NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Organization and Description of Business
Chesapeake Lodging Trust (the “Trust”) is a self-advised real estate investment trust (“REIT”) that was organized in the state of Maryland. The Trust is focused on investments primarily in upper-upscale hotels in major business and convention markets and, on a selective basis, premium select-service hotels in urban settings or unique locations in the United States of America (“U.S.”). As of
June 30, 2019
, the Trust owned
20
hotels with an aggregate of
6,288
rooms in
eight
states and the District of Columbia.
Substantially all of the Trust’s assets are held by, and all of its operations are conducted through, Chesapeake Lodging, L.P., a Delaware limited partnership, which is wholly owned by the Trust (the “Operating Partnership”). For the Trust to qualify as a REIT, it cannot operate hotels. Therefore, the Operating Partnership leases its hotels to taxable REIT subsidiaries (each, a “TRS”), which are wholly owned subsidiaries of the Operating Partnership and are treated as TRSs for federal income tax purposes. The TRSs then engage hotel management companies to operate the hotels pursuant to management agreements.
On May 5, 2019, the Trust entered into the Agreement and Plan of Merger (the “Merger Agreement”) with Park Hotels & Resorts Inc. (“Park”), PK Domestic Property LLC, a Delaware limited liability company and an indirect subsidiary of Park
(“Domestic”), and PK Domestic Sub LLC, a Delaware limited liability company and a direct subsidiary of Domestic (“Merger
Sub,” and, together with Park and Domestic, the “Park Parties”). The Merger Agreement provides that, upon the terms and
subject to the conditions set forth therein and in accordance with applicable law, the Trust will merge with and into Merger Sub, with Merger Sub continuing as the surviving entity (the “Merger”).
Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger:
|
|
•
|
each of the Trust’s outstanding common shares (other than shares held by the Trust, any wholly-owned subsidiary of the Trust or by any of the Park Parties or any of their respective wholly-owned subsidiaries) will be converted into the right to receive
0.628
of a share of Park common stock, par value
$0.01
per share (“Park Common Stock”), and
$11.00
in cash (collectively, the “Merger Consideration”); and
|
|
|
•
|
all unvested awards granted under the Trust’s Equity Plan will vest, entitling the holders to receive the Merger Consideration.
|
No fractional shares of Park Common Stock will be issued in the Merger. The value of any fractional interests of shares
of Park Common Stock to which a holder would otherwise be entitled will be paid in cash. The Merger will be treated as a taxable sale by the Trust of all of its assets to Domestic in exchange for the Merger Consideration and the assumption of all of the Trust’s liabilities, immediately followed by a distribution of the Merger Consideration to the holders of the outstanding common shares in liquidation of the Trust. The parties currently expect the Merger to be completed in mid-to-late September 2019.
In connection with the Merger, Park filed with the Securities and Exchange Commission (the “SEC”) and attained effectiveness of a registration statement on Form S-4 (File No. 333-232123). The definitive proxy statement/prospectus forming a part of that registration statement was first mailed to the Trust’s shareholders on or about August 1, 2019. The Merger is subject to risks and uncertainties, and the Trust cannot assure you that it will be able to complete the Merger on the expected timeline or at all. See Note 12, “Commitment and Contingencies” and “Part II, Item 1A. Risk Factors” included elsewhere in this Quarterly Report on Form 10-Q for more information related to the Merger.
2. Summary of Significant Accounting Policies
Basis of Presentation
—The interim consolidated financial statements presented herein include all of the accounts of the Trust and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. These reclassifications had no effect on previously reported results of operations or retained earnings.
The information in these interim consolidated financial statements is unaudited but, in the opinion of management, reflects all adjustments necessary for a fair presentation of the results for the periods covered. All such adjustments are of a normal, recurring nature unless disclosed otherwise. These interim consolidated financial statements, including notes, have been prepared in accordance with the applicable rules of the SEC and do not include all of the information and disclosures required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Trust’s Form 10-K for the year ended
December 31, 2018
.
Cash and Cash Equivalents
—The Trust considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Restricted Cash
—Restricted cash includes reserves held in escrow for normal replacements of furniture, fixtures and equipment (“FF&E”), property improvement plans (each, a “PIP”), real estate taxes, and property insurance pursuant to certain requirements in the Trust’s hotel management, franchise, and loan agreements.
Investments in Hotels
—The Trust allocates the purchase prices of hotels acquired based on the fair value of the property, FF&E, and identifiable intangible assets acquired and the fair value of the liabilities assumed. In making estimates of fair value for purposes of allocating the purchase price, the Trust utilizes a number of sources of information that are obtained in connection with the acquisition of a hotel, including valuations performed by independent third parties and cost segregation studies. The Trust also considers information obtained about each hotel as a result of its pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired and liabilities assumed. Hotel acquisition costs, such as transfer taxes, title insurance, environmental and property condition reviews, and legal and accounting fees, are expensed in the period incurred if the acquisition of the hotel is determined to be an acquisition of a business; if the acquisition of the hotel is determined to be an acquisition of an asset, hotel acquisition costs are capitalized.
