primarily through brand-mandated property improvement plans (“PIPs”), and through intensive asset management. In January 2017, we entered into the SPA and the Framework Agreement, and the consummation of the transactions contemplated by these agreements has generated, and is expected to continue to generate, additional liquidity through the sale of Class C Units to the Brookfield Investor at the Initial Closing, the Second Closing and at other Subsequent Closings. We also expect to achieve cost savings realized as part of our transition to self-management through reduced property management fees and the elimination of external asset management fees to the Former Advisor (offset by expenses previously borne by the Former Advisor that are now incurred directly by us as a self-managed company). The Subsequent Closings are subject to conditions, and may not be completed on their current terms, or at all, and the cost savings from our transition to self-management may not be realized to the extent we are anticipating, or at all.
While receipt of all the proceeds from our sale of Class C Units at the Initial Closing, the Second Closing and Subsequent Closings would provide the liquidity needed to satisfy certain of our liquidity and capital requirements, including our obligation to redeem all issued and outstanding Grace Preferred Equity Interests ($219.7 million as of September 30, 2018) by February 27, 2019 and certain of our PIP obligations, these amounts may not be sufficient to satisfy all of our capital requirements. We may need to seek additional debt or equity financing consisting of common stock, preferred stock or warrants, or any combination thereof to meet our capital requirements, which may not be available on favorable terms or at all, and may only be obtained subject to the Brookfield Approval Rights.
We sold four non-core assets during the fourth quarter of 2017 and the first quarter of 2018 which generated net proceeds of $4.3 million after associated repayments of Grace Preferred Equity Interests and indebtedness, and we intend to continue to look at opportunities to strategically sell non-core assets and reallocate any capital generated by the sales into opportunities that we believe will produce more attractive stockholder returns. However, we cannot provide any assurance that this strategy will be successful.
We are currently undertaking an approximately $350 million PIP program across a significant portion of our portfolio. We have significant PIP renovation work that we will be required to make during the remainder of 2018 and in future years, and we expect to complete our PIP program over the next two to three years. PIP renovation work has adversely impacted, and is expected to continue to adversely impact, our operating results due to the disruption to the operations of the hotels while renovation work is ongoing. We anticipate that as we complete PIP renovations, our RevPAR at the renovated hotels will increase for a period of time (generally one to two years) and then moderate as the hotel stabilizes. However, we cannot provide any assurance that the PIP renovations at our hotels will have the desired effect of improving the competitive position and enhancing the performance of the hotels renovated. We also anticipate that the hotels in our portfolio that are scheduled for PIP renovations in the future but have not yet been renovated will experience decreases in RevPAR growth and could experience RevPAR declines until they are renovated.
We believe that the continued execution of our hotel reinvestment program, primarily through the brand-mandated PIPs, will maximize long-term value for our stockholders and position us for future success and a potential liquidity event for our
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investors. While it is our intention to achieve a liquidity event, there can be no assurance as to when or if we will ultimately be able to do so and as to the terms of any such liquidity event.
Our results of operations have in the past, and may continue to be, impacted by our acquisition activity. Our hotel portfolio has been acquired through a series of portfolio purchases, as shown in the table below.
Acquisition Date | Portfolio | Number of Hotels | Purchase Price(1) |
March 2014 | Barceló Portfolio | 6 | $110.1 million |
February 2015 | Grace Portfolio | 116(2) | $1.8 billion |
October 2015 | First Summit Portfolio | 10 | $150.1 million |
November 2015 | First Noble Portfolio | 2 | $48.6 million |
December 2015 | Second Noble Portfolio | 2 | $59.0 million |
February 2016 | Third Summit Portfolio | 6 | $108.3 million |
April 2017 | Second Summit Portfolio (referred to herein as the "April Acquisition") | 7 | $66.5 million |
(1) Exclusive of closing costs
(2) Since the acquisition date, five hotels have been sold reducing the size of this portfolio to 111 properties.
Our ability to make future acquisitions is subject to the Brookfield Approval Rights. Additionally, in order to make acquisitions, we will need to obtain additional capital, such as through asset sales or equity or debt financings, and generating capital from these sources is also subject to the Brookfield Approval Rights. There can be no assurance any required prior approval would be provided when requested.
Comparison of the Three Months Ended September 30, 2018 to the Three Months Ended September 30, 2017
Room revenues for the portfolio were $152.1 million for the three months ended September 30, 2018, compared to room revenues of $159.4 million for the three months ended September 30, 2017. The decrease in room revenues was driven by the positive revenue impact in the 2017 period of hurricanes in our Texas and Florida markets that was not repeated in the 2018 period, lower occupancy, and a fewer number of total rooms in the portfolio due to the sale of three hotels during the fourth quarter of 2017 and one hotel during the first quarter of 2018. The decrease in occupancy was driven by a slow return to normal occupancy for hotels that had recently completed renovations and reduced guest demand combined with increased hotel supply especially in markets where we have not yet completed PIP renovations. The occupancy declines for our hotels were generally consistent with our hotels’ competitive sets for the comparable periods. The occupancy declines were offset in part by an increase in ADR. We had seven hotels undergoing PIP renovations at some point during the three months ended September 30, 2018, compared to five hotels in the prior year comparable period.
The table below presents actual operating information of the hotels in our portfolio for the periods in which we have owned them.
Three Months Ended | ||||||||
Total Portfolio | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 17,320 | 17,846 | ||||||
Occ | 77.4 | % | 79.6 | % | ||||
ADR | $ | 125.76 | $ | 124.41 | ||||
RevPAR | $ | 97.35 | $ | 99.02 | ||||
Our results of operations include the hotels we own beginning on the date of each hotel's acquisition and the hotels that we have sold through the date of disposition. The next table below presents pro-forma operating information of the hotels in our portfolio as if we had owned each hotel in our portfolio as of September 30, 2018, for the full periods presented.
