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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2015

OR

 

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

For the transition period from                      to                     

Commission File Number 333-186090

BRE SELECT HOTELS CORP

(Exact name of registrant as specified in its charter)

 

Delaware   35-2464254

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

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

345 Park Avenue

New York, New York

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

(212) 583-5000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

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

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

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

 

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

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

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

 

Common Stock, $0.01 par value per share

 

100

(Class)   Outstanding at August 13, 2015

 

 

 


Table of Contents

BRE SELECT HOTELS CORP

FORM 10-Q

INDEX

 

         Page  
PART I. FINANCIAL INFORMATION   

Item 1.

 

Financial Statements:

  
 

Condensed Consolidated Balance Sheets – June 30, 2015 (Unaudited) and December 31, 2014

     3   
 

Condensed Consolidated Statements of Operations (Unaudited) – Three and Six Months Ended June 30, 2015 and 2014

     4   
 

Condensed Consolidated Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2015 and 2014

     5   
 

Notes to Condensed Consolidated Financial Statements (Unaudited)

     6   

Item 2.

 

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

     16   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     22   

Item 4.

 

Controls and Procedures

     23   

PART II. OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

     24   

Item 1A.

 

Risk Factors

     24   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     24   

Item 3.

 

Defaults Upon Senior Securities

     24   

Item 4.

 

Mine Safety Disclosures

     24   

Item 5.

 

Other Information

     24   

Item 6.

 

Exhibits

     25   

Signatures

     26   

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


Table of Contents

BRE SELECT HOTELS CORP

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

     June 30,
2015
     December 31,
2014
 
     (Unaudited)         

ASSETS

     

Investment in real estate, net of accumulated depreciation of $58,251 and $43,771, respectively

   $ 986,438       $ 974,833   

Cash and cash equivalents

     34,091         22,776   

Restricted cash

     10,294         40,719   

Due from third party managers, net

     7,940         4,764   

Prepaid expenses

     2,498         2,166   

Deferred financing costs, net

     7,310         9,817   

Goodwill

     126,377         126,377   

Other assets

     2,053         912   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 1,177,001       $ 1,182,364   
  

 

 

    

 

 

 

LIABILITIES

     

Accounts payable and accrued expenses

   $ 9,717       $ 18,969   

Due to third party managers, net

     503         1,580   

Mortgages payable

     847,244         847,453   
  

 

 

    

 

 

 

TOTAL LIABILITIES

     857,464         868,002   

Commitments and contingencies (Note 6)

     

7% Series A Cumulative Redeemable Preferred Stock, $1.90 initial liquidation preference, 120,000,000 shares authorized; 72,382,848 issued and outstanding at June 30, 2015 and December 31, 2014

     137,160         137,160   

SHAREHOLDER’S EQUITY

     

Preferred stock, $0.0001 par value, 30,000,000 shares authorized; none issued and outstanding at June 30, 2015 and December 31, 2014

     0         0   

Common stock, $0.01 par value, 100,000 shares authorized; 100 shares issued and outstanding at June 30, 2015 and December 31, 2014

     0         0   

Additional paid-in capital

     172,381         177,202   

Retained earnings

     9,996         0   
  

 

 

    

 

 

 

TOTAL SHAREHOLDER’S EQUITY

     182,377         177,202   
  

 

 

    

 

 

 

TOTAL LIABILITIES AND SHAREHOLDER’S EQUITY

   $ 1,177,001       $ 1,182,364   
  

 

 

    

 

 

 

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

 

3


Table of Contents

BRE SELECT HOTELS CORP

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(in thousands, except share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2015     2014     2015     2014  

REVENUE

        

Room revenue

   $ 71,478      $ 68,504      $ 130,787      $ 125,646   

Other revenue

     4,667        4,829        8,836        9,174   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     76,145        73,333        139,623        134,820   

EXPENSES

        

Operating expense

     17,758        17,007        33,571        32,406   

Hotel administrative expense

     5,971        5,714        11,291        10,984   

Sales and marketing

     5,735        5,467        10,831        10,201   

Utilities

     2,268        2,282        4,655        4,714   

Repair and maintenance

     2,809        2,712        5,467        5,372   

Franchise fees

     3,548        3,408        6,478        6,254   

Management fees

     2,638        2,901        4,764        5,039   

Taxes, insurance and other

     3,742        3,541        7,447        6,891   

General and administrative

     1,400        827        2,165        1,765   

Depreciation expense

     8,424        6,662        15,709        13,234   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     54,293        50,521        102,378        96,860   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss on disposals of investment in real estate

     (2,876     0        (2,876     0   

Operating income

     18,976        22,812        34,369        37,960   

Interest expense, net

     (7,620     (9,713     (15,118     (19,030

Loss on derivatives

     (14     (223     (53     (419
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income tax benefit

     11,342        12,876        19,198        18,511   

Income tax expense

     (1,925     (1,749     (202     (814
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     9,417        11,127        18,996        17,697   

Income from discontinued operations, net of tax (Note 11)

     0        2        0        69   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     9,417        11,129        18,996        17,766   

Series A Preferred Stock dividends declared

     (2,411     (3,231     (4,821     (3,231
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income available for common stockholders

   $ 7,006      $ 7,898      $ 14,175      $ 14,535   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net income per common share

        

From continuing operations, after Series A Preferred Stock dividends

   $ 70,060.00      $ 78,960.00      $ 141,750.00      $ 144,660.00   

From discontinued operations

     0.00        20.00        0.00        690.00   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 70,060.00      $ 78,980.00      $ 141,750.00      $ 145,350.00   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends declared per common share

   $ 90,000.00      $ 90,000.00      $ 90,000.00      $ 140,000.00   

Weighted average common shares outstanding – basic and diluted

     100        100        100        100   

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

 

4


Table of Contents

BRE SELECT HOTELS CORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)

 

     Six Months Ended
June 30,
 
     2015     2014  

Cash flows from operating activities:

    

Net income

   $ 18,996      $ 17,766   

Adjustments to reconcile net income to cash provided by operating activities:

    

Depreciation

     15,709        13,234   

Loss on disposals of investment in real estate

     2,876        0   

Gain on sale of assets

     0        (81

Fair value adjustment of interest rate cap

     53        419   

Amortization of deferred financing costs

     2,507        2,746   

Other non-cash expenses, net

     (15     (15

Changes in operating assets and liabilities:

    

Decrease (increase) in cash restricted for operating expenses

     4,527        (256

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

     (4,253     1,133   

(Increase) decrease in prepaid expenses and other assets

     (1,720     1,554   

Decrease in accounts payable and accrued expenses

     (838     (1,876
  

 

 

   

 

 

 

Net cash provided by operating activities

     37,842        34,624   

Cash flows from investing activities:

    

Capital improvements

     (38,589     (15,362

Proceeds from sale of assets, net

     0        8,102   

Property insurance proceeds

     194        353   

Decrease in cash restricted for property improvements

     25,898        2,567   
  

 

 

   

 

 

 

Net cash used in investing activities

     (12,497     (4,340

Cash flows from financing activities:

    

Payments of mortgage debt

     (209     (6,752

Payments of mezzanine debt

     0        (1,911

Dividends paid to Series A Preferred shareholders

     (4,821     (6,462

Dividends paid to common shareholders

     (9,000     (14,000
  

 