Property and equipment are depreciated using the straight-line method over the estimated useful lives of the assets, generally
15
to
40 years
for buildings and building improvements and
three
to
ten years
for FF&E. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets. Replacements and improvements at the hotels are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of property and equipment, the cost and related accumulated depreciation are removed from the Trust’s accounts and any resulting gain or loss is recognized in the consolidated statements of operations.
Intangible assets and liabilities are recorded on non-market contracts, including air rights, management, and franchise agreements, assumed as part of the acquisition of certain hotels. Above-market and below-market contract values are based on the present value of the difference between contractual amounts to be paid pursuant to the contracts assumed and the Trust’s estimate of the fair market contract rates for corresponding contracts measured over a period equal to the remaining non-cancelable term of the contracts assumed. No value is allocated to market contracts. Intangible assets and liabilities are amortized using the straight-line method over the remaining non-cancelable term of the related contracts.
The Trust reviews its hotels for impairment whenever events or changes in circumstances indicate that the carrying values of the hotels may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse changes in the demand for lodging at the hotels due to declining national or local economic conditions and/or new hotel construction in markets where the hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from the ultimate disposition of a hotel exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the related hotel’s estimated fair market value is recorded and an impairment loss is recognized. No impairment losses have been recognized related to any hotels for the three and six months ended
June 30, 2019
and
2018
.
The Trust classifies a hotel as held for sale in the period in which it has made the decision to dispose of the hotel, a binding agreement to purchase the hotel has been signed under which the buyer has committed a significant amount of nonrefundable cash, and no significant financing contingencies exist which could cause the transaction not to be completed in a timely manner. If these criteria are met, depreciation and amortization of the hotel will cease and an impairment loss will be recognized if the fair value of the hotel, less the costs to sell, is lower than the carrying amount of the hotel. If the sale represents a strategic shift that has (or will have) a major effect on the Trust’s operations and financial results, the Trust will classify the loss, together with the related operating results, as discontinued operations in the consolidated statements of operations and will classify the related assets and liabilities as held for sale in the consolidated balance sheets. As of
June 30, 2019
and December 31, 2018, the Trust had no assets held for sale or liabilities related to assets held for sale.
Revenue Recognition
—Revenues from operations of the hotels are recognized when goods and services are provided and the performance obligations are satisfied, net of any sales, occupancy, or other similar taxes collected from customers. Revenues consist of room sales, food and beverage sales, and other hotel revenues and are presented on a disaggregated basis on the consolidated statements of operations.
Room revenue is generated through short-term contracts with customers whereby customers agree to pay a daily rate for the right to use hotel rooms for one or more nights. The Trust’s performance obligations are fulfilled at the end of each night that the customers are provided the rooms and room revenue is recognized daily at the contract rate in effect for each room night.
Food and beverage revenue is generated when customers agree to pay for food and beverage at a hotel’s restaurant or bar outlets or for banquet and catering services at a hotel. The Trust’s performance obligations are fulfilled at the time that the food and beverage is provided or when the banquet facilities and related dining and other amenities (e.g., audio visual services) are provided.
Other revenue (e.g., parking, marina, resort and cancellation fees, theater, leasing, spa, telephone, and gift shop sales) is recognized at the point in time or over the time period that the associated good or service is provided. Ancillary services (e.g., parking) at certain hotels are provided by third parties and the Trust assesses whether the Trust is the principal or agent in such arrangements. If the Trust is determined to be the agent, revenue is recognized based upon the commission earned from the third party on the provided service. If the Trust is determined to be the principal, revenue is recognized based upon the gross contract price of the provided service. Certain of the Trust’s hotels have retail spaces, restaurants or other spaces which the Trust leases to third parties. Lease revenue is recognized on a straight-line basis over the life of the lease and included within other revenue.
Advance deposits are generally provided when a customer or group of customers provides a deposit for a future stay or banquet event at the Trust’s hotels. Advance deposits are converted to revenue when the associated goods or services are provided to the customer or when a customer with a noncancellable reservation fails to arrive for part or all of the reservation. Conversely, advance deposits are generally refundable upon guest cancellation of the related reservation within an established period of time prior to the reservation.
Prepaid Expenses and Other Assets
—Prepaid expenses and other assets consist of prepaid real estate taxes, prepaid insurance, deposits on hotel acquisitions and loan applications, deferred franchise costs, inventories, deferred tax assets, and other assets.
Deferred Financing Costs
—Deferred financing costs are recorded at cost and consist of loan fees and other costs incurred in issuing debt. Amortization of deferred financing costs is computed using a method that approximates the effective interest method over the term of the related debt and is included in interest expense in the consolidated statements of operations. Unamortized deferred financing costs are included as a direct deduction from long-term debt in the consolidated balance sheets.
Derivative Instruments
—From time to time, the Trust is a party to interest rate swaps, which are considered derivative instruments, in order to manage its interest rate exposure. The Trust’s interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows. The Trust records derivative instruments at fair value as either assets or liabilities and designates them as cash flow hedging instruments at inception. The Trust evaluates the hedge effectiveness of the designated cash flow hedging instruments on a quarterly basis and records the effective portion of the change in the fair value of the cash flow hedging instruments as other comprehensive income (loss). Amounts reported in accumulated other comprehensive income (loss) related to cash flow hedging instruments are reclassified to interest expense as interest payments are made on the variable-rate debt being hedged. The Trust does not enter into derivative instruments for trading or speculative purposes and monitors the financial stability and credit standing of its counterparties.
