Attached files
| file | filename |
|---|---|
| EX-32 - EXHIBIT 32 - Hospitality Investors Trust, Inc. | archosp-exhibit32xq32016.htm |
| EX-31.2 - EXHIBIT 31.2 - Hospitality Investors Trust, Inc. | archosp-exhibit312xq32016.htm |
| EX-31.1 - EXHIBIT 31.1 - Hospitality Investors Trust, Inc. | archosp-exhibit311xq32016.htm |
| EX-3.2 - EXHIBIT 3.2 - Hospitality Investors Trust, Inc. | archosp-exhibit3_2xq32016.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2016
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 000-55394
AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC.
(Exact Name of Registrant as Specified in its Charter)
Maryland | 80-0943668 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
405 Park Avenue, 14th Floor New York, New York | 10022 | |
(Address of Principal Executive Office) | (Zip Code) | |
(212) 415-6500
(Registrant’s Telephone Number, Including Area Code)
Not applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically 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 o
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. (check one):
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company x | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares of the registrant's common stock, $0.01 par value, outstanding as of November 4, 2016 was 38,259,818.
TABLE OF CONTENTS
Page | |
Consolidated Balance Sheets as of September 30, 2016 (Unaudited) and December 31, 2015 | |
Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the Three Months Ended September 30, 2016 and the Three Months Ended September 30, 2015 and for the Nine Months Ended September 30, 2016 and the Nine Months Ended September 30, 2015 | |
Consolidated Statement of Changes in Equity (Unaudited) for the Nine Months Ended September 30, 2016 | |
Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2016 and for the Nine Months Ended September 30, 2015 | |
Notes to Consolidated Financial Statements (Unaudited) | |
i
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share data)
September 30, 2016 | December 31, 2015 | ||||||
(unaudited) | |||||||
ASSETS | |||||||
Real estate investments: | |||||||
Land | $ | 339,819 | $ | 317,871 | |||
Buildings and improvements | 1,832,486 | 1,729,960 | |||||
Furniture, fixtures and equipment | 203,218 | 163,516 | |||||
Total real estate investments | 2,375,523 | 2,211,347 | |||||
Less: accumulated depreciation and amortization | (143,949 | ) | (70,648 | ) | |||
Total real estate investments, net | 2,231,574 | 2,140,699 | |||||
Assets held for sale | 10,171 | — | |||||
Cash and cash equivalents | 50,735 | 46,829 | |||||
Acquisition deposits | 7,500 | 40,504 | |||||
Restricted cash | 37,538 | 71,288 | |||||
Investments in unconsolidated entities | 3,498 | 3,458 | |||||
Below-market lease asset, net | 9,926 | 10,225 | |||||
Prepaid expenses and other assets | 39,121 | 34,836 | |||||
Total Assets | $ | 2,390,063 | $ | 2,347,839 | |||
LIABILITIES, NON-CONTROLLING INTEREST AND EQUITY | |||||||
Mortgage notes payable, net | $ | 1,418,280 | $ | 1,341,033 | |||
Promissory note payable, net | 23,093 | — | |||||
Mandatorily redeemable preferred securities, net | 290,117 | 291,796 | |||||
Accounts payable and accrued expenses | 75,801 | 67,255 | |||||
Due to related parties | 8,757 | 6,546 | |||||
Total Liabilities | $ | 1,816,048 | $ | 1,706,630 | |||
Equity | |||||||
Preferred stock, $0.01 par value, 50,000,000 shares authorized, none issued and outstanding | — | — | |||||
Common stock, $0.01 par value, 300,000,000 shares authorized, 37,833,988 and 36,300,777 shares issued and outstanding, respectively | 378 | 363 | |||||
Additional paid-in capital | 829,129 | 793,786 | |||||
Deficit | (258,216 | ) | (155,680 | ) | |||
Total equity of American Realty Capital Hospitality Trust, Inc. stockholders | 571,291 | 638,469 | |||||
Non-controlling interest - consolidated variable interest entity | 2,724 | 2,740 | |||||
Total Equity | $ | 574,015 | $ | 641,209 | |||
Total Liabilities, Non-controlling Interest and Equity | $ | 2,390,063 | $ | 2,347,839 | |||
The accompanying notes are an integral part of these statements.
1
AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except for share and per share data)
(Unaudited)
Three Months Ended September 30, 2016 | Three Months Ended September 30, 2015 | Nine Months Ended September 30, 2016 | Nine Months Ended September 30, 2015 | ||||||||||||
Revenues | |||||||||||||||
Rooms | $ | 153,182 | $ | 126,205 | $ | 434,455 | $ | 302,706 | |||||||
Food and beverage | 4,850 | 4,041 | 15,422 | 11,202 | |||||||||||
Other | 3,426 | 2,606 | 9,964 | 7,260 | |||||||||||
Total revenue | 161,458 | 132,852 | 459,841 | 321,168 | |||||||||||
Operating expenses | |||||||||||||||
Rooms | 36,958 | 29,752 | 104,984 | 68,395 | |||||||||||
Food and beverage | 4,089 | 3,410 | 12,226 | 8,933 | |||||||||||
Management fees | 11,030 | 5,433 | 32,061 | 12,965 | |||||||||||
Other property-level operating expenses | 58,768 | 50,793 | 175,492 | 120,321 | |||||||||||
Depreciation and amortization | 25,788 | 19,817 | 74,912 | 46,438 | |||||||||||
Impairment of long-lived assets | — | — | 2,399 | — | |||||||||||
Rent | 1,945 | 1,865 | 4,993 | 4,693 | |||||||||||
Total operating expenses | 138,578 | 111,070 | 407,067 | 261,745 | |||||||||||
Income from operations | $ | 22,880 | $ | 21,782 | $ | 52,774 | $ | 59,423 | |||||||
Interest expense | (23,087 | ) | (23,081 | ) | (69,033 | ) | (56,724 | ) | |||||||
Acquisition and transaction related costs | 7 | (698 | ) | (25,270 | ) | (39,129 | ) | ||||||||
Other income (expense) | (542 | ) | (200 | ) | (1,396 | ) | 2,001 | ||||||||
Equity in earnings (losses) of unconsolidated entities | 286 | 228 | 407 | 236 | |||||||||||
General and administrative | (5,128 | ) | (2,020 | ) | (12,623 | ) | (5,984 | ) | |||||||
Total other expenses, net | (28,464 | ) | (25,771 | ) | (107,915 | ) | (99,600 | ) | |||||||
Net income (loss) before taxes | $ | (5,584 | ) | $ | (3,989 | ) | $ | (55,141 | ) | $ | (40,177 | ) | |||
Provision for income taxes | 948 | 939 | 2,246 | 4,295 | |||||||||||
Net income (loss) and comprehensive income (loss) | $ | (6,532 | ) | $ | (4,928 | ) | $ | (57,387 | ) | $ | (44,472 | ) | |||
Less: Net income (loss) attributable to non-controlling interest | 152 | 154 | 278 | 148 | |||||||||||
Net income (loss) attributable to American Realty Capital Hospitality Trust, Inc. | $ | (6,684 | ) | $ | (5,082 | ) | $ | (57,665 | ) | $ | (44,620 | ) | |||
Basic and Diluted net income (loss) per share | $ | (0.17 | ) | $ | (0.19 | ) | $ | (1.50 | ) | (2.00 | ) | ||||
Basic and Diluted weighted average shares outstanding | 38,259,374 | 26,595,560 | 38,183,711 | 22,234,426 | |||||||||||
The accompanying notes are an integral part of these statements.
2
AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC.
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands, except for share data)
(Unaudited)
Common Stock | ||||||||||||||||||||||||||
Number of Shares | Par Value | Additional Paid-in Capital | Deficit | Total Equity of American Realty Capital Hospitality Trust, Inc. Stockholders | Non-controlling Interest | Total Non-controlling Interest and Equity | ||||||||||||||||||||
Balance, December 31, 2015 | 36,300,777 | $ | 363 | $ | 793,786 | $ | (155,680 | ) | $ | 638,469 | $ | 2,740 | $ | 641,209 | ||||||||||||
Issuance of common stock, net | 45,107 | — | 956 | — | 956 | — | 956 | |||||||||||||||||||
Net loss attributable to American Realty Capital Hospitality Trust, Inc. | — | — | — | (57,665 | ) | (57,665 | ) | — | (57,665 | ) | ||||||||||||||||
Net income attributable to non-controlling interest | — | — | — | — | — | 278 | 278 | |||||||||||||||||||
Dividends paid or declared | 1,089,454 | 11 | 24,884 | (44,871 | ) | (19,976 | ) | (294 | ) | (20,270 | ) | |||||||||||||||
Common stock issued through Distribution Reinvestment Plan | 398,650 | 4 | 9,464 | — | 9,468 | — | 9,468 | |||||||||||||||||||
Share-based payments | — | — | 49 | — | 49 | — | 49 | |||||||||||||||||||
Common stock offering costs, commissions and dealer manager fees | — | — | (10 | ) | — | (10 | ) | — | (10 | ) | ||||||||||||||||
Balance, September 30, 2016 | 37,833,988 | $ | 378 | $ | 829,129 | $ | (258,216 | ) | $ | 571,291 | $ | 2,724 | $ | 574,015 | ||||||||||||
The accompanying notes are an integral part of these statements.
3
AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, 2016 | Nine Months Ended September 30, 2015 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (57,387 | ) | $ | (44,472 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 74,912 | 46,438 | ||||||
Impairment of long-lived assets | 2,399 | — | ||||||
Amortization and write-off of deferred financing costs | 8,152 | 7,764 | ||||||
Change in fair value of contingent consideration | 1,454 | (1,720 | ) | |||||
Loss of acquisition deposits | 22,000 | — | ||||||
Other adjustments, net | 249 | 930 | ||||||
Changes in assets and liabilities: | ||||||||
Prepaid expenses and other assets | (4,285 | ) | (19,175 | ) | ||||
Restricted cash | (6,890 | ) | (27,950 | ) | ||||
Due to related parties | 2,479 | (3,417 | ) | |||||
Accounts payable and accrued expenses | 8,406 | 44,907 | ||||||
Net cash provided by operating activities | $ | 51,489 | $ | 3,305 | ||||
Cash flows from investing activities: | ||||||||
Acquisition of hotel assets, net of cash received | (69,892 | ) | (375,777 | ) | ||||
Real estate investment improvements and purchases of property and equipment | (69,828 | ) | (17,386 | ) | ||||
Acquisition deposits | — | (73,144 | ) | |||||
Change in restricted cash related to real estate improvements | 40,602 | (39,699 | ) | |||||
Net cash used in investing activities | $ | (99,118 | ) | $ | (506,006 | ) | ||
Cash flows from financing activities: | ||||||||
Proceeds from issuance of common stock, net | 678 | 495,774 | ||||||
Payments of offering costs | (73 | ) | (61,131 | ) | ||||
Dividends/Distributions paid | (11,500 | ) | (12,164 | ) | ||||
Mandatorily redeemable preferred securities redemptions | (2,270 | ) | (90,760 | ) | ||||
Payment of deferred consideration payable | — | (3,500 | ) | |||||
Proceeds from mortgage note payable | 70,384 | 227,000 | ||||||
Deferred financing fees | (721 | ) | (27,124 | ) | ||||
Repayments of promissory and mortgage notes payable | (5,000 | ) | (64,849 | ) | ||||
Restricted cash for debt service | 37 | (2,747 | ) | |||||
Net cash provided by financing activities | $ | 51,535 | $ | 460,499 | ||||
Net change in cash and cash equivalents | 3,906 | (42,202 | ) | |||||
Cash and cash equivalents, beginning of period | 46,829 | 131,861 | ||||||
Cash and cash equivalents, end of period | $ | 50,735 | $ | 89,659 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Interest paid | $ | 62,854 | $ | 44,617 | ||||
Income taxes paid | $ | 1,163 | $ | 4,870 | ||||
Non-cash investing and financing activities: | ||||||||
Offering costs payable | — | $ | 650 | |||||
Real estate investment improvements and purchases of property and equipment in accounts payable and accrued expenses | $ | 8,950 | $ | 5,321 | ||||
Proceeds receivable from stock sales | — | $ | 2,516 | |||||
4
AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, 2016 | Nine Months Ended September 30, 2015 | |||||||
Seller financed acquisition deposit | $ | 7,500 | — | |||||
Seller financed acquisition | $ | 20,000 | — | |||||
Mortgage and mezzanine debt assumed on real estate investments | — | $ | 904,185 | |||||
Dividends declared but not paid | $ | 4,533 | $ | 4,150 | ||||
Mandatorily redeemable preferred securities issued in acquisition of property and equipment | — | $ | 447,097 | |||||
Common stock issued through distribution reinvestment plan | $ | 9,468 | $ | 11,418 | ||||
The accompanying notes are an integral part of these statements.
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Note 1 - Organization
American Realty Capital Hospitality Trust, Inc. (the "Company") was incorporated on July 25, 2013 as a Maryland corporation and qualified as a real estate investment trust for U.S. federal income tax purposes ("REIT") beginning with the taxable year ended December 31, 2014. The Company was formed primarily to acquire lodging properties in the midscale limited service, extended stay, select service, upscale select service, and upper upscale full service segments within the hospitality sector. As of September 30, 2016, the Company had acquired or had an interest in a total of 142 hotels (including one hotel which was classified as held for sale as of September 30, 2016, and was subsequently sold on October 14, 2016), with a total of 17,351 guest rooms located in 32 states. As of September 30, 2016, all but one of these hotels operated under a franchise or license agreement with a national brand owned by one of Hilton Worldwide, Inc., Marriott International, Inc., Hyatt Hotels Corporation, Starwood Hotels and Resorts Worldwide, and Intercontinental Hotels Group or one of their respective subsidiaries or affiliates.
On January 7, 2014, the Company commenced its primary initial public offering (the "IPO" or the "Offering") on a "reasonable best efforts" basis of up to 80,000,000 shares of common stock, $0.01 par value per share, at a price of $25.00 per share, subject to certain volume and other discounts, pursuant to a registration statement on Form S-11 (File No. 333-190698), as well as up to 21,052,631 shares of common stock available pursuant to the Distribution Reinvestment Plan (the "DRIP") under which the Company's common stockholders could elect to have their cash distributions reinvested in additional shares of the Company's common stock.
On November 15, 2015, the Company suspended the IPO, and, on November 18, 2015, Realty Capital Securities, LLC (the "Former Dealer Manager"), the dealer manager of the IPO, suspended sales activities, effective immediately. On December 31, 2015, the Company terminated the Former Dealer Manager as the dealer manager of the IPO. Prior to suspension of the IPO, the Company depended, and expected to continue to depend, in substantial part on proceeds from the IPO to meet its major capital requirements. Because the Company does not expect it will resume the IPO, it will require funds in addition to operating cash flow and cash on hand to meet its capital requirements.
In March 2016, the Company’s board of directors changed the distribution policy, such that distributions paid with respect to April 2016 were paid in shares of common stock instead of cash. Accordingly, the Company paid a cash distribution to stockholders of record each day during the quarter ended March 31, 2016, but distributions for subsequent periods have been, and unless and until the Company's board of directors determines otherwise, will continue to be paid in shares of common stock. Distributions for the quarter ended June 30, 2016 were paid in common stock in an amount equivalent to $1.70 per
annum, divided by $23.75.
On July 1, 2016, the Company's board of directors approved an estimated net asset value per share of common stock (“Estimated Per-Share NAV”), which was published on the same date. This was the first time that the Company’s board of directors determined an Estimated Per-Share NAV. In connection with its determination of Estimated Per-Share NAV, the Company’s board of directors revised the amount of the distribution to $1.46064 per share per annum, equivalent to a 6.80% annual rate based on the Estimated Per-Share NAV, automatically adjusting if and when the Company publishes an updated Estimated Per-Share NAV. Distributions for the quarter ended September 30, 2016 were paid in shares of common stock in an amount equal to 0.000185792 per share per day, or $1.46064 per annum, divided by $21.48. It is currently anticipated that the Company will publish an updated Estimated Per-Share NAV on at least an annual basis. The distributions are made by the fifth day following each month-end to stockholders of record at the close of business each day during the prior month.
As of September 30, 2016, the Company had approximately 37.8 million shares of common stock outstanding and had received total proceeds of approximately $913.0 million from the IPO and shares issued under the DRIP, net of repurchases. The shares outstanding include shares of common stock issued as stock distributions through September 30, 2016, as a result of the Company's change in distribution policy adopted by the Company's board of directors in March 2016 as described above. The Company will not issue any additional shares of common stock under the DRIP unless and until it recommences paying distributions in cash.
Substantially all of the Company's business is conducted through American Realty Capital Hospitality Operating Partnership, L.P. (the "OP"), a Delaware limited partnership. The Company is the sole general partner and holds substantially all of the units of limited partner interest in the OP ("OP Units"). Additionally, American Realty Capital Hospitality Advisors,
6
LLC (the "Advisor") contributed $2,020 to the OP in exchange for 90 OP Units, which represents a nominal percentage of the aggregate OP ownership. The holders of OP Units have the right to convert OP Units for the cash value of a corresponding number of shares of common stock or, at the option of the OP, a corresponding number of shares of common stock of the Company in accordance with the limited partnership agreement of the OP. The remaining rights of the limited partner interests are limited, however, and do not include the ability to replace the general partner or to approve the sale, purchase or refinancing of the OP's assets.
The Company has no employees. The Company has retained the Advisor to manage certain aspects of the Company's affairs on a day-to-day basis. American Realty Capital Hospitality Properties, LLC or one of its subsidiaries (collectively, the "Property Manager"), serves as property manager and the Property Manager has retained Crestline Hotels & Resorts, LLC ("Crestline"), to provide services, including locating investments, negotiating financing and operating certain hotel assets in the Company's portfolio.
The Advisor, the Property Manager and Crestline are under common control with AR Capital, LLC (“AR Capital”), the parent of the Company’s sponsor, American Realty Capital IX, LLC (the "Sponsor"), and AR Global Investments, LLC, the successor to AR Capital’s business (“AR Global”), as a result of which they are related parties, and each of these entities has received or will receive compensation, fees and expense reimbursements from the Company for services related to the IPO and the investment and management of the Company’s assets.
The Company, directly or indirectly through its taxable REIT subsidiaries ("TRSs"), enters into agreements with the Property Manager, which, in turn, engages Crestline or a third-party sub-property manager to manage the Company’s hotel properties. Crestline is a leading hospitality management company in the United States, and, as of September 30, 2016, had 106 hotels and 15,800 rooms under management in 28 states and the District of Columbia. As of September 30, 2016, 72 of the Company's hotels and 9,594 rooms were managed by Crestline, and 70 of the Company's hotels and 7,757 rooms were managed by third-party sub-property managers.
Note 2 - Summary of Significant Accounting Policies
The accompanying consolidated financial statements of the Company included herein were prepared in accordance with U.S. Generally Accepted Accounting Principles ("GAAP"). Certain immaterial amounts in prior periods have been reclassified in order to conform to current period presentation, including $0.9 million of expense recognized during the six months ended June 30, 2016, that was reclassified from other property-level expenses to general and administrative expenses in the three months ended September 30, 2016. Operating results for the three-month and nine-month periods ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2015, and the notes thereto included in the Company’s Annual Report on Form 10-K, filed with the SEC on March 28, 2016.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. In determining whether the Company has a controlling financial interest in a joint venture and the requirement to consolidate the accounts of that entity, management considers factors such as percentage ownership interest, authority to make decisions and contractual and substantive participating rights of the other partners or members as well as whether the entity is a variable interest entity for which the Company is the primary beneficiary.
Use of Estimates
The preparation of the accompanying consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management makes significant estimates regarding purchase price allocations to record investments in real estate, the useful lives of real estate and real estate taxes, as applicable.
Real Estate Investments
7
The Company allocates the purchase price of properties acquired in real estate investments to tangible and identifiable intangible assets acquired based on their respective fair values at the date of acquisition. Tangible assets include land, land improvements, buildings and furniture, fixtures and equipment. The Company utilizes various estimates, processes and information to determine the property value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Amounts allocated to land, land improvements, buildings and furniture, fixtures and equipment are based on purchase price allocation studies performed by independent third parties or on the Company’s analysis of comparable properties in the Company’s portfolio. Identifiable intangible assets and liabilities, as applicable, are typically related to contracts, including operating lease agreements, ground lease agreements and hotel management agreements, which will be recorded at fair value. The Company also considers information obtained about each property as a result of the Company’s pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.