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Three Months Ended | ||||||||
Pro-forma (144 hotels) | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 17,320 | 17,320 | ||||||
Occ | 77.4 | % | 80.2 | % | ||||
ADR | $ | 125.76 | $ | 125.44 | ||||
RevPAR | $ | 97.35 | $ | 100.65 | ||||
RevPAR change | (3.3 | )% | ||||||
The information in the next table below presents pro-forma operating information for only the hotels that we classify as not under renovation as of September 30, 2018. We consider hotels to be under renovation beginning in the quarter that they start material renovations and continuing until the end of the fourth full quarter following the substantial completion of the renovations. Therefore, hotels classified as under renovation are those which are undergoing renovation during the period or those for which renovations were substantially completed less than four full quarters prior to the three months ended September 30, 2018.
The hotel business is capital-intensive and renovations are a regular part of the business. A large-scale capital project that would cause a hotel to be considered to be under renovation is an extensive renovation of core aspects of the hotel, such as rooms, meeting space, lobby, bars, restaurants, and other public spaces. Both quantitative and qualitative factors are taken into consideration in determining if a particular renovation would cause a hotel to be considered to be under renovation for these purposes, including unusual or exceptional circumstances such as: a reduction or increase in room count, a significant alteration of the business operations, or the closing of material portions of the hotel during the renovation.
Three Months Ended | ||||||||
Pro-forma hotels not under renovation (101 hotels) | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 12,398 | 12,398 | ||||||
Occ | 78.2 | % | 80.8 | % | ||||
ADR | $ | 128.58 | $ | 128.01 | ||||
RevPAR | $ | 100.59 | $ | 103.40 | ||||
RevPAR change | (2.7 | )% | ||||||
The information in the next table below presents pro-forma operating information for a subset of the 101 hotels classified as not under renovation because we completed renovations for these 40 hotels more than four full quarters prior to the three months ended September 30, 2018.
Three Months Ended | ||||||||
Pro-forma hotels not under renovation with completed renovations (40 hotels) | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 4,950 | 4,950 | ||||||
Occ | 79.4 | % | 82.1 | % | ||||
ADR | $ | 129.56 | $ | 127.14 | ||||
RevPAR | $ | 102.92 | $ | 104.34 | ||||
RevPAR change | (1.4 | )% | ||||||
Pro-forma RevPAR for the three months ended September 30, 2018, declined 3.3%, compared to the three months ended September 30, 2017, due to a decline in occupancy, partially offset by an increase in ADR. Pro-forma RevPAR for our hotels not under renovation (101 hotels) decreased by 2.7% in the current period as compared to the prior year period due to decline in occupancy partially offset by an increase in ADR. Pro-forma RevPAR for our hotels classified as not under renovation with renovations previously completed (40 hotels) decreased by 1.4% in the current period as compared to the prior year period, due to a decline in occupancy partially offset by an increase in ADR. The primary driver of the occupancy declines was due to the same factors that impacted the revenue decline for these periods as described above.
Other non-room operating revenues for the portfolio include food and beverage, and other ancillary revenues such as conference center, market, parking, telephone and cancellation fees. Total non-room operating revenues, including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the three months ended September 30, 2018, and
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the three months ended September 30, 2017, increased 5.8% driven by an increase in food and beverage and other ancillary revenue.
Our hotel operating expenses include labor expenses incurred in the day-to-day operation of our hotels. Our hotels have a variety of fixed expenses, such as essential hotel staff, real estate taxes and insurance, and these expenses do not change materially even if the revenues at the hotels fluctuate. Our primary hotel operating expenses are described below:
• | Rooms expense: These costs include labor (housekeeping and rooms operation), reservation systems, room supplies, linen and laundry services. Occupancy is the major driver of rooms expense, due to the cost of cleaning the rooms, with additional expenses that vary with the level of service and amenities provided. |
• | Food and beverage expense: These expenses primarily include labor and the cost of food and beverage. Occupancy and the type of customer staying at the hotel (for example, catered functions generally are more profitable than outlet sales) are the major drivers of food and beverage expense, which correlates closely with food and beverage revenue. |
• | Management fees: Management fees decreased $6.7 million for the three months ended March 31, 2018, reflecting cost savings realized as part of our transition to self-management which occurred on March 31, 2017 through reduced property management fees and the elimination of external asset management fees to the Former Advisor. As discussed further below, this decline was offset in part by an increase in certain general and administrative expenses due to expenses previously borne by the Former Advisor that are now incurred directly by us as a self-managed company. Management fees include base management fees paid to third party property managers and are computed as a percentage of gross revenue. Beginning as of the Initial Closing, the base management fees were reduced from up to 4% to up to 3%. Incentive management fees may be paid to third party property managers when operating profit or other performance metrics exceed certain threshold levels. Asset management fees payable under the Advisory Agreement, which was terminated at the Initial Closing, were computed as a percentage of the lower of the cost or the fair market value of our assets. |
• | Other property-level operating costs: These expenses include labor and other costs associated with other ancillary revenue, such as conference center, parking, market and other guest services, as well as labor and other costs associated with administrative and general, sales and marketing, brand related fees, repairs, maintenance and utility costs. In addition, these expenses include real and personal property taxes and insurance, which are relatively inflexible and do not necessarily change based on changes in revenue or performance at the hotels. |
Total hotel operating expenses (which exclude acquisition and transaction costs, general and administrative and depreciation and amortization and impairment of long-lived assets), including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the three months ended September 30, 2018, and the three months ended September 30, 2017, decreased by approximately 3.1% over the prior year period primarily due to lower rooms expense and other property-level operating expenses associated with the decrease in revenues.
There were no acquisition and transaction related costs during the three months ended September 30, 2018, compared to the prior year period.
General and administrative increased by approximately $0.8 million for the three months ended September 30, 2018, compared to the prior year period, primarily due to higher professional fees. Our general and administrative expenses for the three months ended September 30, 2018 included out-of-pocket legal fees and expenses incurred related to the litigation described at Note 12 of the consolidated financial statements included in this Form 10-Q, and we expect these legal fees and expenses to continue in future periods.