Fair Value Measurements
—The Trust accounts for certain assets and liabilities at fair value. In evaluating the fair value of both financial and non-financial assets and liabilities, GAAP outlines a valuation framework and creates a fair value hierarchy that distinguishes between market assumptions based on market data (observable inputs) and the reporting entity’s own assumptions about market data (unobservable inputs). The three levels of the fair value hierarchy are as follows:
Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that are accessible at the measurement date. An active market is defined as a market in which transactions occur with sufficient frequency and volume to provide pricing on an ongoing basis.
Level 2 – Inputs include quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates, yield curves), and inputs that are derived principally from or corroborated by observable market data correlation or other means.
Level 3 – Unobservable inputs reflect the reporting entity’s own assumptions about the pricing of an asset or liability when observable inputs are not available or when there is minimal, if any, market activity for an identical or similar asset or liability at the measurement date.
Income Taxes
—The Trust has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code. As a REIT, the Trust generally will not be subject to federal income tax on that portion of its net income that does not relate to any of the Trust’s TRSs, and that is currently distributed to its shareholders. The Trust’s TRSs, which lease the Trust’s hotels from the subsidiaries of the Operating Partnership owning them, are subject to federal and state income taxes.
The Trust accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Valuation allowances are provided if based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
Share-Based Compensation
—From time to time, the Trust grants restricted share awards to employees and trustees. To date, the Trust has granted two types of restricted share awards: (1) awards that vest solely on continued employment or service (time-based awards) and (2) awards that vest based on the Trust achieving specified levels of relative total shareholder return
and continued employment (performance-based awards). The Trust measures share-based compensation expense for the restricted share awards based on the fair value of the awards on the date of grant. The fair value of time-based awards is determined based on the closing price of the Trust’s common shares on the measurement date, which is generally the date of grant. The fair value of performance-based awards is determined using a Monte Carlo simulation performed by an independent third party. For time-based awards, share-based compensation expense is recognized on a straight-line basis over the life of the entire award. For performance-based awards, share-based compensation expense is recognized over the requisite service period for each award. No share-based compensation expense is recognized for awards for which employees or trustees do not render the requisite service.
Earnings Per Share
—Basic earnings per share is computed by dividing net income, adjusted for dividends declared on and undistributed earnings allocated to unvested time-based awards, by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income, adjusted for dividends declared on and undistributed earnings allocated to unvested time-based awards, by the weighted-average number of common shares outstanding, plus potentially dilutive securities, such as unvested performance-based awards, during the period. The Trust’s unvested time-based awards are entitled to receive non-forfeitable dividends, if declared. Therefore, unvested time-based awards qualify as participating securities, requiring the allocation of dividends and undistributed earnings under the two-class method to calculate basic earnings per share. The percentage of undistributed earnings allocated to the unvested time-based awards is based on the proportion of the weighted-average unvested time-based awards outstanding during the period to the total of the weighted-average common shares and unvested time-based awards outstanding during the period. No adjustment is made for shares that are anti-dilutive during the period.
Segment Information
—The Trust has determined that its business is conducted in
one
reportable segment, hotel ownership.
Use of Estimates
—The preparation of the interim 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 interim consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements
—In February 2016, the Financial Accounting Standards Board (the “FASB”) issued updated accounting guidance which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new accounting guidance requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on whether or not the lease is effectively a financed purchase by the lessee. The classification of the lease will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases.
The Trust adopted the new accounting guidance on January 1, 2019 and applied it based on the optional transition method provided for, which allows entities to recognize a cumulative-effect adjustment to the balance sheet on the adoption date. The Trust applied certain practical expedients made available under the new accounting guidance under which the Trust was not required to reassess at the adoption date (1) whether any expired or existing contracts were or contained leases, (2) the lease classification for existing leases, (3) initial direct costs for any existing leases, and (4) whether any existing or expired land easements that were not previously accounted for as leases under the previous accounting guidance are or contain leases under the new accounting guidance. The Trust also made an accounting policy election to not recognize right-of-use assets or lease liabilities for leases with terms of 12 months or less. For its ground lease agreements and corporate office lease agreement, all of which were previously accounted for as operating leases, the Trust recognized on its consolidated balance sheet on January 1, 2019 operating lease liabilities of
$72.1 million
and operating lease right-of-use assets of
$75.0 million
, of which
$3.1 million
was reclassified from intangible assets related to a previously recognized favorable ground lease asset and
$0.2 million
was reclassified from other liabilities related to a deferred rent liability associated with the Trust’s corporate office lease agreement. See Note 4, “Leases,” for additional disclosures related to the adoption of this new accounting guidance.