 

   

 

 

 

Net cash used in financing activities

     (14,030     (29,125

Net increase in cash and cash equivalents

     11,315        1,159   

Cash and cash equivalents, beginning of period

     22,776        23,902   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 34,091      $ 25,061   
  

 

 

   

 

 

 

Supplemental Cash Flow Information, including Non-Cash Activities:

    

Interest paid

   $ 12,909      $ 16,709   

Taxes paid

   $ 1,531      $ 919   

Accrued capital improvements

   $ 2,885      $ 783   

Accrued 7% Series A Preferred Stock dividends

   $ 2,411      $ 3,231   

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

 

 

5


Table of Contents

BRE SELECT HOTELS CORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization

BRE Select Hotels Corp, together with its wholly-owned subsidiaries (the “Company”), is a Delaware corporation that made an election, through the filing of Form 1120-REIT for 2012, to qualify as a real estate investment trust, or REIT, for federal income tax purposes. The Company was formed on November 28, 2012 to invest in income-producing real estate in the United States through the acquisition of Apple REIT Six, Inc. (“Apple Six”) on behalf of BRE Select Hotels Holdings LP (“BRE Holdings”), a Delaware limited partnership and an affiliate of the Company. 100% of the common stock of the Company is owned by BRE Holdings, which is an affiliate of Blackstone Real Estate Partners VII L.P. (the “Sponsor”). The acquisition of Apple Six (the “Merger”) was completed on May 14, 2013 (the “Acquisition Date”). As of June 30, 2015, the Company owned 62 hotels located in 18 states with an aggregate of 7,346 rooms.

2. Summary of Significant Accounting Policies

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

Basis of Presentation - The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with standards for the preparation of interim financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation have been included in these condensed consolidated financial statements. Operating results for the interim periods noted herein are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2015. These unaudited financial statements should be read in conjunction with the audited financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

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

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

Restricted Cash - Restricted cash consists of deposits held in escrow for the payment of certain required repairs, capital improvements and property taxes pursuant to the terms of the Company’s mortgages payable, as well as a repairs and improvements reserve required by the Marriott International, Inc. or its affiliates (“Marriott”) management agreements. The Company’s policy is to present changes in restricted cash attributable to property taxes, insurance and ground rent as a component of operating cash flows and changes in restricted cash attributable to repairs and capital improvements as a component of investing cash flows in the consolidated statements of cash flows.

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

Due to Third Party Managers, net - Due to third party managers, net, represents management fees due in excess of the net working capital advanced to and held by the hotel management companies for operation of the hotels.

Investment in Real Estate and Related Depreciation - Real estate is stated at cost, net of accumulated depreciation. Repair and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements that extend the useful life of the real estate asset are capitalized and depreciated over the estimated useful life of the real estate asset. The Company recorded a non-cash loss on disposals of investments in real estate of $2.9 million during the three months ended June 30, 2015, due to early disposal of furniture, fixtures, and equipment in connection with the Company’s capital improvement and renovation plans. Depreciation is computed using the straight-line method over the average estimated useful lives of the assets, which are 39 years for buildings, 10 years for land and building improvements and three to seven years for furniture and equipment.

 

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Impairment of Investment in Real Estate - The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include: (1) a property with current or potential losses from operations, (2) when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or (3) when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares a quarterly recoverability analysis to assist with its evaluation of impairment indicators. The analysis compares each property’s current year actual and forecasted occupancy and revenue per available room (“RevPAR”) compared to the prior year. No triggering events have occurred to indicate the asset carrying values will not be recoverable as of June 30, 2015. If events or circumstances change, such as the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and in such instances an impairment loss would be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.

Goodwill - Goodwill represents the excess of purchase price over fair value of assets acquired and liabilities assumed in business combinations, and is characterized by the intangible assets that do not qualify for separate recognition. In accordance with accounting guidance related to goodwill and other intangible assets, goodwill is not amortized, but instead reviewed for impairment at least annually. The Company performs its annual testing for impairment of goodwill during the fourth quarter of each year and in certain situations between those annual dates if indicators of impairment are present. The impairment analysis for goodwill is performed at the reporting unit level using a two-step approach. The first step is a comparison of the fair value of the reporting unit, determined using an income approach and validated by a market approach, to its carrying amount. If the carrying amount exceeds the fair value, the second step quantifies any impairment write-down by comparing the current implied value of goodwill to the recorded goodwill balance. There was no impairment of goodwill for any of the periods presented. Goodwill recognized is deductible for tax purposes.

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

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

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

Valuation of Deferred Tax Assets - A valuation allowance for deferred tax assets is provided when it is “more likely than not” that some portion or all of the deferred tax assets will not be realized. Realization is dependent upon the generation of future taxable income or the reversal of deferred tax liabilities during the periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in performing this assessment. The Company had a valuation allowance of $0.9 million as of June 30, 2015 for a TRS where it is not considered more likely than not that the deferred tax assets will be realized.

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

Segment Information - The Company derives revenues and cash flows from its hotel portfolio. Hotel portfolio financial information is analyzed for purposes of assessing performance and allocating resources. Therefore, the Company has one operating segment consisting of its hotel portfolio.

 

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New Accounting Pronouncements - In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Under the update, discontinued operations are defined as either (1) a component of an entity (or group of components) that (i) has been disposed of or meets the criteria to be classified as held-for-sale and (ii) represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, or (2) is a business or nonprofit activity that on acquisition, meets the criteria to be classified as held-for-sale. The accounting update is effective on a prospective basis for disposals or assets meeting the definition as held-for-sale for accounting periods beginning on or after December 15, 2014. The Company adopted ASU No. 2014-08 on January 1, 2015.

We expect that future disposals of operating real estate assets will not qualify for discontinued operations reporting treatment, unless the disposals represent a strategic shift that will have a major effect on the Company’s operations and financial results. There were no hotels sold or held for sale during the three and six months ended June 30, 2015.

The discontinued operations presented for the interim periods ended June 30, 2014 represent individual sales of hotels which occurred prior to the Company’s adoption of ASU No. 2014-08 (see Note 11) and represented discontinued operations under the previous accounting guidance.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The update outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The accounting update was initially scheduled to become effective for accounting periods beginning after December 15, 2016. In July 2015, the FASB extended the required implementation date one year to periods beginning after December 15, 2017, permitting entities to early adopt the standard as of the original effective date in ASU 2014-09. The Company is currently assessing the impact this new guidance may have on the Company’s operations and financial results.

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

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30). ASU 2015-03 changes the presentation of debt issuance costs in the financial statements to present such costs as a direct deduction from the related debt liability rather than as an asset. Amortization of debt issuance costs will be reported as interest expense. This standard is effective for annual reporting periods beginning after December 15, 2015. ASU 2015-03 will not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.