Depreciation and amortization increased by approximately $2.0 million for the three months ended September 30, 2018, compared to the prior year period, due to completed PIPs, partially offset by the sale of three hotels during the fourth quarter of 2017 and one hotel during the first quarter of 2018.
Impairment of goodwill and long-lived assets decreased by $5.4 million for the three months ended September 30, 2018, compared to the prior year period. An impairment loss of $5.4 million was recorded during the three months ended September 30, 2017, on the sale of three of four hotels classified as assets held for sale at that time. See Note 16 - Impairments to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q for further details.
Interest expense increased $2.4 million for the three months ended September 30, 2018, compared to the prior year period, primarily driven by an increase in interest rates. Average mortgage debt was $1,513.0 million for the three months ended September 30, 2018, and for the three months ended September 30, 2017. The average interest rate on our mortgage debt was 5.1% for the three months ended September 30, 2018, compared to 4.5% for the three months ended September 30, 2017.
Comparison of the Nine Months Ended September 30, 2018 to the Nine Months Ended September 30, 2017
Room revenues were $439.7 million for the nine months ended September 30, 2018, compared to room revenues of $453.1 million for the nine months ended September 30, 2017. The decrease in room revenues was driven by the positive revenue
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impact in the 2017 period of hurricanes in our Texas and Florida markets that was not repeated in the 2018 period and by lower occupancy primarily as a result of an aggregate of 37 hotels under renovation pursuant to the Company's PIP program at some point during the nine months ended September 30, 2018, and a lower number of total rooms in the portfolio due to the sale of three hotels during the fourth quarter of 2017, and one hotel during the first quarter of 2018. The 37 hotels were under renovation at some point during the nine months ended September 30, 2018, which represented approximately 3,100 nights when a room could not be used due to ongoing renovations, compared to 12 hotels that were under renovation at some point during the nine months ended September 30, 2017, which represented approximately 1,100 nights when a room could not be used due to renovations. The decrease in occupancy was also driven by a slow return to normal occupancy for hotels that had recently completed renovations and reduced guest demand combined with increased hotel supply especially in markets where we have not yet completed PIP renovations. The occupancy declines were offset in part by an increase in ADR and by the impact of the April Acquisition of seven hotels in April 2017.
The table below presents actual operating information of the hotels in our portfolio for the periods in which we owned them.
Nine Months Ended | ||||||||
Total Portfolio | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 17,320 | 17,846 | ||||||
Occ | 75.1 | % | 77.6 | % | ||||
ADR | $ | 125.46 | $ | 123.84 | ||||
RevPAR | $ | 94.26 | $ | 96.10 | ||||
The next table below presents pro-forma operating information of the hotels in our portfolio as if we had owned each hotel in our portfolio as of September 30, 2018, for the full periods presented.
Nine Months Ended | ||||||||
Pro forma (144 hotels) | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 17,320 | 17,320 | ||||||
Occ | 75.2 | % | 78.1 | % | ||||
ADR | $ | 125.55 | $ | 124.50 | ||||
RevPAR | $ | 94.45 | $ | 97.25 | ||||
RevPAR change | (2.9 | )% | ||||||
The information in the next table below presents pro-forma operating information for only the hotels that we classify as not under renovation as of September 30, 2018.
Nine Months Ended | ||||||||
Pro forma hotels not under renovation (101 hotels) | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 12,398 | 12,398 | ||||||
Occ | 77.2 | % | 78.0 | % | ||||
ADR | $ | 126.96 | $ | 125.94 | ||||
RevPAR | $ | 97.99 | $ | 98.25 | ||||
RevPAR change | (0.3 | )% | ||||||
The information in the next table below presents pro-forma operating information for a subset of the 101 hotels classified as not under renovation because we completed renovations for these 40 hotels more than four full quarters prior to the three months ended September 30, 2018.
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Nine Months Ended | ||||||||
Pro-forma hotels not under renovation with completed renovations (40 hotels) | September 30, 2018 | September 30, 2017 | ||||||
Number of rooms | 4,950 | 4,950 | ||||||
Occ | 80.0 | % | 79.2 | % | ||||
ADR | $ | 130.51 | $ | 127.78 | ||||
RevPAR | $ | 104.44 | $ | 101.19 | ||||
RevPAR change | 3.2 | % | ||||||
Pro-forma RevPAR for the nine months ended September 30, 2018, declined 2.9%, compared to the nine months ended September 30, 2017, due to a decline in occupancy, partially offset by an increase in ADR. The primary driver of the occupancy decline was due to the same factors that impacted the revenue decline for these periods as described above. Pro-forma RevPAR for our hotels not under renovation (101 hotels) declined by 0.3% in the current period as compared to the prior year period, due to a decline in occupancy, partially offset by an increase in ADR. Pro-forma RevPAR for our hotels classified as not under renovation with completed renovations (40 hotels) increased by 3.2% in the current period as compared to the prior year period, due to increases in occupancy and ADR.
Other non-room operating revenues for the portfolio include food and beverage, and other ancillary revenues such as conference center, market, parking, telephone and cancellation fees. Total non-room operating revenues, including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the nine months ended September 30, 2018, and the nine months ended September 30, 2017, increased 2.3% driven by an increase in other revenue, partially offset by a decrease in food and beverage revenue.
Total hotel operating expenses (which exclude acquisition and transaction costs, general and administrative, depreciation and amortization and impairment of long-lived assets), including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the nine months ended September 30, 2018, and the nine months ended September 30, 2017, decreased approximately 1.2% over the prior year period primarily due to the reduction in base property management fees and elimination of asset management fees effective as of the Initial Closing and due to lower rooms expense and other property-level operating expenses associated with the decrease in revenues.