3. Property and Equipment
Property and equipment as of
June 30, 2019
and
December 31, 2018
consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2019
|
|
December 31, 2018
|
Land and land improvements
|
|
$
|
286,914
|
|
|
$
|
286,761
|
|
Buildings and leasehold improvements
|
|
1,632,703
|
|
|
1,620,864
|
|
Furniture, fixtures and equipment
|
|
198,666
|
|
|
235,585
|
|
Construction-in-progress
|
|
2,887
|
|
|
14,102
|
|
|
|
2,121,170
|
|
|
2,157,312
|
|
Less: accumulated depreciation and amortization
|
|
(410,198
|
)
|
|
(425,158
|
)
|
Property and equipment, net
|
|
$
|
1,710,972
|
|
|
$
|
1,732,154
|
|
4. Leases
The Trust leases (1) the land, or a portion of the land, under three of its hotels (the Hyatt Regency Mission Bay Spa and Marina, the JW Marriott San Francisco Union Square and the Hilton Denver City Center), (2) its corporate office space and (3) various operating equipment at its hotels (e.g., copiers, postage meters, etc.). All of the Trust’s leases are considered operating leases and the Trust’s leases associated with various operating equipment were determined to be insignificant or short-term. See Note 12, “Commitments and Contingencies,” for additional information relating to the Trust’s ground lease agreements.
For its ground lease agreements and corporate office lease agreement, the Trust recognized on its consolidated balance sheet on January 1, 2019 operating lease liabilities of
$72.1 million
and operating lease right-of-use assets of
$75.0 million
, of which
$3.1 million
was reclassified from intangible assets related to a previously recognized favorable ground lease asset and
$0.2 million
was reclassified from other liabilities related to a deferred rent liability associated with its corporate office lease agreement. The Trust used its incremental borrowing rate as the discount rate to measure the operating lease liabilities and the weighted-average discount rate used was
5.73%
.
As of June 30, 2019, the weighted-average remaining operating lease term was
49.2 years
and the maturities of the operating lease liabilities, due in each of the next five years and thereafter, were (in thousands):
|
|
|
|
|
|
|
|
June 30, 2019
|
2019
|
|
$
|
2,347
|
|
2020
|
|
4,699
|
|
2021
|
|
4,713
|
|
2022
|
|
4,566
|
|
2023
|
|
4,406
|
|
Thereafter
|
|
198,284
|
|
Total minimum lease payments
|
|
219,015
|
|
Imputed interest
|
|
(147,222
|
)
|
Operating lease liabilities
|
|
$
|
71,793
|
|
The Trust incurred total lease expense, which is primarily included within indirect hotel operating expenses in the interim consolidated statement of operations, of
$1.7 million
and
$3.5 million
for the three and six months ended June 30, 2019, respectively. Included in total lease expense for the three months ended June 30, 2019 was
$1.2 million
of operating lease expense,
$0.1 million
of variable lease expense, and
$0.4 million
of short-term lease expense. Included in total lease expense for the six months ended June 30, 2019 was
$2.4 million
of operating lease expense,
$0.7 million
of variable lease expense, and
$0.4 million
of short-term lease expense.
5. Intangible Assets
Intangible assets as of
June 30, 2019
and
December 31, 2018
consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2019
|
|
December 31, 2018
|
Air rights contract
(1)
|
|
$
|
36,105
|
|
|
$
|
36,105
|
|
Favorable ground lease
(2)
|
|
—
|
|
|
3,568
|
|
|
|
36,105
|
|
|
39,673
|
|
Less: accumulated amortization
|
|
(4,827
|
)
|
|
(4,995
|
)
|
Intangible assets, net
|
|
$
|
31,278
|
|
|
$
|
34,678
|
|
|
|
(1)
|
In conjunction with the acquisition of the Hyatt Regency Boston on March 18, 2010, the Trust acquired an air rights contract which expires in
September 2079
and that requires no payments through maturity. The Trust recorded the fair value of the air rights contract of
$36.1 million
as an intangible asset and is amortizing the value over the term of the contract.
|
|
|
(2)
|
In conjunction with the acquisition of the Hilton Denver City Center on October 3, 2011, the Trust assumed a lease agreement for a land parcel underlying a portion of the hotel with an initial term ending
February 2072
that it concluded had below market terms. The Trust recorded a favorable ground lease asset of
$3.6 million
associated with this lease agreement at the time. On January 1, 2019, the Trust reclassified the unamortized balance of this favorable ground lease asset to an operating lease right-of-use asset associated with this lease agreement upon the adoption of the new accounting guidance with respect to leases.