3. Investment in Real Estate, net

Investment in real estate, net as of June 30, 2015 and December 31, 2014 consisted of the following (in thousands):

 

     June 30,
2015
     December 31,
2014
 

Land and Improvements

   $ 154,617       $ 154,353   

Building and Improvements

     823,393         805,183   

Furniture, Fixtures and Equipment

     42,946         34,947   

Construction in Progress

     23,733         24,121   
  

 

 

    

 

 

 
     1,044,689         1,018,604   

Less: Accumulated Depreciation

     (58,251      (43,771
  

 

 

    

 

 

 

Investment in Real Estate, net

   $ 986,438       $ 974,833   
  

 

 

    

 

 

 

 

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4. Mortgages Payable

On December 3, 2014, certain indirect wholly-owned subsidiaries (the “Borrowers”) of the Company entered into a loan agreement (the “Loan Agreement”) with commercial lenders (collectively, the “Lenders”), pursuant to which the Borrowers obtained an $830 million mortgage loan from the Lenders (the “Loan”). The Loan is secured by first-priority, cross-collateralized mortgage liens on 61 of the 62 properties owned or ground-leased by certain subsidiaries of the Company, all related personal property, reserves, a pledge of all income received by the Borrowers with respect to the properties, a pledge of the ownership interests in the operating lessee and a security interest in a cash management account.

A portion of the proceeds from the Loan were used to repay the mortgage and mezzanine loans obtained on May 14, 2013 by the Borrowers, as well as certain indirect wholly-owned subsidiaries of the Company that own direct and indirect interests in the Borrowers (the “Mezzanine Borrowers”), in the aggregate original principal amount of $775 million and with an aggregate outstanding principal amount of $763.9 million as of the date of repayment. Accordingly, on December 3, 2014, the Borrowers and Mezzanine Borrowers repaid in full, cancelled and terminated their respective mortgage and mezzanine loan agreements outstanding at that date without any penalties incurred.

The initial interest rate of the Loan is equal to the one-month London interbank offered rate for deposits, or LIBOR, plus a margin rate of 2.80%. In connection with the Loan, the Borrowers entered into an interest rate cap agreement, which caps the base interest rate before applying the applicable margins on the Loan, for an aggregate notional amount of $830 million, a termination date of December 9, 2016 and a strike rate of 4.50%. The Loan is scheduled to mature on December 9, 2016, with an option for the Borrowers to extend the initial term for three one-year extension terms, subject to certain conditions. The Loan is not subject to any mandatory principal amortization.

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

 

    incur additional secured or unsecured indebtedness;

 

    make cash distributions at any time that the debt yield, representing the quotient (expressed as a percentage) calculated by dividing the annualized net operating income of the properties subject to the Loan by the outstanding principal amount of the indebtedness under the Loan, is less than 7.50% during the first four years of the Loan and 7.75% during the fifth year of the Loan or if there is a default continuing under the Loan, until such time as the debt yield is equal to or greater than 7.50% during the first four years of the Loan and 7.75% during the fifth year of the Loan or the Loan default has been cured;

 

    make investments or acquisitions;

 

    use assets as security in other transactions;

 

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

 

    guarantee other indebtedness; and

 

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

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

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

 

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In addition, the applicable Borrowers for the Loan and BSHH LLC, a Delaware limited liability company (the “Guarantor”) and an affiliate of BRE Holdings, will have recourse liability under the Loan for certain matters typical of a transaction of this type, including, without limitation, relating to losses arising out of actions by the Borrower, Guarantor, Sponsor or their respective affiliates controlled by the Sponsor which constitute fraud, intentional misrepresentation, misappropriation of funds (including insurance proceeds), removal or disposal of any property after an event of default under the Loan, a material violation of the due on sale/encumbrance covenants set forth in the loan agreements, willful misconduct that results in waste to any property and any material modification or voluntary termination of a ground lease without the Lender’s prior written consent if required under the loan agreements. The Borrowers will also have recourse liability for the Loan in the event any security instrument or loan agreement is deemed a fraudulent conveyance or a preference, and the Borrowers and the Guarantor will have recourse liability for the Loan in the event of a voluntary or collusive involuntary bankruptcy of any Borrower or any operating lessee of the properties or in the event Borrower, Guarantor, Sponsor or their respective affiliates controlled by the Sponsor consents to or joins in the application for the appointment of a custodian, receiver, trustee or examiner of any Borrower or the operating lessee of any of the properties or any property, provided, however, the liability of the Guarantor described in this sentence shall not exceed 15% of the principal amount of the Loan outstanding at the time the event occurred.

Concurrent with the execution of the documents reflecting the Loan, the Company executed an Indemnity Agreement in favor of the Guarantor pursuant to which the Company agrees to indemnify and hold the Guarantor harmless from any losses incurred by the Guarantor pursuant to the terms of the guaranty executed by the Guarantor in favor of the Lenders in connection with the Loan.

The Company capitalized $6.9 million of deferred financing costs associated with the Loan. Deferred financing costs consist of amounts paid for direct and indirect costs associated with the origination of the Loan. Such costs are amortized on a straight-line basis (which approximates the effective interest method) over the term of the related debt. Amortization of deferred financing costs totaled $1.3 million and $2.5 million under the mortgage loan for the three and six months ended June 30, 2015, respectively. This compares to amortization of deferred financing costs of $1.4 million and $2.7 million under the previous mortgage and mezzanine loans for the three and six months ended June 30, 2014, respectively, and is included in interest expense in the condensed consolidated statements of operations.

As part of the Merger, the Company assumed an existing loan with a commercial lender secured by the Company’s Fort Worth, Texas Residence Inn property. The loan matures on October 6, 2022 and carries a fixed interest rate of 4.73%. Principal is due monthly with the remaining outstanding principal balance due at maturity of the loan. The outstanding principal balance as of June 30, 2015 was $17.2 million and is included in mortgages payable in the condensed consolidated balance sheets.

Future scheduled principal payments of debt obligations (assuming no exercise of extension options) as of June 30, 2015 are as follows (in thousands):

 

2015 (remaining months)

   $ 212   

2016

     830,440   

2017

     464   

2018

     487   

2019

     510   

Thereafter

     15,131   
  

 

 

 

Total

   $ 847,244   
  

 

 

 

5. Fair Value of Financial Instruments

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

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

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

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

 

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

 

     June 30, 2015      December 31, 2014  
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
 

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

           

Interest rate caps

   $ 6       $ 6       $ 59       $ 59   

Financial assets not measured at fair value:

           

Cash and cash equivalents

   $ 34,091       $ 34,091       $ 22,776       $ 22,776   

Restricted cash

   $ 10,294       $ 10,294       $ 40,719       $ 40,719   

Due from third party managers, net

   $ 7,940       $ 7,940       $ 4,764       $ 4,764   

Financial liabilities not measured at fair value:

           

Accounts payable and accrued expenses

   $ 9,717       $ 9,717       $ 18,969       $ 18,969   

Due to third party managers, net

   $ 503       $ 503       $ 1,580       $ 1,580   

Mortgages payable

   $ 847,244       $ 846,609       $ 847,453       $ 846,927   

Interest rate caps - The Company acquired one interest rate cap agreement, as required by the terms of its Loan, considered to be a derivative financial instrument. The agreement caps the interest rate on the Loan. The Company did not designate the derivative as a hedge for accounting purposes and, accordingly, accounts for the interest rate cap at fair value in the accompanying condensed consolidated balance sheets in other assets with adjustments to fair value recorded in gain (loss) on derivatives in the condensed consolidated statements of operations. The interest rate cap was acquired at a cost of $0.3 million. Fair value is determined by using prevailing market data and incorporating proprietary models based on well recognized financial principles and reasonable estimates where applicable from a third party source. This is considered a Level 2 valuation technique. Fair value changes on the interest rate cap are classified as a component of cash flows from operations.