Acquisition and transaction related costs decreased approximately $0.5 million for the nine months ended September 30, 2018, compared to the prior year period. Acquisition and transaction related costs in the prior year ended September 30, 2017 were due to costs associated with the April Acquisition of seven hotels from Summit.
General and administrative expenses increased approximately $0.6 million for the nine months ended September 30, 2018, compared to the prior year period, primarily due to higher professional fees and the commencement of payment of employee salaries and benefits following our transition to a self-managed company. Our general and administrative expenses for the nine months ended September 30, 2018 included out-of-pocket legal fees and expenses incurred related to the litigation described at Note 12 of the consolidated financial statements included in this Form 10-Q, and we expect these legal fees and expenses to continue in future periods.
Depreciation and amortization increased approximately $4.6 million for the nine months ended September 30, 2018, compared to the prior year period, due to completed PIPs and the April Acquisition of seven hotels from Summit, partially offset by the sale of three hotels during the fourth quarter of 2017 and one hotel during the first quarter of 2018.
Impairment of goodwill and long-lived assets decreased approximately $5.6 million for the nine months ended September 30, 2018, compared to the prior year period. For the nine months ended September 30, 2018, a $17.3 million impairment was recorded related to the long-lived assets of four hotels. See Note 16 - Impairments to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q for further details. For the nine months ended September 30, 2017, a $16.1 million impairment was recorded related to goodwill, and a $6.8 million impairment was recorded related to long-lived assets. See Note 2 - Significant Accounting Policies and Note 16 -Impairments to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q for further details.
Interest expense increased approximately $4.4 million for the nine months ended September 30, 2018, compared to the prior year period, primarily driven by increased mortgage debt, an increase in interest rates and higher amortization of deferred financing costs on the new loans from the April 2017 refinancing transactions. Average mortgage debt was $1,513.0 million for the nine months ended September 30, 2018, compared to $1,466.0 million for the nine months ended September 30, 2017. The average interest rate on our mortgage debt was 4.8% for the nine months ended September 30, 2018, compared to 4.3% for the nine months ended September 30, 2017.
Hotel EBITDA
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This section includes disclosures with respect to hotel earnings before interest, taxes and depreciation and amortization ("Hotel EBITDA"), which is a non-GAAP financial measure. A description of Hotel EBITDA and a reconciliation to the most directly comparable GAAP measure, which is net income (loss) attributable to common stockholders, is provided below.
Hotel EBITDA is used by management as a performance measure and we believe it is useful to investors as a supplemental measure in evaluating our financial performance because it is a measure of hotel profitability that excludes expenses that we believe may not be indicative of the operating performance of our hotels. We believe that using Hotel EBITDA, which excludes the effect of expenses not related to operating hotels and non-cash charges, all of which are based on historical cost and may be of limited significance in evaluating current performance, facilitates comparison of hotel operating profitability between periods. For example, interest expense and general and administrative expenses are not linked to the operating performance of a hotel and Hotel EBITDA is not affected by whether the financing is at the hotel level or corporate level. In addition, depreciation and amortization, because of historical cost accounting and useful life estimates, may distort operating performance at the hotel level. We believe that investors should consider our Hotel EBITDA in conjunction with net income (loss) and other required GAAP measures of our performance to improve their understanding of our operating results.
Hotel EBITDA, or similar measures, are commonly used as performance measures by other public hotel REITs. However, not all public hotel REITs calculate Hotel EBITDA, or similar measures, the same way. Hotel EBITDA should be reviewed in conjunction with other GAAP measurements as an indication of our performance. Hotel EBITDA should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or in its applicability in evaluating our operating performance.
The following table reconciles our net loss attributable to common stockholders in accordance with GAAP to Hotel EBITDA for the three and nine months ended September 30, 2018, and for the three and nine months ended September 30, 2017:
For the Three Months Ended September 30, 2018 | For the Three Months Ended September 30, 2017 | For the Nine Months Ended September 30, 2018 | For the Nine Months Ended September 30, 2017 | |||||||||||||
Net loss attributable to common stockholders | $ | (16,893 | ) | $ | (14,058 | ) | $ | (70,131 | ) | $ | (61,992 | ) | ||||
Deemed dividend related to beneficial conversion feature of Class C Units | — | — | — | 4,535 | ||||||||||||
Dividends on Class C Units | 5,405 | 4,369 | 15,355 | 8,681 | ||||||||||||
Accretion of Class C Units | 663 | 556 | 1,890 | 1,097 | ||||||||||||
Net loss before dividends and accretion (in accordance with GAAP) | (10,825 | ) | (9,133 | ) | (52,886 | ) | (47,679 | ) | ||||||||
Less: Net income (loss) attributable to non-controlling interest | 44 | 154 | 63 | 237 | ||||||||||||
Net loss and comprehensive loss (in accordance with GAAP) | $ | (10,781 | ) | $ | (8,979 | ) | $ | (52,823 | ) | $ | (47,442 | ) | ||||
Depreciation and amortization | 28,446 | 26,464 | 83,070 | 78,519 | ||||||||||||
Impairment of goodwill and long-lived assets | — | 5,396 | 17,255 | 22,838 | ||||||||||||
Interest expense | 27,083 | 24,728 | 78,423 | 74,019 | ||||||||||||
Acquisition and transaction related costs | — | — | 27 | 498 | ||||||||||||
Other income (expense) | (134 | ) | (15 | ) | (247 | ) | (52 | ) | ||||||||
Equity in earnings of unconsolidated entities | (199 | ) | (231 | ) | (101 | ) | (381 | ) | ||||||||
General and administrative | 5,193 | 4,389 | 14,874 | 14,230 | ||||||||||||
Income tax benefit (liability) | (112 | ) | 1,105 | (1,022 | ) | 1,538 | ||||||||||
Hotel EBITDA | $ | 49,496 | $ | 52,857 | $ | 139,456 | $ | 143,767 | ||||||||
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Cash Flows
Net cash provided by operating activities was $71.1 million for the nine months ended September 30, 2018. Cash provided by operating activities was positively impacted primarily by increases in accounts payable and accrued expenses, offset by increases in prepaid expenses and other assets.
