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Watermark Lodging Trust, Inc. - Quarter Report: 2018 September (Form 10-Q)

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the quarterly period ended September 30, 2018
 
 
 
or
 
 
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the transition period from                     to                       
Commission File Number: 000-55461
cwi2highreslogo20.jpg
CAREY WATERMARK INVESTORS 2 INCORPORATED
(Exact name of registrant as specified in its charter)
Maryland
 
46-5765413
(State of incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
50 Rockefeller Plaza
 
 
New York, New York
 
10020
(Address of principal executive office)
 
(Zip Code)
Investor Relations (212) 492-8920
(212) 492-1100
(Registrant’s telephone numbers, including area code)

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer o
Non-accelerated filer þ
 
 
 
Smaller reporting company o
Emerging growth company o
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

Registrant has 31,019,376 shares of Class A common stock, $0.001 par value, and 59,432,600 shares of Class T common stock, $0.001 par value, outstanding at November 2, 2018.
 



INDEX
 
 
Page No.
PART I — FINANCIAL INFORMATION
 
Item 1. Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
PART II — OTHER INFORMATION
 
Item 6. Exhibits

Forward-Looking Statements

This Quarterly Report on Form 10-Q, or this Report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, in Item 2 of Part I of this Report, contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. These statements are based on the current expectations of our management. Forward-looking statements in this Report include, among others, statements about the impact of Hurricane Irma on certain hotels, including the condition of the properties, cost estimates and the timing of resumption of operations. It is important to note that our actual results could be materially different from those projected in such forward-looking statements. You should exercise caution in relying on forward-looking statements, as they involve known and unknown risks, uncertainties, and other factors that may materially affect our future results, performance, achievements or transactions. Information on factors that could impact actual results and cause them to differ from what is anticipated in the forward-looking statements contained herein is included in this Report as well as in our other filings with the Securities and Exchange Commission, or the SEC, including but not limited to those described in Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 as filed with the SEC on March 27, 2018, or the 2017 Annual Report. Except as required by federal securities laws and the rules and regulations of the SEC, we do not undertake to revise or update any forward-looking statements.

All references to “Notes” throughout the document refer to the footnotes to the consolidated financial statements of the registrant in Part I, Item 1. Financial Statements (Unaudited).



CWI 2 9/30/2018 10-Q 2
    


PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.

CAREY WATERMARK INVESTORS 2 INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share and per share amounts)
 
September 30, 2018
 
December 31, 2017
Assets
 
 
 
Investments in real estate:
 
 
 
Hotels, at cost
$
1,461,901

 
$
1,448,030

Accumulated depreciation
(101,289
)
 
(68,088
)
Net investments in hotels
1,360,612

 
1,379,942

Equity investments in real estate
126,058

 
134,738

Cash and cash equivalents
74,064

 
68,527

Restricted cash
29,601

 
29,582

Accounts receivable
26,417

 
17,592

Other assets
10,301

 
11,467

Total assets
$
1,627,053

 
$
1,641,848

Liabilities and Equity
 
 
 
Non-recourse debt, net
$
833,491

 
$
831,329

Accounts payable, accrued expenses and other liabilities
68,416

 
66,053

Due to related parties and affiliates
1,998

 
1,726

Distributions payable
11,092

 
10,955

Total liabilities
914,997

 
910,063

Commitments and contingencies (Note 9)

 

Preferred stock, $0.001 par value, 50,000,000 shares authorized; none issued

 

Class A common stock, $0.001 par value; 320,000,000 shares authorized; 30,667,992 and 29,510,914 shares, respectively, issued and outstanding
31

 
29

Class T common stock, $0.001 par value; 80,000,000 shares authorized; 58,849,143 and 57,871,712 shares, respectively, issued and outstanding
59

 
58

Additional paid-in capital
822,833

 
807,377

Distributions and accumulated losses
(138,873
)
 
(104,809
)
Accumulated other comprehensive income
2,162

 
1,373

Total stockholders’ equity
686,212

 
704,028

Noncontrolling interests
25,844

 
27,757

Total equity
712,056

 
731,785

Total liabilities and equity
$
1,627,053

 
$
1,641,848


See Notes to Consolidated Financial Statements.



CWI 2 9/30/2018 10-Q 3
    


CAREY WATERMARK INVESTORS 2 INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except share and per share amounts)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues
 
 
 
 
 
 
 
Hotel Revenues
 
 
 
 
 
 
 
Rooms
$
63,091

 
$
61,322

 
$
190,375

 
$
172,102

Food and beverage
19,273

 
19,155

 
70,368

 
67,797

Other operating revenue
4,813

 
4,930

 
15,713

 
14,373

Total Hotel Revenues
87,177

 
85,407

 
276,456

 
254,272

Operating Expenses
 
 
 
 
 
 
 
Hotel Expenses
 
 
 
 
 
 
 
Rooms
14,686

 
14,306

 
43,558

 
39,706

Food and beverage
15,999

 
15,671

 
51,572

 
48,696

Other hotel operating expenses
1,358

 
1,308

 
4,196

 
4,322

Sales and marketing
7,508

 
8,099

 
23,138

 
22,635

General and administrative
7,397

 
7,688

 
23,443

 
22,091

Property taxes, insurance, rent and other
4,801

 
5,077

 
15,528

 
14,190

Management fees
3,257

 
2,931

 
9,981

 
9,005

Repairs and maintenance
3,157

 
3,020

 
9,043

 
8,288

Utilities
2,403

 
2,410

 
6,846

 
6,326

Depreciation and amortization
11,423

 
11,647

 
34,175

 
32,133

Total Hotel Expenses
71,989

 
72,157

 
221,480

 
207,392

 
 
 
 
 
 
 
 
Other Operating Expenses
 
 
 
 
 
 
 
Asset management fees to affiliate and other expenses
2,790

 
2,305

 
8,279

 
6,426

Corporate general and administrative expenses
1,712

 
1,483

 
5,551

 
4,778

Loss on hurricane-related property damage
159

 
3,845

 
748

 
3,845

Acquisition-related expenses

 

 

 
4,979

Total Other Operating Expenses
4,661

 
7,633

 
14,578

 
20,028

Operating Income
10,527

 
5,617

 
40,398

 
26,852

Other Income and (Expenses)
 
 
 
 
 
 
 
Interest expense
(10,176
)
 
(9,522
)
 
(30,274
)
 
(25,826
)
Equity in (losses) earnings of equity method investments in real estate
(1,049
)
 
(36
)
 
(3,440
)
 
1,461

Loss on extinguishment of debt
(380
)
 
(256
)
 
(380
)
 
(256
)
Other income
365

 
58

 
551

 
135

Total Other Income and (Expenses)
(11,240
)
 
(9,756
)
 
(33,543
)
 
(24,486
)
(Loss) Income from Operations Before Income Taxes
(713
)
 
(4,139
)
 
6,855

 
2,366

Provision for income taxes
(698
)
 
(1,122
)
 
(2,351
)
 
(3,518
)
Net (Loss) Income
(1,411
)
 
(5,261
)
 
4,504

 
(1,152
)
(Income) loss attributable to noncontrolling interests (inclusive of Available Cash Distributions to a related party of $1,691, $1,894, $3,907, and $3,528, respectively)
(1,194
)
 
3,776

 
(5,521
)
 
983

Net Loss Attributable to CWI 2 Stockholders
$
(2,605
)
 
$
(1,485
)
 
$
(1,017
)
 
$
(169
)
 
 
 
 
 
 
 
 
Class A Common Stock
 
 
 
 
 
 
 
Net (loss) income attributable to CWI 2 Stockholders
$
(834
)
 
$
(472
)
 
$
(182
)
 
$
34

Basic and diluted weighted-average shares outstanding
30,558,370

 
28,889,131

 
30,192,311

 
27,131,807

Basic and diluted (loss) income per share
$
(0.03
)
 
$
(0.02
)
 
$
(0.01
)
 
$

Distributions Declared Per Share
$
0.1749

 
$
0.1749

 
$
0.5247

 
$
0.5206

 
 
 
 
 
 
 
 
Class T Common Stock
 
 
 
 
 
 
 
Net loss attributable to CWI 2 Stockholders
$
(1,771
)
 
$
(1,013
)
 
$
(835
)
 
$
(203
)
Basic and diluted weighted-average shares outstanding
58,977,743

 
57,603,278

 
58,708,033

 
53,364,957

Basic and diluted loss per share
$
(0.03
)
 
$
(0.02
)
 
$
(0.01
)
 
$

Distributions Declared Per Share
$
0.1489

 
$
0.1480

 
$
0.4467

 
$
0.4406


See Notes to Consolidated Financial Statements.


CWI 2 9/30/2018 10-Q 4
    




CAREY WATERMARK INVESTORS 2 INCORPORATED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)
(in thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net (Loss) Income
$
(1,411
)
 
$
(5,261
)
 
$
4,504

 
$
(1,152
)
Other Comprehensive (Loss) Income
 
 
 
 
 
 
 
Unrealized (loss) gain on derivative instruments
(51
)
 
60

 
788

 

Comprehensive (Loss) Income
(1,462
)
 
(5,201
)
 
5,292

 
(1,152
)
 
 
 
 
 
 
 
 
Amounts Attributable to Noncontrolling Interests
 
 
 
 
 
 
 
Net (income) loss
(1,194
)
 
3,776

 
(5,521
)
 
983

Unrealized loss (gain) on derivative instruments
1

 
(3
)
 
1

 
(8
)
Comprehensive (income) loss attributable to noncontrolling interests
(1,193
)
 
3,773

 
(5,520
)
 
975

Comprehensive Loss Attributable to CWI 2 Stockholders
$
(2,655
)
 
$
(1,428
)
 
$
(228
)
 
$
(177
)

See Notes to Consolidated Financial Statements.