|
6
. Long-Term Debt
Long-term debt as of
June 30, 2019
and
December 31, 2018
consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Origination
|
|
Original Principal Amount
|
|
|
|
Interest Rate
|
|
Principal Amortization Period
|
|
June 30,
|
|
December 31,
|
|
|
|
Maturity
|
|
|
|
2019
|
|
2018
|
Unsecured:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revolving credit facility
(1)
|
July 2010
|
|
n/a
|
|
May 2022
|
|
Floating
|
|
n/a
|
|
$
|
—
|
|
|
$
|
—
|
|
Term loan
(2)
|
April 2017
|
|
$
|
225,000
|
|
|
April 2022
|
|
Floating
|
|
n/a
|
|
225,000
|
|
|
225,000
|
|
Secured:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Boston Marriott Newton
|
May 2013
|
|
$
|
60,000
|
|
|
June 2020
|
|
3.63%
|
|
25
|
|
50,311
|
|
|
51,205
|
|
Le Meridien San Francisco
|
July 2013
|
|
$
|
92,500
|
|
|
August 2020
|
|
3.50%
|
|
25
|
|
77,792
|
|
|
79,180
|
|
Hilton Denver City Center
(3)
|
July 2012
|
|
$
|
70,000
|
|
|
August 2022
|
|
4.90%
|
|
30
|
|
61,675
|
|
|
62,383
|
|
Hilton Checkers Los Angeles
|
February 2013
|
|
$
|
32,000
|
|
|
March 2023
|
|
4.11%
|
|
30
|
|
28,271
|
|
|
28,609
|
|
W Chicago – City Center
|
July 2013
|
|
$
|
93,000
|
|
|
August 2023
|
|
4.25%
|
|
25
|
|
79,517
|
|
|
80,815
|
|
Hyatt Herald Square New York/Hyatt Place New York Midtown South
|
July 2014
|
|
$
|
90,000
|
|
|
July 2024
|
|
4.30%
|
|
30
|
|
85,596
|
|
|
86,397
|
|
Hyatt Regency Boston
|
June 2016
|
|
$
|
150,000
|
|
|
July 2026
|
|
4.25%
|
|
30
|
|
142,314
|
|
|
143,471
|
|
|
|
|
|
|
|
|
|
|
|
|
750,476
|
|
|
757,060
|
|
Unamortized deferred financing costs
|
|
|
|
|
|
|
|
|
|
(4,929
|
)
|
|
(5,671
|
)
|
Long-term debt
|
|
|
|
|
|
|
|
|
|
|
$
|
745,547
|
|
|
$
|
751,389
|
|
|
|
(1)
|
The Trust may exercise an option to extend the maturity by
one year
, subject to certain customary conditions. As of
June 30, 2019
, the interest rate in effect was
3.90%
. See below for additional information related to the revolving credit facility.
|
|
|
(2)
|
The term loan bears interest equal to LIBOR plus
1.45%
-
2.20%
(the spread over LIBOR based on the Trust’s consolidated leverage ratio).
Contemporaneous with the closing of the term loan, the Trust entered into an interest rate swap to fix LIBOR at
1.86%
for the
five
-year term (as of
June 30, 2019
, the effective interest rate on the term loan was
3.31%
). Under the terms of this interest rate swap, the Trust pays fixed interest of
1.86%
per annum on a notional amount of
$225.0 million
and receives floating rate interest equal to one-month LIBOR. The effective date of this interest rate swap was
April 21, 2017
and it will mature on
April 21, 2022
.
|
|
|
(3)
|
The loan has a term of
30
years, but is callable by the lender after
10
years, and the Trust expects the lender to call the loan at that time. The indicated maturity is based on the date the loan is callable by the lender.
|
Unsecured revolving credit facility and term loan
On May 31, 2018, the Trust entered into an amended and restated credit agreement with a syndicate of banks to (1) extend the maturity date to
May 2022
and (2) lower the interest rate to LIBOR plus
1.45%
-
2.20%
(the spread over LIBOR continues to be based on the Trust’s consolidated leverage ratio) for its revolving credit facility. The amended credit agreement provides for the possibility of further future increases, up to a maximum of
$450.0 million
, in accordance with the terms of the amended credit agreement. The amended credit agreement also provides for an extension of the maturity date by
one year
, subject to satisfaction of certain customary conditions.
On April 21, 2017, the Trust obtained a
$225.0 million
,
five
-year, unsecured term loan from a syndicate of banks. The term loan provides for the possibility of future increases, up to a maximum amount borrowed of
$375.0 million
, in accordance with the terms of the term loan agreement.
The amount that the Trust can borrow in the aggregate under the revolving credit facility and the term loan is based on the value of the Trust’s hotels included in the borrowing base, as defined in the amended credit agreement and the term loan agreement. As of
June 30, 2019
, the borrowing base included
11
of the Trust’s hotels providing borrowing availability of
$300.0 million
under the revolving credit facility, all of which remained available. The amended credit agreement and the term loan agreement contain financial covenants, including a leverage ratio and a minimum tangible net worth requirement, and additional financial covenants typically found in similar unsecured revolving credit facilities and term loans, including a consolidated secured debt ratio, an unsecured leverage ratio and an unsecured debt service coverage ratio.
Other
Certain of the Trust’s mortgage loan agreements contain standard financial covenants relating to coverage ratios and standard provisions that require loan servicers to maintain escrow accounts for certain items, including real estate taxes, property insurance premiums, and normal replacements of FF&E.