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

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

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

6. Commitments and Contingencies

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

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

The following is a description of the Apple REIT class action litigation:

On December 13, 2011, the United States District Court for the Eastern District of New York (the “District Court”) ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and

 

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Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. Apple Six was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc. et al. class action lawsuit, which was filed on June 20, 2011.

On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against Apple Six, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. (“David Lerner Associates”) and David Lerner. Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. are collectively referred to as “other Apple REIT companies.” The consolidated complaint, purportedly brought on behalf of all purchasers of units in Apple Six and the other Apple REIT companies, or those who otherwise acquired these units that were offered and sold to them by David Lerner Associates or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.

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

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

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

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

After remand, on June 6, 2014, defendants filed a brief in support of their motion to dismiss. On July 9, 2014, plaintiffs filed an opposition brief. Defendants’ reply brief was filed on August 8, 2014. On March 25, 2015, the District Court granted defendants’ motion to dismiss in full, with prejudice. The time to file a notice of appeal of that decision has expired, and no such notice has been filed. The Company does not expect to owe any additional amounts under the cost sharing agreement.

Franchise Agreements - As of June 30, 2015, the Company’s hotel properties, other than the Courtyard in Myrtle Beach, South Carolina, the SpringHill Suites in Fort Worth, Texas and the Marriott in Redmond, Washington, (the “Marriott Managed Properties”) were operated under franchise agreements between the Company’s TRS and Marriott or Hilton Worldwide Holdings Inc. or its affiliates (“Hilton”). The franchise agreements for these hotels allow the properties to operate under the brand identified in the applicable franchise agreements. The management agreements for each of the Marriott Managed Properties allow the Marriott Managed Properties to operate under the brand identified therein. Pursuant to the franchise agreements, the Company pays a royalty fee, generally between 4.5% and 6.0% of room revenue, which is included in franchise fees in the condensed consolidated statements of operations. Program fees, which include additional fees for marketing, are included in sales and marketing expense, and central reservation system and other franchisor costs are included in operating expense in the condensed consolidated statements of operations.

Management Agreements - As of June 30, 2015, each of the Company’s 62 hotels were operated and managed, under separate management agreements, by affiliates of the following companies: Marriott, Western International (“Western”), Larry Blumberg & Associates (“LBA”), White Lodging Services Corporation (“White”), Inn Ventures, Inc. (“Inn Ventures”), Interstate Hotels & Resorts, Inc. (“Interstate”), OTO Development, LLC (“OTO”), or Sage Hospitality (“Sage”). The management agreements require the Company to pay a monthly fee calculated as a percentage of revenues, generally between 2.0% - 7.0%, as well as annual

 

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incentive fees, if applicable, and are included in management fees in the consolidated statements of operations. The agreements have remaining terms generally ranging from less than one to 19 years. The agreements with less than one year remaining in their term generally automatically renew on annual or month-to-month terms unless either party to the agreement gives prior notice of the termination thereof. If the Company terminates a management agreement prior to its expiration, it may be liable for estimated management fees through the remaining term and liquidated damages. Additionally, the Company, from time to time, enters into management agreements to manage retail premises ancillary to its hotels. During 2015, the Company changed the management of certain hotels with no material financial impact to the Company.

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

Ground Leases - As of June 30, 2015, four of the Company’s hotel properties had ground leases with remaining terms ranging from two to eight years, which may be extended at the Company’s election. Two properties, the Courtyard in Tuscaloosa, Alabama and the Fairfield Inn in Tuscaloosa, Alabama, are leased to the Company pursuant to a single ground lease. The ground lease for the Residence Inn in Pittsburgh, Pennsylvania originated at the time of the Merger and has a term of 18 years. Payments under this lease are payable to a subsidiary of the Company and, therefore eliminated in consolidation and excluded from the table below. Each of the remaining three leases has the option for the Company to extend the lease. The Residence Inn in Portland, Oregon has a lease for parking space which is included in the table below. Ground lease expenses totaled $0.1 million for each of the three and six months ended June 30, 2015 and 2014, and are included in taxes, insurance and other in the condensed consolidated statements of operations. The aggregate amounts of minimum lease payments under these lease agreements for the five years subsequent to June 30, 2015 and thereafter are as follows (in thousands):

 

2015 (remaining months)

   $ 137   

2016

     275   

2017

     240   

2018

     206   

2019

     99   

Thereafter

     424   
  

 

 

 

Total

   $ 1,381   
  

 

 

 

7. 7% Series A Cumulative Redeemable Preferred Stock

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

On December 31, 2014, approximately $47.5 million of the proceeds of the Loan were used to redeem 24,650,000 shares of the Series A Preferred Stock. Shares were redeemed on a pro rata basis from each shareholder at a redemption price of $1.9281 per share, which was comprised of the $1.90 liquidation preference per share plus $0.0281 in accumulated and unpaid dividends earned through the December 31, 2014 redemption date.

On September 30, 2013, BRE Holdings purchased approximately 2.0 million shares of the Series A Preferred Stock for $1.30 per share as part of a tender offer extended to all shareholders. As of June 30, 2015, BRE Holdings owned approximately 1.5 million shares of the Series A Preferred Stock due to the redemption.

The initial liquidation preference of $1.90 per share will be subject to downward adjustment should net costs and payments relating to certain legacy litigation and regulatory matters exceed $3.5 million from the date of the Merger Agreement (November 29, 2012). The Company recognizes changes in the redemption value immediately as they occur and adjusts the carrying amount of the Series A Preferred Stock to equal the redemption value at the end of each reporting period. As of June 30, 2015, the initial liquidation preference had not been adjusted.

On March 31, 2015, the Board of Directors of the Company declared a dividend for the Series A Preferred Stock of $0.0333 per share, which was paid on April 15, 2015 to shareholders of record on April 1, 2015. On June 30, 2015, the Board of Directors of the Company declared a dividend for the Series A Preferred Stock of $0.0333 per share, which was payable on July 15, 2015 to shareholders of record on July 1, 2015.

 

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As of June 30, 2015, the Company accrued $2.4 million for the dividend declared on June 30, 2015, which is included in accounts payable and accrued expenses in the condensed consolidated balance sheets.

8. Shareholders’ Equity

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

Holders of the Company’s common stock are entitled to one vote for each share of common stock held. At June 30, 2015 and December 31, 2014, there were 100 shares of common stock issued and outstanding.

On May 11, 2015, the Board of Directors of the Company declared a dividend for common stock of $90,000 per share, which was paid on May 13, 2015.

9. Income Taxes

The Company accounts for TRS income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The analysis utilized by the Company in determining the deferred tax valuation allowance involves considerable management judgment and assumptions. For the three months ended June 30, 2015 and 2014, the Company recorded $1.9 million and $1.7 million of income tax expense, respectively. For the six months ended June 30, 2015 and 2014, the Company recorded $0.2 million and $0.8 million of income tax expense, respectively. Tax expense for the three and six months ended June 30, 2015 and 2014 is comprised of federal and state income taxes.