CWI 2 9/30/2018 10-Q 5
    


CAREY WATERMARK INVESTORS 2 INCORPORATED
CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)
Nine Months Ended September 30, 2018 and 2017
(in thousands, except share and per share amounts)
 
CWI 2 Stockholders
 
 
 
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Distributions
and
Accumulated
Losses
 
Accumulated
Other
Comprehensive
Income
 
Total CWI 2
Stockholders’
Equity
 
Noncontrolling
Interests
 
Total
Stockholders’
Equity
 
Class A
 
Class T
 
 
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
Balance at January 1, 2018
29,510,914

 
$
29

 
57,871,712

 
$
58

 
$
807,377

 
$
(104,809
)
 
$
1,373

 
$
704,028

 
$
27,757

 
$
731,785

Net (loss) income
 
 
 
 
 
 
 
 
 
 
(1,017
)
 
 
 
(1,017
)
 
5,521

 
4,504

Shares issued, net of offering costs
581,465

 
1

 
1,236,670


1

 
20,495

 
 
 
 
 
20,497

 
 
 
20,497

Shares issued to affiliates
708,627

 
1

 
 
 
 
 
7,785

 
 
 
 
 
7,786

 
 
 
7,786

Distributions to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
(7,433
)
 
(7,433
)
Stock dividends issued
277,069

 

 
539,694

 
1

 
 
 
 
 
 
 
1

 
 
 
1

Shares issued under share incentive plans
17,535

 

 
 
 
 
 
134

 
 
 
 
 
134

 
 
 
134

Stock-based compensation to directors
15,384

 

 
 
 
 
 
171

 
 
 
 
 
171

 
 
 
171

Distributions declared ($0.5247 and $0.4467 per share to Class A and Class T, respectively)
 
 
 
 
 
 
 
 
 
 
(33,047
)
 
 
 
(33,047
)
 
 
 
(33,047
)
Other comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
789

 
789

 
(1
)
 
788

Repurchase of shares
(443,002
)
 

 
(798,933
)
 
(1
)
 
(13,129
)
 
 
 
 
 
(13,130
)
 
 
 
(13,130
)
Balance at September 30, 2018
30,667,992

 
$
31

 
58,849,143

 
$
59

 
$
822,833

 
$
(138,873
)
 
$
2,162

 
$
686,212

 
$
25,844

 
$
712,056

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2017
22,414,128

 
$
22

 
40,447,362

 
$
40

 
$
573,135

 
$
(59,115
)
 
$
896

 
$
514,978

 
$
35,131

 
$
550,109

Net loss
 
 
 
 
 
 
 
 
 
 
(169
)
 

 
(169
)
 
(983
)
 
(1,152
)
Shares issued, net of offering costs
5,826,566

 
6

 
16,709,647

 
17

 
226,392

 
 
 
 
 
226,415

 
 
 
226,415

Shares issued to affiliates
839,720

 
1

 
 
 
 
 
8,984

 
 
 
 
 
8,985

 
 
 
8,985

Distributions to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
(6,822
)
 
(6,822
)
Purchase of membership interest from noncontrolling interest
 
 
 
 
 
 
 
 
(3,524
)
 
 
 
 
 
(3,524
)
 
 
 
(3,524
)
Stock dividends issued
230,038

 

 
434,259

 

 
 
 
 
 
 
 

 
 
 

Stock-based compensation to directors
15,384

 

 
 
 
 
 
165

 
 
 
 
 
165

 
 
 
165

Shares issued under share incentive plans
14,071

 

 
 
 
 
 
172

 
 
 
 
 
172

 
 
 
172

Distributions declared ($0.5206 and $0.4406 per share to Class A and Class T, respectively)
 
 
 
 
 
 
 
 
 
 
(29,251
)
 
 
 
(29,251
)
 
 
 
(29,251
)
Other comprehensive (loss) income
 
 
 
 
 
 
 
 
 
 
 
 
(8
)
 
(8
)
 
8

 

Repurchase of shares
(156,397
)
 

 
(231,682
)
 

 
(3,969
)
 
 
 
 
 
(3,969
)
 
 
 
(3,969
)
Balance at September 30, 2017
29,183,510

 
$
29

 
57,359,586

 
$
57

 
$
801,355

 
$
(88,535
)
 
$
888

 
$
713,794

 
$
27,334

 
$
741,128


See Notes to Consolidated Financial Statements.


CWI 2 9/30/2018 10-Q 6
    


CAREY WATERMARK INVESTORS 2 INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
 
Nine Months Ended September 30,
 
2018
 
2017
Cash Flows — Operating Activities
 
 
 
Net income (loss)
$
4,504

 
$
(1,152
)
Adjustments to net income (loss):
 
 
 
Depreciation and amortization
34,175

 
32,133

Asset management fees to affiliates settled in shares
7,793

 
6,157

Equity in losses (earnings) of equity method investments in real estate
3,440

 
(1,461
)
Amortization of deferred key money, deferred financing costs and other
1,001

 
582

Loss on hurricane-related property damage
748

 
3,845

Amortization of stock-based compensation
403

 
418

Loss on extinguishment of debt
380

 
254

Acquisition fees to affiliates settled in shares

 
3,097

Net changes in other assets and liabilities
(4,081
)
 
170

Distributions of earnings from equity method investments
812

 
1,309

Increase (decrease) in due to related parties and affiliates
318

 
(7,231
)
Funding of hurricane-related remediation work
(163
)
 

Receipt of key money and other deferred incentive payments

 
2,688

Net Cash Provided by Operating Activities
49,330

 
40,809

 
 
 
 
Cash Flows — Investing Activities
 
 
 
Capital expenditures
(11,232
)
 
(14,568
)
Distributions from equity investments in excess of cumulative equity income
5,176

 

Capital contributions to equity investment in real estate
(486
)
 

Acquisition of hotels

 
(168,884
)
Purchase of equity interest

 
(99,386
)
Deposits released for hotel investments

 
1,521

Net Cash Used in Investing Activities
(6,542
)
 
(281,317
)
 
 
 
 
Cash Flows — Financing Activities
 
 
 
Proceeds from mortgage financing
49,000

 
301,900

Scheduled payments and prepayments for mortgage principal
(47,502
)
 
(42,000
)
Distributions paid
(32,910
)
 
(25,839
)
Proceeds from issuance of shares, net of offering costs
15,508

 
232,478

Repurchase of shares
(13,130
)
 
(3,969
)
Distributions to noncontrolling interests
(7,433
)
 
(6,822
)
Deferred financing costs
(548
)
 
(2,090
)
Purchase of interest rate cap
(118
)
 
(16
)
Withholdings on restricted stock units
(99
)
 
(81
)
Repayment of notes payable to affiliate

 
(210,000
)
Purchase of membership interest from noncontrolling interest

 
(3,524
)
Deposits released for mortgage financing

 
2,235

Deposits for mortgage financing

 
(725
)
Net Cash (Used in) Provided by Financing Activities
(37,232
)
 
241,547

 
 
 
 
Change in Cash and Cash Equivalents and Restricted Cash During the Period
 
 
 
Net increase in cash and cash equivalents and restricted cash
5,556

 
1,039

Cash and cash equivalents and restricted cash, beginning of period
98,109

 
99,793

Cash and cash equivalents and restricted cash, end of period
$
103,665

 
$
100,832


See Notes to Consolidated Financial Statements.


CWI 2 9/30/2018 10-Q 7
    


Notes to Consolidated Financial Statements (Unaudited)

CAREY WATERMARK INVESTORS 2 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Business

Organization

Carey Watermark Investors 2 Incorporated, or CWI 2, together with its consolidated subsidiaries, is a publicly owned, non-listed real estate investment trust, or REIT, that invests in, manages and seeks to enhance the value of, interests in lodging and lodging-related properties in the United States. We conduct substantially all of our investment activities and own all of our assets through CWI 2 OP, LP, or the Operating Partnership. We are a general partner and a limited partner of, and own a 99.985% capital interest in, the Operating Partnership. Carey Watermark Holdings 2, LLC, or Carey Watermark Holdings 2, which is owned indirectly by W. P. Carey Inc., or WPC, holds a special general partner interest in the Operating Partnership.

We are managed by Carey Lodging Advisors, LLC, or our Advisor, an indirect subsidiary of WPC. Our Advisor manages our overall portfolio, including providing oversight and strategic guidance to the independent hotel operators that manage our hotels. CWA 2, LLC, a subsidiary of Watermark Capital Partners, or the Subadvisor, provides services to our Advisor primarily relating to acquiring, managing, financing and disposing of our hotels and overseeing the independent operators that manage the day-to-day operations of our hotels. In addition, the Subadvisor provides us with the services of Mr. Michael G. Medzigian, our Chief Executive Officer, subject to the approval of our independent directors.

We held ownership interests in 12 hotels at September 30, 2018, including ten hotels that we consolidate, or our Consolidated Hotels, and two hotels that we record as equity investments, or our Unconsolidated Hotels.
 
Public Offering

We raised offering proceeds in our initial public offering of $280.3 million from our Class A common stock and $571.0 million from our Class T common stock. The offering commenced on May 22, 2014 and closed on July 31, 2017. We have fully invested the proceeds from our initial public offering. In addition, from inception through September 30, 2018, $18.6 million and $35.8 million of distributions were reinvested in our Class A and Class T common stock, respectively, as a result of our distribution reinvestment plan, or DRIP.

Note 2. Basis of Presentation

Basis of Presentation

Our interim consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of our consolidated financial position, results of operations and cash flows in accordance with generally accepted accounting principles in the United States, or GAAP.

In the opinion of management, the unaudited financial information for the interim periods presented in this Report reflects all normal and recurring adjustments necessary for a fair statement of financial position, results of operations and cash flows. Our interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements and accompanying notes for the year ended December 31, 2017, which are included in our 2017 Annual Report, as certain disclosures that would substantially duplicate those contained in the audited consolidated financial statements have not been included in this Report. Operating results for interim periods are not necessarily indicative of operating results for an entire year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in our consolidated financial statements and the accompanying notes. Actual results could differ from those estimates.