Net cash used in investing activities was $79.1 million for the nine months ended September 30, 2018, primarily attributable to capital investments in our properties, offset by the proceeds from the sale of a hotel.
Net cash flow used in financing activities was $0.8 million for the nine months ended September 30, 2018. Cash provided by the net proceeds from the sale of Class C Units was more than fully offset by the use of a portion of those net proceeds to partially redeem the Grace Preferred Equity Interests, cash distributions paid on Class C Units and repurchases of shares of common stock.
Election as a REIT
We elected and qualified to be taxed as a REIT commencing with our taxable year ended December 31, 2014. In order to continue to qualify as a REIT, we must annually distribute to our stockholders 90% of our REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain, and must comply with various other organizational and operational requirements. As of December 31, 2017, we had $152.1 million of net operating loss ("NOL") carry forward that may be used in the future to reduce the amount otherwise required to be distributed by us to meet REIT requirements. These NOLs will not begin to expire for over a decade.
As a REIT, we generally will not be subject to U.S. federal income tax on that portion of our taxable income or capital gain which is distributed to our stockholders. Each of our hotels is leased to a taxable REIT subsidiary which is owned by the OP. A taxable REIT subsidiary is subject to federal, state and local income taxes. If we fail to remain qualified as a REIT in any subsequent year after electing REIT status and do not qualify for certain statutory relief provisions, our income for that year will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially and adversely affect our net income and cash flow. However, we believe that we will continue to operate so as to remain qualified as a REIT.
Liquidity and Capital Resources
As of September 30, 2018, we had cash and cash equivalents on hand of $82.7 million. Under certain of our debt obligations, we are required to maintain minimum liquidity of $15.0 million to comply with financial covenants, and we expect to satisfy this covenant through liquidity we maintain at individual hotels as well as through other sources.
As of September 30, 2018, we had principal outstanding of $1.5 billion under our indebtedness plus an additional $219.7 million in liquidation value of Grace Preferred Equity Interests (which are treated as indebtedness for accounting purposes), most of which was incurred in acquiring the properties we currently own. On February 27, 2018, we used $10.6 million of proceeds from the Second Closing to reduce the liquidation value of the Grace Preferred Equity Interests to $223.5 million, and thereby satisfied our obligation to redeem 50.0% of the Grace Preferred Equity Interests originally issued by such date. During the nine months ended September 30, 2018, we also used $3.8 million of proceeds from the sale of one of our hotels to further reduce the liquidation value of the Grace Preferred Equity Interests to $219.7 million as of September 30, 2018. The Grace Preferred Equity Interests are required to be redeemed in full by February 27, 2019, and we intend to utilize proceeds from Subsequent Closings to redeem the Grace Preferred Equity Interests on or prior to such date. The Subsequent Closings are subject to conditions, and there can be no assurance they will be completed on their current terms, or at all.
Our major capital requirements include capital expenditures required pursuant to our PIPs and related reserve deposits, interest and principal payments under our indebtedness, distributions and mandatory redemptions payable with respect to the Grace Preferred Equity Interests and distributions payable with respect to Class C Units. Prior to the suspension of our IPO in November 2015, we depended, and expected to continue to depend, in substantial part on proceeds from our IPO to meet our major capital requirements. Our IPO terminated in accordance with its terms in January 2017.
Following the suspension of our IPO, we required funds in addition to operating cash flow and cash on hand to meet our capital requirements. Accordingly, we undertook and evaluated a variety of transactions to generate additional liquidity to address our capital requirements, including changing our distribution policy, extending certain of our obligations under PIPs, extending obligations to pay contingent consideration, marketing and selling assets and seeking debt or equity financing transactions. In January 2017, we entered into the SPA and the Framework Agreement, and the consummation of the transactions contemplated by these agreements in March 2017 has, and is expected to continue to, generate additional liquidity through the sale of Class C Units to the Brookfield Investor at the Initial Closing, the Second Closing and at other
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Subsequent Closings. We also expect to achieve cost savings realized as part of our transition to self-management, in accordance with the Framework Agreement, through reduced property management fees and the elimination of external asset management fees to the Former Advisor (offset by expenses previously borne by the Former Advisor that are now incurred directly by us as a self-managed company).
Pursuant to the SPA, at the Initial Closing, we used a portion of the net proceeds to redeem $47.3 million in outstanding Grace Preferred Equity Interests and to pay in full the $23.7 million outstanding under a loan payable to Summit in connection with a February 2016 acquisition of six hotels from Summit and a new purchase price deposit on the April Acquisition. Pursuant to the SPA, subsequent to the Initial Closing, we used $26.9 million of the net proceeds to pay a portion of the purchase price for the April Acquisition and $15.0 million to fund PIPs and related lender reserves. Pursuant to the SPA, the gross proceeds from the sale of the Class C Units at the Second Closing were used as follows: (i) $10.6 million to redeem outstanding Grace Preferred Equity Interests; and (ii) $14.4 million to fund brand-mandated PIPs and related lender reserves.
The Brookfield Investor has agreed to purchase additional Class C Units at Subsequent Closings in an aggregate amount not to exceed $240.0 million. Generally, the proceeds from the sale of Class C Units at Subsequent Closings may be used to redeem the Grace Preferred Equity Interests at or around the time they are required to be redeemed, with the balance available to fund PIPs and related lender reserves, repay amounts then outstanding with respect to mortgage debt principal and interest and working capital. As of September 30, 2018, $219.7 million in liquidation value of Grace Preferred Equity Interests was outstanding, and, accordingly, $20.3 million in Class C Units was available to be issued at Subsequent Closings to meet any other capital requirements. The Subsequent Closings are subject to conditions, and there can be no assurance they will be completed on their current terms, or at all.