10. Related Party Transactions

The Sponsor and its affiliates are in the business of making investments in companies and real estate assets and currently own, and may, from time to time acquire and hold, in each case, interests in businesses or assets that compete directly or indirectly with the Company. In addition, certain affiliates of the Sponsor have significant influence over Hilton, which indirectly owns the entities that serve as franchisors and receive franchise fees for 27 of the hotels owned by the Company. In connection with the Sponsor’s and its affiliates’ business activities, the Sponsor, BRE Holdings or any of their affiliates, including, without limitation, Hilton or its subsidiaries, may from time to time enter into arrangements with the Company or its subsidiaries. These arrangements may be subject to restrictions on affiliate transactions contained in agreements entered into in connection with the Loan. The Company incurred $4.6 million and $4.0 million of franchise fees, marketing fees, and other expenses during the three months ended June 30, 2015 and 2014, respectively, under agreements with Hilton or its subsidiaries. The Company incurred $8.5 million and $7.5 million of franchise fees, marketing fees, and other expenses during the six months ended June 30, 2015 and 2014, respectively, under agreements with Hilton or its subsidiaries.

In addition, the Company uses Hilton to procure select capital improvements for its hotels. Under this arrangement, the Company paid Hilton $0.3 million and $0 during the three months ended June 30, 2015 and 2014, respectively, and $3.1 million and $0 during the six months ended June 30, 2015 and 2014, respectively. In addition, the Company owed Hilton $0 and $1.2 million as of June 30, 2015 and December 31, 2014, respectively, related to capital improvements, which is included in accounts payable and accrued expenses in the condensed consolidated balance sheets.

A management company provided services to the Company including financial, accounting, administrative and other services that may be requested from time to time pursuant to a corporate services agreement. Affiliates of the Sponsor hold a management interest in this management company. The Company paid $0.3 million and $0.2 million to this management company during the three months ended June 30, 2015 and 2014, respectively, and $0.8 million and $0.4 million during the six months ended June 30, 2015 and 2014, respectively. In addition, the Company owed this management company $0.2 million and $0 as of June 30, 2015 and December 31, 2014, respectively, which is included in accounts payable and accrued expenses in the condensed consolidated balance sheets.

 

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11. Discontinued Operations

The Company sold four hotels during 2014 as summarized below (in thousands):

 

Hotel

  

Sale Date

   Net Proceeds      Gain/
(Loss)
 

Fairfield Inn - Orange Park, Florida

   April 23, 2014    $ 2,978       ($ 67

Fairfield Inn - Birmingham, Alabama

   May 8, 2014      1,509         223   

SpringHill Suites - Savannah, Georgia

   June 2, 2014      3,405         (285

SpringHill Suites - Montgomery, Alabama

   September 4, 2014      1,488         (21
     

 

 

    

 

 

 

Total

      $ 9,380       ($ 150
     

 

 

    

 

 

 

The results of operations for these properties prior to the sale are classified as income from discontinued operations in the accompanying condensed consolidated statement of operations for the three and six months ended June 30, 2014.

The following table sets forth the operating results from discontinued operations (in thousands).

 

     Three Months
Ended
June 30,
2014
     Six Months
Ended
June 30,
2014
 

Total revenue

   $ 941       $ 2,225   

Hotel operating expenses

     724         1,716   

Taxes, insurance and other

     29         132   

General and administrative

     23         58   

Interest expense

     181         301   

Income tax expense

     63         30   

Gain from hotel dispositions

     81         81   
  

 

 

    

 

 

 

Income from discontinued operations

   $ 2       $ 69   
  

 

 

    

 

 

 

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

 

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

In this report, the terms “the Company,” “we” or “our” refer to BRE Select Hotels Corp, together with its wholly-owned subsidiaries.

Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential,” “forecast” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; risks associated with the Company’s indebtedness; financing risks; regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; competition within the hotel and real estate industry; risks associated with the Company’s legal proceedings; and the factors discussed in the sections entitled “Risk Factors” in the Company’s Annual Report on Form 10-K filed on March 20, 2015 (the “Form 10-K”) and in this report. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust (“REIT”) involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the SEC. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statements or cautionary factors as a result of new information, future events or otherwise, except as required by law.

Overview

We were formed to invest in income-producing real estate in the United States through the acquisition of Apple Six. On May 14, 2013, we completed the acquisition of Apple Six (the “Merger”) pursuant to the Merger Agreement, by and between us, BRE Holdings and Apple Six, pursuant to which Apple Six merged with and into us. As of June 30, 2015, we owned 62 hotels located in 18 states with an aggregate of 7,346 rooms.

We made an election, through the filing of Form 1120-REIT for 2012, to qualify as a real estate investment trust, or REIT, for federal income tax purposes. In order to qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we distribute at least 90% of our adjusted taxable income to our shareholders, subject to certain adjustments and excluding any net capital gain. We currently intend to adhere to these requirements to qualify for REIT status. There can be no assurance that we will qualify as a REIT for any particular year, however. If we fail to qualify as a REIT for any taxable year, we would be subject to federal income tax at corporate rates and distributions to our shareholders would not qualify for the dividends paid deduction. This tax liability would reduce net earnings available for distribution to our shareholders. In addition, we would generally be disqualified from treatment as a REIT for the year in which we lose our REIT status and for the four taxable years following such year.

Hotels Owned

The following table summarizes the location, brand, manager and number of rooms for each of the 62 hotels the Company owned at June 30, 2015, all of which were acquired on May 14, 2013 in connection with the Merger.

 

City

  

State

  

Name

  

Manager

   Rooms  

Dothan

   Alabama    Courtyard    LBA      78   

Dothan

   Alabama    Hampton Inn & Suites    LBA      85   

Huntsville

   Alabama    Fairfield Inn    LBA      79   

Huntsville

   Alabama    Residence Inn    LBA      78   

Tuscaloosa

   Alabama    Courtyard    LBA      78   

Tuscaloosa

   Alabama    Fairfield Inn    LBA      63   

 