CWI 2 9/30/2018 10-Q 8
    


Notes to Consolidated Financial Statements (Unaudited)

Basis of Consolidation

Our consolidated financial statements reflect all of our accounts, including those of our controlled subsidiaries. The portions of equity in consolidated subsidiaries that are not attributable, directly or indirectly, to us are presented as noncontrolling interests. All significant intercompany accounts and transactions have been eliminated.

When we obtain an economic interest in an entity, we evaluate the entity to determine if it should be deemed a variable interest entity, or VIE, and, if so, whether we are the primary beneficiary and are therefore required to consolidate the entity. We apply accounting guidance for consolidation of VIEs to certain entities in which the equity investors do not have 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 from other parties. Certain decision-making rights within a loan or joint-venture agreement can cause us to consider an entity a VIE. Limited partnerships and other similar entities which operate as a partnership will be considered a VIE unless the limited partners hold substantive kick-out rights or participation rights. Significant judgment is required to determine whether a VIE should be consolidated. We review the contractual arrangements provided for in the partnership agreement or other related contracts to determine whether the entity is considered a VIE, and to establish whether we have any variable interests in the VIE. We then compare our variable interests, if any, to those of the other variable interest holders to determine which party is the primary beneficiary of the VIE based on whether the entity (i) has the power to direct the activities that most significantly impact the economic performance of the VIE and (ii) has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. The liabilities of these VIEs are non-recourse to us and can only be satisfied from each VIE’s respective assets.

At both September 30, 2018 and December 31, 2017, we considered four entities to be VIEs, of which we consolidated three, as we are considered the primary beneficiary. The following table presents a summary of selected financial data of consolidated VIEs included in the consolidated balance sheets (in thousands):
 
September 30, 2018
 
December 31, 2017
Net investments in hotels
$
569,416

 
$
579,206

Total assets
609,548

 
617,207

 
 
 
 
Non-recourse debt, net
$
320,527

 
$
320,304

Total liabilities
351,214

 
350,249


Accounting Policy Update

In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 supersedes or replaces nearly all GAAP revenue recognition guidance. The new guidance establishes a new control-based revenue recognition model that changes the basis for deciding when revenue is recognized over time or at a point in time and expands the disclosures about revenue. The new guidance also applies to sales of real estate and the new principles-based approach is largely based on the transfer of control of the real estate to the buyer. We adopted this guidance for our interim and annual periods beginning January 1, 2018 using the modified retrospective method. We performed a comprehensive evaluation of the impact of the new standard across our revenue streams, and determined that the timing of revenue recognition and its classification in our consolidated financial statements will remain substantially unchanged. The adoption of ASU 2014-09 did not have a material impact on our consolidated financial statements.

Revenue consists of amounts derived from hotel operations, including the sale of rooms, food and beverage and revenue from other operating departments, such as parking, spa, resort fees and gift shops, and are presented on a disaggregated basis on the consolidated statements of operations. These revenues are recorded net of any sales or occupancy taxes, which are collected from our guests as earned. All rebates or discounts are recorded as a reduction in revenue and there are no material contingent obligations with respect to rebates or discounts offered by us.

We recognize revenue when control of the promised good or service is transferred to the guest, in an amount that reflects the consideration we expect to receive in exchange for the promised good or service. Room revenue is generated through contracts with guests whereby the guest agrees to pay a daily rate for the right to use a hotel room for an agreed upon length of stay. Our contract performance obligations are fulfilled at the end of the day that the guest is provided the room and revenue is recognized daily at the contract rate. Food and beverage revenue, including restaurant and banquet and catering services, are


CWI 2 9/30/2018 10-Q 9
    


Notes to Consolidated Financial Statements (Unaudited)

recognized at a point in time once food and beverage has been provided. Other operating department revenue for services such as parking, spa and other ancillary services, is recognized at a point in time when the goods and services are provided to the guest. We may engage third parties to provide certain services at the hotel, for example, audiovisual services. We evaluate each of these contracts to determine if the hotel is the principal or the agent in the transaction, and record the revenues as appropriate (i.e. gross vs. net).

Payment is due at the time that goods or services are rendered or billed. For room revenue, payment is typically due and paid in full at the end of the stay with some guests prepaying for their rooms prior to the stay. For package revenue, where ancillary guest services are included with the guests’ hotel reservations in a package arrangement, we allocate revenue based on the stand-alone selling price for each of the components of the package. We applied a practical expedient to not disclose the value of unsatisfied performance obligations for contracts that have an original expected length of one year or less. Any contracts that have an original expected length of greater than one year are insignificant.

Reclassifications
 
Certain prior period amounts have been reclassified to conform to the current period presentation.

Restricted Cash — In connection with our adoption of ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, as described below, we revised our consolidated statements of cash flows to include restricted cash when reconciling the beginning-of-period and end-of-period cash amounts shown on the statement of cash flows. As a result, we retrospectively revised prior periods presented to conform to the current period presentation. Restricted cash consists primarily of amounts escrowed pursuant to the terms of our mortgage debt to fund planned renovations and improvements (including at hotels damaged by Hurricane Irma), property taxes, insurance, and normal replacement of furniture, fixtures and equipment at our hotels. The following table provides a reconciliation of cash and restricted cash reported within the consolidated balance sheets to the consolidated statements of cash flows (in thousands):
 
September 30, 2018
 
December 31, 2017
Cash and cash equivalents
$
74,064

 
$
68,527

Restricted cash
29,601

 
29,582

Total cash and cash equivalents and restricted cash
$
103,665

 
$
98,109


Recent Accounting Pronouncements

Pronouncements Adopted as of September 30, 2018

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 intends to reduce diversity in practice for certain cash flow classifications, including, but not limited to (i) debt prepayment or debt extinguishment costs, (ii) contingent consideration payments made after a business combination, (iii) proceeds from the settlement of insurance claims, (iv) distributions received from equity method investees and (v) separately identifiable cash flows and application of the predominance principle. We retrospectively adopted this guidance for our interim and annual periods beginning January 1, 2018. The adoption of ASU 2016-15 did not have an impact on our consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 intends to reduce diversity in practice for the classification and presentation of changes in restricted cash on the statement of cash flows. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We retrospectively adopted this guidance for our interim and annual periods beginning January 1, 2018. See Restricted Cash above for additional information.



CWI 2 9/30/2018 10-Q 10
    


Notes to Consolidated Financial Statements (Unaudited)

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist companies and other reporting organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The changes to the definition of a business will likely result in more acquisitions being accounted for as asset acquisitions across all industries. The guidance is effective for annual reporting periods beginning after December 15, 2017, and the interim periods within those annual periods. We adopted this guidance for our interim and annual periods beginning January 1, 2018. We have had no acquisitions since the adoption of this guidance; however, we expect that certain future hotel acquisitions may be considered asset acquisitions rather than business combinations, which would affect the capitalization of acquisition costs (such costs are expensed for business combinations and capitalized for asset acquisitions).

In February 2017, the FASB issued ASU 2017-05, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20). ASU 2017-05 clarifies that a financial asset is within the scope of Subtopic 610-20 if it meets the definition of an in substance nonfinancial asset. The amendments define the term “in substance nonfinancial asset,” in part, as a financial asset promised to a counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) that are promised to the counterparty in the contract is concentrated in nonfinancial assets. If substantially all of the fair value of the assets that are promised to the counterparty in a contract is concentrated in nonfinancial assets, then all of the financial assets promised to the counterparty are in substance nonfinancial assets within the scope of Subtopic 610-20. This amendment also clarifies that nonfinancial assets within the scope of Subtopic 610-20 may include nonfinancial assets transferred within a legal entity to a counterparty. For example, a parent company may transfer control of nonfinancial assets by transferring ownership interests in a consolidated subsidiary. We adopted this guidance for our interim and annual periods beginning January 1, 2018. We will appropriately apply the guidance to prospective disposals of nonfinancial assets within the scope of Subtopic 610- 20.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 removes, modifies, and adds certain fair value disclosure requirements. We adopted this guidance for our interim period beginning July 1, 2018. The adoption of this standard did not have a material impact on our consolidated financial statements.

Pronouncements to be Adopted after September 30, 2018

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 modifies the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a contract, the lessee and the lessor. ASU 2016-02 provides new guidelines that change the accounting for leasing arrangements for lessees, whereby their rights and obligations under substantially all leases, existing and new, would be capitalized and recorded on the balance sheet. For lessors, however, the accounting remains largely equivalent to the current model, with the distinction between operating, sales-type and direct financing leases retained, but updated to align with certain changes to the lessee model and the new revenue recognition standard.

Early application is permitted for all entities. ASU 2016-02 provides two transition methods. The first transition method allows for application of the new model at the beginning of the earliest comparative period presented. Under the second transition method, comparative periods would not be restated, with any cumulative effect adjustments recognized in the opening balance of retained earnings in the period of adoption. In addition, a practical expedient was recently issued by the FASB which allows lessors to combine non-lease components with related lease components if certain conditions are met. We will adopt this guidance for our interim and annual periods beginning January 1, 2019 and expect to use the second transition method. We are evaluating the impact of ASU 2016-02 and have not yet determined if it will have a material impact on our business or our consolidated financial statements but the application of the new standard will require additional quantitative and qualitative disclosures.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 will make more financial and nonfinancial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess hedge effectiveness. It is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. ASU 2017-12 will be effective in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. We are in the process of evaluating the impact of adopting ASU 2017-12 on our consolidated financial statements and will adopt the standard for the fiscal year beginning January 1, 2019.



CWI 2 9/30/2018 10-Q 11
    


Notes to Consolidated Financial Statements (Unaudited)

Note 3. Agreements and Transactions with Related Parties

Agreements with Our Advisor and Affiliates

We have an advisory agreement with our Advisor, which we refer to herein as the Advisory Agreement, to perform certain services for us under a fee arrangement, including managing our overall business, our investments and certain administrative duties. The Advisory Agreement has a term of one year and may be renewed for successive one-year periods. Our Advisor also has a subadvisory agreement with the Subadvisor, which we refer to herein as the Subadvisory Agreement, whereby our Advisor pays 25% of the fees that it earns under the Advisory Agreement and Available Cash Distributions and 30% of the subordinated incentive distributions to the Subadvisor in return for certain personnel services.