We engage in a continued process of renovating and improving our hotels. Since acquisition we have reinvested more than $295.8 million in our hotels through PIPs and other capital improvements. This includes the approximately $350 million PIP program we are currently undertaking across a significant portion of the portfolio. We expect to complete our PIP program over the next two to three years. As of September 30, 2018, we have substantially completed work on 78 of the 141 hotels that are part of our PIP program. During the third quarter of 2018 we began PIP work on five hotels, and, during the fourth quarter of 2018, we anticipate beginning PIP work on an additional 16 hotels, of which the first five hotels are expected to have work substantially completed in the fourth quarter of 2018 and the other 16 hotels are expected to have work substantially completed by the second quarter of 2019. We expect to spend approximately $110 million as part of our PIP program and other capital improvements during 2018, $85.2 million of which has been spent as of September 30, 2018. We periodically deposit reserves with our mortgage lenders that we utilize to fund a portion of the PIP work and other capital improvements. As of September 30, 2018, we had $11.1 million of PIP and other capital improvements reserves. We are scheduled to fund an additional $6.3 million in PIP reserves with our mortgage lenders during the remainder of 2018, and $26.6 million during the period from 2019 through 2021.
Our PIP program represents capital expenditures required by the franchisors as a condition to the acquisition of the hotel and the entry into a long-term franchise agreement. Our PIP program does not include, and we will also be required by the franchisors to perform, periodic capital expenditures to bring the physical condition of the hotel into compliance with the specifications and standards each hotel franchisor or hotel brand has developed, such as cyclical renovations with respect to soft goods (such as carpeting, bedspreads, artwork and upholstery) and case goods (such as furniture and fixtures such as armoires, chairs, beds, desks, tables, mirrors and lighting fixtures).
To date, we have funded our PIP program primarily from proceeds from our IPO, which was suspended at the end of 2015 and terminated in accordance with its terms in January 2017, operating cash flows, and proceeds from borrowings and the sale of Class C Units to the Brookfield Investor. We expect to fund our ongoing PIP program and other capital improvements primarily from operating cash flows and cash on hand.
We have financed substantially all of our hotels with mortgage debt and, in some cases, mezzanine debt. The maturity date and certain other terms of our mortgage and mezzanine debt obligations are summarized at Note 5 of the consolidated financial statements included in this Form 10-Q. We intend to manage the maturity of these debt obligations by extending or refinancing the related debt at or prior to maturity. Depending upon market conditions, we may seek to generate additional liquidity from financing and refinancing of hotels in our portfolio, and this liquidity, to the extent available, may be utilized for various corporate purposes such as to repay other indebtedness, fund the PIP program or, subject to the Brookfield Approval Rights, for new hotel acquisitions.
In April 2017, we refinanced $895.4 million principal amount then outstanding under the mortgage and mezzanine indebtedness encumbering 95 hotels in the Grace Portfolio with new mortgage and mezzanine loans encumbering 87 of those properties (the “87-Pack Loans”). The 87-Pack Loans have an aggregate principal amount of $915.0 million and mature in
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May 2019, subject to three one-year extension rights at our option. Also in April 2017, we refinanced $235.5 million principal amount then outstanding under a term loan agreement secured by 20 of our hotels that was scheduled to mature in August 2018, with a new term loan secured by those hotels as well as the seven hotels acquired in the April Acquisition and one unencumbered hotel from our existing portfolio. The term loan has an aggregate principal amount of $310.0 million and matures in May 2019, subject to three one-year extension rights at our option.
As of September 30, 2018, our loan-to-value ratio was 68.0% including the Grace Preferred Equity Interests, and our loan-to-value ratio excluding the Grace Preferred Equity Interests, was 59.3%. These leverage percentages are calculated based on consolidated balance sheet values.
We believe we will be successful in extending or refinancing our mortgage and mezzanine debt, but we cannot provide any assurance in this regard. Our ability to refinance debt will be affected by various factors existing at the relevant time, such as capital and credit market conditions, the state of the national and regional economies, local real estate conditions, the equity in and value of the related collateral and our financial condition. Any refinancing may also require prior approval under the Brookfield Approval Rights if it is not as specifically set forth in the annual business plan (including the annual operating and capital budget) required under the terms of the Redeemable Preferred Share (the "Annual Business Plan") or in a principal amount not greater than the amount to be refinanced and on terms no less favorable to us. If we are not able to extend these debt obligations or refinance them when they mature, we will be required to seek alternative financing to continue our operations. No assurance can be given that any extension, refinancing or alternative financing will be available when required or that we will be able to negotiate acceptable terms. Moreover, if interest rates are higher when these loans are refinanced or replaced with alternative financing, our cash flow would be reduced.
Whether or not we generate additional liquidity from any refinancing activity, we believe our current sources of additional liquidity will allow us to meet our existing capital requirements, although there can be no assurance the amounts actually generated will be sufficient for these purposes. The Subsequent Closings are subject to conditions, and may not be completed on their current terms, or at all, the cost savings from our transition to self-management may not be realized to the extent we are anticipating, or at all, and our operating cash flows depend on the operating results of our hotels, which may fluctuate. Accordingly, we may require additional liquidity to meet our capital requirements, which may not be available on favorable terms or at all. Any additional debt or equity financing consisting of common stock, preferred stock or warrants, or any combination thereof to meet our capital requirements may also only be obtained subject to the Brookfield Approval Rights, and there can be no assurance this prior approval will be provided when requested, or at all. If obtained, any additional or alternative debt or equity financing could be on terms that would not be favorable to us or our stockholders, including high interest rates, in the case of debt financing, and substantial dilution, in the case of equity issuances or convertible securities. Moreover, because we are required to use 35% of the proceeds from the issuance of interests in us or any of our subsidiaries, to redeem the Grace Preferred Equity Interests at par, up to a maximum of $350 million in redemptions for any 12-month period, it may be more difficult to obtain equity financing from an alternative source in an amount required to meet our capital requirements.