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Anchorage

   Alaska    Hampton Inn    Interstate      101   

Anchorage

   Alaska    Hilton Garden Inn    Interstate      125   

Anchorage

   Alaska    Homewood Suites    Interstate      122   

Phoenix

   Arizona    Hampton Inn    OTO      99   

Arcadia

   California    Hilton Garden Inn    OTO      124   

Arcadia

   California    SpringHill Suites    OTO      86   

Bakersfield

   California    Hilton Garden Inn    Interstate      120   

Folsom

   California    Hilton Garden Inn    Inn Ventures      100   

Foothill Ranch

   California    Hampton Inn    OTO      84   

Lake Forest

   California    Hilton Garden Inn    OTO      103   

Milpitas

   California    Hilton Garden Inn    Inn Ventures      161   

Roseville

   California    Hilton Garden Inn    Inn Ventures      131   

San Francisco

   California    Hilton Garden Inn    White      169   

Boulder

   Colorado    Marriott    White      157   

Glendale

   Colorado    Hampton Inn & Suites    Sage      133   

Lakewood

   Colorado    Hampton Inn    Sage      170   

Farmington

   Connecticut    Courtyard    White      119   

Rocky Hill

   Connecticut    Residence Inn    White      96   

Wallingford

   Connecticut    Homewood Suites    White      104   

Clearwater

   Florida    SpringHill Suites    Interstate      79   

Lake Mary

   Florida    Courtyard    Interstate      83   

Lakeland

   Florida    Residence Inn    LBA      78   

Panama City

   Florida    Courtyard    LBA      84   

Pensacola

   Florida    Courtyard    LBA      90   

Pensacola

   Florida    Fairfield Inn    LBA      62   

Pensacola

   Florida    Hampton Inn & Suites    LBA      85   

Tallahassee

   Florida    Hilton Garden Inn    Interstate      99   

Albany

   Georgia    Courtyard    LBA      84   

Columbus

   Georgia    Residence Inn    LBA      78   

Valdosta

   Georgia    Courtyard    LBA      84   

Mt. Olive

   New Jersey    Residence Inn    White      123   

Somerset

   New Jersey    Homewood Suites    White      123   

Saratoga Springs

   New York    Hilton Garden Inn    White      112   

Roanoke Rapids

   North Carolina    Hilton Garden Inn    Interstate      147   

Hillsboro

   Oregon    Courtyard    Inn Ventures      155   

Hillsboro

   Oregon    Residence Inn    Inn Ventures      122   

Hillsboro

   Oregon    TownePlace Suites    Inn Ventures      136   

Portland

   Oregon    Residence Inn    Inn Ventures      258   

Pittsburgh

   Pennsylvania    Residence Inn    White      156   

Myrtle Beach

   South Carolina    Courtyard    Marriott      135   

Nashville

   Tennessee    Homewood Suites    Interstate      121   

Arlington

   Texas    SpringHill Suites    Western      121   

Arlington

   Texas    TownePlace Suites    Western      94   

Dallas

   Texas    SpringHill Suites    Western      148   

Fort Worth

   Texas    Homewood Suites    Interstate      137   

Fort Worth

   Texas    Residence Inn    Western      149   

Fort Worth

   Texas    SpringHill Suites    Marriott      145   

Laredo

   Texas    Homewood Suites    Western      105   

Laredo

   Texas    Residence Inn    Western      109   

Las Colinas

   Texas    TownePlace Suites    Western      135   

McAllen

   Texas    Hilton Garden Inn    Western      104   

Fredericksburg

   Virginia    Hilton Garden Inn    Interstate      148   

Kent

   Washington    TownePlace Suites    Inn Ventures      152   

Mukilteo

   Washington    TownePlace Suites    Inn Ventures      128   

Redmond

   Washington    Marriott    Marriott      262   

Renton

   Washington    Hilton Garden Inn    Inn Ventures      150   
           

 

 

 

Total number of rooms

     7,346   
           

 

 

 

 

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Key Indicators of Operating Performance

We use a variety of operating information and metrics to evaluate the operating performance of our hotels. These key indicators include financial information that is prepared in accordance with U.S. GAAP, along with other non-U.S. GAAP financial measures. In addition, we use industry standard statistical information and comparative data, some of which may not be financial in nature. In evaluating financial condition and operating performance, the most important indicators that we focus on are:

 

    Occupancy - Occupancy represents the total number of hotel rooms sold in a given period divided by the total number of hotel rooms available, and is a key measure of the utilization of our hotels’ available capacity. Occupancy is a major driver of room revenue, as well as other revenue categories including food and beverage revenues. We use occupancy as a primary measure of demand at each of our hotels during a given period of time. Occupancy also guides us in determining achievable levels of average daily rate (“ADR”). Fluctuations in occupancy are accompanied by fluctuations in most categories of variable operating costs, such as utility cost and certain labor costs such as housekeeping, resulting in varying levels of hotel profitability.

 

    Average Daily Rate (ADR) - ADR represents the average room price at a hotel or group of hotels and is computed by dividing total hotel room revenues by the total number of rooms sold in a given period. ADR trends provide information concerning the customer base and pricing environment at our hotels. Increases in ADR typically result in higher operating margins and overall profitability, since variable hotel expenses do not increase correspondingly. As a result, ADR trends are carefully monitored to manage pricing levels.

 

    Revenue per Available Room (RevPAR) - RevPAR is the product of occupancy and ADR. It does not include non-room revenues such as food and beverage revenue or other ancillary revenues for guest services provided by the hotel. We use RevPAR to identify trend information for comparable properties and regions.

RevPAR Index is another commonly used metric in the lodging industry, and measures each hotel’s market share in relation to its competitive set with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The RevPAR Index for a particular hotel is calculated as the quotient of (1) the subject hotel’s RevPAR divided by (2) the average RevPAR of the hotels in the subject’s competitive set, multiplied by 100.

One critical component of this calculation is the determination of a hotel’s competitive set, which consists of a small group of hotels within its relevant market. We work with each hotel’s management company to assess and agree on each hotel’s competitive set. Many factors are involved in determining each hotel’s competitive set, including geographic location, brand affiliation, and comparable service levels provided.

Executive Summary

Our hotel portfolio experienced continued improvement in revenues in the three and six months ended June 30, 2015 as compared to the same period in the prior year, while operating income declined in both periods largely due to increased depreciation expense and loss on disposals of investment in real estate. Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of our hotels as compared to other hotels within their respective local markets, in general, continues to meet our expectations.

We believe the remainder of 2015 will offer attractive growth for both the hotel industry and our portfolio because of the expected increased demand versus available supply. In addition, the aggressive renovation plan we started in 2014 for many of our hotels has continued into 2015. The resulting property improvements are expected to further improve our financial results through increased ADR at our properties.

During 2015, we changed the management of the following hotels:

 

City

  

State

  

Name

  

Old Manager

  

New Manager

  

Effective
Date

 
Clearwater    Florida    SpringHill Suites    LBA    Interstate      1/30/2015   
Lake Mary    Florida    Courtyard    LBA    Interstate      1/30/2015   
Anchorage    Alaska    Hampton Inn    Stonebridge    Interstate      5/1/2015   
Anchorage    Alaska    Hilton Garden Inn    Stonebridge    Interstate      5/1/2015   
Anchorage    Alaska    Homewood Suites    Stonebridge    Interstate      5/1/2015   
Phoenix    Arizona    Hampton Inn    Stonebridge    OTO      5/1/2015   
Arcadia    California    Hilton Garden Inn    Stonebridge    OTO      5/1/2015   
Arcadia    California    SpringHill Suites    Stonebridge    OTO      5/1/2015   
Foothill Ranch    California    Hampton Inn    Stonebridge    OTO      5/1/2015   

 

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Lake Forest    California    Hilton Garden Inn    Stonebridge    OTO      5/1/2015   
Glendale    Colorado    Hampton Inn & Suites    Stonebridge    Sage      5/1/2015   
Lakewood    Colorado    Hampton Inn    Stonebridge    Sage      5/1/2015   

We will continue to review the performance of our hotel portfolio and make management changes, if necessary, in order to optimize the financial performance of each property.

On June 5, 2015, we evacuated and temporarily closed the Homewood Suites in Fort Worth, Texas due to damage incurred from extensive flooding in the area during late May. Remediation work was started immediately, and the hotel is expected to remain closed for several months for the required remediation work and repairs. Our insurance carriers were notified in June of the pending claim which is in the process of being evaluated.

We continually monitor the profitability of our properties and attempt to maximize shareholder value by timely disposing of properties. During 2014, we sold the Birmingham, Alabama Fairfield Inn; Montgomery, Alabama SpringHill Suites; Orange Park, Florida Fairfield Inn; and Savannah, Georgia SpringHill Suites, as it was determined in connection with the Merger that these properties did not fit our long-term strategic plan. The results of operations of these four hotels are classified as discontinued operations in the 2014 condensed consolidated financial statements and are not included in the financial results summarized below.