The following tables present a summary of fees we paid, expenses we reimbursed and distributions we made to our Advisor, the Subadvisor and other affiliates, as described below, in accordance with the terms of those agreements (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Amounts Included in the Consolidated Statements of Operations
 
 
 
 
 
 
 
Asset management fees
$
2,607

 
$
2,188

 
$
7,793

 
$
6,157

Available Cash Distributions
1,691

 
1,894

 
3,907

 
3,528

Personnel and overhead reimbursements
968

 
872

 
2,969

 
2,628

Acquisition fees

 

 

 
4,415

Interest expense

 

 

 
332

Accretion of interest on annual distribution and shareholder servicing fee (a)

 

 

 
198

 
$
5,266

 
$
4,954

 
$
14,669

 
$
17,258

 
 
 
 
 
 
 
 
Other Transaction Fees Incurred
 
 
 
 
 
 
 
Capitalized loan refinancing fees
$
245

 
$
280

 
$
245

 
$
280

Capitalized acquisition fees for equity method investment (b)

 
6,195

 

 
6,195

Selling commissions and dealer manager fees

 
367

 

 
13,199

Organization and offering costs

 
224

 

 
1,422

Annual distribution and shareholder servicing fee (a)

 

 

 
8,439

 
$
245

 
$
7,066

 
$
245

 
$
29,535

___________
(a)
Starting with the third quarter 2017 distribution and shareholder servicing fee (which was paid in October 2017), we began making payments directly to selected dealers rather than through Carey Financial, LLC, or Carey Financial, a subsidiary of WPC and the former dealer manager of our offering; therefore, this activity is no longer considered a related party transaction.
(b)
Our Advisor elected to receive 50% of the acquisition fee related to our investment in the Ritz-Carlton Bacara, Santa Barbara Venture in shares of our common stock and 50% in cash.

The following table presents a summary of amounts included in Due to related parties and affiliates in the consolidated financial statements (in thousands):
 
September 30, 2018
 
December 31, 2017
Amounts Due to Related Parties and Affiliates
 
 
 
Asset management fees and other to our Advisor
$
1,129

 
$
877

Reimbursable costs to our Advisor
858

 
768

Due to other affiliates
11

 

Organization and offering costs to our Advisor

 
81

 
$
1,998

 
$
1,726



CWI 2 9/30/2018 10-Q 12
    


Notes to Consolidated Financial Statements (Unaudited)


Asset Management Fees, Disposition Fees and Loan Refinancing Fees

We pay our Advisor an annual asset management fee equal to 0.55% of the aggregate Average Market Value of our Investments, both as defined in the Advisory Agreement. If our Advisor elects to receive all or a portion of its fees in shares of our Class A common stock, the number of shares issued is determined by dividing the dollar amount of fees by our most recently published estimated net asset value per share, or NAV, for Class A shares. For the nine months ended September 30, 2018 and 2017, $7.8 million and $5.9 million, respectively, in asset management fees were settled in shares of our Class A common stock. At September 30, 2018, our Advisor owned 2,285,933 shares (2.6%) of our outstanding common stock. Asset management fees are included in Asset management fees to affiliate and other in the consolidated financial statements.

Acquisition Fees to our Advisor

Pursuant to our Advisory Agreement, our Advisor is entitled to acquisition fees of 2.5% of the total investment cost of the properties acquired, including on our proportionate share of equity method investments and loans originated by us. The total fees to be paid may not exceed 6% of the aggregate contract purchase price of all investments, as measured over a period specified in our Advisory Agreement.

Available Cash Distributions

Carey Watermark Holdings 2’s special general partner interest entitles it to receive distributions of 10% of Available Cash, as defined in the agreement of limited partnership of the Operating Partnership, or Available Cash Distributions, generated by the Operating Partnership, subject to certain limitations. In addition, in the event of the dissolution of the Operating Partnership, Carey Watermark Holdings 2 will be entitled to receive distributions of up to 15% of any net proceeds, provided certain return thresholds are met for the initial investors in the Operating Partnership. Available Cash Distributions are included in Income attributable to noncontrolling interests in the consolidated financial statements.

Personnel and Overhead Reimbursements

Under the terms of the Advisory Agreement, our Advisor generally allocates expenses of dedicated and shared resources, including the cost of personnel, rent and related office expenses, between us and our affiliate, Carey Watermark Investors Incorporated, or CWI 1, based on total pro rata hotel revenues on a quarterly basis. Pursuant to the Subadvisory Agreement, after we reimburse our Advisor, it will subsequently reimburse the Subadvisor for personnel costs and other charges, including the services of our Chief Executive Officer, subject to the approval of our board of directors. These reimbursements are included in Corporate general and administrative expenses and Due to related parties and affiliates in the consolidated financial statements and are being settled in cash. We have also granted restricted stock units to employees of the Subadvisor pursuant to our 2015 Equity Incentive Plan.

Selling Commissions and Dealer Manager Fees

Through June 30, 2017, Carey Financial was entitled to receive an annual distribution and shareholder servicing fee in connection with our Class T common stock, which it may have re-allowed to selected dealers. Beginning with the payment for the third quarter of 2017, which was paid in October 2017, the distribution and shareholder servicing fee was paid by us directly to selected dealers rather than through Carey Financial; therefore, this activity is no longer considered a related party transaction. The amount of the distribution and shareholder servicing fee is 1.0% of the NAV of our Class T common stock. The distribution and shareholder servicing fee accrues daily and is payable quarterly in arrears. We will no longer incur the distribution and shareholder servicing fee after July 31, 2023; the fees may end sooner if the total underwriting compensation paid in respect of the offering reaches 10.0% of the gross offering proceeds or if we undertake a liquidity event, as described in our prospectus, before that date. During the nine months ended September 30, 2017, $8.8 million of distribution and shareholder servicing fees were charged to stockholders’ equity and $3.6 million of such fees were paid to Carey Financial, which it may have re-allowed to selected dealers. During the nine months ended September 30, 2018, we paid $4.4 million of distribution and shareholder servicing fees to selected dealers.



CWI 2 9/30/2018 10-Q 13
    


Notes to Consolidated Financial Statements (Unaudited)

Pursuant to our former dealer manager agreement with Carey Financial, it received a selling commission for sales of our Class A and Class T common stock during our initial public offering, which closed on July 31, 2017. During the three months ended March 31, 2017, Carey Financial received a selling commission of $0.82 and $0.22 per share sold and a dealer manager fee of $0.35 and $0.30 per share sold for the Class A and Class T common stock, respectively. In connection with the extension of our initial public offering in 2017, we adjusted our offering prices in April 2017 to reflect our NAVs as of December 31, 2016, with a selling commission of $0.84 and $0.23 per share sold and a dealer manager fee of $0.36 and $0.31 per share sold for the Class A and Class T common stock, respectively, which were paid through the termination of our offering on July 31, 2017. The selling commissions were re-allowed and a portion of the dealer manager fees could have been re-allowed to selected dealers. These amounts are recorded in Additional paid-in capital in the consolidated financial statements. During the nine months ended September 30, 2017, we paid selling commissions and dealer manager fees totaling $13.2 million.

Organization and Offering Costs

Pursuant to the Advisory Agreement, we were liable for certain expenses related to our public offering, which were deducted from the gross proceeds of the offering. We reimbursed Carey Financial and selected dealers for reasonable bona fide due diligence expenses incurred that were supported by a detailed and itemized invoice. Our Advisor was reimbursed for all organization expenses and offering costs incurred in connection with our offering (excluding selling commissions and the dealer manager fees), which terminated on July 31, 2017. Through the life of our initial public offering, our Advisor incurred organization and offering costs on our behalf of approximately $9.1 million, all of which has been paid.  

During the offering period, costs incurred in connection with raising of capital were recorded as deferred offering costs. Upon receipt of offering proceeds, we charged the deferred offering costs to stockholders’ equity. During the nine months ended September 30, 2017, $2.7 million of deferred offering costs were charged to stockholders’ equity.

Other Transactions with Affiliates

Working Capital Facility

On October 19, 2017, our Operating Partnership entered into a $25.0 million secured credit facility with WPC to fund our working capital needs, which we refer to as the Working Capital Facility, and all previous authorizations regarding loans from WPC were terminated. Pursuant to the related credit agreement, as amended, the loan bears interest at the London Interbank Offered Rate, or LIBOR, plus 1.0% and matures on the earlier of December 31, 2019 and the expiration or termination of the Advisory Agreement. We serve as guarantor of the Working Capital Facility and have pledged our unencumbered equity interest in certain properties as collateral, as further described in the related pledge and security agreement. As of September 30, 2018, no amounts are outstanding under the Working Capital Facility.
 
Jointly Owned Investments

At September 30, 2018, we owned interests in three ventures with our affiliate, CWI 1: the Marriott Sawgrass Golf Resort & Spa, a Consolidated Hotel, and the Ritz-Carlton Key Biscayne and the Ritz-Carlton Bacara, Santa Barbara, both Unconsolidated Hotels. A third party also owns an interest in the Ritz-Carlton Key Biscayne. CWI 1 is a publicly owned, non-listed REIT that is also advised by our Advisor and invests in lodging and lodging-related properties. See Note 5 for further discussion.



CWI 2 9/30/2018 10-Q 14
    


Notes to Consolidated Financial Statements (Unaudited)

Note 4. Net Investments in Hotels

Net investments in hotels are summarized as follows (in thousands):
 
September 30, 2018
 
December 31, 2017
Buildings
$
1,092,526

 
$
1,092,315

Land
236,078

 
236,078

Furniture, fixtures and equipment
92,800

 
87,664

Building and site improvements
37,258

 
28,865

Construction in progress
3,239

 
3,108

Hotels, at cost
1,461,901

 
1,448,030

Less: Accumulated depreciation
(101,289
)
 
(68,088
)
Net investments in hotels
$
1,360,612

 
$
1,379,942


During the nine months ended September 30, 2018, we retired fully depreciated furniture, fixtures and equipment aggregating $1.0 million.