Investments in real estate that are not considered to be business combinations under GAAP are recorded at cost. Improvements and replacements are capitalized when they extend the useful life of the asset. Costs of repairs and maintenance are expensed as incurred. Depreciation of the Company's assets is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, 15 years for land improvements, five years for furniture, fixtures and equipment, and the shorter of the useful life or the remaining lease term for leasehold interests.
The Company is required to make subjective assessments as to the useful lives of the Company’s assets for purposes of determining the amount of depreciation to record on an annual basis with respect to the Company’s investments in real estate. These assessments have a direct impact on the Company’s net income because if the Company were to shorten the expected useful lives of the Company’s investments in real estate, the Company would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
Below-Market Lease
The below-market lease intangible is based on the difference between the market rent and the contractual rent and is discounted to a present value using an interest rate reflecting the Company's current assessment of the risk associated with the leases acquired (See Note 4 - Leases). Acquired lease intangible assets are amortized over the remaining lease term. The amortization of a below-market lease is recorded as an increase to rent expense on the Consolidated Statements of Operations and Comprehensive Income (Loss).
Impairment of Long-Lived Assets
When circumstances indicate the carrying value of a property may not be recoverable, the Company reviews the asset for impairment. This review is based on an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. The estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of demand, competition and other factors. If an impairment exists due to the inability to recover the carrying value of a property, an impairment loss will be recorded to the extent that the carrying value exceeds the estimated fair value of the property. An impairment loss results in an immediate negative adjustment reflected in net income. An impairment loss of $2.4 million was recorded on one hotel during the quarter ended June 30, 2016 (See Note 13 - Impairment of Long-Lived Assets). The Company has not recorded an impairment in any other periods.
Assets Held for Sale (Long Lived-Assets)
When the Company initiates the sale of long-lived assets, it assesses whether the assets meet the criteria to be considered assets held for sale. The review is based on whether the following criteria are met:
• | Management has committed to a plan to sell the asset group; |
• | The subject assets are available for immediate sale in their present condition; |
• | The Company is actively locating buyers as well as other initiatives required to complete the sale; |
• | The sale is probable and the transfer is expected to qualify for recognition as a complete sale in one year; |
• | The long-lived asset is being actively marketed for sale at a price that is reasonable in relation to fair value; and |
8
• | Actions necessary to complete the plan indicate it is unlikely significant changes will be made to the plan or the plan will be withdrawn. |
If all the criteria are met, a long-lived asset held for sale is measured at the lower of its carrying amount or fair value less cost to sell, and the Company will cease recording depreciation. The Company had one hotel that qualified to be treated as an asset held for sale as of September 30, 2016, which was subsequently sold on October 14, 2016 (See Note 14 - Assets Held for Sale and Note 15 - Subsequent Events).
Cash and Cash Equivalents
Cash and cash equivalents include cash in bank accounts as well as investments in highly-liquid money market funds with original maturities of three months or less.
Restricted Cash
Restricted cash consists of amounts required under mortgage agreements for future capital improvements to owned assets, future interest and property tax payments and cash flow deposits while subject to mortgage agreement restrictions. For purposes of the statement of cash flows, changes in restricted cash caused by changes to the amount needed for future capital improvements are treated as investing activities, changes related to future debt service payments are treated as financing activities, and changes related to real estate tax payments and excess cash flow deposits are treated as operating activities.
Deferred Financing Fees
Deferred financing fees represent commitment fees, legal fees and other costs associated with obtaining commitments for financing. These fees are amortized over the terms of the respective financing agreements using the effective interest method. Costs incurred in seeking financial transactions that do not close are expensed in the period in which it is determined that the financing will not be successful.
In April 2015, the Financial Accounting Standards Board (“FASB”) issued ASU 2015-03 Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), which was designed to simplify the presentation of debt issuance costs. The amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Prior to application of this new guidance, the Company presented debt issuance costs as an asset on the Consolidated Balance Sheets. The recognition and measurement guidance for debt issuance costs were not affected by the amendments in ASU 2015-03. The Company adopted this ASU as of January 1, 2016, on a retrospective basis. The impact to the Consolidated Balance Sheets as of December 31, 2015, was to reduce total assets, mortgage notes payable, and mandatorily redeemable preferred securities by $18.8 million.
Variable Interest Entities
Accounting Standards Codification 810 ("ASC 810") contains the guidance surrounding the definition of variable interest entities ("VIE"), the definition of variable interests and the consolidation rules surrounding VIEs. In general, VIEs are entities in which equity investors lack the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.
In February 2015, the FASB issued Accounting Standards Update 2015-02 (“ASU 2015-02”), which amended ASC 810. The amendment modifies the evaluation of whether certain legal entities are VIEs, eliminates the presumption that a general partner should consolidate a limited partnership, and affects the consolidation analysis of reporting entities that are involved with VIEs. The revised guidance was effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. The Company adopted this guidance effective January 1, 2016. The Company has evaluated the impact of the adoption of the new guidance on its consolidated financial statements and has determined the Company’s OP is considered a VIE. However, the Company meets the disclosure exemption criteria as the Company is the primary beneficiary of the VIE and the Company’s partnership interest is considered a majority voting interest. As such, the new guidance did not have an impact on the Company’s consolidated financial statements.
The Company also has variable interests in VIEs through its investments in entities which own the Westin Virginia Beach Town Center (the "Westin Virginia Beach") and the Hilton Garden Inn Blacksburg.
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Once it is determined that the Company holds a variable interest in an entity, GAAP requires that the Company perform a qualitative analysis to determine (i) which entity has the power to direct the matters that most significantly impact the VIE’s financial performance; and (ii) if the Company has the obligation to absorb the losses of the VIE that could potentially be significant to the VIE or the right to receive the benefits of the VIE that could potentially be significant to the VIE. An entity that has both of these characteristics is deemed to be the primary beneficiary and is required to consolidate the VIE.
The Company holds an interest in BSE/AH Blacksburg Hotel, LLC (the "HGI Blacksburg JV"), an entity that owns the assets of the Hilton Garden Inn Blacksburg, and an interest in TCA Block 7 Hotel, LLC (the "Westin Virginia Beach JV"), an entity that owns the assets of the Westin Virginia Beach.
During the quarter ended June 30, 2015, upon the acquisition of an additional equity interest in the HGI Blacksburg JV, the Company concluded that it was the primary beneficiary, with the power to direct activities that most significantly impact its economic performance, and therefore consolidated the entity in its consolidated financial statements subsequent to the acquisition (See Note 3 - Business Combinations).
The Company has concluded it is not the primary beneficiary with the power to direct activities that most significantly impact economic performance of the Westin Virginia Beach JV, and has therefore not consolidated the entity. The Company has accounted for the entity under the equity method of accounting and included it in investments in unconsolidated entities in the accompanying Consolidated Balance Sheets.
The Company classifies the distributions from its investments in unconsolidated entities in the Consolidated Statements of Cash Flows based upon an evaluation of the specific facts and circumstances of each distribution. For example, distributions of cash generated by property operations are classified as cash flows from operating activities. However, distributions received as a result of property sales are classified as cash flows from investing activities.
Revenue Recognition
The Company recognizes hotel revenue as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel services.
Income Taxes
The Company qualified to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code commencing with its tax year ended December 31, 2014. In order to continue to qualify as a REIT, the Company must annually distribute to its stockholders 90% of its REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gains, and must comply with various other organizational and operational requirements. The Company generally will not be subject to federal corporate income tax on that portion of its REIT taxable income that it distributes to its stockholders. The Company may be subject to certain state and local taxes on its income, property tax and federal income and excise taxes on its undistributed income. The Company's hotels are leased to TRSs which are owned by the OP. The TRSs are subject to federal, state and local income taxes.
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss, capital loss, and tax credit carryovers. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which such amounts are expected to be realized or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including future reversals of existing taxable temporary differences, future projected taxable income and tax planning strategies.
GAAP prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. The Company must determine whether it is "more-likely-than-not" that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement in order to determine the amount of benefit to recognize in the financial statements. This accounting standard applies to all tax positions related to income taxes.
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Earnings/Loss per Share
The Company calculates basic income or loss per share by dividing net income or loss for the period by the weighted-average shares of its common stock outstanding for a respective period. Diluted income per share takes into account the effect of dilutive instruments, such as stock options and unvested stock awards, except when doing so would be anti-dilutive. Beginning with distributions payable with respect to April 2016 and through November 2016, the Company has paid cumulative distributions of 1,519,210 shares of common stock and adjusted retroactively for all periods presented its computation of loss per share in order to reflect this change in capital structure. The Company expects it will continue to make similar retroactive adjustments in subsequent quarters for so long as it continues to pay distributions in shares of common stock (See Note 8 - Common Stock).
Fair Value Measurements
In accordance with ASC 820, Fair Value Measurement, certain assets and liabilities are recorded at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability between market participants in an orderly transaction on the measurement date. The market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability is known as the principal market. When no principal market exists, the most advantageous market is used. This is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received or minimizes the amount that would be paid. Fair value is based on assumptions market participants would make in pricing the asset or liability. Generally, fair value is based on observable quoted market prices or derived from observable market data when such market prices or data are available. When such prices or inputs are not available, the reporting entity should use valuation models.
The Company’s financial instruments recorded at fair value on a recurring basis are categorized based on the priority of the inputs used to measure fair value. The inputs used in measuring fair value are categorized into three levels, as follows:
• | Level 1 - Inputs that are based upon quoted prices for identical instruments traded in active markets. |
• | Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar investments in markets that are not active, or models based on valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the investment. |
• | Level 3 - Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. |
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
Advertising Costs
The Company expenses advertising costs for hotel operations as incurred. These costs were $4.6 million for the three months ended September 30, 2016, and $3.8 million for the three months ended September 30, 2015. Advertising expense was $13.2 million for the nine months ended September 30, 2016, and $9.1 million for the nine months ended September 30, 2015.
Allowance for Doubtful Accounts
Receivables consist principally of trade receivables from customers and are generally unsecured and are due within 30 to 90 days. The Company records a provision for uncollectible accounts using the allowance method. Expected credit losses associated with trade receivables are recorded as an allowance for doubtful accounts. The allowance for doubtful accounts is estimated based upon historical patterns of credit losses for aged receivables as well as specific provisions for certain identifiable, potentially uncollectible balances. When internal collection efforts on accounts have been exhausted, the accounts are written off and the associated allowance for doubtful accounts is reduced. Trade receivable balances, net of the allowance
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for doubtful accounts, are included in prepaid expenses and other assets in the accompanying Consolidated Balance Sheets, and are as follows (in thousands):
September 30, 2016 | December 31, 2015 | ||||||
Trade receivables | $ | 7,746 | $ | 5,848 | |||
Allowance for doubtful accounts | (558 | ) | (697 | ) | |||
Trade receivables, net of allowance | $ | 7,188 | $ | 5,151 | |||
Reportable Segments
The Company has determined that it has one reportable segment, with activities related to investing in real estate. The Company’s investments in real estate generate room revenue and other income through the operation of the properties, which comprise 100% of the total consolidated revenues. Management evaluates the operating performance of the Company’s investments in real estate on an individual property level, none of which represent a reportable segment.
Derivative Transactions
The Company at certain times enters into derivative instruments to hedge exposure to changes in interest rates. The Company’s derivatives as of September 30, 2016, consist of interest rate cap agreements which it believes will help to mitigate its exposure to increasing borrowing costs under floating rate indebtedness. The Company has elected not to designate its interest rate cap agreements as cash flow hedges. The impact of the interest rate caps for the three-month and nine-month periods ended September 30, 2016, was immaterial to the consolidated financial statements.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09 Revenue from Contracts with Customers ("ASU 2014-09"), which requires an entity to recognize the amount of revenue to which it expects to be entitled to for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. In April 2015, the FASB proposed an accounting standards update for ASU 2014-09 for the deferral of the effective date of ASU 2014-09. This proposal defers the effective date of ASU 2014-09 from annual reporting periods beginning after December 15, 2016, back one year, to annual reporting periods beginning after December 15, 2017 for all public business entities, certain not-for-profit entities, and certain employee benefit plans. Early application of ASU 2014-09 is permitted as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. In April and May 2016, two amendments ("ASU 2016-10" and "ASU 2016-12") were made in which guidance related to accounting for revenue from contracts with customers was clarified further. ASU 2016-10 provides clarity around identifying performance obligations and licensing implementation guidance. ASU 2016-12 addresses topics such as collectability criterion, presentation of sales tax, non-cash consideration, completed contracts at transition and technical corrections. There have been no adjustments to the effective date of ASU 2014-09. The Company is evaluating the effect that ASU 2014-09, ASU 2016-10 and ASU 2016-12 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method and has not determined the effect of the standard on its ongoing financial reporting.
In August 2014, the FASB issued ASU 2014-15 Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”), which describes how an entity should assess its ability to meet obligations and sets rules for how this information should be disclosed in the financial statements. The standard provides accounting guidance that will be used along with existing auditing standards. The adoption of ASU 2014-15 becomes effective for the Company on its fiscal year ending December 31, 2016, and all subsequent annual periods. Early adoption is permitted. The adoption of ASU 2014-15 is not expected to have a material effect on the Company's consolidated financial statements.
In January 2015, the FASB issued ASU 2015-01 Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items (“ASU 2015-01”), which eliminates from GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement-Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. The adoption of ASU 2015-01 became effective for the Company for its fiscal year ending December 31, 2016. The adoption of ASU 2015-01 did not have a material effect on the Company’s consolidated financial statements.
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In September 2015, the FASB issued ASU 2015-16 Business Combinations ("ASU 2015-16"), which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. ASU 2015-16 also requires the acquirer to record in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects as a result of the change to the acquisition date. Additionally, ASU 2015-16 requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Company adopted this ASU as of January 1, 2016. No prior year restatements are permitted for this change in policy. The adoption of ASU 2015-16 did not have a material effect on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02 Leases ("ASU 2016-02"), which requires an entity to separate lease components from nonlease components in a contract. ASU 2016-02 provides more guidance on how to identify and separate components than did previous GAAP. ASU 2016-02 requires lessees to recognize assets and liabilities arising from operating leases on the balance sheet. This amendment has not fundamentally changed lessor accounting, however some changes have been made to align and conform to the lessee guidance. The adoption of ASU 2016-02 becomes effective for the Company for the fiscal year beginning after December 15, 2018, and all subsequent annual and interim periods. Upon adoption, the Company will be required to recognize its operating leases, which are primarily comprised of one operating lease of the Georgia Tech Hotel & Conference Center and nine ground leases, on the balance sheet. Early adoption is permitted.
In March 2016, the FASB issued ASU 2016-07 Investments—Equity Method and Joint Ventures ("ASU 2016-07"), which requires that an equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The adoption of ASU 2016-07 becomes effective for the Company for the fiscal year beginning after December 15, 2016, and all subsequent annual and interim periods. Early adoption is permitted. The adoption of ASU 2016-07 is not expected to have a material effect on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09 Compensation—Stock Compensation ("ASU 2016-09"), which requires that all excess tax benefits and all tax deficiencies should be recognized as income tax expense or benefits in the income statement. These benefits and deficiencies are discrete items in the reporting period in which they occur. An entity should not consider these benefits or deficiencies in determining the annual estimated tax rate. The adoption of ASU 2016-09 becomes effective for the Company for the fiscal year beginning after December 15, 2016, and all subsequent annual and interim periods. Early adoption is permitted. The adoption of ASU 2016-09 is not expected to have a material effect on the Company’s consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15 Statement of Cash Flows—Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"), which addresses the presentation and classification of certain cash flow receipts and payments. The adoption of ASU 2016-15 becomes effective for the Company for the fiscal year beginning after December 15, 2017, and all subsequent annual and interim periods. The adoption of ASU 2016-15 is not expected to have a material effect on the Company's consolidated financial statements.
Note 3 - Business Combinations
Barceló Portfolio: On March 21, 2014, the Company completed an acquisition comprising investments in six hotels (the "Barceló Portfolio") through fee simple, leasehold and joint venture interests. The aggregate purchase price of the Barceló Portfolio was approximately $110.1 million, exclusive of closing costs. The Barceló Portfolio consists of (i) three wholly owned hotel assets, the Baltimore Courtyard Inner Harbor Hotel (the "Baltimore Courtyard"), the Courtyard Providence Downtown Hotel (the "Providence Courtyard") and the Homewood Suites by Hilton Stratford (the "Stratford Homewood Suites"); (ii) one leased asset, the Georgia Tech Hotel & Conference Center and (iii) equity interests in two joint ventures that each own one hotel, the Westin Virginia Beach and the Hilton Garden Inn Blacksburg.
Grace Acquisition: On February 27, 2015, the Company acquired a portfolio of 116 hotels (the "Grace Portfolio") through fee simple or leasehold interests from certain subsidiaries of Whitehall Real Estate Funds, an investment arm controlled by The Goldman Sachs Group, Inc.
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The aggregate purchase price under the purchase agreement was $1.808 billion, exclusive of closing costs and subject to certain adjustments at closing. After adjustments, the net purchase price was $1.800 billion. Approximately $221.7 million of the purchase price was satisfied with cash on hand, approximately $904.2 million (fair value on the acquisition date) through the assumption of existing mortgage and mezzanine indebtedness (comprising the "Assumed Grace Mortgage Loan" and the "Assumed Grace Mezzanine Loan", collectively, the "Assumed Grace Indebtedness") and approximately $227.0 million through additional mortgage financing (the "Original Additional Grace Mortgage Loan"). The Original Additional Grace Mortgage Loan was refinanced during October 2015 (the “Refinanced Additional Grace Mortgage Loan” and, together with the Assumed Grace Indebtedness, the "Grace Indebtedness") (See Note 5 - Mortgage Notes Payable).
The remaining $447.1 million of the contract purchase price was satisfied by the issuance of the preferred equity interests (the "Grace Preferred Equity Interests") in two newly-formed Delaware limited liability companies, ARC Hospitality Portfolio I Holdco, LLC and ARC Hospitality Portfolio II Holdco, LLC, (the "Holdco entities"), each of which is an indirect subsidiary of the Company and an indirect owner of the Grace Portfolio. The holders of the Grace Preferred Equity Interests were entitled to monthly distributions at a rate of 7.50% per annum for the first 18 months following closing, through August 2016, and 8.00% per annum thereafter. On liquidation of the Holdco entities, the holders of the Grace Preferred Equity Interests are entitled to receive their original value (as reduced by redemptions) prior to any distributions being made to the Company or the Company's stockholders. Beginning in April 2015, the Company became obligated to use 35% of any IPO proceeds to redeem the Grace Preferred Equity Interests at par, up to a maximum of $350.0 million in redemptions for any 12-month period. As of September 30, 2016, the Company has redeemed $154.8 million of the Grace Preferred Equity Interests, resulting in $292.3 million of liquidation value remaining outstanding under the Grace Preferred Equity Interests.
As of September 30, 2016, the Company is required to redeem 50.0% of the Grace Preferred Equity Interests originally issued, or an additional $68.8 million by February 27, 2018, and is required to redeem the remaining $223.5 million by February 27, 2019. Because the Company does not expect it will resume the IPO, it will require funds in addition to operating cash flow and cash on hand to meet its capital requirements. There can be no assurances that the Company will be able to secure these additional funds.
The Company is also required, in certain circumstances, to apply debt proceeds to redeem the Grace Preferred Equity Interests at par. In addition, the Company has the right, at its option, to redeem the Grace Preferred Equity Interests, in whole or in part, at any time at par. The holders of the Grace Preferred Equity Interests have certain consent rights over major actions by the Company relating to the Grace Portfolio. In connection with the issuance of the Grace Preferred Equity Interests, the Company and the OP have made certain guarantees and indemnities to the sellers and their affiliates or indemnifying the sellers and their affiliates related to the Grace Portfolio. If the Company is unable to satisfy the redemption, distribution or other requirements of the Grace Preferred Equity Interests (including if there is a default under the related guarantees provided by the Company and the OP), the holders of the Grace Preferred Equity Interests have certain rights, including the ability to assume control of the operations of the Grace Portfolio through the assumption of control of the Holdco entities. Due to the fact that the Grace Preferred Equity Interests are mandatorily redeemable and certain of their other characteristics, the Grace Preferred Equity Interests are treated as debt in accordance with GAAP.