Results of Operations

Results of Operations for the Three and Six Months Ended June 30, 2015 and 2014 (in thousands):

 

     Three Months
Ended
June 30, 2015
     Percent
of
Revenue
    Three Months
Ended
June 30, 2014
     Percent
of
Revenue
 

Total hotel revenue

     76,145         100   $ 73,333         100

Hotel operating expenses

     40,727         53     39,491         54

Taxes, insurance and other expense

     3,742         5     3,541         5

General and administrative expense

     1,400         2     827         1

Depreciation

     8,424           6,662      

Loss on disposals of investment in real estate

     2,876           0      

Interest expense, net

     7,620           9,713      

Loss on derivatives

     14           223      

Income tax expense

     1,925           1,749      
     Six Months
Ended
June 30, 2015
     Percent
of
Revenue
    Six Months
Ended
June 30, 2014
     Percent
of
Revenue
 

Total hotel revenue

   $ 139,623         100   $ 134,820         100

Hotel operating expenses

     77,057         55     74,970         56

Taxes, insurance and other expense

     7,447         5     6,891         5

General and administrative expense

     2,165         2     1,765         1

Depreciation

     15,709           13,234      

Loss on disposals of investment in real estate

     2,876           0      

Interest expense, net

     15,118           19,030      

Loss on derivatives

     53           419      

Income tax expense

     202           814      

Revenues

The Company’s principal source of revenue is hotel revenue, consisting of room and other related revenue. For the three months ended June 30, 2015 and 2014, the Company had total hotel revenue from continuing operations of $76.1 million and $73.3 million, respectively. For the six months ended June 30, 2015 and 2014, total hotel revenue from continuing operations was $139.6 million and $134.8 million, respectively. For the three months ended June 30, 2015 and 2014, the hotels achieved average occupancy of 79.5% and 80.8%, ADR of $135.27 and $126.83 and RevPAR of $107.50 and $102.46, respectively. For the six months ended June 30, 2015 and 2014, the hotels achieved average occupancy of 75.2% and 76.5%, ADR of $131.18 and $123.44 and RevPAR of $98.63 and $94.48, respectively.

 

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The increase in hotel revenues was driven by a 6.7% and 6.3% increase, respectively, in ADR during the three and six months ended June 30, 2015 compared to the same periods in the prior year. This strong ADR increase was due to our ability to increase rates, in particular at our newly renovated properties, along with overall strong demand within the upscale limited service segment of the industry. Occupancy decreased by 1.6% and 1.7%, respectively, during the three and six months ended June 30, 2015 compared to the same periods in the prior year largely due to out-of-service rooms at hotels undergoing renovations.

Expenses

Hotel operating expenses consist of direct room expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the three months ended June 30, 2015 and 2014, hotel operating expenses from continuing operations totaled $40.7 million and $39.5 million, respectively, representing 53% and 54%, respectively, of total hotel revenue. For the six months ended June 30, 2015 and 2014, hotel operating expenses from continuing operations totaled $77.1 million and $75.0 million, respectively, representing 55% and 56%, respectively, of total hotel revenue. Results for the three and six months ended June 30, 2015 reflect the impact of the increases in revenues and the Company’s efforts to control costs. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utilities by monitoring and sharing utilization data across its hotels and management companies. Although operating expenses will increase as occupancy and revenue increases, the Company has and expects to continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality service levels at each property.

Taxes, insurance, and other expenses from continuing operations for the three months ended June 30, 2015 and 2014 were $3.7 million and $3.5 million, or 5% and 5% of total hotel revenue, respectively. Taxes, insurance, and other expenses from continuing operations for the six months ended June 30, 2015 and 2014 were $7.4 million and $6.9 million, or 5% and 5% of total hotel revenue, respectively. Property taxes have continued to increase in 2015 as the economy has continued to improve and localities reassessed property values accordingly.

General and administrative expense from continuing operations for the three months ended June 30, 2015 and 2014 was $1.4 million and $0.8 million, or 2% and 1% of total hotel revenue, respectively. General and administrative expense from continuing operations for the six months ended June 30, 2015 and 2014 was $2.2 million and $1.8 million, or 2% and 1% of total hotel revenue, respectively. The principal components of general and administrative expense are advisory fees and expenses, legal fees, accounting fees, and reporting expenses. The increase in 2015 as compared to 2014 is largely due to increased advisory fees in order to support our growing revenues and operations of our hotels.

Depreciation expense from continuing operations for the three months ended June 30, 2015 and 2014 was $8.4 million and $6.7 million, respectively. Depreciation expense from continuing operations for the six months ended June 30, 2015 and 2014 was $15.7 million and $13.2 million, respectively. The increase in 2015 compared to 2014 was due to the increased renovation activity in 2014 at our hotels, and resulting higher levels of fixed assets in-service is expected to increase depreciation expense for the foreseeable future.

Interest expense, net for the three months ended June 30, 2015 and 2014 was $7.6 million and $9.7 million, respectively. Interest expense, net for the six months ended June 30, 2015 and 2014 was $15.1 million and $19.0 million, respectively. Interest expense decreased due to the lower interest rate on the debt we obtained in December 2014 compared to the debt that originated at the time of the Merger. The Company capitalized interest of $0.1 million and $0 in the three months ended June 30, 2015 and 2014, respectively, and $0.2 million and $0 for the six months ended June 30, 2015 and 2014, respectively, related to capital improvement projects at several of our hotels.

Operating Metrics and Non-U.S. GAAP Financial Measures

Below is a summary of our key operating metrics for the three and six months ended June 30, 2015 and 2014:

 

     For the three months ended June 30,     For the six months ended June 30,  

Statistical Data

   2015     2014     2015     2014  

Occupancy

     79.5     80.8     75.2     76.5

ADR

   $ 135.27      $ 126.83      $ 131.18      $ 123.44   

RevPAR

   $ 107.50      $ 102.46      $ 98.63      $ 94.48   

RevPAR Index

     117        119        116        120   

In addition, two key non-U.S. GAAP financial measures that we use to evaluate our performance are EBITDA and Adjusted EBITDA.

 

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EBITDA - EBITDA is defined as net income or loss excluding interest, income taxes, and depreciation and amortization. We believe EBITDA is a useful measure to evaluate operating performance between periods, as it removes the impact of our capital structure (interest expense) and asset base (depreciation and amortization) from our operating results.

Adjusted EBITDA - We further adjust EBITDA for certain additional items, including extinguishment of mortgages payable and mezzanine loans, gain or loss on hotels held for sale, loss on disposals of investments in real estate, derivatives and merger transaction costs. We believe that Adjusted EBITDA provides additional useful supplemental information about our ongoing operating performance.