Hurricane-Related Disruption

Hurricane Irma made landfall in September 2017, impacting one of our Consolidated Hotels, the Marriott Sawgrass Golf Resort & Spa, which sustained damage and was forced to close for a short period of time. During the three and nine months ended September 30, 2018, we recognized losses on hurricane-related property damage of $0.2 million and $0.7 million, respectively. During both the three and nine months ended September 30, 2017, we recognized losses on hurricane-related damage of $3.8 million.
 
Three Months Ended September 30,
(in thousands)
2018
 
2017
Net write-off of fixed assets
$
147

 
$
6,160

Remediation work performed
7

 
990

Decrease (increase) to property damage insurance receivables
5

 
(3,305
)
Loss on hurricane-related property damage
$
159

 
$
3,845

 
Nine Months Ended September 30,
(in thousands)
2018
 
2017
Net (write-up) write-off of fixed assets (a)
$
(279
)
 
$
6,160

Remediation work performed
118

 
990

Decrease (increase) to property damage insurance receivables
909

 
(3,305
)
Loss on hurricane-related property damage
$
748

 
$
3,845

___________
(a)
Includes write-offs totaling $1.3 million during the nine months ended September 30, 2018 resulting from pre-existing damage (which was discovered as a result of Hurricane Irma and is not covered by insurance).

As the restoration work continues to be performed, the estimated total costs will change. Any changes to property damage estimates will be recorded in the periods in which they are determined and any additional remediation work will be recorded in the periods in which it is performed. 




CWI 2 9/30/2018 10-Q 15
    


Notes to Consolidated Financial Statements (Unaudited)

Construction in Progress

At September 30, 2018 and December 31, 2017, construction in progress, recorded at cost, was $3.2 million and $3.1 million, respectively, and related primarily to restoration of the Marriott Sawgrass Golf Resort & Spa as a result of the damage caused by Hurricane Irma and planned renovations at the Ritz-Carlton San Francisco at September 30, 2018 and planned renovations at the San Diego Marriott La Jolla and the Renaissance Atlanta Midtown Hotel at December 31, 2017. Upon substantial completion of renovation work, costs are reclassified from construction in progress to buildings, building and site improvements and furniture, fixture and equipment, as applicable, and depreciation will commence.

We capitalize interest expense and certain other costs, such as property taxes, property insurance, utilities expense and hotel incremental labor costs, related to hotels undergoing major renovations. We capitalized less than $0.2 million and less than $0.1 million of such costs during the three months ended September 30, 2018 and 2017, respectively, and $0.3 million and $0.4 million during the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018 and December 31, 2017, accrued capital expenditures were $3.8 million and $0.5 million, respectively, representing non-cash investing activity.

Pro Forma Financial Information

The following unaudited consolidated pro forma financial information presents our financial results as if our acquisition of the Charlotte Marriott City Center on June 1, 2017, and the new financing related to this acquisition, had occurred on January 1, 2016. This transaction was accounted for as a business combination. No hotel acquisitions occurred during the three and nine months ended September 30, 2018.

The pro forma financial information is not necessarily indicative of what the actual results would have been had this acquisition actually occurred on the date listed above, nor does it purport to represent the results of operations for further periods.

(Dollars in thousands, except per share amounts)


Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
Pro forma total revenues
$
85,407

 
$
270,096

 
 
 
 
Pro forma net (loss) income
$
(5,261
)
 
$
4,733

Pro forma loss attributable to noncontrolling interests
3,776

 
983

Pro forma net (loss) income attributable to CWI 2 stockholders
$
(1,485
)
 
$
5,716

 
 
 
 
Pro forma (loss) income per Class A share:
 
 
 
Net (loss) income attributable to CWI 2 stockholders
$
(472
)
 
$
2,189

Basic and diluted pro forma weighted-average shares outstanding
28,889,131

 
30,761,196

Basic and diluted pro forma (loss) income per share
$
(0.02
)
 
$
0.07

 
 
 
 
Pro forma (loss) income per Class T share:
 
 
 
Net (loss) income attributable to CWI 2 stockholders
$
(1,013
)
 
$
3,527

Basic and diluted pro forma weighted-average shares outstanding
57,603,578

 
53,364,957

Basic and diluted pro forma (loss) income per share
$
(0.02
)
 
$
0.07


The pro forma weighted-average shares outstanding were determined as if the number of shares required to raise any funds needed for the acquisition of the Charlotte Marriott City Center were issued on January 1, 2016. We assumed that we would have issued Class A shares to raise such funds. For pro forma purposes, we assumed all acquisition costs for the acquisition of the Charlotte Marriott City Center were incurred on January 1, 2016.



CWI 2 9/30/2018 10-Q 16
    


Notes to Consolidated Financial Statements (Unaudited)

Note 5. Equity Investments in Real Estate

At September 30, 2018, we owned equity interests in two Unconsolidated Hotels, one with CWI 1 and one together with CWI 1 and an unrelated third party. We do not control the ventures that own these hotels, but we exercise significant influence over them. We account for these investments under the equity method of accounting (i.e., at cost, increased or decreased by our share of earnings or losses, less distributions, plus contributions and other adjustments required by equity method accounting, such as basis differences from acquisition costs paid to our Advisor that we incur and other-than-temporary impairment charges, if any).

Under the conventional approach of accounting for equity method investments, an investor applies its percentage ownership interest to the venture’s net income to determine the investor’s share of the earnings or losses of the venture. This approach is inappropriate if the venture’s capital structure gives different rights and priorities to its investors. Therefore, we follow the hypothetical liquidation at book value method in determining our share of these ventures’ earnings or losses for the reporting period as this method better reflects our claim on the ventures’ book value at the end of each reporting period. Earnings for our equity method investments are recognized in accordance with each respective investment agreement and, where applicable, based upon the allocation of the investment’s net assets at book value as if the investment was hypothetically liquidated at the end of each reporting period.

We classify distributions received from equity method investments using the cumulative earnings approach. Distributions received are considered returns on the investment and classified as cash inflows from operating activities. If, however, the investor’s cumulative distributions received, less distributions received in prior periods determined to be returns of investment, exceeds cumulative equity in earnings recognized, the excess is considered a return of investment and is classified as cash inflows from investing activities.

Hurricane-Related Disruption

The Ritz-Carlton Key Biscayne was impacted by Hurricane Irma when it made landfall in September 2017. The hotel sustained damage and was forced to close for a short period of time. During the three and nine months ended September 30, 2017, the venture recorded a loss on hurricane-related property damage of $3.3 million; however, there was no net impact to our investment in the venture under the hypothetical liquidation at book value method of accounting as a result of our priority return on the investment. The venture recorded a $0.1 million gain on hurricane-related property damage during both the three and nine months ended September 30, 2018.

The following table sets forth our ownership interests in our equity investments in real estate and their respective carrying values. The carrying values of these ventures are affected by the timing and nature of distributions (dollars in thousands):
Unconsolidated Hotels
 
State
 
Number
of Rooms
 
% Owned
 
Our Initial
Investment (a)
 
Acquisition Date
 
Hotel Type
 
Carrying Value at
 
 
 
 
 
 
 
September 30, 2018
 
December 31, 2017
Ritz-Carlton Bacara, Santa Barbara Venture (b) (c)
 
CA
 
358

 
60.0
%
 
$
99,386

 
9/28/2017
 
Resort
 
$
88,607

 
$
97,584

Ritz-Carlton Key Biscayne Venture (d) (e)
 
FL
 
451

 
19.3
%
 
37,559

 
5/29/2015
 
Resort
 
37,451

 
37,154

 
 
 
 
809

 
 
 
$
136,945

 
 
 
 
 
$
126,058

 
$
134,738

___________
(a)
This amount represents purchase price plus capitalized costs, inclusive of fees paid to our Advisor, at the time of acquisition.
(b)
This investment represents a tenancy-in-common interest; the remaining 40% interest is owned by CWI 1.
(c)
We received net cash distributions of $0.2 million and $4.7 million from this investment during the three and nine months ended September 30, 2018, respectively.
(d)
CWI 1 acquired a 47.4% interest in the venture on the same date.  The remaining 33.3% interest is retained by the original owner. The number of rooms presented includes 149 condo-hotel units that participate in the resort rental program. This investment is considered a VIE (Note 2). We do not consolidate this entity because we are not the primary beneficiary and the nature of our involvement in the activities of the entity allows us to exercise significant influence but does not give us power over decisions that significantly affect the economic performance of the entity.
(e)
We received $0.8 million of cash distributions from this investment during the nine months ended September 30, 2018. No distributions were received from this investment during the three months ended September 30, 2018.



CWI 2 9/30/2018 10-Q 17
    


Notes to Consolidated Financial Statements (Unaudited)

The following table sets forth our share of equity in (losses) earnings from our Unconsolidated Hotels, which is based on the hypothetical liquidation at book value model, as well as amortization adjustments related to basis differentials from acquisitions of investments (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Unconsolidated Hotels
 
2018
 
2017
 
2018
 
2017
Ritz-Carlton Key Biscayne Venture
 
$
(755
)
 
$
763

 
$
1,108

 
$
2,260

Ritz-Carlton Bacara, Santa Barbara Venture
 
(294
)
 
(799
)
 
(4,548
)
 
(799
)
Total equity in (losses) earnings of equity method investments in real estate
 
$
(1,049
)
 
$
(36
)
 
$
(3,440
)
 
$
1,461


No other-than-temporary impairment charges were recognized during the three or nine months ended September 30, 2018 and 2017.

At September 30, 2018 and December 31, 2017, the unamortized basis differences on our equity investments were $7.8 million and $8.0 million, respectively. Net amortization of the basis differences reduced the carrying values of our equity investments by $0.1 million and less than $0.1 million during the three months ended September 30, 2018 and 2017, respectively, and by $0.2 million and less than $0.1 million, respectively, for the nine months ended September 30, 2018 and 2017.