The following table presents the allocation of the assets acquired and liabilities assumed by the Company on February 27, 2015 (in thousands):
Assets acquired and liabilities assumed | February 27, 2015 | |||
Land | $ | 274,512 | ||
Buildings and improvements | 1,391,695 | |||
Below-market lease obligation | 2,605 | |||
Furniture, fixtures and equipment | 127,954 | |||
Prepaid expenses and other assets | 8,247 | |||
Accounts payable and accrued expenses | (5,002 | ) | ||
Total operating assets acquired, net | 1,800,011 | |||
Financing of real estate investments | (1,351,282 | ) | ||
Total assets acquired, net | $ | 448,729 | ||
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HGI Blacksburg JV: On May 20, 2015, the Company acquired an additional equity interest in the HGI Blacksburg JV, increasing its percentage ownership to 56.5% from 24.0%. As a result of this transaction, the Company concluded that it is the primary beneficiary, with the power to direct activities that most significantly impact economic performance of the HGI Blacksburg JV, and therefore consolidated the entity in its consolidated financial statements subsequent to the acquisition. The purchase price of the additional equity interest was approximately $2.2 million, exclusive of closing costs. The joint venture asset holds one hotel, the Hilton Garden Inn Blacksburg.
Summit Acquisitions: In June 2, 2015, the Company entered into agreements with affiliates of Summit Hotel Properties, Inc. (the "Summit Sellers"), as amended from time to time thereafter, to purchase fee simple interests in a portfolio of 26 hotels in three separate closings for a total purchase price of approximately $347.4 million, subject to closing prorations and other adjustments. The first closing was completed on October 15, 2015.
On October 15, 2015, the Company completed the acquisition of ten hotels (the "First Summit Closing") for $150.1 million, which was funded with $7.6 million previously paid as an earnest money deposit, $45.6 million from the Company’s IPO and $96.9 million from an advance, secured by a mortgage on the hotels in the First Summit Closing, under the SN Term Loan (See Note 5 - Mortgage Notes Payable).
The following table presents the preliminary allocation of the assets acquired and liabilities assumed by the Company for the First Summit Closing on October 15, 2015 (in thousands):
Assets acquired and liabilities assumed | October 15, 2015 | |||
Land | $ | 16,949 | ||
Buildings and improvements | 120,414 | |||
Furniture, fixtures and equipment | 12,706 | |||
Accounts payable and accrued expenses | (1,042 | ) | ||
Total operating assets acquired, net | 149,027 | |||
SN Term Loan | (96,850 | ) | ||
Total assets acquired, net | $ | 52,177 | ||
The Company is finalizing the fair value of certain tangible and intangible assets acquired and adjustments may be made to the preliminary purchase price allocation shown above.
On December 29, 2015, the second closing of hotels to be acquired from the Summit Sellers was terminated. The Company and the Summit Sellers agreed to terminate the purchase agreement pursuant to which the Company had the right to acquire a fee simple interest in ten hotels (the "Second Summit Closing") for a total purchase price of $89.1 million. As a result of this termination, the Company forfeited $9.1 million in non-refundable earnest money deposits.
On February 11, 2016, the Company completed the acquisition of six hotels (the "Third Summit Closing") from the Summit Sellers for an aggregate purchase price of $108.3 million, which together with certain closing costs, was funded with $18.5 million previously paid as an earnest money deposit, $20.0 million in proceeds from a loan from the Summit Sellers (the "Summit Loan") described in Note 6 - Promissory Note Payable, and $70.4 million from an advance, secured by a mortgage on the hotels in the Third Summit Closing, under the SN Term Loan. The acquisition was immaterial to the consolidated financial statements.
Also on February 11, 2016, the Company entered into an agreement with the Summit Sellers to reinstate, with certain changes, the purchase agreement (the "Reinstatement Agreement") related to the hotels in the Second Summit Closing, pursuant to which the Company had been scheduled to acquire from the Summit Sellers ten hotels for an aggregate purchase price of $89.1 million.
Pursuant to the Reinstatement Agreement, the Second Summit Closing is scheduled to occur on December 30, 2016 and $7.5 million (the “New Deposit”) borrowed by the Company from the Summit Sellers was used as a new earnest money deposit.
Under the Reinstatement Agreement, the Summit Sellers have the right to market and ultimately sell any or all of the hotels in the Second Summit Closing to a bona fide third party purchaser without the consent of the Company at any time prior to the Company completing its acquisition of the Second Summit Closing. If any hotel is sold in this manner, the Reinstatement
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Agreement will terminate with respect to such hotel and the purchase price will be reduced by the amount allocated to such hotel. If all (but not less than all) of the hotels in the Second Summit Closing are sold in this manner, or if the Reinstatement Agreement is terminated with respect to all (but not less than all) of the hotels in the Second Summit Closing under certain other circumstances (including if there are title issues or material casualties or condemnations involving a particular hotel), then the New Deposit will be automatically applied towards any then outstanding principal balance of the Summit Loan, and any remaining balance of the New Deposit will be remitted to the Company. In June 2016, the Summit Sellers informed the Company that two of the ten hotels had been sold, thereby reducing the Second Summit Closing to eight hotels for an aggregate purchase price of $77.2 million.
Noble Acquisitions: On June 15, 2015, the Company entered into agreements with affiliates of Noble Investment Group, LLC (the "Noble Sellers"), as amended from time to time thereafter, to purchase fee simple interests in a portfolio of 13 hotels in four separate closing for a total purchase price of $300.0 million.
On November 2, 2015, the Company completed the acquisition of two hotels (the "First Noble Closing") from the Noble Sellers for $48.6 million, which was funded with $3.6 million previously paid as an earnest money deposit, $19.0 million from the Company’s IPO and $26.0 million from an advance, secured by a mortgage on the hotels in the First Noble Closing under the SN Term Loan.
On December 2, 2015, the Company completed the acquisition of two hotels (the “Second Noble Closing”) from the Noble Sellers for an aggregate purchase price of $59.0 million, which was funded with $4.4 million previously paid as an earnest money deposit, $12.3 million in proceeds from the Company’s IPO and $42.3 million from an advance, secured by a mortgage on the hotels in the Second Noble Closing under the SN Term Loan.
On January 25, 2016, the third and fourth closing of the Noble acquisition comprising nine hotels in total were terminated. The Company and the Noble Sellers agreed to terminate each of the applicable hotels purchase agreements. As a result of this termination, the Company forfeited $22.0 million in non-refundable earnest money deposits.
Note 4 - Leases
In connection with its acquisitions the Company has assumed various lease agreements. These lease agreements primarily comprise one operating lease of the Georgia Tech Hotel & Conference Center and nine ground leases which are also classified as operating leases. The following table summarizes the Company's future minimum rental commitments under these leases (in thousands).
Minimum Rental Commitments | Amortization of Above and Below Market Lease Intangibles to Rent Expense | |||||||
For the three months ending December 31, 2016 | $ | 1,298 | $ | 100 | ||||
Year ending December 31, 2017 | 5,210 | 398 | ||||||
Year ending December 31, 2018 | 5,217 | 398 | ||||||
Year ending December 31, 2019 | 5,227 | 398 | ||||||
Year ending December 31, 2020 | 5,265 | 398 | ||||||
Thereafter | 87,014 | 8,234 | ||||||
Total | $ | 109,231 | $ | 9,926 | ||||
The Company has allocated values to certain above and below-market lease intangibles based on the difference between market rents and rental commitments under the leases. During the three months ended September 30, 2016 and September 30, 2015, and the nine months ended September 30, 2016 and September 30, 2015, amortization of below-market lease intangibles, net, to rent expense was $0.1 million and $0.1 million, and $0.3 million and $0.3 million, respectively. Rent expense for the three months ended September 30, 2016 and September 30, 2015, and nine months ended September 30, 2016 and September 30, 2015, was $1.8 million and $1.8 million, and $4.7 million and $4.4 million, respectively.
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Note 5 - Mortgage Notes Payable
The Company’s mortgage notes payable as of September 30, 2016 and December 31, 2015 consist of the following, respectively (in thousands):
Outstanding Mortgage Notes Payable | ||||||||||||||
Encumbered Properties | September 30, 2016 | December 31, 2015 | Interest Rate | Payment | Maturity | |||||||||
Baltimore Courtyard & Providence Courtyard | $ | 45,500 | $ | 45,500 | 4.30% | Interest Only, Principal paid at Maturity | April 2019 | |||||||
Hilton Garden Inn Blacksburg Joint Venture | 10,500 | 10,500 | 4.31% | Interest Only, Principal paid at Maturity | June 2020 | |||||||||
Assumed Grace Mortgage Loan - 96 properties in Grace Portfolio | 801,198 | 801,430 | LIBOR plus 3.29% | Interest Only, Principal paid at Maturity | May 2017, subject to two, one year extension rights | |||||||||
Assumed Grace Mezzanine Loan - 96 properties in Grace Portfolio | 102,726 | 102,550 | LIBOR plus 4.77% | Interest Only, Principal paid at Maturity | May 2017, subject to two, one year extension rights | |||||||||
Refinanced Additional Grace Mortgage Loan - 20 properties in Grace Portfolio and one additional property | 232,000 | 232,000 | 4.96% | Interest Only, Principal paid at Maturity | October 2020 | |||||||||
SN Term Loan - 20 properties in Summit and Noble Portfolios | 235,484 | 165,100 | LIBOR plus between 3.25% and 3.75% | Interest Only, Principal paid at Maturity | August 2018, subject to two, one year extension rights | |||||||||
Total Mortgage Notes Payable | $ | 1,427,408 | $ | 1,357,080 | ||||||||||
Less: Deferred Financing Fees, Net | $ | 9,128 | $ | 16,047 | ||||||||||
Total Mortgage Notes Payable, Net | $ | 1,418,280 | $ | 1,341,033 | ||||||||||
Interest expense related to the Company's mortgage notes payable for the three months ended September 30, 2016 and for the three months ended September 30, 2015, was $15.2 million and $12.7 million, respectively. Interest expense related to the Company's mortgage notes payable for the nine months ended September 30, 2016 and for the nine months ended September 30, 2015, was $44.7 million and $29.3 million, respectively.
Baltimore Courtyard and Providence Courtyard
The Baltimore Courtyard and Providence Courtyard Loan matures on April 6, 2019. On May 6, 2014 and each month thereafter, the Company is required to make an interest only payment based on the outstanding principal and a fixed annual interest rate of 4.30%. The entire principal amount is due at maturity.
Hilton Garden Inn Blacksburg Joint Venture
The Hilton Garden Inn Blacksburg Joint Venture Loan matures June 6, 2020. On July 6, 2015 and each month thereafter, the Company is required to make an interest only payment based on the outstanding principal and a fixed annual interest rate of 4.31%. The entire principal amount is due at maturity.
Assumed Grace Indebtedness
The Assumed Grace Mortgage Loan and the Assumed Grace Mezzanine Loan mature on May 1, 2017, subject to two (one-year) extension rights which, if both are exercised, would result in an outside maturity date of May 1, 2019. The extensions on the Assumed Grace Mortgage Loan and the Assumed Grace Mezzanine Loan can only occur if certain conditions are met, including a condition that a minimum ratio of net operating income to debt outstanding be satisfied. There can be no assurance that the Company will be able to meet these conditions and extend these loans pursuant to their terms. The Assumed Grace Mortgage Loan carries an interest rate of London Interbank Offered Rate ("LIBOR") plus 3.29%, and the Assumed Grace Mezzanine Loan carries an interest rate of LIBOR plus 4.77%, for a combined weighted average interest rate of LIBOR plus 3.46%. Pursuant to the Assumed Grace Indebtedness, the Company has agreed to make periodic payments into an escrow
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account for the property improvement plans required by the franchisors. The Assumed Grace Indebtedness includes the following financial covenants: minimum consolidated net worth and minimum consolidated liquidity. As of September 30, 2016, the Company was in compliance with these financial covenants.
Refinanced Additional Grace Mortgage Loan
The Refinanced Additional Grace Mortgage Loan carries a fixed annual interest rate of 4.96% per annum with a maturity date on October 6, 2020. Pursuant to the Refinanced Additional Grace Mortgage Loan, the Company agreed to make periodic payments into an escrow account for the property improvement plans required by the franchisors. The Refinanced Additional Grace Mortgage Loan includes the following financial covenants: minimum consolidated net worth and minimum consolidated liquidity. As of September 30, 2016, the Company was in compliance with these financial covenants.
SN Term Loan
On August 21, 2015, the Company entered into a Term Loan Agreement with Deutsche Bank AG New York Branch, as administrative agent and Deutsche Bank Securities Inc., as sole lead arranger and book-running manager (as amended, the "SN Term Loan"). On October 15, 2015, the Company amended and restated the SN Term Loan and made the initial draw down of borrowings of $96.9 million in connection with the First Summit Closing. On November 2, 2015, the Company drew down borrowings of $26.0 million in connection with the First Noble Closing. On December 2, 2015 the Company drew down borrowings of $42.3 million in connection with the Second Noble Closing. On February 11, 2016, the Company drew down borrowings of $70.4 million in connection with the Third Summit Closing, and amended the SN Term Loan to reduce the lenders’ total commitment from $450.0 million to $293.4 million. On July 1, 2016, the period in which the Company had the ability to further draw down on the SN Term Loan expired, reducing the lenders' total commitment to $235.5 million. No additional amounts are available to be drawn under the SN Term Loan. Due to the amendment and the expiration, the Company recorded a reduction to its deferred financing fees associated with the SN Term Loan. The reduction of $3.0 million was reflected as a general and administrative expense in the Consolidated Statements of Operations and Comprehensive Income (Loss).
The SN Term Loan provided for financing (the “Loans”) at a rate equal to a base rate plus a spread of between 3.25% and 3.75% for Eurodollar rate Loans and between 2.25% and 2.75% for base rate Loans, depending on the aggregate debt yield and aggregate loan-to-value of the properties securing the Loans measured periodically. Prior to November 1, 2015, all spreads were 0.5% less than they will be during the rest of the term. The SN Term Loan has a term of three years, with two one-year extension options, and is secured by the fee interest in the hotels acquired. The extensions on the SN Term Loan can only occur if certain conditions are met, including a condition that a minimum ratio of net operating income to debt outstanding be satisfied. If the Company exercises the extension options the Loans will amortize in an amount of 2.5% per annum payable quarterly. There can be no assurance that we will be able to meet these conditions and extend this loan pursuant to its terms.
Pursuant to the SN Term Loan, the Company agreed to make periodic payments into an escrow account for the property improvement plans required by the franchisors. The SN Term Loan includes the following financial covenants: minimum debt service coverage ratio, minimum consolidated net worth and minimum consolidated liquidity. As of September 30, 2016, the Company was in compliance with these financial covenants.
Note 6 - Promissory Note Payable
The Company’s promissory note payable as of September 30, 2016 and December 31, 2015 were as follows (in thousands):
Outstanding Promissory Note Payable | |||||||||||
Note Payable | September 30, 2016 | December 31, 2015 | Interest Rate | ||||||||
Summit Loan Promissory Note | $ | 23,172 | $ | — | 13.0 | % | |||||
Less: Deferred Financing Fees, Net | 79 | — | |||||||||
Promissory Notes Payable, Net | $ | 23,093 | $ | — | |||||||
On February 11, 2016, the Summit Sellers loaned the Company $27.5 million under the Summit Loan. Proceeds from the Summit Loan totaling $20.0 million were used to pay a portion of the purchase price of the Third Summit Closing and proceeds
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from the Summit Loan totaling $7.5 million were used as a new purchase price deposit on the reinstated Second Summit Closing.
The Summit Loan initially bears interest at a rate of 13.0% per annum, of which 9.0% is paid in cash monthly and an additional 4% (the “Added Rate”) accrues and is compounded monthly and added to the outstanding principal balance at maturity unless otherwise paid in cash by the Company. The Summit Loan has an initial maturity date of February 11, 2017, and the Seller Loan Agreement provides for two one-year extensions at the Company’s option, subject to the payment in cash of the interest accrued at the Added Rate. Upon each extension, the Added Rate will be increased by 1%. As required pursuant to the Summit Loan, the Company paid principal in the amount of $3.0 million during the quarter ended September 30, 2016, and $5.0 million for the nine months ended September 30, 2016. No other principal payments are required pursuant to the Summit Loan prior to maturity. The Company may pre-pay the Summit Loan in whole or in part without penalty at any time.
The Company also made certain other agreements with respect to future sales and purchases of hotels under the Summit Loan.
Interest expense related to the Company's promissory notes payable for the three months ended September 30, 2016 was $0.8 million. There was no interest expense related to the Company's promissory notes payable for the three months ended September 30, 2015. Interest expense related to the Company's promissory notes payable for the nine months ended September 30, 2016 and for the nine months ended September 30, 2015, was $2.2 million and $1.4 million, respectively. Interest expense recognized for the nine months ended September 30, 2015 was related to notes payable in connection with the Barceló Portfolio, which were repaid in full during the quarter ended June 30, 2015.
Note 7 - Accounts Payable and Accrued Expenses
The following is a summary of the components of accounts payable and accrued expenses (in thousands):
September 30, 2016 | December 31, 2015 | ||||||
Trade accounts payable and accrued expenses | $ | 60,957 | $ | 57,472 | |||
Contingent consideration from Barceló Portfolio (See Note 10 - Commitments and Contingencies) | 4,618 | 3,164 | |||||
Hotel accrued salaries and related liabilities | 10,226 | 6,619 | |||||
Total | $ | 75,801 | $ | 67,255 | |||
Note 8 - Common Stock
The Company had 37,833,988 shares and 36,300,777 shares of common stock outstanding and had received total proceeds of $913.0 million and $902.9 million as of September 30, 2016 and December 31, 2015, respectively. The shares outstanding include shares of common stock issued as stock distributions through September 30, 2016, as a result of the Company's change in distribution policy adopted by the Company's board of directors in March 2016 as described below.
Distributions
On February 3, 2014, the Company's board of directors authorized, and the Company declared, distributions payable in cash to stockholders of record each day during the applicable month equal to $0.0046575343 per day (or $0.0046448087 if a 366-day year), or $1.70 per annum, per share of common stock. The first distribution was paid in May 2014 to holders of record in April 2014. The distributions are payable by the fifth day following each month end to stockholders of record at the close of business each day during the prior month.
To date, the Company has funded all of its cash distributions with proceeds from the Offering, which was suspended as of December 31, 2015.
Because the Company requires funds in addition to its operating cash flow and cash on hand to meet its capital requirements, in March 2016 the Company’s board of directors changed the distribution policy, such that distributions paid with respect to April 2016 were paid in shares of common stock instead of cash. Accordingly, the Company paid a cash distribution to stockholders of record each day during the quarter ended March 31, 2016, but distributions for subsequent periods have been and, unless and until the Company's board of directors determines otherwise, will continue to be paid in shares of common stock. Distributions for the quarter ended June 30, 2016 were paid in common stock in an amount equivalent to $1.70 per annum, divided by $23.75.
On July 1, 2016, the Company's board of directors approved an Estimated Per-Share NAV, which was published on the same date. This was the first time that the Company’s board of directors determined an Estimated Per-Share NAV. In connection with its determination of Estimated Per-Share NAV, the Company’s board of directors revised the amount of the distribution to $1.46064 per share per annum, equivalent to a 6.80% annual rate based on Estimated Per-Share NAV, automatically adjusting if
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and when the Company publishes an updated Estimated Per-Share NAV. It is currently anticipated that the Company will publish an updated Estimated Per-Share NAV on at least an annual basis. The Company’s board of directors authorized distributions, payable in shares of common stock, at a rate of 0.068 multiplied by the Estimated Per-Share NAV in effect as of the close of business on the applicable date. Therefore, beginning with distributions payable with respect to July 2016, the Company has paid distributions to its stockholders in shares of common stock on a monthly basis to stockholders of record each day during the prior month in an amount equal to 0.000185792 per share per day, or $1.46064 per annum, divided by $21.48.
The Company’s distribution policy is subject to revision at the discretion of its board of directors, and may be changed at any time. There can be no assurance that the Company will continue to pay distributions in shares of common stock or be able to pay distributions in cash in the future. The Company’s ability to make future cash distributions will depend on its future cash flows and may be dependent on its ability to obtain additional liquidity, which may not be available on favorable terms, or at all.
Share Repurchase Program
On January 28, 2016, the Company announced that its board of directors had unanimously approved an amendment and restatement of the Company's share repurchase program (the "SRP"), which became effective on February 28, 2016. Under the SRP as amended and restated, subject to certain conditions, stockholders that purchased shares of common stock of the Company or received their shares from the Company (directly or indirectly) through one or more non-cash transactions and have held their shares for a period of at least one year may request that the Company repurchase their shares of common stock so long as the repurchase otherwise complies with the provisions of Maryland law. Repurchase requests made following the death or qualifying disability of a stockholder are not subject to any minimum holding period.