On May 14, 2018, we commenced a self-tender offer (the “Company Offer”) for up to 1,000,000 shares of common stock at a price of $7.05 per share. The Company Offer was made in response to an unsolicited offer to stockholders commenced on May 7, 2018 by a third party. The Company Offer expired at 5:00 p.m., New York City time, on June 29, 2018. On June 29, 2018, a total of 170,260 shares were tendered in the Company Offer and purchased and subsequently retired by the Company, for an aggregate purchase price of $1.2 million, which we funded with cash on hand. On August 2, 2018, we were advised that, due to an error by the Depositary for the Company Offer, a total of 912 shares were improperly accepted in the Company Offer. Upon correction of this error, the total shares purchased and retired by us was 169,348 shares.
On September 24, 2018, we announced that our board of directors had adopted a new share repurchase program (the "SRP"), effective as of October 1, 2018. Pursuant to the SRP, any stockholder of our common stock may request that we repurchase all or a portion of their shares of common stock at a price established by the board of directors (the “Repurchase Price”). The Repurchase Price is initially $9.00 per share and may be changed by the board of directors from time to time in its sole discretion. Repurchases will be made quarterly at the Repurchase Price effective on the last day of the quarter. Repurchases under the SRP will be limited to a maximum number of shares of common stock for any quarter equal to the lower of 1,000,000 shares of common stock or 5% of the number of shares of common stock outstanding as of the last day of the previous quarter. The board of directors may modify, suspend, reactivate or terminate the SRP at any time and has the power, in its sole discretion, to repurchase fewer shares than have been requested in any particular quarter, or none at all. We intend to fund repurchases under the SRP from operating cash flows and cash on hand.
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Distributions
Our distribution policy is subject to revision at the discretion of our board of directors, and may be changed at any time. There can be no assurance that we will resume paying distributions in shares of common stock or in cash at any time in the future. Our ability to make future cash distributions will depend on our future cash flows and may be dependent on our ability to obtain additional liquidity, which may not be available on favorable terms, or at all.
Currently, under the Brookfield Approval Rights, prior approval is required before we can declare or pay any distributions or dividends to our common stockholders, except for cash distributions equal to or less than $0.525 per annum per share.
For the period from May 2014 until May 2016 when we commenced paying distributions in common
stock, we paid cash distributions, all of which were funded with proceeds from our IPO and proceeds realized from the sale of common stock issued pursuant to our DRIP.
Our IPO was suspended on November 15, 2015 and terminated on January 7, 2017, the third anniversary of the commencement of our IPO, in accordance with its terms.
In March 2016, our board of directors changed the distribution policy, such that distributions paid with respect to April 2016, were paid in shares of common stock instead of cash to all stockholders, and not at the election of each stockholder. Accordingly, we paid a cash distribution to stockholders of record each day during the three months ended March 31, 2016, but any distributions for subsequent periods were paid in shares of common stock.
On January 13, 2017, our board of directors suspended paying distributions to stockholders entirely and suspended our DRIP.
Following the Initial Closing, commencing on June 30, 2017, holders of Class C Units are entitled to receive, with respect to each Class C Unit, fixed, quarterly cumulative cash distributions at a rate of 7.50% per annum from legally available funds. If we fail to pay these cash distributions when due, the per annum rate will increase to 10% until all accrued and unpaid distributions required to be paid in cash are reduced to zero.
Also commencing on June 30, 2017, holders of Class C Units are also entitled to receive, with respect to each Class C Unit, a fixed, quarterly, cumulative distribution payable in Class C Units at a rate of 5% per annum ("PIK Distributions"). If we fail to redeem the Brookfield Investor when required to do so pursuant to the limited partnership agreement of the OP, the 5% per annum PIK Distribution rate will increase to a per annum rate of 7.50%, and would further increase by 1.25% per annum for the next four quarterly periods thereafter, up to a maximum per annum rate of 12.5%.
The number of Class C Units delivered in respect of the PIK Distributions on any distribution payment date is equal to the number obtained by dividing the amount of PIK Distribution by $14.75.
Following the Initial Closing, the holders of Class C Units are also entitled to tax distributions under the certain limited circumstances described in the limited partnership agreement of the OP.
For the three and nine months ended September 30, 2018, we paid cash distributions of $3.2 million and $9.2 million, respectively, on the Class C Units, and PIK Distributions of 146,594.53 and 416,402.88, respectively, to the Brookfield Investor, as the sole holder of the Class C Units.
Contractual Obligations
We have the following contractual obligations as of September 30, 2018:
Debt Obligations:
The following is a summary of principal and interest due under our mortgage debt obligations over the next five years and thereafter as of September 30, 2018 (in thousands):
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Total | 2018 | 2019-2021 | 2022 | Thereafter | ||||||||||||||||
Principal payments due on mortgage notes payable | $ | 1,513,000 | $ | — | $ | 288,000 | $ | 1,225,000 | $ | — | ||||||||||
Interest payments due on mortgage notes payable | 261,089 | 19,493 | 215,097 | 26,499 | — | |||||||||||||||
Total | $ | 1,774,089 | $ | 19,493 | $ | 503,097 | $ | 1,251,499 | $ | — | ||||||||||
Mortgage notes payable due dates assume exercise of all borrower extension options. Estimated interest payments on our variable rate debt are based on interest rates as of September 30, 2018.
The following is a summary of the distribution and redemption obligations under the Grace Preferred Equity Interests, our mandatorily redeemable preferred securities, over the next five years and thereafter as of September 30, 2018 (in thousands):
Total | 2018 | 2019-2021 | 2022 | Thereafter | ||||||||||||||||
Mandatory redemptions due on mandatorily redeemable preferred securities | $ | 219,746 | $ | — | $ | 219,746 | $ | — | $ | — | ||||||||||
Monthly distributions due on mandatorily redeemable preferred securities | 8,567 | 4,383 | 4,184 | — | — | |||||||||||||||
Total | $ | 228,313 | $ | 4,383 | $ | 223,930 | $ | — | $ | — | ||||||||||
Class C Unit Obligations:
The following table reflects the cash distributions obligations on the Class C Units over the next five years and thereafter as of September 30, 2018 (in thousands):
Total | 2018 | 2019-2021 | 2022 | Thereafter | ||||||||||||||||
Distributions on Class C Units | $ | 49,547 | $ | 3,285 | $ | 42,518 | $ | 3,744 | $ | — | ||||||||||
The foregoing summary does not include the impact of Class C Units that may be issued at Subsequent Closings or their associated PIK Distributions.