The following tables present combined summarized financial information of our equity investments in real estate. Amounts provided are the total amounts attributable to the ventures and does not represent our proportionate share (in thousands):
 
September 30, 2018
 
December 31, 2017
Real estate, net
$
645,071

 
$
646,943

Other assets
81,653

 
82,461

Total assets
726,724

 
729,404

Debt
416,574

 
416,335

Other liabilities
49,538

 
38,969

Total liabilities
466,112

 
455,304

Members’ equity
$
260,612

 
$
274,100

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues
$
38,226

 
$
13,612

 
$
137,896

 
$
62,014

Expenses
(42,986
)
 
(18,326
)
 
(141,279
)
 
(63,037
)
Gain (loss) on hurricane-related property damage
56

 
(3,333
)
 
71

 
(3,333
)
Net loss attributable to equity method investments
$
(4,704
)
 
$
(8,047
)
 
$
(3,312
)
 
$
(4,356
)

Note 6. Fair Value Measurements

The fair value of an asset is defined as the exit price, which is the amount that would either be received when an asset is sold or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance establishes a three-tier fair value hierarchy based on the inputs used in measuring fair value. These tiers are: Level 1, for which quoted market prices for identical instruments are available in active markets, such as money market funds, equity securities and U.S. Treasury securities; Level 2, for which there are inputs other than quoted prices included within Level 1 that are observable for the instrument, such as certain derivative instruments, including interest rate caps and swaps; and Level 3, for securities that do not fall into Level 1 or Level 2 and for which little or no market data exists, therefore requiring us to develop our own assumptions.



CWI 2 9/30/2018 10-Q 18
    


Notes to Consolidated Financial Statements (Unaudited)

Items Measured at Fair Value on a Recurring Basis

Derivative Assets and Liabilities — Our derivative assets and liabilities are comprised of interest rate caps and swaps that were measured at fair value using readily observable market inputs, such as quotations on interest rates. These derivative instruments were classified as Level 2 as these instruments are custom, over-the-counter contracts with various bank counterparties that are not traded in an active market (Note 7).

We did not have any transfers into or out of Level 1, Level 2 and Level 3 category of measurements during the three or nine months ended September 30, 2018 or 2017. Gains and losses (realized and unrealized) recognized on items measured at fair value on a recurring basis included in earnings are reported in Other income and (expenses) in the consolidated financial statements.

Our non-recourse debt, which we have classified as Level 3, had a carrying value of $833.5 million and $831.3 million at September 30, 2018 and December 31, 2017, respectively, and an estimated fair value of $825.3 million and $831.7 million at September 30, 2018 and December 31, 2017, respectively. We determined the estimated fair value using a discounted cash flow model with rates that take into account the interest rate risk. We also considered the value of the underlying collateral, taking into account the quality of the collateral and the then-current interest rate.

We estimated that our other financial assets and liabilities had fair values that approximated their carrying values at both September 30, 2018 and December 31, 2017.

Items Measured at Fair Value on a Non-Recurring Basis (Including Impairment Charges)

We periodically assess whether there are any indicators that the value of our real estate investments may be impaired or that their carrying value may not be recoverable. Where the undiscounted cash flows for an asset are less than the asset’s carrying value when considering and evaluating the various alternative courses of action that may occur, we recognize an impairment charge to reduce the carrying value of the asset to its estimated fair value. Further, when we classify an asset as held for sale, we carry the asset at the lower of its current carrying value or its fair value, less estimated cost to sell. We did not recognize any impairment charges during the three and nine months ended September 30, 2018 or 2017.

Note 7. Risk Management and Use of Derivative Financial Instruments

Risk Management

In the normal course of our ongoing business operations, we encounter economic risk. There are two main components of economic risk that impact us: interest rate risk and market risk. We are primarily subject to interest rate risk on our interest-bearing assets and liabilities. Market risk includes changes in the value of our properties and related loans.

Derivative Financial Instruments

When we use derivative instruments, it is generally to reduce our exposure to fluctuations in interest rates. We have not entered into, and do not plan to enter into, financial instruments for trading or speculative purposes. In addition to entering into derivative instruments on our own behalf, we may also be a party to derivative instruments that are embedded in other contracts, which are considered to be derivative instruments. The primary risks related to our use of derivative instruments include: (i) a counterparty to a hedging arrangement defaulting on its obligation and (ii) a downgrade in the credit quality of a counterparty to such an extent that our ability to sell or assign our side of the hedging transaction is impaired. While we seek to mitigate these risks by entering into hedging arrangements with large financial institutions that we deem to be creditworthy, it is possible that our hedging transactions, which are intended to limit losses, could adversely affect our earnings. Furthermore, if we terminate a hedging arrangement, we may be obligated to pay certain costs, such as transaction or breakage fees. We have established policies and procedures for risk assessment, as well as the approval, reporting and monitoring of derivative financial instrument activities.

We measure derivative instruments at fair value and record them as assets or liabilities, depending on our rights or obligations under the applicable derivative contract. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. For a derivative designated, and that qualified as a cash flow hedge, the effective portion of the change in fair value of the derivative is recognized in Other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of the change in fair value of any derivative is immediately recognized in earnings.



CWI 2 9/30/2018 10-Q 19
    


Notes to Consolidated Financial Statements (Unaudited)

The following table sets forth certain information regarding our derivative instruments on our Consolidated Hotels (in thousands):
Derivatives Designated as Hedging Instruments 
 
 
 
Asset Derivatives Fair Value at
 
Balance Sheet Location
 
September 30, 2018
 
December 31, 2017
Interest rate swap
 
Other assets
 
$
1,905

 
$
1,480

Interest rate caps
 
Other assets
 
204

 
36

 
 
 
 
$
2,109

 
$
1,516


All derivative transactions with an individual counterparty are governed by a master International Swap and Derivatives Association agreement, which can be considered as a master netting arrangement; however, we report all our derivative instruments on a gross basis in our consolidated financial statements. At both September 30, 2018 and December 31, 2017, no cash collateral had been posted nor received for any of our derivative positions.

We recognized unrealized gains of $0.2 million and less than $0.1 million in Other comprehensive income on derivatives in connection with our interest rate swap and caps during the three months ended September 30, 2018 and 2017, respectively, and unrealized gains of $1.2 million and unrealized losses of $0.2 million during the nine months ended September 30, 2018 and 2017, respectively.

We reclassified $0.2 million and less than $0.1 million from Other comprehensive income on derivatives into Interest expense during the three months ended September 30, 2018 and 2017, respectively, and $0.4 million and $0.2 million during the nine months ended September 30, 2018 and 2017, respectively, with the reclassifications resulting in a decrease to interest expense during both the three and nine months ended September 30, 2018.

Amounts reported in Other comprehensive income related to our interest rate swap and caps will be reclassified to Interest expense as interest expense or income is incurred on our variable-rate debt. At September 30, 2018, we estimated that $1.3 million will be reclassified as Interest income during the next 12 months related to our interest rate swap and caps.

Interest Rate Swap and Caps

We are exposed to the impact of interest rate changes primarily through our borrowing activities. To limit this exposure, we attempt to obtain mortgage financing on a long-term, fixed-rate basis. However, from time to time, we or our investment partners may obtain variable-rate non-recourse and limited-recourse mortgage loans and, as a result, may enter into interest rate swap or cap agreements with counterparties. Interest rate swaps, which effectively convert the variable-rate debt service obligations of a loan to a fixed rate, are agreements in which one party exchanges a stream of interest payments for a counterparty’s stream of cash flow over a specific period. The face amount on which the swaps are based is not exchanged. An interest rate cap limits the effective borrowing rate of variable-rate debt obligations while allowing participants to share in downward shifts in interest rates. Our objective in using these derivatives is to limit our exposure to interest rate movements.

The interest rate swap and caps that we had outstanding on our Consolidated Hotels at September 30, 2018 were designated as cash flow hedges and are summarized as follows (dollars in thousands): 
 
 
Number of
 
Notional
 
Fair Value at
Interest Rate Derivatives
 
Instruments
 
Amount
 
September 30, 2018
Interest rate swap
 
1

 
$
100,000

 
$
1,905

Interest rate caps
 
6

 
297,500

 
204

 
 
 
 
 
 
$
2,109


Credit Risk-Related Contingent Features

We measure our credit exposure on a counterparty basis as the net positive aggregate estimated fair value of our derivatives, net of any collateral received. No collateral was received as of September 30, 2018. At September 30, 2018, our total credit exposure was $2.2 million and the maximum exposure to any single counterparty was $2.0 million.



CWI 2 9/30/2018 10-Q 20
    


Notes to Consolidated Financial Statements (Unaudited)

Some of the agreements we have with our derivative counterparties contain cross-default provisions that could trigger a declaration of default on our derivative obligations if we default, or are capable of being declared in default, on certain of our indebtedness. At September 30, 2018, we had not been declared in default on any of our derivative obligations. At both September 30, 2018 and December 31, 2017, we had no derivatives that were in a net liability position.