Repurchases pursuant to the SRP, when requested, generally will be made semiannually (each six-month period ending June 30 or December 31, a “semi-annual period”). Repurchases for any semi-annual period will be limited to a maximum of 2.5% of the weighted average number of shares of common stock outstanding during the previous fiscal year, with a maximum for any fiscal year of 5.0% of the weighted average number of shares of common stock outstanding during the previous fiscal year.
Repurchases pursuant to the SRP for any given semi-annual period will be funded from proceeds received during that same semi-annual period through the issuance of common stock pursuant to the DRIP, unless the board of directors in its sole discretion makes available other funds for this purpose. As described further above, beginning with distributions payable with respect to April 2016, the Company commenced paying distributions to its stockholders in shares of common stock instead of cash. The Company will not issue any additional shares of common stock under the DRIP unless and until it recommences paying distributions in cash. The Company also does not expect the board of directors will make other funds available for these purposes until the Company is able to obtain additional liquidity on favorable terms. Accordingly, the Company does not currently expect to make any repurchases under the SRP during 2016.
To the extent the Company makes repurchases under the SRP, the repurchase price per share for requests other than for death or disability will be an amount equal to the then-current Estimated Per-Share NAV, in each case multiplied by a percentage equal to:
• | 92.5%, if the person seeking repurchase has held his or her shares for a period greater than one year and less than two years; |
• | 95%, if the person seeking repurchase has held his or her shares for a period greater than two years and less than three years; |
• | 97.5%, if the person seeking repurchase has held his or her shares for a period greater than three years and less than four years; or |
• | 100%, if the person seeking repurchase has held his or her shares for a period greater than four years. |
In the case of requests for death or disability, the repurchase price per share will be equal to the Estimated Per-Share NAV at the time of repurchase.
If the establishment of an Estimated Per-Share NAV occurs during any semi-annual period, any repurchase requests received during such semi-annual period will be paid at a price based on Estimated Per-Share NAV applicable on the last day of the semi-annual period, as described above.
Distribution Reinvestment Plan
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Pursuant to the DRIP, to the extent the Company pays distributions in cash, stockholders may elect to reinvest distributions by purchasing shares of common stock. No dealer manager fees or selling commissions are paid with respect to shares purchased pursuant to the DRIP. The shares purchased pursuant to the DRIP have the same rights and are treated in the same manner as all other shares of the Company's common stock. The board of directors may designate that certain cash or other distributions be excluded from the DRIP. The Company has the right to amend or suspend any aspect of the DRIP or terminate the DRIP with ten days’ notice to participants. Shares issued under the DRIP are recorded to equity in the Consolidated Balance Sheets in the period distributions are paid. There were 1,226,867 shares issued under the DRIP as of September 30, 2016 and 828,217 shares issued under the DRIP as of December 31, 2015. Commencing with distributions paid with respect to April 2016, the Company has paid distributions in shares of common stock instead of cash. The Company will not issue any additional shares of common stock under the DRIP unless and until it recommences paying distributions in cash.
All shares issued under the DRIP were purchased at $23.75 per share. If and when the Company issues any additional shares of common stock under the DRIP, distributions reinvested in common stock will be at a price equal to the Estimated Per-Share NAV.
Note 9 - Fair Value Measurements
The Company is required to disclose the fair value of financial instruments which it is practicable to estimate. The fair value of cash and cash equivalents, accounts receivable and accounts payable and accrued expenses approximate their carrying amounts due to the relatively short maturity of these items. The following table shows the carrying values and the fair values of material liabilities that qualify as financial instruments (in thousands):
September 30, 2016 | |||||||
Carrying Amount | Fair Value | ||||||
Mortgage and promissory notes payable(1) | $ | 1,450,580 | $ | 1,451,968 | |||
(1) Carrying amount does not include the associated deferred financing fees as of September 30, 2016. | |||||||
The fair value of the mortgage and promissory notes payable were determined using the discounted cash flow method and applying current market rates and is classified as level 3 under the fair value hierarchy. As described in Note 10 - Commitments and Contingencies, the carrying amount of the contingent consideration related to the Barceló Portfolio acquisition was remeasured to fair value as of September 30, 2016.
As described in Note 13 - Impairment of Long Lived Assets, the Company recorded an impairment charge of $2.4 million during the quarter ended June 30, 2016, to reflect one hotel asset at its fair value of $6.2 million. This value was determined using one or more unobservable inputs representing a nonrecurring level 3 fair value measurement.
Note 10 - Commitments and Contingencies
Litigation
In the ordinary course of business, the Company may become subject to litigation, claims and regulatory matters. There are no material legal or regulatory proceedings pending or known to be contemplated against the Company at the date of this filing.
Environmental Matters
In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. The Company has not been notified by any governmental authority of any non-compliance, liability or other claim and is not aware of any other environmental condition that it believes will have a material adverse effect on the results of operations.
Contingent Consideration
Included as part of the acquisition of the Barceló Portfolio is a contingent consideration payable to the seller based on the operating results of the Baltimore Courtyard, Providence Courtyard and Stratford Homewood Suites. During August 2016, the Company and the seller entered into an agreement extending and modifying the payment terms of the contingent consideration.
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The amount payable is calculated by applying a contractual capitalization rate to the excess earnings before interest, taxes, and depreciation and amortization, earned in the third year after the acquisition over an agreed upon target, provided the contingent consideration generally will not be less than $4.1 million or exceed $4.6 million. In each of the quarters ended March 31, 2016, June 30, 2016, and September 30, 2016, the Company revised its forecast resulting in an increase in the contingent consideration payable of $1.4 million, including $0.6 million during the quarter ended September 30, 2016. The change in the contingent consideration payable is reflected in other income (expense) in the Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine month periods ended September 30, 2016. The contingent consideration payable as of September 30, 2016 is $4.6 million. The Company anticipates paying the contingent consideration on July 3, 2017.
Note 11 - Related Party Transactions and Arrangements
As of September 30, 2016, American Realty Capital Hospitality Special Limited Partner, LLC (the "Special Limited Partner"), which is wholly owned by AR Capital, owned 9,153 shares of the Company’s outstanding common stock. Additionally, as of September 30, 2016, AR Capital, the parent of the Sponsor, owned 22,881 shares of the Company's outstanding common stock, and AR Global owned 6,587 shares of the Company's outstanding common stock.
The Company's Former Dealer Manager served as the dealer manager of the IPO. SK Research, LLC and American National Stock Transfer, LLC ("ANST"), both subsidiaries of the parent company of the Former Dealer Manager, provided other general professional services through December 2015 and January 2016, respectively. RCS Capital Corporation ("RCAP"), the parent company of the Former Dealer Manager and certain of its affiliates that provided services to the Company, filed for Chapter 11 bankruptcy protection in January 2016, prior to which it was also under common control with AR Capital, the parent of the Company's Sponsor, and AR Global. In May 2016, RCAP and its affiliated debtors emerged from bankruptcy under the new name, Aretec Group, Inc.
The Advisor and its affiliates are entitled to a variety of fees, and may incur and pay costs and fees on behalf of the Company for which they are entitled to reimbursement. The Company had a payable due to related parties related to operating, acquisition, financing and offering costs of $8.8 million and $6.5 million as of September 30, 2016 and December 31, 2015, respectively.
Fees Paid in Connection with the Offering
The Former Dealer Manager was paid fees and compensation in connection with the sale of the Company's common stock in the Offering prior to its suspension. The Former Dealer Manager was paid a selling commission of up to 7.0% of the per share purchase price of the Company’s Offering proceeds before reallowance of commissions earned by participating broker-dealers. In addition, the Former Dealer Manager was paid up to 3.0% of the gross proceeds from the sale of shares, before reallowance to participating broker-dealers, as a dealer-manager fee. The Former Dealer Manager was entitled to reallow its dealer-manager fee to participating broker-dealers. A participating broker dealer was entitled to elect to receive a fee equal to 7.5% of the gross proceeds from the sale of shares by such participating broker dealer, with 2.5% thereof paid at the time of such sale and 1.0% thereof paid on each anniversary of the closing of such sale up to and including the fifth anniversary of the closing of such sale. If this option was elected, the dealer manager fee has been reduced to 2.5% of gross proceeds.
On December 31, 2015, the Company, the Advisor and the Former Dealer Manager mutually agreed, pursuant to a termination agreement dated December 31, 2015, to terminate the Exclusive Dealer Manager Agreement dated January 7, 2014 among the Company, the Advisor and the Former Dealer Manager.
No dealer manager fees or selling commissions have been paid with respect to shares which were purchased pursuant to the DRIP.
The table below shows the commissions and fees incurred from and payable to the Former Dealer Manager for the Offering during the three months ended September 30, 2016 and 2015, the nine months ended September 30, 2016 and 2015, and the associated payable as of September 30, 2016 and December 31, 2015, which is recorded in due to related parties on the Company's Consolidated Balance Sheets (in thousands):
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Three Months Ended September 30, | Nine Months Ended September 30, | Payable as of | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | September 30, 2016 | December 31, 2015 | |||||||||||||||||||
Total commissions and fees incurred from the Dealer Manager | $ | — | $ | 13,289 | $ | 71 | $ | 47,914 | $ | — | $ | 1 | ||||||||||||
The Advisor and its affiliates were paid compensation and/or received reimbursement for services relating to the Offering, including transfer agency services provided by ANST, an affiliate of the Former Dealer Manager. The Company is responsible for the Offering and related costs (excluding selling commissions and dealer manager fees) up to a maximum of 2.0% of gross proceeds received from the Offering, measured at the end of the Offering. Offering costs in excess of the 2.0% cap as of the end of the Offering are the Advisor’s responsibility. As of September 30, 2016, Offering and related costs (excluding selling commissions and dealer manager fees) exceeded 2.0% of gross proceeds received from the Offering by $5.9 million.
Offering costs incurred by the Advisor or its affiliated entities on behalf of the Company have generally been recorded as a reduction to additional paid-in-capital on the accompanying Consolidated Balance Sheets. The table below shows compensation and reimbursements incurred and payable to the Advisor and its affiliates for services relating to the Offering during the three months ended September 30, 2016 and 2015, the nine months ended September 30, 2016 and 2015, and the associated amounts payable as of September 30, 2016 and December 31, 2015, which is recorded in due to related parties on the Company’s Consolidated Balance Sheets (in thousands).
Three Months Ended September 30, | Nine Months Ended September 30, | Payable as of | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | September 30, 2016 | December 31, 2015 | |||||||||||||||||||
Total compensation and reimbursement for services provided by the Advisor and its affiliates related to the Offering | $ | — | $ | 4,045 | $ | — | $ | 13,979 | $ | 433 | $ | 787 | ||||||||||||
AR Capital was a party to a services agreement with RCS Advisory Services, LLC ("RCS Advisory"), an affiliate of the Former Dealer Manager, pursuant to which RCS Advisory and its affiliates provided the Company and certain other companies sponsored by AR Global with services (including, without limitation, transaction management, compliance, due diligence, event coordination and marketing services, among others) on a time and expenses incurred basis or at a flat rate based on services performed. AR Capital instructed RCS Advisory to stop providing such services in November 2015 and no services have since been provided by RCS Advisory.
The Company was also party to a transfer agency agreement with ANST, pursuant to which ANST provided the Company with transfer agency services (including broker and stockholder servicing, transaction processing, year-end IRS reporting and other services), and supervisory services overseeing the transfer agency services performed by a third-party transfer agent. AR Global received written notice from ANST on February 10, 2016 that it would wind down operations by the end of the month and would withdraw as the transfer agent effective February 29, 2016. On February 26, 2016, the Company entered into a definitive agreement with DST Systems, Inc., its previous provider of sub-transfer agency services, to provide the Company directly with transfer agency services (including broker and stockholder servicing, transaction processing, year-end IRS reporting and other services). Following the suspension of the IPO on November 15, 2015, fees payable with respect to transfer agency services are included in general and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income (Loss) during the period the service was provided.
Fees Paid in Connection With the Operations of the Company
Fees Paid to the Advisor
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The Advisor is paid an acquisition fee of 1.5% of (A) the contract purchase price of each acquired property and (B) the amount advanced for a loan or other investment. The Advisor may also be reimbursed for expenses incurred in the process of acquiring properties, in addition to third-party costs the Company may pay directly to, or reimburse the Advisor for. Additionally, the Company may reimburse the Advisor for legal expenses it or its affiliates directly incur in the process of acquiring properties in an amount not to exceed 0.1% of the contract purchase price of the Company’s assets acquired. Once the proceeds from the Offering have been fully invested, the aggregate amount of acquisition fees and financing coordination fees (as described below) may not exceed 1.9% of the contract purchase price, for any new investments, including reinvested proceeds, and the amount advanced for a loan or other investment, for all the assets acquired. In no event will the total of all acquisition fees, acquisition expenses and any financing coordination fees (as described below) payable with respect to the Company's total portfolio of investments, calculated after the close of the Offering and once the Company has invested substantially all the proceeds of the Offering, exceed 4.5% of (A) the contract purchase price of all of the Company's properties and (B) the amount advanced for all of the Company's loans or other investments. Fees paid to the Advisor related to acquisitions are reported as a component of net income (loss) in the period incurred.
If the Advisor provides services in connection with the origination or refinancing of any debt that the Company obtains and uses to acquire properties or to make other permitted investments, or that is assumed, directly or indirectly, in connection with the acquisition of properties, the Company will pay the Advisor or its assignees a financing coordination fee equal to 0.75% of the amount available and/or outstanding under such financing, subject to certain limitations. Fees paid to the Advisor related to debt financings are deferred and amortized over the term of the related debt instrument.
The Advisor receives a fee for asset management services it provides to the Company. For asset management services provided by the Advisor prior to October 1, 2015, the Advisor received a subordinated participation in the form of performance-based restricted, forfeitable partnership units of the OP (designated as “Class B Units”).
On November 11, 2015, the Company, the OP and the Advisor agreed to an amendment to the advisory agreement (as amended, the "Advisory Agreement"), pursuant to which, effective October 1, 2015, the Company became required to pay asset management fees in cash (subject to certain coverage limitations during the pendency of the Offering), or shares of the Company's common stock, or a combination of both, at the Advisor’s election, and the asset management fee is paid on a monthly basis. The monthly fees are equal to:
• | The cost of the Company’s assets (until July 1, 2016, then the lower of the cost of the Company's assets or the fair market value of the Company's assets), multiplied by |
• | 0.0625%. |
For asset management services provided by the Advisor prior to October 1, 2015, the Company issued Class B Units on a quarterly basis in an amount equal to:
•The cost of the Company’s assets multiplied by
•0.1875%, divided by
• | The value of one share of common stock as of the last day of such calendar quarter, which was equal to $22.50 (the Offering price prior to its suspension minus selling commissions and dealer manager fees). |
The Advisor is entitled to receive distributions on the Class B Units it has received in connection with its asset management subordinated participation at the same rate as distributions received on the Company’s common stock. Such distributions are in addition to the incentive fees and other distributions the Advisor and its affiliates may receive from the Company and the OP, including without limitation, the annual subordinated performance fee and the subordinated participation in net sales proceeds, the subordinated incentive listing distribution or the subordinated distribution upon termination of the Advisory Agreement, each as described below.
The Class B Units do not become unrestricted until certain performance conditions are satisfied, including until the adjusted market value of the OP’s assets plus applicable distributions equals or exceeds the aggregate capital contributed by investors plus an amount equal to a 6.0% cumulative, pre-tax, non-compounded annual return to investors, and the occurrence of a sale of all or substantially all of the OP’s assets, a listing of the Company’s common stock, or a termination of the Advisory Agreement without cause. A total of 524,956 Class B Units have been issued as of September 30, 2016 for asset management services performed by the Advisor, and a total of 12,311 shares of common stock have been issued as of September 30, 2016 to the Advisor for distributions payable on the Class B Units.
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The issuance of Class B Units did not result in any expense on the Company’s consolidated statements of operations, except for distributions paid on the Class B Units. The distributions payable on Class B Units for periods through March 31, 2016 were paid in cash. Beginning in the second quarter ended June 30, 2016, the Company began paying distributions on the Class B Units in shares of common stock on the same terms paid to the Company’s stockholders.
The table below presents the Class B Units distribution expense for the three months ended September 30, 2016 and 2015 respectively, and for the nine months ended September 30, 2016, and 2015, respectively, and the associated payable as of September 30, 2016 and December 31, 2015, which is recorded in due to related parties on the Company's Consolidated Balance Sheets (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | Payable as of | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | September 30, 2016 | December 31, 2015 | |||||||||||||||||||
Class B Units distribution expense | $ | 193 | $ | 96 | $ | 637 | $ | 224 | $ | 62 | $ | 92 | ||||||||||||
The table below presents the asset management fees, acquisition fees, acquisition cost reimbursements and financing coordination fees charged by the Advisor in connection with the operations of the Company for the three months ended September 30, 2016 and 2015, and for the nine months ended September 30, 2016 and 2015, and the associated payable as of September 30, 2016 and December 31, 2015, which is recorded in due to related parties on the Company's Consolidated Balance Sheets (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | Payable as of | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | September 30, 2016 | December 31, 2015 | |||||||||||||||||||
Asset management fees | $ | 4,469 | $ | — | $ | 13,446 | $ | — | $ | 39 | $ | 1,190 | ||||||||||||
Acquisition fees | $ | — | $ | — | $ | 1,624 | $ | 27,203 | $ | — | $ | — | ||||||||||||
Acquisition cost reimbursements | $ | — | $ | — | $ | 108 | $ | 1,808 | $ | — | $ | — | ||||||||||||
Financing coordination fees | $ | — | $ | 3,375 | $ | 206 | $ | 15,254 | $ | — | $ | — | ||||||||||||
$ | 4,469 | $ | 3,375 | $ | 15,384 | $ | 44,265 | $ | 39 | $ | 1,190 | |||||||||||||
In March 2016, the Company, the OP and the Advisor further amended (the "Amendment") the Advisory Agreement to provide the Company with the right to pay up to $500,000 per month of asset management fees payable to the Advisor under the Advisory Agreement in shares of the Company’s common stock for the period of time beginning on June 1, 2016 and ending on June 1, 2017. The Company's right to pay such portion of the asset management fees in shares of common stock will commence on the date (the “Trigger”) that the elimination of its payment of cash distributions is insufficient to provide adequate liquidity levels consistent with assumptions mutually agreed to in good faith by the Company's independent directors and the Advisor from time to time (the “Relief Period”). As of September 30, 2016, the Trigger has not occurred and the Company has not exercised this right.
The Company's right is subject to termination on the earlier of:
• | the date on which the Company has completed a public or private offering, which provides net proceeds in excess of $500,000 multiplied by the remaining months prior to June 1, 2017, after repayment or redemption of any indebtedness or preferred stock which is repayable or redeemable out of the proceeds of such offering; |
• | the date on which the Company has completed an asset sale or borrowing, which provides net proceeds in excess of $50.0 million, after repayment or redemption of any indebtedness or preferred stock which is repayable or redeemable out of the proceeds of such transaction; |
• | the date that the Company’s board of directors declares a distribution all or a portion of which is payable in cash; |
• | a change of control (as defined in the Amendment), any restructuring of the Company’s debt or preferred stock that results in net proceeds in excess of $500,000 multiplied by the remaining months prior to June 1, 2017, after |
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repayment or redemption of any indebtedness or preferred stock which is repayable or redeemable out of the proceeds of such transaction or such transaction results in the reduction in other cash usage by the Company during the Relief Period in excess of $500,000 multiplied by the remaining months prior to June 1, 2017, or a sale, exchange, transfer or other disposition of substantially all of the Company’s assets; or
• | termination of the Advisory Agreement. |
If an event described in the fourth or fifth bullets above occurs, the Company has agreed to redeem any shares of common stock issued to the Advisor as payment of asset management fees as described above for cash at the original issuance price. Pursuant to the Amendment, the Company also agreed to certain registration rights for the benefit of the Advisor with respect to the resale of the shares of common stock issued to the Advisor as payment of asset management fees as described above.
Pursuant to the Amendment, the Company also agreed, subject to the effectiveness of an amendment of the Company’s charter, to extend the term of the Advisory Agreement to June 1, 2017 and that the notice period for terminating the Advisory Agreement will be ninety (90) days’ notice instead of sixty (60) days’ notice if the Trigger occurs prior to an expiration of the term. In August 2016, the stockholders of the Company approved the charter amendment and it became effective.
In order to increase operating cash flows and the ability to pay distributions from operating cash flows, the Advisor may elect to waive certain fees. Because the Advisor may waive certain fees, cash flow from operations that would have been paid to the Advisor may be available to pay distributions to stockholders. The fees that may be forgiven are not deferrals and accordingly, will not be paid to the Advisor. In certain instances, to improve the Company’s working capital, the Advisor may elect to absorb a portion of the Company’s general and administrative costs. No expenses were absorbed by the Advisor during the nine months ended September 30, 2016 or for the year ended December 31, 2015, respectively.