The following table is a reconciliation of our GAAP net income to EBITDA and Adjusted EBITDA for the three and six months ended June 30, 2015 and 2014 (in thousands):

 

     For the three months ended June 30,      For the six months ended June 30,  
     2015      2014      2015      2014  

Net income (1)

   $ 9,417       $ 11,129       $ 18,996       $ 17,766   

Depreciation and amortization

     8,424         6,662         15,709         13,234   

Interest expense, net

     7,620         9,713         15,118         19,030   

Income tax expense

     1,925         1,749         202         814   
  

 

 

    

 

 

    

 

 

    

 

 

 

EBITDA

     27,386         29,253         50,025         50,844   

Gain on hotels held for sale

     0         (81      0         (81

Loss on disposals of investment in real estate

     2,876         0         2,876         0   

Loss on derivatives

     14         223         53         419   
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

   $ 30,276       $ 29,395       $ 52,954       $ 51,182   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes net income from discontinued operations

Liquidity and Capital Resources

Operating cash flow from our hotel properties is our principal source of liquidity. We anticipate that our cash flows from operations will provide adequate capital for all anticipated uses, including all scheduled principal and interest payments on our outstanding indebtedness, ongoing capital commitments to fund capital improvements, dividends on the Series A Preferred Stock, distributions necessary to maintain our qualification as a REIT and other capital obligations associated with conducting our business.

Mortgage Loans

On December 3, 2014, certain of our indirect wholly-owned subsidiaries (the “Borrowers”) entered into a loan agreement (the “Loan Agreement”) with commercial lenders (collectively, the “Lenders”), pursuant to which the Borrowers obtained a mortgage loan from the Lenders (the “Loan”) in an aggregate principal amount of $830 million. The Loan is secured by first-priority, cross-collateralized mortgage liens on 61 of the 62 properties owned or ground-leased by certain of our subsidiaries, all related personal property, reserves, a pledge of all income received by the Borrowers with respect to the properties, a pledge of the ownership interests in the operating lessee and a security interest in a cash management account. The loan proceeds were used to repay the mortgage and mezzanine loans outstanding which were obtained in connection with the Merger, and to redeem approximately 25% of the outstanding 7% Series A Preferred Stock.

As of June 30, 2015, we had $847.2 million in mortgages payable, comprised of $830.0 million aggregate principal amount outstanding under the Loan, which is secured by 61 of our 62 properties, and $17.2 million assumed in the Merger, which is secured by the Fort Worth, Texas Residence Inn property.

Capital Expenditures

We have ongoing capital commitments to fund capital improvements. We are required, under all of the hotel franchise agreements and under our loan agreements, to make a percentage of the gross revenues from each hotel available for the repair, replacement and refurbishing of furniture, fixtures, and equipment at such hotel, provided that under the loan agreements such amounts may be used for certain capital expenditures with respect to the hotels. Pursuant to the Loan Agreement, at closing we were required to deposit $26.0 million into a restricted cash account to fund required capital improvements. In addition, we must deposit monthly in a lender escrow an amount equal to the sum of 4%-5% of total revenue, excluding revenue from the Marriott managed hotels, per the terms of our franchise and management agreements. These funds can then be used for capital enhancements to the properties. We spent $38.6 million in capital improvements in the first half of this year, and expect to spend an additional $20 to $30 million on capital improvements during the remainder of this year. Due to the early disposal of furniture, fixtures and equipment in connection with these capital improvements, we recorded a loss on disposals of investment in real estate of $2.9 million.

 

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Distributions

To qualify as a REIT, we are required to distribute at least 90% of our ordinary income to our shareholders. We intend to adhere to these distribution and the other requirements to qualify for REIT status.

BRE Holdings owns 100% of our issued and outstanding common stock. In 2014, dividends on our common stock were paid quarterly in February, May, August and November each year. On May 13, 2015, we paid a dividend for the common stock of $90,000 per share. Any decision to declare and pay dividends on our common stock in the future will be made at the sole discretion of our Board of Directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our Board of Directors may deem relevant.

On January 15, 2015, we paid a dividend for the Series A Preferred Stock of $0.0333 per share to shareholders of record on January 1, 2015. On April 15, 2015, we paid a dividend for the Series A Preferred Stock of $0.0333 per share to shareholders of record on April 1, 2015. On June 30, 2015, our Board of Directors declared a dividend for the Series A Preferred Stock of $0.0333 per share, which was payable on July 15, 2015 to shareholders of record on July 1, 2015. Dividends for the Series A Preferred Stock are anticipated to be paid quarterly in January, April, July and October each year.

Contractual Obligations

Our contractual obligations have not changed significantly from those disclosed in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Contractual Obligations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

Impact of Inflation

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

Insurance

We carry comprehensive insurance, including general liability, property, rental loss and umbrella liability coverage on all of our hotels. In addition, we carry flood coverage on certain hotels when available on commercially reasonable terms for hotels where we believe such coverage is warranted or required under the terms of our debt agreements. We have selected policy specifications and insured limits which we believe to be appropriate given the relative risk of loss, the cost of the coverage and industry practice, and as such believe our hotels are adequately insured.

Seasonality

Demand in the lodging industry is impacted by recurring seasonal patterns. For properties located in non-resort markets, demand is generally lower in the winter months due to decreased travel and higher in the spring and summer months during peak travel season. Accordingly, we expect that we will have lower revenue, operating income and cash flow in the first and fourth quarters, and higher revenue, operating income and cash flow in the second and third quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, we expect to utilize cash on hand or, if necessary, any available other financing sources to make distributions to shareholders.

Critical Accounting Policies

There have been no significant changes in our critical accounting policies or estimates from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

For the Company’s disclosures about market risk, please see “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014. There have been no material changes to the Company’s disclosures about market risk in Part II, Item 7A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

 

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Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company’s management, with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this Form 10-Q. Based upon that evaluation, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer concluded that, as of June 30, 2015, the Company’s disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

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

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

Apple Six was party to certain legal matters at the time of its acquisition by the Company. Following completion of its acquisition of Apple Six, the Company as the surviving corporation in the Merger, became involved in these legacy matters. The initial liquidation preference of $1.90 per share of Series A Preferred Stock is subject to downward adjustment should net costs and payments relating to certain litigation and regulatory legacy matters exceed $3.5 million, including the litigation described in note 6 of the Notes to the Condensed Consolidated Financial Statements. The legacy SEC investigation was settled in 2014. As of June 30, 2015, the initial liquidation preference has not been adjusted. The information regarding this litigation can be found under “Commitments and Contingencies” in note 6 of the Notes to the Condensed Consolidated Financial Statements contained in this quarterly report and is incorporated by reference into this Item 1.

 

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the section entitled “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014, which could materially adversely affect the Company’s business, financial condition, results of operations (including revenues and profitability), operating cash flow and value. The risks described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014 are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial also could materially adversely affect its business, financial condition, results of operations (including revenues and profitability), operating cash flow and value. There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

 

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

None.

 

Item 3. Defaults upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

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

 

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Item 6. Exhibits

 

Exhibit

Number

  

Description of Documents

  31.1    Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
  31.2    Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
  32.1    Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **
  99.1    Section 13(r) Disclosure. *
101    The following materials from BRE Select Hotels Corp’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text and in detail. *

 

 

* Filed herewith
** Furnished herewith

 

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Table of Contents

SIGNATURES

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

 

    BRE SELECT HOTELS CORP

Date: August 13, 2015

    By:  

/s/ WILLIAM J. STEIN

      William J. Stein
      Chief Executive Officer and Senior Managing Director
      (Principal Executive Officer)

Date: August 13, 2015

    By:  

/s/ BRIAN KIM

      Brian Kim
      Chief Financial Officer, Vice President and Managing Director
      (Principal Financial Officer and Principal Accounting Officer)

 

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