Note 8. Debt

Our debt consists of mortgage notes payable, which are collateralized by the assignment of hotel properties. The following table presents the non-recourse debt, net on our Consolidated Hotels (dollars in thousands):
 
 
 
 
 
 
 
 
Carrying Amount at
 
 
 
 
 
 
Current
 
 
 
 
Consolidated Hotels
 
Interest Rate
 
Rate Type
 
Maturity Date
 
September 30, 2018
 
December 31, 2017
San Jose Marriott (a) (b)
 
4.90%
 
Variable
 
7/2019
 
$
87,824

 
$
87,655

Marriott Sawgrass Golf Resort & Spa (a)
 
5.95%
 
Variable
 
11/2019
 
77,997

 
78,000

Seattle Marriott Bellevue (a) (c)
 
3.88%
 
Variable
 
1/2020
 
99,652

 
99,453

Le Méridien Arlington (a) (c)
 
4.90%
 
Variable
 
6/2020
 
34,752

 
34,645

Renaissance Atlanta Midtown Hotel (a) (b) (d)
 
4.38%
 
Variable
 
8/2021
 
48,268

 
46,945

Ritz-Carlton San Francisco
 
4.59%
 
Fixed
 
2/2022
 
142,878

 
142,851

Charlotte Marriott City Center
 
4.53%
 
Fixed
 
6/2022
 
102,451

 
102,338

Courtyard Nashville Downtown
 
4.15%
 
Fixed
 
9/2022
 
54,993

 
54,820

Embassy Suites by Hilton Denver-Downtown/Convention Center
 
3.90%
 
Fixed
 
12/2022
 
99,806

 
99,772

San Diego Marriott La Jolla
 
4.13%
 
Fixed
 
8/2023
 
84,870

 
84,850

 
 
 
 
 
 
 
 
$
833,491

 
$
831,329

___________
(a)
These mortgage loans have variable interest rates, which have effectively been capped or converted to fixed rates through the use of interest rate caps or swaps (Note 7). The interest rates presented for these mortgage loans reflect the rates in effect at September 30, 2018 through the use of an interest rate cap or swap, as applicable.
(b)
These mortgage loans have two one-year extension options, which are subject to certain conditions. The maturity dates in the table do not reflect the extension options.
(c)
These mortgage loans each have a one-year extension option, which are subject to certain conditions. The maturity dates in the table do not reflect the extension option.
(d)
At December 31, 2017, this debt was comprised of a $34.0 million senior mortgage loan and a $13.5 million mezzanine loan, both with variable interest rates subject to caps. On August 8, 2018, we refinanced these loans with one non-recourse mortgage loan totaling $49.0 million. See below for further discussion.

Most of our mortgage loan agreements contain “lock-box” provisions, which permit the lender to access or sweep a hotel’s excess cash flow and would be triggered under limited circumstances, including the failure to maintain minimum debt service coverage ratios. If a provision were triggered, we would generally be permitted to spend an amount equal to our budgeted hotel operating expenses, taxes, insurance and capital expenditure reserves for the relevant hotel. The lender would then hold all excess cash flow after the payment of debt service in an escrow account until certain performance hurdles are met.

Covenants

Pursuant to our mortgage loan agreements, our consolidated subsidiaries are subject to various operational and financial covenants, including minimum debt service coverage ratios. At September 30, 2018, we were in compliance with the applicable covenants for each of our mortgage loans.

Financing Activity During 2018

On August 8, 2018, we refinanced the Renaissance Atlanta Midtown senior mortgage and mezzanine loans totaling $34.0 million and $13.5 million, respectively, with one non-recourse mortgage loan totaling $49.0 million, which has a floating annual interest rate of LIBOR plus 2.3% with the interest rate decreasing to LIBOR plus 2.0% upon achieving a specific


CWI 2 9/30/2018 10-Q 21
    


Notes to Consolidated Financial Statements (Unaudited)

minimum debt service coverage ratio as described in the loan agreement. We have entered into an interest rate cap agreement with respect to this variable rate loan. The new loan matures in August 2021. We recognized a net loss on extinguishment of debt of $0.4 million on this refinancing during both the three and nine months ended September 30, 2018.

Scheduled Debt Principal Payments

Scheduled debt principal payments during the remainder of 2018, each of the next four calendar years following December 31, 2018 and thereafter are as follows (in thousands):
Years Ending December 31,
 
Total
2018 (remainder)
 
$

2019
 
170,895

2020
 
137,056

2021
 
53,498

2022
 
395,710

Thereafter through 2023
 
79,741

 
 
836,900

Unamortized deferred financing costs
 
(3,409
)
Total
 
$
833,491


Note 9. Commitments and Contingencies

At September 30, 2018, we were not involved in any material litigation. Various claims and lawsuits arising in the normal course of business are pending against us, including liens for which we may obtain a bond, provide collateral or provide an indemnity, but we do not expect the results of such proceedings to have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Hotel Management Agreements

As of September 30, 2018, our Consolidated Hotel properties are operated pursuant to long-term management agreements with three different management companies, with initial terms ranging from five to 40 years. For hotels operated with separate franchise agreements, each management company receives a base management fee, generally ranging from 2.5% to 3.0% of hotel revenues. Six of our management agreements contain the right and license to operate the hotels under specified brands; no separate franchise agreements exist and no separate franchise fee is required for these hotels. The management agreements that include the benefit of a franchise agreement incur a base management fee generally ranging from 3.0% to 7.0% of hotel revenues. The management companies are generally also eligible to receive an incentive management fee, which is typically calculated as a percentage of operating profit, either (i) in excess of projections with a cap or (ii) after we have received a priority return on our investment in the hotel. We incurred management fee expense, including amortization of deferred management fees, of $3.3 million and $2.9 million for the three months ended September 30, 2018 and 2017, respectively, and $10.0 million and $9.0 million for the nine months ended September 30, 2018 and 2017, respectively.



CWI 2 9/30/2018 10-Q 22
    


Notes to Consolidated Financial Statements (Unaudited)

Franchise Agreements

As of September 30, 2018, we had three franchise agreements with Marriott-owned brands and one with a Hilton-owned brand related to our Consolidated Hotels. The franchise agreements have initial terms ranging from 20 to 25 years (excluding six hotels that receive the benefits of a franchise agreement pursuant to management agreements, as discussed above). Our franchise agreements grant us the right to the use of the brand name, systems and marks with respect to specified hotels and establish various management, operational, record-keeping, accounting, reporting and marketing standards and procedures that the licensed hotel must comply with. In addition, the franchisor establishes requirements for the quality and condition of the hotel and its furniture, fixtures and equipment, and we are obligated to expend such funds as may be required to maintain the hotel in compliance with those requirements. Typically, our franchise agreements provide for a license fee, or royalty, of 3.0% to 6.0% of room revenues and, if applicable, 3.0% of food and beverage revenue. In addition, we generally pay 1.0% to 4.0% of room revenues as marketing and reservation system contributions for the system-wide benefit of brand hotels. Franchise fees are included in sales and marketing expense in our consolidated financial statements. We incurred franchise fee expense, including amortization of deferred franchise fees, of $1.5 million and $1.7 million for the three months ended September 30, 2018 and 2017, respectively, and $4.4 million and $4.8 million for the nine months ended September 30, 2018 and 2017, respectively.

Capital Expenditures and Reserve Funds

With respect to our hotels that are operated under management or franchise agreements with major international hotel brands and for most of our hotels subject to mortgage loans, we are obligated to maintain furniture, fixtures and equipment reserve accounts for future capital expenditures at these hotels, sufficient to cover the cost of routine improvements and alterations at the hotels. The amount funded into each of these reserve accounts is generally determined pursuant to the management agreements, franchise agreements and/or mortgage loan documents for each of the respective hotels and typically ranges between 3% and 5% of the respective hotel’s total gross revenue. At September 30, 2018 and December 31, 2017$19.4 million and $16.5 million, respectively, was held in furniture, fixtures and equipment reserve accounts for future capital expenditures and is included in Restricted cash in the consolidated financial statements.

Renovation Commitments

Certain of our hotel franchise and loan agreements require us to make planned renovations to our hotels. Additionally, from time to time, certain of our hotels may undergo renovations as a result of our decision to upgrade portions of the hotels, such as guestrooms, public space, meeting space, and/or restaurants, in order to better compete with other hotels and alternative lodging options in our markets. At September 30, 2018, we had various contracts outstanding with third parties in connection with the renovation of certain of our hotels. The remaining commitments under these contracts at September 30, 2018 totaled $16.4 million. Funding for a renovation will first come from our furniture, fixtures and equipment reserve accounts, to the extent permitted by the terms of the management agreement. Should these reserves be unavailable or insufficient to cover the cost of the renovation, we will fund all or the remaining portion of the renovation with existing cash resources, proceeds available under our Working Capital Facility and/or other sources of available capital.



CWI 2 9/30/2018 10-Q 23
    


Notes to Consolidated Financial Statements (Unaudited)

Note 10. Loss Per Share and Equity

Loss Per Share

The following table presents loss per share (in thousands, except share and per share amounts):
 
Three Months Ended September 30, 2018
 
Three Months Ended September 30, 2017
 
Basic and Diluted Weighted-Average
Shares Outstanding 
 
Allocation of Loss
 
Basic and Diluted Loss
Per Share 
 
Basic and Diluted Weighted-Average
Shares Outstanding 
 
Allocation of Loss
 
Basic and Diluted Loss Per Share 
Class A common stock
30,558,370

 
$
(834
)
 
$
(0.03
)
 
28,889,131

 
$
(472
)
 
$
(0.02
)
Class T common stock
58,977,743

 
(1,771
)
 
(0.03
)
 
57,603,278

 
(1,013
)
 
(0.02
)
Net loss attributable to CWI 2 stockholders
 
 
$
(2,605
)
 
 
 
 
 
$
(1,485
)
 
 

 
Nine Months Ended September 30, 2018
 
Nine Months Ended September 30, 2017
 
Basic and Diluted Weighted-Average
Shares Outstanding 
 
Allocation of Loss
 
Basic and Diluted Loss
Per Share 
 
Basic and Diluted Weighted-Average
Shares Outstanding 
 
Allocation of Income (Loss)
 
Basic and Diluted Income (Loss) Per Share 
Class A common stock
30,192,311

 
$
(182
)
 
$
(0.01
)
 
27,131,807

 
$
34

 
$

Class T common stock
58,708,033

 
(835
)
 
(0.01
)
 
53,364,957

 
(203
)
 

Net loss attributable to CWI 2 stockholders
 
 
$
(1,017
)
 
 
 
 
 
$
(169
)
 
 

The allocation of net loss attributable to CWI 2 stockholders is calculated based on the weighted-average shares outstanding for Class A common stock and Class T common stock for each respective period. The allocation for the Class A common stock excludes the accretion of interest on the annual distribution and shareholder servicing fee of $0.2 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively, and $0.5 million and $0.3 million for the nine months ended September 30, 2018 and 2017, respectively, which is only applicable to holders of Class T common shares (Note 3).