The Company reimburses the Advisor’s costs for providing administrative services, subject to the limitation that the Company will not reimburse the Advisor for any amount by which the Company’s operating expenses at the end of the four preceding fiscal quarters exceeds the greater of (a) 2.0% of average invested assets and (b) 25.0% of net income other than any additions to reserves for depreciation, bad debt, impairment or other similar non-cash reserves and excluding any gain from the sale of assets for that period, unless the Company’s independent directors determine that such excess was justified based on unusual and nonrecurring factors which they deem sufficient, in which case the excess amount may be reimbursed to the Advisor in subsequent periods. Additionally, the Company reimburses the Advisor for personnel costs in connection with other services; however, the Company will not reimburse the Advisor for personnel costs, including executive salaries, in connection with services for which the Advisor receives acquisition fees, acquisition expenses or real estate commissions.
The table below represents reimbursements to the Advisor for the three months ended September 30, 2016 and 2015, and for the nine months ended September 30, 2016 and 2015, and the associated payable as of September 30, 2016 and December 31, 2015, which is recorded in due to related parties on the Company's Consolidated Balance Sheets (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | Payable as of | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | September 30, 2016 | December 31, 2015 | |||||||||||||||||||
Total general and administrative expense reimbursement for services provided by the Advisor | $ | 574 | $ | — | $ | 1,702 | $ | — | $ | 344 | $ | 72 | ||||||||||||
The Advisor at its election may also contribute capital to enhance the Company’s cash position for working capital and distribution purposes. Any contributed capital amounts are not reimbursable to the Advisor. Further, any capital contributions are made without any corresponding issuance of common or preferred shares. There were no contributions to capital from the Advisor for the three months ended September 30, 2016 and 2015, or the nine months ended September 30, 2016 and 2015.
Fees Paid to the Property Manager and Crestline
The Company pays a property management fee of up to 4.0% of the monthly gross receipts from the Company's properties to the Property Manager. The Property Manager, in turn, pays a portion of the property management fees to Crestline or a third-party sub-property manager, as applicable. The Company also reimburses Crestline or a third-party sub-property manager, as applicable, for property level expenses, as well as fees and expenses of such sub-property manager. The Company does not,
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however, reimburse Crestline or any third-party sub-property manager for general overhead costs or for the wages and salaries and other employee-related expenses of employees of such sub-property managers, other than employees or subcontractors who are engaged in the on-site operation, management, maintenance or access control of the Company’s properties, and, in certain circumstances, who are engaged in off-site activities.
The Company will also pay its Property Manager (which payment has been assigned to Crestline) an annual incentive fee equal to 15% of the amount by which the operating profit from the properties sub-managed by Crestline for such fiscal year (or partial fiscal year) exceeds 8.5% of the total investment of such properties. The Company has agreed and may in the future agree to similar incentive fee arrangements with the Property Manager and certain of the third party sub-property managers. Incentive fees incurred by the Company were less than $0.1 million for the three months ended September 30, 2016 and were $0.1 million for the nine months ended September 30, 2016, respectively, and $0.1 million in incentive fees were incurred by the Company for the three months ended and nine months ended September 30, 2015, respectively.
The table below shows the management fees (including incentive fees described above) and reimbursable expenses incurred by the Company from Crestline or the Property Manager (and not payable to a third party sub-property manager) during three months ended September 30, 2016 and 2015, and during the nine months ended September 30, 2016, and 2015, respectively, and the associated payable as of September 30, 2016 and December 31, 2015 (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | Payable as of | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | September 30, 2016 | December 31, 2015 | |||||||||||||||||||
Total management fees and reimbursable expenses incurred from Crestline | $ | 4,134 | $ | 2,631 | $ | 12,305 | $ | 6,564 | $ | 1,461 | $ | 1,106 | ||||||||||||
Total management fees incurred from Property Manager | $ | 2,262 | $ | 2,055 | $ | 6,501 | $ | 5,000 | $ | 6,419 | $ | 3,553 | ||||||||||||
Total | $ | 6,396 | $ | 4,686 | $ | 18,806 | $ | 11,564 | $ | 7,880 | $ | 4,659 | ||||||||||||
Fees and Participations Paid in Connection with the Liquidation or Listing
The Company is required to pay the Advisor an annual subordinated performance fee calculated on the basis of the Company’s total return to stockholders, payable monthly in arrears, such that for any year in which the Company’s total return on stockholders’ capital exceeds 6.0% per annum, the Advisor will be entitled to 15.0% of the excess total return but not to exceed 10.0% of the aggregate total return for such year. This fee will be payable only upon the sale of assets, other disposition or refinancing of such assets, which results in the return on stockholders’ capital exceeding 6.0% per annum. No subordinated performance fees were incurred during the three months ended or nine months ended September 30, 2016 or 2015, respectively.
The Company may pay a brokerage commission to the Advisor on the sale of property, not to exceed the lesser of 2.0% of the contract sale price of the property and 50.0% of the total brokerage commission paid if a third-party broker is also involved; provided, however, that in no event may the real estate commissions paid to the Advisor, its affiliates and unaffiliated third parties exceed the lesser of 6.0% of the contract sales price and a reasonable, customary and competitive real estate commission, in each case, payable to the Advisor if the Advisor or its affiliates, as determined by a majority of the independent directors, provided a substantial amount of services in connection with the sale. No such fees were incurred during the three months ended or nine months ended September 30, 2016 or 2015, respectively.
The Special Limited Partner is entitled to receive a subordinated participation in the net sales proceeds of the sale of real estate assets of 15.0% of the remaining net sale proceeds after return of capital contributions to investors plus payment to investors of a 6.0% cumulative, pre-tax, non-compounded annual return on the capital contributed by investors. The Special Limited Partner will not be entitled to the subordinated participation in net sale proceeds unless the Company’s investors have received a 6.0% cumulative non-compounded return on their capital contributions plus the return of their capital. No such participation became due and payable during the three months ended or nine months ended September 30, 2016 or 2015, respectively.
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If the common stock of the Company is listed on a national exchange, the Special Limited Partner is entitled to receive a subordinated incentive listing distribution of 15.0% of the amount by which the Company’s market value plus distributions exceeds the aggregate capital contributed by investors plus an amount equal to a 6.0% cumulative, pre-tax, non-compounded annual return on their capital contributions. The Special Limited Partner will not be entitled to the subordinated incentive listing distribution unless investors have received a 6.0% cumulative, pre-tax non-compounded annual return on their capital contributions. No such distributions were incurred during the three months ended or nine months ended September 30, 2016 or 2015, respectively. Neither the Special Limited Partner nor any of its affiliates can earn both the subordinated participation in the net sale proceeds and the subordinated incentive listing distribution.
Upon termination or non-renewal of the Advisory Agreement with the Advisor, with or without cause, the Special Limited Partner, through its controlling interest in the Advisor, is entitled to receive distributions from the OP equal to 15.0% of the amount by which the sum of the Company’s market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to a 6.0% cumulative, pre-tax, non-compounded annual return to investors. The Special Limited Partner may elect to defer its right to receive a subordinated distribution upon termination until either a listing on a national securities exchange or another liquidity event occurs. No such distributions were incurred during the three months ended or nine months ended September 30, 2016 or 2015, respectively.
Note 12 - Economic Dependency
Under various agreements, the Company has engaged or will engage the Advisor and its affiliates to provide certain services that are essential to the Company, including asset management services, supervision of the management, asset acquisition and disposition decisions, as well as other administrative responsibilities for the Company including accounting services and investor relations.
As a result of these relationships, the Company is dependent upon the Advisor and its affiliates. In the event that these companies are unable to provide the Company with the respective services, the Company will be required to find alternative providers of these services.
Note 13 - Impairment of Long-Lived Assets
In the second quarter ended June 30, 2016, the Company identified an indicator of impairment at one of its hotels, primarily due to decreased operating performance. As required by Accounting Standards Codification section 360 (ASC 360), once an indicator of impairment is identified, the Company is required to perform a test for recoverability. This test compares the sum of the estimated undiscounted future cash flows attributable to the hotel to its carrying amount. The Company determined that the estimated undiscounted future cash flows attributable to the hotel did not exceed its carrying amount and an impairment existed.
The Company then determined the fair value of the hotel using the discounted cash flow method to be $6.2 million, approximately $2.4 million less than the carrying amount of the hotel at June 30, 2016 of $8.6 million, and recorded the impairment loss in the Consolidated Statements of Operations and Comprehensive Income (Loss). The Company has not recorded an impairment in any other periods.
Note 14 - Assets Held for Sale
As part of the Company's efforts to address its capital requirements, the Company has been marketing select hotels for sale. If completed, these sales will generate net proceeds that can be used to meet liquidity requirements, eliminate any associated future PIP obligations, and reduce debt associated with these hotels. As of September 30, 2016 the Company had one hotel that was held for sale, which was subsequently sold on October 14, 2016 (See Note 15 - Subsequent Events). The sale of the hotel does not represent a strategic shift that has, or will have, a major effect on the Company’s operations and financial results, and therefore the operating results for the period of ownership of this property are included in income from continuing operations for the three months ended and nine months ended September 30, 2016 and September 30, 2015, respectively.
Assets held for sale as of September 30, 2016 consisted of the following (in thousands):
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September 30, 2016 | |||
Land | $ | 2,675 | |
Buildings and improvements | 7,069 | ||
Furniture, fixtures and equipment | 1,450 | ||
11,194 | |||
Less: Accumulated Depreciation | (1,023 | ) | |
Assets Held for Sale | $ | 10,171 | |
Note 15 - Subsequent Events
The Company has evaluated subsequent events through the filing of this Quarterly Report on Form 10-Q, and determined that there have not been any events that have occurred that would require adjustments to disclosures in the accompanying condensed consolidated financial statements except for the following transactions:
Issuances of Common Stock
Subsequent to the quarter ended September 30, 2016 and through November 4, 2016, the Company issued 429,907 shares of common stock as stock distributions.
Sale of Hotel
On October 14, 2016, the Company completed the sale of one hotel for a sales price of $13.0 million, resulting in a gain of approximately $2.5 million, which will be reflected in the Company’s consolidated statements of operations in the fourth quarter of 2016. The Company used the proceeds from the sale to reduce the Assumed Grace Indebtedness by $8.5 million, redeem $2.1 million in mandatorily redeemable preferred securities, and for other general corporate purposes.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with the accompanying condensed consolidated financial statements of American Realty Capital Hospitality Trust, Inc. and the notes thereto. As used herein, the terms "Company," "we," "our," "our company" or "us" refer to American Realty Capital Hospitality Trust, Inc., a Maryland corporation, including, as required by context, to American Realty Capital Hospitality Operating Partnership, L.P. (the "OP"), a Delaware limited partnership, and to its subsidiaries. We are externally managed by American Realty Capital Hospitality Advisors, LLC (our "Advisor"), a Delaware limited liability company.
Forward-Looking Statements
Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Those statements include statements regarding the intent, belief or current expectations of our company and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as "may," "will," "seeks," "anticipates," "believes," "estimates," "expects," "plans," "intends," "should" or similar expressions. Actual results may differ materially from those contemplated by such forward-looking statements. Further, forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law.
The following are some of the risks and uncertainties, although not all risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:
• | All of our executive officers are also officers, managers and/or holders of a direct or indirect controlling interest in the Advisor or other entities affiliated with AR Capital, LLC (“AR Capital”), the parent of our sponsor, American Realty Capital IX, LLC (the "Sponsor"), and AR Global Investments, LLC, the successor to AR Capital’s business (“AR Global”). As a result, our executive officers, our Advisor and its affiliates face conflicts of interest, including significant conflicts created by our Advisor's compensation arrangements with us. These conflicts could result in unanticipated actions. |
• | We suspended our initial public offering of common stock (our "IPO" or our "Offering") on November 15, 2015, effective as of December 31, 2015. Prior to the suspension of our IPO, we depended, and expected to continue to depend, in substantial part on proceeds from our IPO to meet our major capital requirements. As of September 30, 2016, we are required to redeem 50.0% of our mandatorily redeemable preferred securities (the "Grace Preferred Equity Interests") originally issued, or an additional $68.8 million by February 27, 2018, and we are required to redeem the remaining $223.5 million by February 27, 2019. Because we do not expect we will resume the IPO, we will require funds in addition to operating cash flow and cash on hand to meet our capital requirements, including payments due on our outstanding indebtedness. |
• | Because we require funds in addition to our operating cash flow and cash on hand to meet our capital requirements, beginning with distributions payable with respect to April 2016 we began paying distributions to our stockholders in shares of common stock instead of cash. There can be no assurance that we will continue to pay distributions in shares of common stock or resume paying distributions in cash in the future. Our ability to make future cash distributions will depend on our future cash flows and may be dependent on our ability to obtain additional liquidity on favorable terms. |
• | We are evaluating a variety of alternatives for obtaining additional liquidity, but there can be no assurance that we will be successful in obtaining sufficient proceeds from any of these pursuits to meet our capital requirements. |
• | All of the properties we own are hotels, and we are subject to risks inherent in the hospitality industry. |
• | We will require additional debt or equity financing to complete our pending acquisition of eight hotels for an aggregate purchase price of $77.2 million (the “Pending Acquisition”) from Summit Hotel OP, LP, the operating partnership of Summit Hotel Properties, Inc. (collectively, “Summit”), and there can be no assurance that such additional capital will be available on favorable terms, or at all. Any failure to complete our Pending Acquisition could cause us to default under the agreement and forfeit a $7.5 million deposit. |
• | Because our IPO has raised substantially less proceeds than expected, we will not be able to make additional investments unless we are able to identify additional debt or equity capital on favorable terms and our ability to achieve our original investment objectives has been adversely affected. |
• | No public market currently exists, or may ever exist, for shares of our common stock and our shares are, and may continue to be, illiquid. |
• | Increases in interest rates could increase the amount of our debt payments. |
• | We have incurred substantial indebtedness, which may limit our future operational and financial flexibility. |
• | We are obligated to pay fees to our Advisor and its affiliates, which may be substantial. |
• | We may fail to realize the expected benefits of our acquisitions of hotels within the anticipated timeframe or at all and we may incur unexpected costs. |
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• | We are subject to risks associated with any dislocations or liquidity disruptions that may exist or occur in the credit markets of the United States from time to time. |
• | Our failure to continue to qualify to be treated as a real estate investment trust for U.S. federal income tax purposes ("REIT") which would result in higher taxes, may adversely affect operations. |
All forward-looking statements should also be read in light of the risks identified in Item 1A of our Annual Report on Form 10-K.
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Overview
We were incorporated on July 25, 2013 as a Maryland corporation and qualified as a REIT beginning with the taxable year ended December 31, 2014. We were formed primarily to acquire lodging properties in the midscale limited service, extended stay, select service, upscale select service, and upper upscale full service segments within the hospitality sector. As of September 30, 2016, we had acquired or had an interest in a total of 142 hotels (including one hotel which was classified as held for sale as of September 30, 2016, and was subsequently sold on October 14, 2016) with a total of 17,351 guestrooms located in 32 states. As of September 30, 2016, all but one of our hotels operated under a franchise or license agreement with a national brand owned by one of Hilton Worldwide, Inc., Marriott International, Inc., Hyatt Hotels Corporation, Starwood Hotels and Resorts Worldwide, and Intercontinental Hotels Group or one of their respective subsidiaries or affiliates.
On January 7, 2014, we commenced our IPO on a "reasonable best efforts" basis of up to 80,000,000 shares of common stock, $0.01 par value per share, at a price of $25.00 per share, subject to certain volume and other discounts, pursuant to a registration statement on Form S-11 (File No. 333-190698), as well as up to 21,052,631 shares of common stock available pursuant to the Distribution Reinvestment Plan (the "DRIP") under which our common stockholders could elect to have their cash distributions reinvested in additional shares of our common stock.
On November 15, 2015, we suspended our IPO, and, on November 18, 2015, Realty Capital Securities, LLC (the "Former Dealer Manager"), the dealer manager of our IPO, suspended sales activities, effective immediately. On December 31, 2015, we terminated the Former Dealer Manager as the dealer manager of our IPO.
Because we require funds in addition to our operating cash flow and cash on hand to meet our capital requirements, beginning with distributions payable with respect to April 2016 we began paying distributions to our stockholders in shares of common stock instead of cash. Concurrently with this change to our distribution policy, we amended our agreement with our Advisor to give us the right, for a period commencing on June 1, 2016 and ending on June 1, 2017, subject to certain conditions, to pay up to $500,000 per month of asset management fees payable to our Advisor under our agreement with our Advisor in shares of our common stock.
We believe the actions we are undertaking and have undertaken as described elsewhere in this Form 10-Q, such as changes to our distribution policy, extending certain of our obligations under brand-mandated property improvement plans (“PIPs”), marketing select assets for sale, one of which has now been sold, and amendments to our agreement with our Advisor to permit the payment of a portion of the asset management fee in shares of our common stock under certain circumstances, will provide adequate liquidity to satisfy our capital requirements for the next twelve months, but these measures may not be sufficient to meet our capital requirements for this period.
On July 1, 2016, our board of directors approved an estimated net asset value per share of common stock (“Estimated Per-Share NAV”) equal to $21.48 as of March 31, 2016, which was published on the same date. This was the first time that our board of directors determined an Estimated Per-Share NAV. In connection with its determination of Estimated Per-Share NAV, our board of directors revised the amount of the distribution to $1.46064 per share per annum, equivalent to a 6.80% annual rate based on the Estimated Per-Share NAV, automatically adjusting if and when we publish an updated Estimated Per-Share NAV. Distributions for the quarter ended September 30, 2016 were paid in shares of common stock in an amount equal to 0.000185792 per share per day, or $1.46064 per annum, divided by $21.48. It is currently anticipated that we will publish an updated Estimated Per-Share NAV on at least an annual basis. The distributions are made by the fifth day following each month-end to stockholders of record at the close of business each day during the prior month.
As of September 30, 2016, we had approximately 37.8 million shares of common stock outstanding and had received total proceeds of approximately $913.0 million from the IPO and shares issued under the DRIP, net of repurchases. The shares outstanding include shares of common stock issued as stock distributions as a result of our change in distribution policy adopted by our board of directors in March 2016. We will not issue any additional shares of common stock under the DRIP unless and until we recommence paying distributions in cash.
Substantially all of our business is conducted through the OP. We are the sole general partner and hold substantially all of the units of limited partner interest in the OP entitled “OP Units” ("OP Units"). Additionally, our Advisor contributed $2,020 to the OP in exchange for 90 OP Units, which represents a nominal percentage of the aggregate OP ownership. The holders of OP Units have the right to convert OP Units for the cash value of a corresponding number of shares of common stock or, at the option of the OP, a corresponding number of shares of common stock of us in accordance with the limited partnership agreement of the OP. The remaining rights of the limited partner interests are limited, however, and do not include the ability to replace the general partner or to approve the sale, purchase or refinancing of the OP's assets.
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We have no employees. We have retained the Advisor to manage certain aspects of our affairs on a day-to-day basis. American Realty Capital Hospitality Properties, LLC or one of its subsidiaries (collectively, the "Property Manager"), serves as our property manager and the Property Manager has retained Crestline Hotels & Resorts, LLC ("Crestline") to provide services, including locating investments, negotiating financing and operating certain hotel assets in our portfolio.
The Advisor, the Property Manager and Crestline are under common control with AR Global and AR Capital, as a result of which they are related parties, and each of these entities has received or will receive compensation, fees and expense reimbursements from us for services related to our IPO and the investment and management of our assets.
We, directly or indirectly through our taxable REIT subsidiaries, enter into agreements with the Property Manager, which, in turn, engages Crestline or a third-party sub-property manager to manage our hotel properties. Crestline is a leading hospitality management company in the United States, and, as of September 30, 2016, had 106 hotels and 15,800 rooms under management in 28 states and the District of Columbia. As of September 30, 2016, 72 of our hotels and 9,594 rooms were managed by Crestline, and 70 of our hotels and 7,757 rooms were managed by third-party sub-property managers.
Significant Accounting Estimates and Critical Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include our accounts and those of our subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. In determining whether we have a controlling financial interest in a joint venture and the requirement to consolidate the accounts of that entity, management considers factors such as percentage ownership interest, authority to make decisions and contractual and substantive participating rights of the other partners or members as well as whether the entity is a variable interest entity for which we are the primary beneficiary.