As of
June 30, 2019
, the Trust was in compliance with all financial covenants under its borrowing arrangements. As of
June 30, 2019
, the Trust’s weighted-average interest rate on its long-term debt was
3.90%
. Future scheduled principal payments of debt obligations (assuming no exercise of extension options) as of
June 30, 2019
are as follows (in thousands):
|
|
|
|
|
|
Year
|
|
Amounts
|
2019
|
|
$
|
7,158
|
|
2020
|
|
135,326
|
|
2021
|
|
9,984
|
|
2022
|
|
291,635
|
|
2023
|
|
100,623
|
|
Thereafter
|
|
205,750
|
|
|
|
$
|
750,476
|
|
7. Indirect Expenses
Indirect hotel operating expenses for the three and six months ended
June 30, 2019
and
2018
consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Administrative and general
|
$
|
13,979
|
|
|
$
|
13,125
|
|
|
$
|
26,868
|
|
|
$
|
25,412
|
|
Advertising and sales
|
11,365
|
|
|
11,504
|
|
|
21,521
|
|
|
21,785
|
|
Repairs and maintenance
|
5,222
|
|
|
5,287
|
|
|
10,414
|
|
|
10,631
|
|
Utilities
|
3,503
|
|
|
3,629
|
|
|
7,087
|
|
|
7,277
|
|
Franchise fees
|
2,554
|
|
|
2,748
|
|
|
4,673
|
|
|
5,037
|
|
Management fees
|
5,574
|
|
|
5,864
|
|
|
10,569
|
|
|
10,483
|
|
Property and other taxes
|
7,281
|
|
|
8,474
|
|
|
15,569
|
|
|
16,701
|
|
Insurance, leases and other
|
2,931
|
|
|
2,913
|
|
|
5,858
|
|
|
6,011
|
|
Indirect hotel operating expenses
|
$
|
52,409
|
|
|
$
|
53,544
|
|
|
$
|
102,559
|
|
|
$
|
103,337
|
|
8. Earnings Per Share
The following is a reconciliation of the amounts used in calculating basic and diluted earnings per share (in thousands, except share and per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Numerator:
|
|
|
|
|
|
|
|
Net income
|
$
|
18,241
|
|
|
$
|
23,810
|
|
|
$
|
26,492
|
|
|
$
|
30,359
|
|
Less: Dividends declared on unvested time-based awards
|
(119
|
)
|
|
(119
|
)
|
|
(237
|
)
|
|
(240
|
)
|
Less: Undistributed earnings allocated to unvested time-based awards
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Net income available to common shareholders, excluding amounts attributable to unvested time-based awards
|
$
|
18,122
|
|
|
$
|
23,691
|
|
|
$
|
26,255
|
|
|
$
|
30,119
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
Weighted-average number of common shares outstanding–basic
|
59,394,134
|
|
|
59,133,648
|
|
|
59,392,327
|
|
|
59,126,894
|
|
Effect of dilutive unvested performance-based awards
|
867,669
|
|
|
659,415
|
|
|
848,937
|
|
|
633,871
|
|
Weighted-average number of common shares outstanding–diluted
|
60,261,803
|
|
|
59,793,063
|
|
|
60,241,264
|
|
|
59,760,765
|
|
|
|
|
|
|
|
|
|
Net income available per common share:
|
|
|
|
|
|
|
|
Basic
|
$
|
0.31
|
|
|
$
|
0.40
|
|
|
$
|
0.44
|
|
|
$
|
0.51
|
|
Diluted
|
$
|
0.30
|
|
|
$
|
0.40
|
|
|
$
|
0.44
|
|
|
$
|
0.50
|
|
For the three and six months ended June 30, 2019,
no
unvested performance-based awards were excluded from diluted weighted-average common shares outstanding. For the three and six months ended June 30,
2018
,
107,559
unvested performance-based awards were excluded from diluted weighted-average common shares outstanding as the awards had not achieved the specific levels of relative total shareholder return required for vesting at each period end.
9. Shareholders’ Equity
Common Shares
—The Trust is authorized to issue up to
400,000,000
common shares,
$.01
par value per share. Each outstanding common share entitles the holder to
one
vote on all matters submitted to a vote of shareholders. Holders of the Trust’s common shares are entitled to receive distributions when authorized by the Trust’s board of trustees out of assets legally available for the payment of distributions.
For the
six months
ended
June 30, 2019
, the Trust issued
1,360
unrestricted common shares and
548,419
restricted common shares to its trustees and employees. For the
six months
ended
June 30, 2019
, the Trust repurchased
47,653
common shares from employees to satisfy the minimum statutory tax withholding requirements related to the vesting of their previously granted restricted common shares. As of
June 30, 2019
, the Trust had
60,765,796
common shares outstanding.
For the
six months
ended
June 30, 2019
, the Trust paid or its board of trustees declared the following dividends per common share:
|
|
|
|
|
|
|
|
|
|
|
|
Record Date
|
|
Payment Date
|
|
Dividend Per Common Share
|
Fourth Quarter 2018
|
|
December 31, 2018
|
|
January 15, 2019
|
|
$
|
0.40
|
|
First Quarter 2019
|
|
March 29, 2019
|
|
April 15, 2019
|
|
$
|
0.40
|
|
Second Quarter 2019
|
|
June 28, 2019
|
|
July 15, 2019
|
|
$
|
0.40
|
|
Preferred Shares
—The Trust is authorized to issue up to 100,000,000 preferred shares, $.01 par value per share. The Trust’s board of trustees is required to set for each class or series of preferred shares the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, and terms or conditions of redemption. No preferred shares were outstanding as of
June 30, 2019
.