Lease Obligations:
The following table reflects the minimum base rental cash payments under our ground and hotel lease obligations over the next five years and thereafter as of September 30, 2018 (in thousands):
Total | 2018 | 2019-2021 | 2022 | Thereafter | ||||||||||||||||
Lease payments due | $ | 98,754 | $ | 1,248 | $ | 15,763 | $ | 5,292 | $ | 76,451 | ||||||||||
Property Improvement Plan Reserve Deposits:
The following table reflects estimated PIP reserve deposits that are required under our mortgage debt obligations over the next five years and thereafter as of September 30, 2018 (in thousands):
Total | 2018 | 2019-2021 | 2022 | Thereafter | ||||||||||||||||
PIP reserve deposits due | $ | 32,895 | $ | 6,324 | $ | 26,571 | $ | — | $ | — | ||||||||||
Related Party Transactions and Agreements
See Note 13 - Related Party Transactions and Arrangements to our consolidated financial statements included in this report.
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Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our long-term debt, which consists of secured financings, bears interest at fixed and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes in earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as cap agreements, swaps, collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We would not hold or issue these derivative contracts for trading or speculative purposes.
As of September 30, 2018, we had not fixed the interest rate for $1.2 billion of our secured variable-rate debt. As a result, we are subject to the potential impact of rising interest rates, which could negatively impact our profitability and cash flows. In order to mitigate our exposures to changes in interest rates, we have entered into interest rate cap agreements with respect to all $1.2 billion of our variable-rate debt. The estimated impact on our annual results of operations, of an increase or decrease of 100 basis points in interest rates, would be to increase or decrease annual interest expense by approximately $12.4 million. The estimated impact assumes no changes in our capital structure. As the information presented above includes only those exposures that exist as of September 30, 2018, it does not consider those exposures or positions that could arise after that date. The information represented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.
Item 4. Controls and Procedures.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q and determined that the disclosure controls and procedures are effective.
No change occurred in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the three months ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
We are not a party to any material pending legal or regulatory proceedings, other than as set forth below.
In February 2018, one of our stockholders, Tom Milliken, filed a derivative complaint (the “Complaint”) on behalf of us and against us, as well as the Former Advisor, the Former Property Manager, various affiliates of those entities (together, the “Former Advisor Defendants”), and certain of our current and former directors and officers of the Company (the “Director Defendants”). The Complaint was filed in the District Court for the Southern District of New York on February 26, 2018. The Complaint alleges, among other things, that the Former Advisor and the Director Defendants breached their fiduciary duties to us and our stockholders by putting their own interests above our interests, which breach was aided and abetted by certain of the Former Advisor Defendants. The Complaint also asserts claims of breach of contract against the Director Defendants, corporate waste against the Former Advisor and certain of the Director Defendants, and unjust enrichment against certain of the Director Defendants and Former Advisor Defendants. We had been investigating the above claims and others made by the stockholder since receipt of a shareholder demand letter from Mr. Milliken's attorneys in July 2017 and a supplemental demand letter in December 2017. In March 2018, we received a new demand letter from a different stockholder making substantially similar claims to those contemplated by the Complaint. The claims made in the Complaint and the new demand letter do not seek recovery of losses from or damages against us, but instead allege that we have sustained damages as a result of actions by the Former Advisor Defendants and the Director Defendants, and therefore no accrual of any potential liability was necessary as of September 30, 2018, other than for incurred out-of-pocket legal fees and expenses. We have consulted with our outside legal counsel and established a special litigation committee comprised solely of independent directors, which is investigating the claims made by both stockholders and evaluating the next steps that will be taken. In May 2018, we filed a motion to stay the Complaint pending the outcome of the investigation, and, in August 2018, the District Court granted our motion.
Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed in our 2017 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On July 2, 2018, 7,210 restricted shares of common stock were awarded under our amended and restated employee and director incentive restricted share plan to a wholly owned subsidiary of the Brookfield Investor in respect of the service on our board of directors by the two directors elected to our board of directors by the Brookfield Investor pursuant to its rights as the holder of the Redeemable Preferred Share. This transaction was exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as amended.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
None.
Item 5. Other Information.
None.
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Item 6. Exhibits.
EXHIBIT INDEX
The following exhibits are included in this Quarterly Report on Form 10-Q for the three months ended September 30, 2018 (and are numbered in accordance with Item 601 of Regulation S-K).
Exhibit No. | Description | |
10.1* | ||
10.2* | ||
31.1* | ||
31.2* | ||
32* | ||
101* | XBRL (eXtensible Business Reporting Language). The following materials from Hospitality Investors Trust, Inc. Quarterly Report on Form 10-Q for the nine months ended September 30, 2018, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations and Comprehensive Loss, (iii) the Consolidated Statements of Changes in Stockholders' Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements. | |
* Filed herewith
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HOSPITALITY INVESTORS TRUST, INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
HOSPITALITY INVESTORS TRUST, INC. | |
Dated: November 8, 2018 | By: /s/ Jonathan P. Mehlman Name: Jonathan P. Mehlman Title: Chief Executive Officer and President (Principal Executive Officer) |
Dated: November 8, 2018 | By: /s/ Edward T. Hoganson Name: Edward T. Hoganson Title: Chief Financial Officer and Treasurer (Principal Financial Officer and Principal Accounting Officer) |
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