Use of Estimates
The preparation of the accompanying consolidated financial statements in conformity with U.S. Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management makes significant estimates regarding revenue recognition, purchase price allocations to record investments in real estate, the useful lives of real estate and real estate taxes, as applicable.
Real Estate Investments
We allocate the purchase price of properties acquired in real estate investments to tangible and identifiable intangible assets acquired based on their respective fair values at the date of acquisition. Tangible assets include land, land improvements, buildings and furniture, fixtures and equipment. We utilize various estimates, processes and information to determine the property value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Amounts allocated to land, land improvements, buildings and furniture, fixtures and equipment are based on purchase price allocation studies performed by independent third parties or our analysis of comparable properties in our portfolio. Identifiable intangible assets and liabilities, as applicable, are typically related to contracts, including operating lease agreements, ground lease agreements and hotel management agreements, which will be recorded at fair value. We also consider information obtained about each property as a result of our pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.
Investments in real estate that are not considered to be business combinations under GAAP are recorded at cost. Improvements and replacements are capitalized when they extend the useful life of the asset. Costs of repairs and maintenance are expensed as incurred. Depreciation of our assets is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, 15 years for land improvements, five years for furniture, fixtures and equipment, and the shorter of the useful life or the remaining lease term for leasehold interests.
We are required to make subjective assessments as to the useful lives of our assets for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
Below-Market Lease
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The below-market lease intangible is based on the difference between the market rent and the contractual rent and is discounted to a present value using an interest rate reflecting our current assessment of the risk associated with the leases assumed at acquisition. Acquired lease intangible assets are amortized over the remaining lease term. The amortization of a below-market lease is recorded as an increase to rent expense on the consolidated statements of operations.
Impairment of Long-Lived Assets
When circumstances indicate the carrying value of a property may not be recoverable, we review the asset for impairment. This review is based on an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. The estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of demand, competition and other factors. If an impairment exists due to the inability to recover the carrying value of a property, an impairment loss will be recorded to the extent that the carrying value exceeds the estimated fair value of the property. An impairment loss results in an immediate negative adjustment reflected in net income. An impairment loss of $2.4 million was recorded on one hotel during the quarter ended June 30, 2016 (See Note 13 - Impairment of Long-Lived Assets to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q). We have not recorded an impairment in any other period.
Assets Held for Sale (Long-Lived Assets)
When we initiate the sale of long-lived assets, we assess whether the assets meet the criteria to be considered assets held for sale. The review is based on whether the following criteria are met:
• | Management has committed to a plan to sell the asset group; |
• | The subject assets are available for immediate sale in their present condition; |
• | We are actively locating buyers as well as other initiatives required to complete the sale; |
• | The sale is probable and the transfer is expected to qualify for recognition as a complete sale in one year; |
• | The long-lived asset is being actively marketed for sale at a price that is reasonable in relation to fair value; and |
• | Actions necessary to complete the plan indicate it is unlikely significant changes will be made to the plan or the plan will be withdrawn. |
If all the criteria are met, a long-lived asset held for sale is measured at the lower of its carrying amount or fair value less cost to sell, and we will cease recording depreciation. We had one hotel that qualified to be treated as an asset held for sale as of September 30, 2016, which was subsequently sold on October 14, 2016 (See Note 14 - Assets Held for Sale and Note 15 - Subsequent Events to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q).
Cash and Cash Equivalents
Cash and cash equivalents include cash in bank accounts as well as investments in highly-liquid money market funds with original maturities of three months or less.
Restricted Cash
Restricted cash consists of amounts required under mortgage agreements for future capital improvements to owned assets, future interest and property tax payments and cash flow deposits while subject to mortgage agreement restrictions. For purposes of the statement of cash flows, changes in restricted cash caused by changes to the amount needed for future capital improvements are treated as investing activities, changes related to future debt service payments are treated as financing activities, and changes related to real estate tax payments and excess cash flow deposits are treated as operating activities.
Deferred Financing Fees
Deferred financing fees represent commitment fees, legal fees and other costs associated with obtaining commitments for financing. These fees are amortized over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing fees are expensed when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financial transactions that do not close are expensed in the period in which it is determined that the financing will not be successful.
In April 2015, the Financial Accounting Standards Board (“FASB”) issued ASU 2015-03 Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), which was designed to simplify the presentation of debt issuance costs. The amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Prior to the
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application of this new guidance, we presented debt issuance costs as an asset on the Consolidated Balance Sheets. The recognition and measurement guidance for debt issuance costs were not affected by the amendments in ASU 2015-03. We adopted this ASU as of January 1, 2016. The impact to the Consolidated Balance Sheets as of December 31, 2015, was to reduce total assets, mortgage notes payable, and mandatorily redeemable preferred securities by $18.8 million.
Variable Interest Entities
Accounting Standards Codification 810 ("ASC 810"), Consolidation contains the guidance surrounding the definition of variable interest entities ("VIE"), the definition of variable interests and the consolidation rules surrounding VIEs. In general, VIEs are entities in which equity investors lack the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. We have variable interests in VIEs through our investments in entities which own the Westin Virginia Beach Town Center (the "Westin Virginia Beach") and the Hilton Garden Inn Blacksburg.
Once it is determined that we hold a variable interest in an entity, GAAP requires that we perform a qualitative analysis to determine (i) which entity has the power to direct the matters that most significantly impact the VIE’s financial performance; and (ii) if we have the obligation to absorb the losses of the VIE that could potentially be significant to the VIE or the right to receive the benefits of the VIE that could potentially be significant to the VIE. An entity that has both of these characteristics is deemed to be the primary beneficiary and is required to consolidate the VIE.
In February 2015, the FASB issued Accounting Standards Update 2015-02 (“ASU 2015-02”), which amended ASC 810. The amendment modifies the evaluation of whether certain legal entities are VIEs, eliminates the presumption that a general partner should consolidate a limited partnership, and affects the consolidation analysis of reporting entities that are involved with VIEs. The revised guidance was effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. We adopted this guidance effective January 1, 2016. We have evaluated the impact of the adoption of the new guidance on our consolidated financial statements and we have determined that our OP is considered a VIE. However, we meet the disclosure exemption criteria as we are the primary beneficiary of the VIE and our partnership interest is considered a majority voting interest. As such, the new guidance did not have an impact on our consolidated financial statements.
We hold an interest in BSE/AH Blacksburg Hotel, LLC (the "HGI Blacksburg JV"), an entity that owns the assets of the Hilton Garden Inn Blacksburg, and an interest in TCA Block 7 Hotel, LLC (the "Westin Virginia Beach JV"), an entity that owns the assets of the Westin Virginia Beach.
During the quarter ended June 30, 2015, upon the acquisition of an additional equity interest in the HGI Blacksburg JV, we concluded that we were the primary beneficiary, with the power to direct activities that most significantly impact its economic performance, and therefore consolidated the entity in our consolidated financial statements subsequent to the acquisition (See Note 3 - Business Combinations to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q).We have concluded we are not the primary beneficiary with the power to direct activities that most significantly impact economic performance of the Westin Virginia Beach JV, and have therefore not consolidated the entity. We have accounted for the Westin Virginia Beach JV under the equity method of accounting and included it in investments in unconsolidated entities in the accompanying Consolidated Balance Sheets.
Revenue Recognition
We recognize hotel revenue as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel services.
Income Taxes
We elected and qualified to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code commencing with our tax year ended December 31, 2014. In order to continue to qualify as a REIT, we must annually distribute to our stockholders 90% of our REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gains, and must comply with various other organizational and operational requirements. We generally will not be subject to federal corporate income tax on that portion of our REIT taxable income that we distribute to our stockholders. We may be subject to certain state and local taxes on our income, property tax and federal income and excise taxes on our undistributed income. Our hotels are leased to taxable REIT subsidiaries ("TRSs") which are owned by the OP. The TRSs are subject to federal, state and local income taxes.
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net
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operating loss, capital loss, and tax credit carryovers. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which such amounts are expected to be realized or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including future reversals of existing taxable temporary differences, future projected taxable income and tax planning strategies.
GAAP prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. We must determine whether it is "more-likely-than-not" that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement in order to determine the amount of benefit to recognize in the financial statements. This accounting standard applies to all tax positions related to income taxes.
Earnings/Loss per Share
We calculate basic income or loss per share by dividing net income or loss for the period by the weighted-average shares of our common stock outstanding for a respective period. Diluted income per share takes into account the effect of dilutive instruments, such as stock options and unvested stock awards, except when doing so would be anti-dilutive. Beginning with distributions payable with respect to April 2016 and through November 2016, we have paid cumulative distributions of 1,519,210 shares of common stock and adjusted retroactively for all periods presented our computation of loss per share in order to reflect this change in capital structure. We expect we will continue to make similar retroactive adjustments in subsequent quarters for so long as we continue to pay distributions in shares of common stock.
Fair Value Measurements
In accordance with ASC 820, Fair Value Measurement, certain assets and liabilities are recorded at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability between market participants in an orderly transaction on the measurement date. The market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability is known as the principal market. When no principal market exists, the most advantageous market is used. This is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received or minimizes the amount that would be paid. Fair value is based on assumptions market participants would make in pricing the asset or liability. Generally, fair value is based on observable quoted market prices or derived from observable market data when such market prices or data are available. When such prices or inputs are not available, the reporting entity should use valuation models.
Our financial instruments recorded at fair value on a recurring basis are categorized based on the priority of the inputs used to measure fair value. The inputs used in measuring fair value are categorized into three levels, as follows:
• | Level 1 - Inputs that are based upon quoted prices for identical instruments traded in active markets. |
• | Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar investments in markets that are not active, or models based on valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the investment. |
• | Level 3 - Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. |
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
Advertising Costs
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We expense advertising costs for hotel operations as incurred. These costs were $4.6 million for the three months ended September 30, 2016 and $3.8 million for the three months ended September 30, 2015. Advertising expense was $13.2 million for the nine months ended September 30, 2016 and $9.1 million for the nine months ended September 30, 2015.
Allowance for Doubtful Accounts
Receivables consist principally of trade receivables from customers and are generally unsecured and are due within 30 to 90 days. We record a provision for uncollectible accounts using the allowance method. Expected credit losses associated with trade receivables are recorded as an allowance for doubtful accounts. The allowance for doubtful accounts is estimated based upon historical patterns of credit losses for aged receivables as well as specific provisions for certain identifiable, potentially uncollectible balances. When internal collection efforts on accounts have been exhausted, the accounts are written off and the associated allowance for doubtful accounts is reduced.
Derivative Transactions
We at certain times enter into derivative instruments to hedge exposure to changes in interest rates. Our derivatives as of September 30, 2016, consisted of interest rate cap agreements, which we believe will help to mitigate our exposure to increasing borrowing costs under floating rate indebtedness. We have elected not to designate our interest rate cap agreements as cash flow hedges. The impact of the interest rate caps for the three months and nine months ended September 30, 2016, to the consolidated financial statements was immaterial.
Reportable Segments
We have determined that we have one reportable segment, with activities related to investing in real estate. Our investments in real estate generate room revenue and other income through the operation of the properties, which comprise 100% of the total consolidated revenues. Management evaluates the operating performance of our investments in real estate on an individual property level, none of which represent a reportable segment.
Revenue Performance Metrics
We measure hotel revenue performance by evaluating revenue metrics such as:
• | Occupancy percentage (“Occ”) - Occ represents the total number of hotel rooms sold in a given period divided by the total number of rooms available. Occ measures the utilization of our hotels' available capacity. |
• | Average Daily Rate (“ADR”) - ADR represents total hotel room revenues divided by the total number of rooms sold in a given period. |
• | Revenue per Available room (“RevPAR”) - RevPAR is the product of ADR and Occ. |
Occ, ADR, and RevPAR are commonly used measures within the hotel industry to evaluate hotel operating performance. ADR and RevPAR do not include food and beverage or other revenues generated by the hotels. We evaluate individual hotel RevPAR performance on an absolute basis with comparisons to budget, to prior periods and to the competitive set in the market, as well as on a company-wide and regional basis.
Our Occ, ADR and RevPAR performance may be affected by macroeconomic factors such as regional and local employment growth, personal income and corporate earnings, office vacancy rates and business relocation decisions, airport and other business and leisure travel, new hotel property construction, renovations and the pricing strategies of competitors. In addition, our Occ, ADR and RevPAR performance is dependent on the continued success of our franchisors and brands.
We generally expect that room revenues will make up a significant majority of our total revenues, and our revenue results will therefore be highly dependent on maintaining and improving Occ and ADR, which drive RevPAR.
Results of Operations
In March of 2014 we closed on the acquisition of interests in six hotels through fee simple, leasehold and joint venture interests (the "Barceló Portfolio") for an aggregate purchase price of $110.1 million, exclusive of closing costs. In February 2015, we closed on the acquisition of interests in 116 hotels through fee simple and leasehold interests (the "Grace Portfolio") for an aggregate purchase price of $1.8 billion, exclusive of closing costs. In October 2015, we closed on the acquisition of interests in 10 hotels through fee simple interests (the "First Summit Portfolio") for an aggregate purchase price of $150.1 million, exclusive of closing costs. In November and December 2015, we closed on the acquisition of interests in four hotels through fee simple interests (the "First Noble and Second Noble Portfolios") for an aggregate purchase price of $107.6 million, exclusive of closing costs. During December 2015 and January 2016, we terminated our obligation to acquire 24 additional hotels, and as a result forfeited an aggregate of $41.1 million in non-refundable deposits. In February 2016, we completed the
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acquisition of six hotels through fee simple interests (the "Third Summit Portfolio" and, together with the First Summit Portfolio and the First Noble and Second Noble Portfolios, the “Summit and Noble Portfolios”) for an aggregate purchase price of $108.3 million, exclusive of closing costs. Also in February 2016, we reinstated our obligation under a previously terminated agreement with Summit, which we refer to as our Pending Acquisition, to purchase ten hotels for an aggregate purchase price of $89.1 million, and made a new purchase price deposit of $7.5 million. In June 2016, the Summit Sellers informed the Company that two of the ten hotels had been sold, thereby reducing the Pending Acquisition to eight hotels for an aggregate purchase price of $77.2 million.
Because we have raised less proceeds in our IPO than originally contemplated, we will require additional debt or equity financing to fund up to $69.7 million in closing consideration for our Pending Acquisition. Any failure to complete our Pending Acquisition could cause us to default under the reinstated purchase agreement and forfeit the $7.5 million deposit. We also do not expect to make future acquisitions unless we can obtain equity or debt financing in addition to the additional capital we need to meet our existing capital requirements.
Following the suspension of our IPO, one of our primary business objectives has been a focus on meeting our capital requirements. In light of this objective, we have been marketing select hotels for sale, one of which has now been sold, and we have extended certain of our obligations under our PIPs, and we anticipate that we will seek additional PIP extensions. Asset sales and the deferral of PIP obligations, if completed, could adversely impact our operating results.
PIP renovation work has adversely impacted our operating results due to the disruptions to the operations of the hotels being renovated. Additionally, we have significant PIP renovation work that we will be required to make in future years which will also adversely impact our operating results.
Current market concerns regarding the potential softening of hospitality demand, and recent political and economic uncertainty have led us and many other public lodging companies to curtail revenue growth estimates. Any of these factors could adversely impact the financial performance of our properties and hence our results of operations.
The closing of our Pending Acquisition is scheduled for December 30, 2016, but Summit has the right to market and ultimately sell any or all of the hotels to be purchased to a bona fide third party purchaser without our consent at any time prior to the completion of our Pending Acquisition. Whether or not Summit engages, or is successful, in any efforts to market these hotels is beyond our control and, accordingly, there can be no assurance we will be able to complete our Pending Acquisition in whole or in part. See Note 3 - Business Combinations to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q, for additional discussion of these transactions.
Following amendments to our agreement with the Advisor and the limited partnership agreement of the OP on November 11, 2015, we became required to pay asset management fees, which may be in cash, shares of our common stock or a combination of both, at the Advisor’s election, on a monthly basis effective October 1, 2015, equal to the cost of our assets (until July 1, 2016, then the lower of the cost of our assets or the fair market value of our assets), multiplied by 0.0625%. We ceased causing units of limited partnership in our OP ("Class B Units") to be issued to the Advisor with respect to periods commencing on or after September 30, 2015. Historically, the issuance of Class B Units was not reflected as an expense in our consolidated statements of operations, except for the distributions made on the associated Class B Units. Beginning in the fourth quarter of 2015, our consolidated statements of operations include an expense for the asset management fee payable in cash, shares of our common stock, or a combination thereof.
In March of 2016, we amended our agreement with our Advisor to give us the right, for a period commencing on June 1, 2016 and ending on June 1, 2017, subject to certain conditions, to pay up to $500,000 per month of asset management fees payable to our Advisor under our agreement with our Advisor in shares of our common stock. As of September 30, 2016, none of these conditions have been met, and we have not exercised this right.
Comparison of the Three Months Ended September 30, 2016 to the Three Months Ended September 30, 2015
Room revenues were $153.2 million for the three months ended September 30, 2016, compared to room revenues of $126.2 million for the three months ended September 30, 2015. The increase in room revenues was primarily due to our acquisitions of the Summit and Noble Portfolios, which were completed during the fourth quarter of 2015 and the first quarter of 2016.
The following table presents actual operating information of the hotels in our portfolio commencing on the date we acquired them.
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Three Months Ended | ||||||||
Total Portfolio | September 30, 2016 | September 30, 2015 | ||||||
Number of rooms | 17,351 | 14,924 | ||||||
Occ | 79.9 | % | 79.3 | % | ||||
ADR | $ | 122.67 | $ | 118.75 | ||||
RevPAR | $ | 97.98 | $ | 94.14 | ||||
Our results of operations only include the results of operations of the hotels we have acquired beginning on the date of each hotel's acquisition. The following table presents pro-forma operating information of the hotels in our portfolio as if we had owned each hotel in our portfolio for the full periods presented. The information in the table includes the hotels that we classify as under renovation. We consider hotels to be under renovation beginning in the quarter that they start material renovations and continuing until the end of the fourth full quarter following the substantial completion of the renovations. The hotel business is capital-intensive and renovations are a regular part of the business. A large-scale capital project that would cause a hotel to be considered to be under renovation is an extensive renovation of core aspects of the hotel, such as rooms, meeting space, lobby, bars, restaurants, and other public spaces. Both quantitative and qualitative factors are taken into consideration in determining if a particular renovation would cause a hotel to be considered to be under renovation for these purposes, including unusual or exceptional circumstances such as: a reduction or increase in room count, a significant alteration of the business operations, or the closing of material portions of the hotel during the renovation.
Three Months Ended | ||||||||
Pro forma (142 hotels) | September 30, 2016 | September 30, 2015 | ||||||
Number of rooms | 17,351 | 17,351 | ||||||
Occ | 79.9 | % | 80.0 | % | ||||
ADR | $ | 122.67 | $ | 120.73 | ||||
RevPAR | $ | 97.98 | $ | 96.53 | ||||
RevPAR change | 1.5 | % | ||||||
The following table presents pro-forma operating information of the hotels in our portfolio as if we had owned each hotel in our portfolio for the full periods presented, further adjusted to exclude the impact of 34 hotels that we classify as under renovation.
Three Months Ended | ||||||||
Pro forma hotels not under renovation (108 hotels) | September 30, 2016 | September 30, 2015 | ||||||
Number of rooms | 13,014 | 13,014 | ||||||
Occ | 80.8 | % | 80.4 | % | ||||
ADR | $ | 123.04 | $ | 121.82 | ||||
RevPAR | $ | 99.36 | $ | 97.98 | ||||
RevPAR change | 1.4 | % | ||||||
Pro-forma RevPAR for the three months ended September 30, 2016, compared to the three months ended September 30, 2015, increased by 1.5% due to an increase in ADR. Pro-forma RevPAR for our hotels not under renovation increased 1.4% in the current period as compared to the prior year period, due to an increase in occupancy and ADR.
Other non-room operating revenues for the portfolio include food and beverage, and other ancillary revenues such as conference center, market, parking, telephone and cancellation fees. Total non-room operating revenues, including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the three months ended September 30, 2016, and the three months ended September 30, 2015, increased 1.4% over the prior year period driven primarily by other ancillary revenue.