10. Equity Plan
In January 2010, the Trust established the Chesapeake Lodging Trust Equity Plan (the “Plan”), which provides for the issuance of equity-based awards, including restricted shares, unrestricted shares, share options, share appreciation rights, and other awards based on the Trust’s common shares. Employees and trustees of the Trust and other persons that provide services to the Trust are eligible to participate in the Plan. The compensation committee of the board of trustees administers the Plan and determines the number of awards to be granted, the vesting period, and the exercise price, if any.
In June 2018, the Trust’s common shareholders approved an amendment to the Plan to, among other things, increase the number of shares available for issuance under the Plan by
1,250,000
shares and extend the term of the Plan to June 2028. Shares that are issued under the Plan to any person pursuant to an award are counted against the aggregate number of shares available for issuance under the Plan as one share for every one share granted. If any shares covered by an award are not purchased or are forfeited, if an award is settled in cash, or if an award otherwise terminates without delivery of any shares, then the number of common shares counted against the aggregate number of shares available under the Plan with respect to the award will, to the extent of any such forfeiture or termination, again be available for making awards under the Plan. As of
June 30, 2019
, subject to increases that may result in the case of any future forfeiture or termination of currently outstanding awards,
1,033,175
common shares were reserved and available for future issuances under the Plan.
The Trust will make appropriate adjustments to outstanding awards and the number of shares available for issuance under the Plan, including the individual limitations on awards, to reflect share dividends, share splits, spin-offs and other similar events. While the compensation committee can terminate or amend the Plan at any time, no amendment can adversely impair the rights of grantees with respect to outstanding awards. In addition, an amendment will be contingent on approval of the Trust’s common shareholders to the extent required by law or if the amendment would materially increase the benefits accruing to participants under the Plan, materially increase the aggregate number of shares that can be issued under the Plan, or materially modify the requirements as to eligibility for participation in the Plan. Unless terminated earlier, the Plan will terminate in June 2028, but will continue to govern unexpired awards.
For the
six months
ended
June 30, 2019
, the Trust granted
548,419
restricted common shares to certain employees and trustees, of which
135,920
shares were time-based awards and
412,499
shares were performance-based awards (the “2019 Performance-Based Awards”). The time-based awards are eligible to vest at the annual rate of one-third of the number of restricted shares granted commencing on the first anniversary of their issuance. The 2019 Performance-Based Awards are eligible to vest at
December 31, 2021
. Dividends on the 2019 Performance-Based Awards accrue, but are not paid unless the related shares vest. The fair value of the 2019 Performance-Based Awards was
$9.49
per share and was determined using a Monte Carlo simulation with the following assumptions: volatility of
23.52%
; an expected term equal to the requisite service period for the awards; and a risk-free interest rate of
2.57%
.
The actual number of shares under the 2019 Performance-Based Awards that vest will be based on the Trust’s total shareholder return (“TSR”), as defined in the restricted share agreements, measured over a
three
-year performance period ending
December 31, 2021
, relative to the total return generated by a market-cap weighted index that includes seven lodging REITs (the "Performance Peer Group"). The payout schedule for the 2019 Performance-Based Awards is as follows, with linear interpolation for performance between
67%
and
100%
, and between
100%
and
133%
of the Performance Peer Group:
|
|
|
|
Trust TSR as % of Performance Peer Group Total Return
|
|
Payout (% of Maximum)
|
<67%
|
|
0%
|
67%
|
|
25%
|
100%
|
|
50%
|
≥133%
|
|
100%
|
If the Trust’s TSR is negative for the performance period, no shares under the 2019 Performance-Based Awards will vest. If the Trust’s TSR is positive for the performance period and the total return of the Performance Peer Group is negative,
100%
of the shares subject to vesting under the 2019 Performance-Based Awards will vest.
As of
June 30, 2019
, there was approximately
$10.9 million
of unrecognized share-based compensation expense related to restricted common shares. The unrecognized share-based compensation expense is expected to be recognized over a weighted-average period of
2.0
years.
The following is a summary of the Trust’s restricted common share activity for the
six months
ended
June 30, 2019
:
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
|
Weighted-Average Grant-Date Fair Value
|
Restricted common shares as of December 31, 2018
|
|
953,429
|
|
|
$
|
15.39
|
|
Granted
|
|
548,419
|
|
|
$
|
13.12
|
|
Vested
|
|
(130,186
|
)
|
|
$
|
25.99
|
|
Forfeited
|
|
—
|
|
|
$
|
—
|
|
Restricted common shares as of June 30, 2019
|
|
1,371,662
|
|
|
$
|
13.48
|
|
11. Fair Value Measurements and Derivative Instrument
The following table sets forth the Trust’s financial assets and liabilities measured at fair value by level within the fair value hierarchy (in thousands). Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value at June 30, 2019
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Liabilities:
|
|
|
|
|
|
|
|
|
Interest rate swap (included within other liabilities)
|
|
$
|
1,441
|
|
|
$
|
—
|
|
|
$
|
1,441
|
|
|
$
|
—
|
|
|
|
$
|
1,441
|
|
|
$
|
—
|
|
|
$
|
1,441
|
|
|
$
|
—
|
|
Derivative instruments are classified within Level 2 of the fair value hierarchy as they are valued using third-party pricing models which contain inputs that are derived from observable market data. Where possible, the values produced by the pricing models are verified to market prices. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility, and correlations of such inputs.