Our operating expenses include labor expenses incurred in the day-to-day operation of our hotels. Our hotels have a variety of fixed expenses, such as essential hotel staff, real estate taxes and insurance, and these expenses do not change materially even if the revenues at the hotels fluctuate. Our primary operating expenses are described below:
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• | Rooms expense: These costs include labor (housekeeping and rooms operation), reservation systems, room supplies, linen and laundry services. Occupancy is the major driver of rooms expense, due to the cost of cleaning the rooms, with additional expenses that vary with the level of service and amenities provided. |
• | Food and beverage expense: These expenses primarily include labor and the cost of food and beverage. Occupancy and the type of customer staying at the hotel (for example, catered functions generally are more profitable than outlet sales) are the major drivers of food and beverage expense, which correlates closely with food and beverage revenue. |
• | Management fees: Base management fees paid are computed as a percentage of gross revenue. Incentive management fees may be paid when operating profit or other performance metrics exceed certain threshold levels. Asset management fees are computed as a percentage of the lower of the cost or the fair market value of our assets. |
• | Other property-level operating costs: These expenses include labor and other costs associated with other ancillary revenue, such as conference center, parking, market and other guest services, as well as labor and other costs associated with administrative and general, sales and marketing, brand related fees, repairs, maintenance and utility costs. In addition, these expenses include real and personal property taxes and insurance, which are relatively inflexible and do not necessarily change based on changes in revenue or performance at the hotels. |
Total operating expenses (excluding depreciation and amortization), including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the three months ended September 30, 2016, and the three months ended September 30, 2015, increased approximately 5.2% over the prior year period primarily due to our commencing to pay asset management fees in cash beginning in the fourth quarter of 2015, and growth in rooms expense primarily associated with the growth in room revenue.
Depreciation and amortization increased approximately $6.0 million for the three months ended September 30, 2016, compared to the prior year period, due primarily to acquisitions and completed PIPs.
Interest expense was $23.1 million for the three months ended September 30, 2016, and for the three months ended September 30, 2015.
We had no acquisition and transaction related costs for the three months ended September 30, 2016. Acquisition and transaction related costs for the three months ended September 30, 2015, were primarily due to costs associated with the acquisition of 10 hotels (the "First Summit Closing"), which was completed in the fourth quarter of 2015.
General and administrative increased approximately $3.1 million for the three months ended September 30, 2016, compared to the prior year period, primarily due to expenses we are required to reimburse to our Advisor, an increase in professional fees, and due to a reclassification of certain expenses from other property-level expenses to general and administrative expenses.
Other income (expense) changed by approximately $0.3 million for the three months ended September 30, 2016, compared to the prior year period, primarily due to the change in the fair value associated with the contingent consideration payable due in connection with the acquisition of the Barceló Portfolio.
Comparison of the Nine Months Ended September 30, 2016 to the Nine Months Ended September 30, 2015
Room revenues were $434.5 for the nine months ended September 30, 2016, compared to room revenues of $302.7 million for the nine months ended September 30, 2015. The increase in room revenues was primarily due to our acquisitions of the Summit and Noble Portfolios, which were completed during the fourth quarter of 2015 and the first quarter of 2016, and the Grace Portfolio, which was completed during the first quarter of 2015.
The following table presents actual operating information of the hotels in our portfolio commencing on the date we acquired them.
Nine Months Ended | ||||||||
Total Portfolio | September 30, 2016 | September 30, 2015 | ||||||
Number of rooms | 17,351 | 14,924 | ||||||
Occ | 76.8 | % | 79.0 | % | ||||
ADR | $ | 121.90 | $ | 119.88 | ||||
RevPAR | $ | 93.60 | $ | 94.70 | ||||
Our results of operations only include the results of operations of the hotels we have acquired beginning on the date of each hotel's acquisition. The following table presents pro-forma operating information of the hotels in our portfolio as if we had
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owned each hotel in our portfolio for the full periods presented. The information in the table includes the hotels that we classify as under renovation.
Nine Months Ended | ||||||||
Pro forma (142 hotels) | September 30, 2016 | September 30, 2015 | ||||||
Number of rooms | 17,351 | 17,351 | ||||||
Occ | 76.7 | % | 77.6 | % | ||||
ADR | $ | 121.84 | $ | 119.29 | ||||
RevPAR | $ | 93.47 | $ | 92.55 | ||||
RevPAR change | 1.0 | % | ||||||
The following table presents pro-forma operating information of the hotels in our portfolio as if we had owned each hotel in our portfolio for the full periods presented, further adjusted to exclude the impact of 34 hotels that we classify as under renovation.
Nine Months Ended | ||||||||
Pro forma hotels not under renovation (108 hotels) | September 30, 2016 | September 30, 2015 | ||||||
Number of rooms | 13,014 | 13,014 | ||||||
Occ | 77.9 | % | 77.6 | % | ||||
ADR | $ | 121.65 | $ | 119.34 | ||||
RevPAR | $ | 94.80 | $ | 92.60 | ||||
RevPAR change | 2.4 | % | ||||||
Pro-forma RevPAR for the nine months ended September 30, 2016, compared to the nine months ended September 30, 2015, increased by 1.0% due to an increase in ADR, partially offset by a decrease in occupancy driven by the impact of hotels under renovation. Pro-forma RevPAR for our hotels not under renovation increased 2.4% in the current period as compared to the prior year period, driven by an increase in occupancy and ADR.
Total non-room operating revenues, including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the nine months ended September 30, 2016, and for the nine months ended September 30, 2015, decreased approximately 0.9% over the prior year period primarily driven by lower other ancillary revenue.
Total operating expenses (excluding depreciation and amortization and impairment of long-lived assets), including the results of the hotels in our portfolio as if we had owned each hotel in our portfolio for the nine months ended September 30, 2016, and for the nine months ended September 30, 2015, increased approximately 8.4% over the prior year period primarily due to our commencing to pay asset management fees in cash beginning in the fourth quarter of 2015, growth in rooms expense primarily associated with the growth in room revenue, and higher other property level expenses. Hotels under renovation had a higher percentage increase in operating expenses due to costs incurred as a result of the business disruption associated with the renovations.
Depreciation and amortization increased approximately $28.5 million for the nine months ended September 30, 2016, compared to the prior year period, due primarily to acquisitions and completed PIPs.
Impairment of long-lived assets was $2.4 million for the nine months ended September 30, 2016, due to the recognition of an impairment on one hotel.
Interest expense increased approximately $12.3 million for the nine months ended September 30, 2016, compared to the prior year period, due primarily to additional mortgage and promissory notes, and mandatorily redeemable preferred securities.
Acquisition and transaction related costs decreased approximately $13.9 million for the nine months ended September 30, 2016, compared to the prior year period. Acquisition and transaction related costs for the nine months ended September 30, 2016 were primarily attributable to costs associated with the acquisition of the Third Summit Portfolio and forfeited deposits related to terminated acquisitions of approximately $22.0 million. Acquisition and transaction related costs for the nine months ended September 30, 2015 were primarily attributable to costs associated with the acquisition of the Grace Portfolio.
General and administrative increased approximately $6.6 million for the nine months ended September 30, 2016, compared to the prior year period, primarily due to the write-off of deferred financing fees of $3.0 million, expenses we are required to reimburse to our Advisor, and increased professional fees.
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Other income (expense) changed by approximately $3.4 million for the nine months ended September 30, 2016, compared to the nine months ended September 30, 2015. The change was primarily due to the expense recorded in the current year period and the gain recorded in the prior year period related to the change in the fair value associated with the contingent consideration payable due in connection with the acquisition of the Barceló Portfolio.
Non-GAAP Financial Measures
This section includes non-GAAP financial measures, including funds from operations ("FFO"), modified funds from operations ("MFFO"), and hotel earnings before interest, taxes and depreciation and amortization ("Hotel EBITDA"). Descriptions of these non-GAAP measures and reconciliations to the most directly comparable GAAP measure, which is net income (loss), is provided below.
Funds from Operations and Modified Funds from Operations
The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, and straight-line amortization of intangibles, which implies that the value of a real estate asset diminishes predictably over time. We believe that, because real estate values historically rise and fall with market conditions, including, but not limited to, inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using the historical accounting convention for depreciation and certain other items may not be fully informative.
Because of these factors, the National Association of Real Estate Investment Trusts (“NAREIT”), an industry trade group, has published a standardized measure of performance known as FFO, which is used in the REIT industry as a supplemental performance measure. We believe FFO, which excludes certain items such as real estate-related depreciation and amortization, is an appropriate supplemental measure of a REIT’s operating performance. FFO is not equivalent to our net income or loss as determined under GAAP.
We define FFO, a non-GAAP measure, consistent with the standards set forth in the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the “White Paper”). The White Paper defines FFO as net income or loss computed in accordance with GAAP, but excluding gains or losses from sales of property and real estate related impairments, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.
We believe that the use of FFO provides a more complete understanding of our performance to investors and to management, and, when compared year over year, reflects the impact on our operations from trends in occupancy rates, ADR, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income.
Changes in the accounting and reporting promulgations under GAAP that were put into effect in 2009 subsequent to the establishment of NAREIT’s definition of FFO, such as the change to expense as incurred rather than capitalize and depreciate acquisition fees and expenses incurred for business combinations or property acquisitions, has resulted in acquisition fees and expenses being expensed under GAAP. These changes had a particularly significant impact on publicly registered, non-listed REITs, which typically have a significant amount of acquisition activity in the early part of their existence, particularly during the period when they are raising capital through ongoing initial public offerings and typically paying acquisition fees.
Because of these factors, the Investment Program Association (the “IPA”), an industry trade group, has published a standardized measure of performance known as MFFO, which the IPA has recommended as a supplemental measure for publicly registered, non-listed REITs. MFFO is designed to be reflective of the ongoing operating performance of publicly registered, non-listed REITs by adjusting for those costs that are more reflective of acquisitions and investment activity, along with other items the IPA believes are not indicative of the ongoing operating performance of a publicly registered, non-listed REITs, such as straight-lining of rents as required by GAAP. We believe it is appropriate to use MFFO as a supplemental measure of operating performance because we believe that, when compared year over year, both before and after we have deployed all of our Offering proceeds and are no longer incurring a significant amount of acquisitions fees or other related costs, it reflects the impact on our operations from trends in occupancy rates, ADR, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income. MFFO is not equivalent to our net income or loss as determined under GAAP.
We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations (the “Practice Guideline”) issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for acquisition and transaction related fees and expenses and other items. In calculating MFFO, we follow the Practice Guideline and exclude acquisition and transaction-related fees and expenses, amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent
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and lease payments), accretion of discounts and amortization of premiums on debt investments, mark-to-market adjustments included in net income, gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis.
We believe that, because MFFO excludes costs that we consider more reflective of acquisition activities and other non-operating items, MFFO can provide, on a going-forward basis, an indication of the sustainability (that is, the capacity to continue to be maintained) of our operating performance after the period in which we are acquiring properties and once our portfolio is stabilized. We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry and allows for an evaluation of our performance against other publicly registered, non-listed REITs.
Not all REITs, including publicly registered, non-listed REITs, calculate FFO and MFFO the same way. Accordingly, comparisons with other REITs, including publicly registered, non-listed REITs, may not be meaningful. Furthermore, FFO and MFFO are not indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as determined under GAAP as an indication of our performance, as an alternative to cash flows from operations, as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders (although we are not currently paying cash distributions). FFO and MFFO should be reviewed in conjunction with other GAAP measurements as an indication of our performance. FFO and MFFO should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or in its applicability in evaluating our operating performance. The methods utilized to evaluate the performance of a publicly registered, non-listed REIT under GAAP should be construed as more relevant measures of operational performance and considered more prominently than the non-GAAP measures, FFO and MFFO, and the adjustments to GAAP in calculating FFO and MFFO.
Neither the SEC, NAREIT, the IPA nor any other regulatory body or industry trade group has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, NAREIT, the IPA or another industry trade group may publish updates to the White Paper or the Practice Guideline or the SEC or another regulatory body could standardize the allowable adjustments across the publicly registered, non-listed REIT industry and we would have to adjust our calculation and characterization of FFO or MFFO accordingly.
The table below reflects the items deducted from or added to net income (loss) attributable to stockholders in our calculation of FFO and MFFO for the periods indicated. In calculating our FFO and MFFO, we exclude the impact of amounts attributable to our non-controlling interests and the portion of the adjustment allocable to non-controlling interests.
For the Three Months Ended September 30, 2016 | For the Three Months Ended September 30, 2015 | For the Nine Months Ended September 30, 2016 | For the Nine Months Ended September 30, 2015 | ||||||||||
Net loss attributable to American Realty Capital Hospitality Trust Inc. (in accordance with GAAP) | $ | (6,684 | ) | $ | (5,082 | ) | $ | (57,665 | ) | $ | (44,620 | ) | |
Depreciation and amortization | 25,788 | 19,817 | 74,912 | 46,438 | |||||||||
Impairment of long-lived assets | — | — | 2,399 | — | |||||||||
Adjustment to our share of depreciation and amortization for variable interest entities | (11 | ) | (14 | ) | (26 | ) | 161 | ||||||
FFO attributable to stockholders | $ | 19,093 | $ | 14,721 | $ | 19,620 | $ | 1,979 | |||||
Acquisition fees and expenses | (7 | ) | 698 | 25,270 | 39,129 | ||||||||
Change in fair value of contingent consideration | 550 | 207 | 1,454 | (1,720 | ) | ||||||||
Change in fair value equity interest | — | — | — | (219 | ) | ||||||||
Amortization of below-market lease intangible asset, net | 100 | 100 | 299 | 305 | |||||||||
MFFO attributable to stockholders | $ | 19,736 | $ | 15,726 | $ | 46,643 | $ | 39,474 | |||||
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Hotel EBITDA
Hotel EBITDA is used by management as a performance measure and we believe it is useful to investors as a supplemental measure in evaluating our financial performance because it is a measure of hotel profitability that excludes expenses that we believe may not be indicative of the operating performance of our hotels. We believe that using Hotel EBITDA, which excludes the effect of non-operating expenses and non-cash charges, all of which are based on historical cost and may be of limited significance in evaluating current performance, facilitates comparison of hotel operating profitability between periods. For example, interest expense is not linked to the operating performance of a hotel and Hotel EBITDA is not affected by whether the financing is at the hotel level or corporate level. In addition, depreciation and amortization, because of historical cost accounting and useful life estimates, may distort operating performance at the hotel level. We believe that investors should consider our Hotel EBITDA in conjunction with net income (loss) and other required GAAP measures of our performance to improve their understanding of our operating results.
Hotel EBITDA, or similar measures, are commonly used as performance measures by other public hotel REITs. However, not all public hotel REITs calculate Hotel EBITDA, or similar measures, the same way. Hotel EBITDA should be reviewed in conjunction with other GAAP measurements as an indication of our performance. Hotel EBITDA should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or in its applicability in evaluating our operating performance.
The following table reconciles the Company's net loss in accordance with GAAP to Hotel EBITDA for the three and nine months ended September 30, 2016, and for the twelve months ended December 31, 2015 (unaudited in thousands):
For the Three Months Ended September 30, 2016 | For the Nine Months Ended September 30, 2016 | For the Twelve Months Ended December 31, 2015 (unaudited) | ||||||||
Net loss attributable to American Realty Capital Hospitality Trust Inc. (in accordance with GAAP) | $ | (6,684 | ) | $ | (57,665 | ) | $ | (94,826 | ) | |
Less: Net income attributable to non-controlling interest | 152 | 278 | 189 | |||||||
Net loss and comprehensive loss (in accordance with GAAP) | $ | (6,532 | ) | $ | (57,387 | ) | $ | (94,637 | ) | |
Depreciation and amortization | 25,788 | 74,912 | 68,500 | |||||||
Impairment of long-lived assets | — | 2,399 | — | |||||||
Interest expense | 23,087 | 69,033 | 80,667 | |||||||
Acquisition and transaction related costs | (7 | ) | 25,270 | 64,513 | ||||||
Other expense | 542 | 1,396 | 491 | |||||||
Equity in earnings of unconsolidated entities | (286 | ) | (407 | ) | (238 | ) | ||||
General and administrative | 5,128 | 12,623 | 11,621 | |||||||
Provision for income taxes | 948 | 2,246 | 3,106 | |||||||
Hotel EBITDA | $ | 48,668 | $ | 130,085 | $ | 134,023 | ||||
Cash Flows
Net cash provided by operating activities was $51.5 million for the nine months ended September 30, 2016. Cash provided by operating activities was positively impacted primarily by increases in accounts payable and accrued expenses, partially offset by acquisition and transaction related costs, increases in restricted cash, and increases in prepaid expenses and other assets.
Net cash used in investing activities was $99.1 million for the nine months ended September 30, 2016, attributable to acquisitions and capital investments in our properties, partially offset by a decrease in restricted cash.
Net cash flow provided by financing activities was $51.8 million for the nine months ended September 30, 2016. Cash provided by financing activities was primarily impacted by proceeds from mortgage notes payable, partially offset by cash distributions paid, payments of mandatorily redeemable preferred securities and promissory notes payable.
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Election as a REIT
We elected and qualified to be taxed as a REIT commencing with our taxable year ended December 31, 2014. In order to continue to qualify as a REIT, we must annually distribute to our stockholders 90% of our REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gains. As a REIT, we generally will not be subject to U.S. federal income tax on that portion of our taxable income or capital gain which is distributed to our stockholders. Our hotels are leased to a TRS which is owned by the OP. A TRS is subject to federal, state and local income taxes. If we fail to remain qualified for taxation purposes as a REIT in any subsequent year after electing REIT status and do not qualify for certain statutory relief provisions, our income for that year will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially and adversely affect our net income and cash available for distribution. However, we believe that we will continue to operate so as to remain qualified as a REIT.
Liquidity and Capital Resources
As of September 30, 2016, we had cash on hand of $50.7 million. Under certain of our debt obligations, we are required to maintain minimum liquidity of $20.0 million to comply with financial covenants, and we expect to satisfy this covenant through liquidity we maintain at individual hotels as well as through other sources.
On November 15, 2015, we suspended our IPO and, on November 18, 2015, the Former Dealer Manager suspended sales activities, effective immediately. On December 31, 2015, we terminated the Former Dealer Manager as the dealer manager of our IPO. Prior to suspension of our IPO, we depended, and expected to continue to depend, in substantial part on proceeds from our IPO to meet our major capital requirements. Because we do not expect we will resume our IPO, we will require funds in addition to operating cash flow and cash on hand to meet our capital requirements. Moreover, to the extent we sell assets to generate needed cash, our ability to generate future cash flow from operations will be adversely impacted. As described in greater detail below, we are undertaking and evaluating a variety of transactions to generate additional liquidity to address our capital requirements. However, there can be no assurance that we will be successful in our efforts to address all of our capital needs.
Following the suspension of our IPO in November 2015, our primary business objective has been a focus on meeting our capital requirements and on maximizing the value of our existing portfolio by continuing to invest in our hotels primarily through PIPs, and through intensive asset management. Our major capital requirements during the remainder of 2016 and in future periods include PIP obligations pursuant to our franchise agreements and related escrows required by lenders under our indebtedness, interest and principal payments under our indebtedness, interest and mandatory redemptions on the Grace Preferred Equity Interests, and asset management fees and expense reimbursements payable to our Advisor.
As of September 30, 2016, we had principal outstanding of $1.5 billion under our indebtedness plus an additional $292.3 million in liquidation value of Grace Preferred Equity Interests (which are treated as indebtedness for accounting purposes), most of which was incurred in acquiring the properties we currently own. As of September 30, 2016, we are required to redeem 50.0% of the Grace Preferred Equity Interests originally issued, or an additional $68.8 million by February 27, 2018, and we are required to redeem the remaining $223.5 million by February 27, 2019. As of September 30, 2016, we have $927.1 million in principal outstanding under our indebtedness that will mature in 2017, which we may extend at our option if certain conditions are met, including compliance with financial ratios. There can be no assurance that we will be able to meet these conditions. See Note 5 – Mortgage Notes Payable and Note 6 –Promissory Notes Payable to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q for further information on this indebtedness. See also “Contractual Obligations” below for a tabular presentation of maturity dates of our debt and the Grace Preferred Equity Interests as of September 30, 2016.
Substantially all of our properties have been pledged as security under our indebtedness. If our cash flow from operations and other available sources are insufficient to fund interest and principal under our indebtedness or make mandatory redemptions of the Grace Preferred Equity Interests we could lose control of our properties.
We are also required to fund up to $69.7 million in closing consideration for our Pending Acquisition (including amounts we intend to finance, although there can be no assurance we will be able to obtain financing on reasonable terms, or at all), which is scheduled to occur in December 2016. Failure to do so could cause us to forfeit up to $7.5 million in non-refundable earnest money deposits.
As part of our efforts to address our capital requirements, we began paying distributions to our stockholders in shares of common stock instead of cash, beginning with distributions payable with respect to April 2016. We have also been seeking, and continue to seek, to identify and evaluate potential debt or equity financing transactions, which could consist of common stock, preferred stock or warrants, or any combination thereof. Such issuances could be below the offering price in our IPO or Estimated Per-Share NAV. Moreover, because we are required to use 35% of the proceeds from the issuance of interests in us or any of our subsidiaries to redeem the Grace Preferred Equity Interests at par, up to a maximum of $350 million in redemptions for any 12-month period, it may be more difficult to obtain equity financing from an alternative source in an
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amount required to meet our capital requirements. There can be no assurance that we will be successful in entering into any financing that will address all of our capital needs.
We have also extended certain of our PIP obligations and anticipate we will seek additional PIP extensions. PIP extensions delay the need to use capital for those purposes, but do not eliminate it. If we default on a franchise agreement as a result of our failure to comply with the PIP requirements, the franchisor may have the right to terminate the applicable agreement, we may be required to pay the franchisor liquidated damages, and we may also be in default under the applicable hotel indebtedness.
We have also been marketing select hotels for sale, one of which was sold on October 14, 2016 (See Note 15 - Subsequent Events to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q). The sale of this hotel and other hotels, if completed, will generate net proceeds that can be used to meet liquidity requirements, eliminate any associated future PIP obligations, and reduce debt associated with these hotels.
Concurrently with the change in our distribution policy, we amended (the “Amendment”) our agreement with our Advisor (as amended, the “Advisory Agreement”) to provide us with the right to pay up to $500,000 per month of asset management fees payable to our Advisor under the Advisory Agreement in shares of our common stock for the period of time beginning on June 1, 2016 and ending on June 1, 2017. Our right to pay such portion of the asset management fees in shares of common stock will commence on the date (the “Trigger”) that the elimination of our payment of cash distributions is insufficient to provide adequate liquidity levels consistent with assumptions mutually agreed to in good faith by our independent directors and our Advisor from time to time (the “Relief Period”). As of September 30, 2016, the Trigger has not occurred and we have not exercised this right. See Note 11 - Related Party Transactions and Arrangements to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q for additional discussion.
We have also have extended the payment date of the contingent consideration payable on the Barceló Portfolio acquisition, which is approximately $4.6 million, until July 3, 2017 (See Note 10 - Commitment and Contingencies to our accompanying consolidated financial statements included in this Quarterly Report on Form 10-Q).
There can be no assurance as to how effective the above and any other measures we undertake will be, and they are not expected to be sufficient to address all of our capital needs. Moreover, asset sales and the deferral of PIP obligations could adversely impact our operating results and hence our operating cash flow.
If obtained, any additional debt or equity financing could be on terms that would not be favorable to us or our stockholders, including interest rates that are higher than existing rates on our debt in the case of debt financing, and substantial dilution in the case of equity issuances or convertible securities.
Because we have raised less proceeds in our IPO than originally contemplated, our ability to achieve our original investment objective of a loan-to-value ratio of 50% has been adversely affected. As of September 30, 2016, our loan-to-value ratio, including the Grace Preferred Equity Interests, was 72.9%, and our loan-to-value ratio excluding the Grace Preferred Equity Interests was 60.7%. Our leverage levels will also impact our ability to obtain additional financing on favorable terms, or at all.
Under our charter, the maximum amount of our total indebtedness may not exceed 300% of our total “net assets” (which is generally defined in our charter as our assets less our liabilities) as of the date of any borrowing, which is generally equal to approximately 75% of the cost of our investments; however, we may exceed that limit if such excess is approved by a majority of our independent directors. This charter limitation, however, does not apply to individual real estate assets or investments. In all events, we expect that our secured and unsecured borrowings will be reasonable in relation to the net value of our assets and will be reviewed by our board of directors at least quarterly.
Prior to our entry into agreements related to our acquisition and financing activities during 2014 and 2015, a majority of our independent directors waived the total portfolio leverage requirement of our charter with respect to acquisition and financing activities should such total portfolio leverage exceed 300% of our total "net assets" in connection with such acquisition and financing activities. Our total portfolio leverage (which includes the Grace Preferred Equity Interests) has significantly exceeded this 300% limit at times. As of September 30, 2016, our total portfolio leverage was 241%.
We are also subject to covenants, such as debt service coverage ratios and negative pledges, in our existing indebtedness that restrict our ability to make future borrowings.
Distributions
Beginning in May 2014 with respect to holders of record in April 2014, we paid cash distributions on a monthly basis to stockholders of record each day during the prior month in an amount which is equivalent to $1.70 per annum per share of common stock. The distributions are payable by the fifth day following each month end to stockholders of record at the close of business each day during the prior month. Because we require funds in addition to our operating cash flow and cash on hand to meet our capital requirements, in March 2016, our board of directors changed our distribution policy such that, beginning with distributions with respect to April 2016, we began paying distributions to our stockholders in shares of
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common stock instead of cash on a monthly basis to stockholders of record each day during the prior month. Distributions for the quarter ended June 30, 2016 were paid in common stock in an amount equivalent to $1.70 per annum, divided by $23.75.
In July 2016, in connection with its determination of Estimated Per-Share NAV, our board of directors revised the amount of the distribution to $1.46064 per share per annum, equivalent to a 6.80% annual rate based on the Estimated Per-Share NAV, automatically adjusting if and when we publish an updated Estimated Per-Share NAV. Distributions for the quarter ended September 30, 2016 were paid in shares of common stock in an amount equal to 0.000185792 per share per day, or $1.46064 per annum, divided by $21.48. It is currently anticipated that we will publish an updated Estimated Per-Share NAV on at least an annual basis. The distributions are made by the fifth day following each month-end to stockholders of record at the close of business each day during the prior month.
Our distribution policy is subject to revision at the discretion of our board of directors, and may be changed at any time. There can be no assurance that we will continue to pay distributions in shares of common stock as set forth above or be able to pay distributions in cash in the future. Our ability to make future cash distributions will depend on our future cash flows and may be dependent on our ability to obtain additional liquidity, which may not be available on favorable terms, or at all.
During the three months ended September 30, 2016, we issued 650,036 shares of common stock as distributions to our stockholders.
The following table shows the sources for the payment of cash distributions to common stockholders for the periods presented (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||||||||||||||
Distributions: | ||||||||||||||||||||||||||||
Cash distributions paid | $ | — | $ | 5,679 | $ | 11,206 | $ | 12,164 | ||||||||||||||||||||
Cash distributions reinvested | — | 5,451 | 9,468 | 11,417 | ||||||||||||||||||||||||
Total distributions | $ | — | $ | 11,130 | $ | 20,674 | $ | 23,581 | ||||||||||||||||||||
Source of distribution coverage: | ||||||||||||||||||||||||||||
Cash flows provided by operations | $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | — | — | % | ||||||||||||
Offering proceeds from issuance of common stock | $ | — | — | % | $ | 5,679 | 51.0 | % | $ | 11,206 | 54.2 | % | $ | 12,164 | 51.6 | % | ||||||||||||
Offering proceeds reinvested in common stock issued under DRIP | $ | — | — | % | $ | 5,451 | 49.0 | % | $ | 9,468 | 45.8 | % | $ | 11,417 | 48.4 | % | ||||||||||||
Total sources of distributions | $ | — | — | % | $ | 11,130 | 100.0 | % | $ | 20,674 | 100.0 | % | $ | 23,581 | 100.0 | % | ||||||||||||
Cash flows provided by operations (GAAP) | $ | 28,999 | $ | 19,227 | $ | 51,195 | $ | 3,305 | ||||||||||||||||||||
Net income (loss) (GAAP) | $ | (6,532 | ) | $ | (4,928 | ) | $ | (57,387 | ) | $ | (44,472 | ) | ||||||||||||||||
For the period from our inception in July 2013 through May 2016 when we commenced paying distributions in common stock, we paid distributions in cash, all of which were funded with proceeds from our IPO and proceeds realized from the sale of common stock issued pursuant to our DRIP. We will not issue any additional shares of common stock under the DRIP unless and until we pay distributions in cash instead of shares of common stock.
The below table shows the distributions paid on shares outstanding in cash and shares of our common stock valued at either $23.75 price per share, or $21.48 price per share subsequent to establishing our Estimated Per-Share NAV, for the nine months ended September 30, 2016 (in thousands).
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Payment Date | Weighted Average Shares Outstanding (1) | Amount Paid in Cash | Amount Reinvested under DRIP | Issuance of Common Stock for Distributions | ||||
January 4, 2016 | 36,414 | $2,780 | $2,448 | — | ||||
February 2, 2016 | 36,530 | $2,855 | $2,393 | — | ||||
March 1, 2016 | 36,627 | $2,688 | $2,233 | — | ||||
April 1, 2016 | 36,728 | $2,880 | $2,394 | — | ||||
May 2, 2016 | 36,936 | $3 | — | $5,118 (2) | ||||
June 1, 2016 | 37,167 | — | — | $5,318 (3) | ||||
July 1, 2016 | 37,392 | — | — | $5,176 (4) | ||||
August 1, 2016 | 37,614 | — | — | $4,626 (5) | ||||
September 1, 2016 | 37,834 | — | — | $4,657(6) | ||||
Total | $11,206 | $9,468 | $24,895 | |||||
(1) Represents the weighted average shares outstanding for the period related to the respective payment date (2) Represents 215,481 shares of common stock valued at $23.75 per share (3) Represents 223,939 shares of common stock valued at $23.75 per share (4) Represents 217,946 shares of common stock valued at $23.75 per share (5) Represents 215,323 shares of common stock valued at $21.48 per share (6) Represents 216,616 shares of common stock valued at $21.48 per share and 151 shares of common stock valued at $23.75 | ||||||||
The following table compares cumulative distributions paid to cumulative net income (loss) (in accordance with GAAP) for the period from July 25, 2013 (date of inception) through September 30, 2016 (in thousands):
For the Period from July 25, 2013 (date of inception) to | ||||
September 30, 2016 | ||||
Distributions paid: | ||||
Common stockholders in cash (including distributions reinvested through DRIP) | $ | 61,447 | ||
Issuance of common stock for distributions | $ | 24,895 | ||
Total distributions paid | $ | 86,342 | ||
Reconciliation of net loss: | ||||
Revenues | $ | 940,896 | ||
Acquisition and transaction related | (100,667 | ) | ||
Depreciation and amortization | (146,208 | ) | ||
Impairment of long-lived Assets | $ | (2,399 | ) | |
Other operating expenses | (669,539 | ) | ||
Other non-operating expenses | (183,005 | ) | ||
Income tax | (5,943 | ) | ||
Net loss (in accordance with GAAP) | $ | (166,865 | ) | |
Cash flows provided by operations | $ | 48,052 | ||
FFO attributable to stockholders | $ | (18,267 | ) | |
Contractual Obligations
We have the following contractual obligations as of September 30, 2016:
Debt Obligations:
The following is a summary of our mortgage notes payable obligations as of September 30, 2016 (in thousands):
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Total | 2016 | 2017-2019 | 2020 | Thereafter | ||||||||||||||||
Principal payments due on mortgage notes payable | $ | 1,427,385 | $ | — | $ | 958,232 | $ | 469,153 | $ | — | ||||||||||
Interest payments due on mortgage notes payable | 187,726 | 12,170 | 158,505 | 17,051 | — | |||||||||||||||
Total | $ | 1,615,111 | $ | 12,170 | $ | 1,116,737 | $ | 486,204 | $ | — | ||||||||||
Mortgage notes payable due dates assume exercise of all borrower extension options.
The following is a summary of our promissory note payable obligations as of September 30, 2016 (in thousands):
Total | 2016 | 2017-2019 | 2020 | Thereafter | ||||||||||||||||
Principal payments due on promissory note payable | $ | 26,236 | $ | — | $ | 26,236 | $ | — | $ | — | ||||||||||
Interest payments due on promissory note payable | 5,214 | 526 | 4,688 | — | — | |||||||||||||||
Total | $ | 31,450 | $ | 526 | $ | 30,924 | $ | — | $ | — | ||||||||||
Promissory note payable due dates assume exercise of all borrower extension options.
The following is a summary of our mandatorily redeemable preferred securities as of September 30, 2016 (in thousands):
Total | 2016 | 2017-2019 | 2020 | Thereafter | ||||||||||||||||
Principal payments due on mandatorily redeemable preferred securities | $ | 292,253 | $ | — | $ | 292,253 | $ | — | $ | — | ||||||||||
Interest payments due on mandatorily redeemable preferred securities | 50,833 | 4,345 | 46,488 | — | — | |||||||||||||||
Total | $ | 343,086 | $ | 4,345 | $ | 338,741 | $ | — | $ | — | ||||||||||
Lease Obligations:
The following table reflects the minimum base rental cash payments due from us over the next five years and thereafter for our ground and other lease obligations as of September 30, 2016 (in thousands):
Total | 2016 | 2017-2019 | 2020 | Thereafter | ||||||||||||||||
Lease payments due | $ | 109,165 | $ | 1,232 | $ | 15,654 | $ | 5,265 | $ | 87,014 | ||||||||||
Property Improvement Plan Reserve Deposits:
The following table reflects required property improvement plan reserve deposits under our mortgage debt obligations over the next five years as of September 30, 2016 (in thousands):
Total | 2016 | 2017-2019 | 2020 | Thereafter | ||||||||||||||||
PIP reserve deposits due | $ | 43,801 | $ | 9,667 | $ | 34,134 | $ | — | $ | — | ||||||||||
Related Party Transactions and Agreements
See Note 11 - Related Party Transactions and Arrangements to our consolidated financial statements included in this report.
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Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our long-term debt, which consists of secured financings, bears interest at fixed and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes in earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We would not hold or issue these derivative contracts for trading or speculative purposes.
As of September 30, 2016, we had not fixed the interest rate for $1.1 billion of our secured variable-rate debt. As a result, we are subject to the potential impact of rising interest rates, which could negatively impact our profitability and cash flows. In order to mitigate our exposures to changes in interest rates, we have entered into interest rate cap agreements with respect to approximately $1.1 billion of our variable-rate debt. The estimated impact on our annual results of operations, of an increase of 100 basis points in interest rates, would be to increase annual interest expense by approximately $11.6 million. Decreasing interest rates by 100 basis points, but to no lower than a zero percent variable rate, would decrease annual interest expense by $6.0 million. The estimated impact assumes no changes in our capital structure. As the information presented above includes only those exposures that exist as of September 30, 2016, it does not consider those exposures or positions that could arise after that date. The information represented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.
Item 4. Controls and Procedures.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q and determined that the disclosure controls and procedures are effective.
No change occurred in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the three months ended September 30, 2016 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
We are not a party to any material pending legal proceedings.
Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed in our 2015 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
For the three months ended September 30, 2016, a total of 4,188 shares of common stock, on the date and in the amount in the table below, were issued to three directors of the Company for director-related compensation. The issuance of these shares is exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as amended.
Shares Granted | |
July 28, 2016 | 4,188 |
Total | 4,188 |
On January 7, 2014, we commenced our IPO on a "reasonable best efforts" basis of up to 80,000,000 shares of common stock at a price of $25.00 per share, subject to certain volume and other discounts, pursuant to a registration statement on Form S-11 (File No. 333-190698), filed with the SEC (the “Registration Statement”). The Registration Statement also covers up to 21,052,631 shares of common stock available pursuant to the DRIP under which our common stockholders could elect to have their cash distributions reinvested in additional shares our common stock.
On November 15, 2015, we suspended our IPO, which was conducted by the Former Dealer Manager, as exclusive wholesale distributor, effective December 31, 2015, and, on November 18, 2015, the Former Dealer Manager suspended sales activities it performed pursuant to the dealer manager agreement for the IPO, effective immediately. On December 31, 2015, we entered into a termination agreement with the Former Dealer Manager to terminate the dealer manager agreement. On January 4, 2016, we registered an additional 3,656,000 shares of common stock, $0.01 par value per share, to be issued under the DRIP pursuant to a new registration statement on Form S-3 (File No. 333-208855).
As of September 30, 2016, we had approximately 37.8 million shares of common stock outstanding and had received total proceeds of approximately $913.0 million from the IPO and shares issued under the DRIP, net of repurchases. The shares outstanding include shares of common stock issued as stock distributions through September 30, 2016, as a result of the Company’s change in distribution policy adopted by the Company’s board of directors in March 2016. We will not issue any additional shares of common stock under the DRIP unless and until we recommence paying distributions in cash.
The following table reflects cumulative offering costs associated with the issuance of common stock:
For the Period from July 25, 2013 (date of inception) to | ||||
(In thousands) | September 30, 2016 | |||
Selling commissions and dealer manager fees | $ | 85,249 | ||
Other offering costs | 23,559 | |||
Total offering costs | $ | 108,808 | ||
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The Former Dealer Manager was able to reallow the selling commissions and a portion of the dealer manager fees to participating broker-dealers. The following table details cumulative selling commissions incurred and reallowed related to the sale of shares of common stock:
For the Period from July 25, 2013 (date of inception) to | ||||
(In thousands) | September 30, 2016 | |||
Total commissions paid to the Former Dealer Manager | $ | 85,249 | ||
Less: | ||||
Commissions to participating brokers | 58,710 | |||
Reallowance to participating broker dealers | 10,047 | |||
Net to the Former Dealer Manager | $ | 16,492 | ||
As of September 30, 2016, we have incurred $108.8 million of cumulative offering costs in connection with the issuance and distribution of our registered securities. Cumulative offering proceeds from the sale of common stock exceeded cumulative offering costs by $801.9 million at September 30, 2016.
As of September 30, 2016, cumulative offering costs included $85.2 million of selling commissions and dealer manager fees and $19.6 million of offering cost reimbursements incurred from the Advisor and Former Dealer Manager. We are obligated to reimburse the Advisor or its affiliates, as applicable, for organization and offering costs paid by them on our behalf, provided that the Advisor is obligated to reimburse us to the extent organization and offering costs (excluding selling commissions and the dealer manager fee) incurred by us in our IPO exceed 2.0% of gross offering proceeds in the IPO.
Through September 30, 2016, we have received $885.5 million in proceeds from the IPO excluding the DRIP, all of which has been used as follows: (i) $85.2 million to pay selling commissions and dealer manager fees to our Former Dealer Manager; (ii) $19.6 million to reimburse our Advisor for Offering expenses; (iii) $54.5 million to pay acquisition fees, acquisition cost reimbursements, and financing coordination fees to our Advisor; (iv) $29.4 million to pay cash distributions to our stockholders; (v) $221.7 million to fund part of the purchase price of the Grace Portfolio, $53.2 million to fund part of the purchase price of the First Summit Portfolio, $39.3 million to fund part of the purchase price of the First Noble and Second Noble Portfolios, and $18.5 million to fund part of the purchase price of the Third Summit Portfolio; (vi) $219.7 million in repayments of debt and redemptions of Grace Preferred Equity Interests; (vii) $41.1 million in deposits forfeited related to terminated acquisitions; (viii) $95.4 million to fund capital expenditures; and (ix) $6.2 million to pay advisory and other service fees to the Former Dealer Manager and one of its affiliates, RCS Advisory; and (x) $1.7 million to repurchase shares of our common stock pursuant to the SRP.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
None.
Item 5. Other Information.
None.
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Item 6. Exhibits.
EXHIBIT INDEX
The following exhibits are included in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2016 (and are numbered in accordance with Item 601 of Regulation S-K).
Exhibit No. | Description | |
3.1 (1) | Articles of Amendment and Restatement of American Realty Capital Hospitality Trust, Inc. | |
3.2 * | Articles of Amendment to the Articles of Amendment and Restatement of American Realty Capital Hospitality Trust, Inc. | |
31.1 * | Certification of the Principal Executive Officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 * | Certification of the Principal Financial Officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32 * | Written statements of the Principal Executive Officer and Principal Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101 * | XBRL (eXtensible Business Reporting Language). The following materials from American Realty Capital Hospitality Trust, Inc.'s Quarterly Report on Form 10-Q for the nine months ended September 30, 2016, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations and Comprehensive Loss, (iii) the Consolidated Statements of Changes in Stockholders' Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements. | |
* Filed herewith
(1) Filed as an exhibit to Pre-Effective Amendment No. 3 to the Company's Registration Statement on Form S-11/A with the SEC on December 9, 2013.
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AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AMERICAN REALTY CAPITAL HOSPITALITY TRUST, INC. | |
Dated: November 10, 2016 | By: /s/ Jonathan P. Mehlman Name: Jonathan P. Mehlman Title: Chief Executive Officer and President (Principal Executive Officer) |
Dated: November 10, 2016 | By: /s/ Edward T. Hoganson Name: Edward T. Hoganson Title: Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer and Principal Accounting Officer) |
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