The Trust’s financial instruments in addition to those disclosed in the table above include cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses, and long-term debt. The carrying values reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, accounts receivable, and accounts payable and accrued expenses approximate fair value. The Trust estimates the fair value of its fixed rate debt by discounting the future cash flows of each instrument using estimated market rates of debt instruments with similar maturities and credit profiles. These inputs are classified as Level 3 within the fair value hierarchy. As of
June 30, 2019
, the carrying value reported in the consolidated balance sheet for the Trust’s long-term debt approximated its fair value.
12. Commitments and Contingencies
Management Agreements
—The Trust’s hotels operate pursuant to management agreements with various third-party management companies. Each management company receives a base management fee generally between
2%
and
4%
of hotel revenues. The management companies are also eligible to receive an incentive management fee if hotel operating income, as defined in the management agreements, exceeds certain performance thresholds. The incentive management fee is generally calculated as a percentage of hotel operating income after the Trust has received a priority return on its investment in the hotel.
Franchise Agreements
—As of
June 30, 2019
,
10
of the Trust’s hotels operated pursuant to franchise agreements with hotel brand companies and
10
hotels operated pursuant to management agreements with hotel brand companies that allowed them to operate under their respective brands. Under the
10
franchise agreements, the Trust generally pays a royalty fee ranging from
3%
to
6%
of room revenues and up to
3%
of food and beverage revenues, plus additional fees for marketing, central reservation systems, and other franchisor costs that amount to between
1%
and
5%
of room revenues.
Ground Lease Agreements
—The Trust leases the land underlying the Hyatt Regency Mission Bay Spa and Marina pursuant to a lease agreement, which has an initial term ending
January 2056
. Rent due under the lease agreement is the greater of base rent or percentage rent. Base rent resets every
three years
over the remaining term of the lease equal to
75%
of the average of the actual rent paid over the
two years
preceding the base rent reset year. As of December 31, 2018, base rent was
$2.3 million
per year. Base rent reset on February 1, 2019 to
$2.7 million
per year and the next base rent reset will occur in 2022. Annual percentage rent is calculated based on various percentages of the hotel’s various sources of revenue, including room, food and beverage, and marina rentals, earned during the period.
The Trust also leases the land underlying the JW Marriott San Francisco Union Square pursuant to a lease agreement, which has a term ending
January 2083
. Rent due under the lease agreement is the greater of base rent or percentage rent. Base rent resets every
five years
over the remaining term of the lease based on the level of inflation, as defined in the agreement, over the preceding
five years
, but in no event resulting in an increase of more than
125%
of the base rent in effect immediately prior to the reset year (nor subject to any decrease). As of December 31, 2018, base rent was
$1.7 million
per year. Base rent reset on January 1, 2019 to
$2.0 million
per year and the next base rent reset will occur in 2024. In
January 2034
, base rent will reset to
10%
of the fair market value of the underlying land as determined by a valuation performed by an independent third party, if such reset results in an increase over the base rent in effect immediately prior to the reset year. Annual percentage rent is calculated based on various percentages of the hotel’s various sources of revenue, including room and food and beverage, earned during the period.
FF&E Reserves
—Pursuant to its management, franchise and loan agreements, the Trust is required to establish a FF&E reserve for each hotel to cover the cost of replacing FF&E. Contributions to the FF&E reserve are based on a percentage of gross revenues at each hotel. The Trust is generally required to contribute between
3%
and
5%
of gross revenues over the term of the agreements.
Litigation
—Following the May 6, 2019 announcement that the Trust and Park had entered into the Merger Agreement, two purported shareholder class actions were filed in the United States District Court for the District of Delaware captioned:
Kent v. Chesapeake Lodging Trust, et al., No. 1:19-cv-01201 (D.Del.)
(filed June 25, 2019) and
Terlinden v. Chesapeake Lodging Trust, et al., No. 1:19-cv-01263 (D.Del.)
(filed July 8, 2019). The complaint in each case alleges purported violations of the federal securities laws and names as defendants the Trust, the individual members of the Trust’s board of trustees and the Park, Domestic and Merger Sub. The plaintiffs allege that the Trust and the individual defendants violated Section 14(a) of the Exchange Act, and Rule 14a-9 promulgated thereunder, by providing inadequate disclosure regarding the proposed merger in the registration statement on Form S-4 filed by Park with the SEC on June 14, 2019. The plaintiffs also allege that the individual defendants, Park, Domestic and Merger Sub violated Section 20(a) of the Exchange Act. Plaintiffs seek, among other things, to enjoin or rescind the merger, an award of damages in the event the merger is consummated, and an award of costs and attorneys’ fees. The Trust believes that these claims are without merit, and intends to vigorously defend against them.
13. Subsequent Event
On July 23, 2019, the Trust entered into an agreement to sell the
122
-room Hyatt Herald Square New York and the
185
-room Hyatt Place New York Midtown South, both located in New York, New York, for an aggregate sale price of
$138.0 million
, or approximately
$450,000
per key, subject to customary pro-rations at closing. The proposed sale by the Trust of these New York hotels is anticipated to occur in mid-to-late September 2019 prior to completion of the Trust’s proposed Merger.