Transfer from Noncontrolling Interest

On March 30, 2017, we purchased the incentive membership interest in the Courtyard Nashville Downtown venture from an unaffiliated third party for $3.5 million. Our acquisition of the membership interest is accounted for as an equity transaction, and we recorded an adjustment of approximately $3.5 million to Additional paid-in capital in our consolidated statement of equity for the nine months ended September 30, 2017 related to the difference between the carrying value and the purchase price. No gain or loss was recognized in the consolidated statement of operations.

Reclassifications Out of Accumulated Other Comprehensive Income

The following table presents a reconciliation of changes in Accumulated other comprehensive income by component for the periods presented (in thousands):
 
 
Three Months Ended September 30,
Gains and Losses on Derivative Instruments
 
2018
 
2017
Beginning balance
 
$
2,211

 
$
831

Other comprehensive income before reclassifications
 
167

 
38

Amounts reclassified from accumulated other comprehensive income to:
 
 
 
 
Interest expense
 
(217
)
 
22

Total
 
(217
)
 
22

Net current period other comprehensive (loss) income
 
(50
)
 
60

Net current period other comprehensive loss (income) attributable to noncontrolling interests
 
1

 
(3
)
Ending balance
 
$
2,162

 
$
888




CWI 2 9/30/2018 10-Q 24
    


Notes to Consolidated Financial Statements (Unaudited)

 
 
Nine Months Ended September 30,
Gains and Losses on Derivative Instruments
 
2018
 
2017
Beginning balance
 
$
1,373

 
$
896

Other comprehensive income (loss) before reclassifications
 
1,232

 
(210
)
Amounts reclassified from accumulated other comprehensive income to:
 
 
 
 
Interest expense
 
(444
)
 
210

Total
 
(444
)
 
210

Net current period other comprehensive income
 
788

 

Net current period other comprehensive loss (income) attributable to noncontrolling interests
 
1

 
(8
)
Ending balance
 
$
2,162

 
$
888


Distributions

The following table presents the quarterly per share distributions declared by our board of directors for the third quarter of 2018, payable in cash and in shares of our Class A and Class T common stock to stockholders of record on September 28, 2018:
Class A common stock
 
Class T common stock
Cash
 
Shares
 
Total
 
Cash
 
Shares
 
Total
$
0.1410

 
$
0.0339

 
$
0.1749

 
$
0.1150

 
$
0.0339

 
$
0.1489


These distributions were paid on October 15, 2018 in the aggregate amount of $11.1 million. Distributions that are payable in shares of our Class A and Class T common stock are recorded at par value in our consolidated financial statements.

During the nine months ended September 30, 2018, our board of directors declared distributions in the aggregate amount of $12.8 million for our Class A common stock and $20.2 million for our Class T common stock, which equates to $0.5247 per share and $0.4467 per share, respectively.

Note 11. Income Taxes

We elected to be treated as a REIT and believe that we have been organized and have operated in such a manner to maintain our qualification as a REIT for federal and state income tax purposes. As a REIT, we are generally not subject to corporate level federal income taxes on earnings distributed to our stockholders. Since inception, we have distributed at least 100% of our taxable income annually and intend to do so for the tax year ending December 31, 2018. Accordingly, we have not included any provisions for federal income taxes related to the REIT in the accompanying consolidated financial statements for the three and nine months ended September 30, 2018 and 2017. We conduct business in various states and municipalities within the United States, and, as a result, we or one or more of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. As a result, we are subject to certain state and local taxes and a provision for such taxes is included in the consolidated financial statements.
Certain of our subsidiaries have elected taxable REIT subsidiary, or TRS, status. A TRS may provide certain services considered impermissible for REITs and may hold assets that REITs may not hold directly. The accompanying consolidated financial statements include an interim tax provision for our TRSs for the three and nine months ended September 30, 2018 and 2017. Current income tax expense was $0.6 million and $1.0 million for the three months ended September 30, 2018 and 2017, respectively, and $2.6 million and $3.5 million for the nine months ended September 30, 2018 and 2017, respectively.


CWI 2 9/30/2018 10-Q 25
    


Notes to Consolidated Financial Statements (Unaudited)

Our TRSs are subject to U.S. federal and state income taxes. As such, deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities at the enacted tax rates expected to be in effect when the temporary differences reverse. A valuation allowance for deferred tax assets is provided if we believe that it is more likely than not that we will not realize the tax benefit of deferred tax assets based on available evidence at the time the determination is made. A change in circumstances may cause us to change our judgment about whether a deferred tax asset will more likely than not be realized. We generally report any change in the valuation allowance through our income statement in the period in which such changes in circumstances occur. In December 2017, the Tax Cuts and Jobs Act was enacted, which reduced the federal corporate income tax rate from 35% to 21%, effective January 1, 2018. Tax reform also contained other provisions that may have an impact on the future realizability of our deferred tax assets. The majority of our deferred tax assets relate to net operating losses, accrued expenses and deferred key money liabilities. Provision for income taxes included a net deferred income tax expense of $0.1 million for both the three months ended September 30, 2018 and 2017, and net deferred income tax benefit of $0.2 million and net deferred income tax expense of less than $0.1 million for the nine months ended September 30, 2018 and 2017, respectively.



CWI 2 9/30/2018 10-Q 26
    


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

Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide the reader with information that will assist in understanding our financial statements and the reasons for changes in certain key components of our financial statements from period to period. Management’s Discussion and Analysis of Financial Condition and Results of Operations also provides the reader with our perspective on our financial position and liquidity, as well as certain other factors that may affect our future results. Our Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the 2017 Annual Report and subsequent reports filed under the Securities Exchange Act of 1934, as amended, or the Exchange Act.

Business Overview

As described in more detail in Item 1 of the 2017 Annual Report, we are a publicly-owned, non-listed REIT that invests in, manages and seeks to enhance the value of interests in lodging and lodging-related properties. We have fully invested our offering proceeds in a diversified lodging portfolio, including full-service, select-service and resort hotels. Our results of operations are significantly impacted by seasonality, acquisition-related expenses and hotel renovations. We have invested in and then initiated significant renovations at certain hotels. Generally, during the renovation period, a portion of total rooms are unavailable and hotel operations are often disrupted, negatively impacting our results of operations. At September 30, 2018, we held ownership interests in 12 hotels, with a total of 4,424 rooms.

Our board of directors is beginning the process of evaluating strategic alternatives, including a combination with CWI 1, and intends to form a special committee of independent directors to undertake the evaluation. There can be no assurance as to the form or timing of any transaction or that a transaction will be pursued at all. We do not intend to discuss the evaluation process unless and until the board completes its evaluation.


Financial and Operating Highlights

(Dollars in thousands, except average daily rate, or ADR, and revenue per available room, or RevPAR)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Hotel revenues
$
87,177

 
$
85,407

 
$
276,456

 
$
254,272

Loss on hurricane-related property damage
159

 
3,845

 
748

 
3,845

Acquisition-related expenses

 

 

 
4,979

Net loss attributable to CWI 2 stockholders
(2,605
)
 
(1,485
)
 
(1,017
)
 
(169
)
 
 
 
 
 
 
 
 
Cash distributions paid
10,977

 
10,202

 
32,910

 
25,839

 
 
 
 
 
 
 
 
Net cash provided by operating activities
 
 
 
 
49,330

 
40,809

Net cash used in investing activities (a)
 
 
 
 
(6,542
)
 
(281,317
)
Net cash (used in) provided by financing activities (a)
 
 
 
 
(37,232
)
 
241,547

 
 
 
 
 
 
 
 
Supplemental Financial Measures: (b)
 
 
 
 
 
 
 
FFO attributable to CWI 2 stockholders
11,533

 
9,342

 
37,863

 
29,397

MFFO attributable to CWI 2 stockholders
11,976

 
11,504

 
38,567

 
36,346

 
 
 
 
 
 
 
 
Consolidated Hotel Operating Statistics
 
 
 
 
 
 
 
Occupancy
80.5
%
 
79.5
%
 
80.3
%
 
79.8
%
ADR
$
235.75

 
$
231.99

 
$
240.11

 
$
234.49

RevPAR
189.70

 
184.38

 
192.90

 
187.16

___________
(a)
On January 1, 2018, we adopted ASU 2016-18, which revised how certain items are presented in the consolidated statements of cash flows. As a result of adopting this guidance, we retrospectively revised net cash used in investing activities and net cash (used in) provided by financing activities within our consolidated statements of cash flows for the nine months ended September 30, 2017, as described in Note 2.


CWI 2 9/30/2018 10-Q 27
    


(b)
We consider the performance metrics listed above, including funds from operations, or FFO, and modified funds from operations, or MFFO, which are supplemental measures that are not defined by GAAP, referred to herein as non-GAAP measures, to be important measures in the evaluation of our results of operations and capital resources. We evaluate our results of operations with a primary focus on the ability to generate cash flow necessary to meet our objective of funding distributions to stockholders. See Supplemental Financial Measures below for our definitions of these non-GAAP measures and reconciliations to their most directly comparable GAAP measures.

The comparison of our results period over period is influenced by both the number and size of the hotels consolidated in each of the respective periods. At both September 30, 2018 and 2017, we owned ten Consolidated Hotels, with one of those hotels acquired during the second quarter of 2017.

Portfolio Overview

Summarized Acquisition Data

The following table sets forth acquisition data and therefore excludes subsequent improvements and capitalized costs for our ten Consolidated Hotels and two Unconsolidated Hotels. Amounts for our initial investment for our Consolidated Hotels represent the fair value of net assets acquired less the fair value of noncontrolling interests, exclusive of acquisition expenses and the fair value of any debt assumed, at the time of acquisition. Amounts for our initial investment for our Unconsolidated Hotels represent purchase price plus capitalized costs, inclusive of fees paid to our Advisor, at the time of acquisition (dollars in thousands).
Hotels
 
State
 
Number
of Rooms
 
% Owned
 
Our
Initial
Investment
 
Acquisition Date
 
Hotel Type
 
Renovation Status at September 30, 2018
Consolidated Hotels
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015 Acquisitions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marriott Sawgrass Golf Resort & Spa (a) (b)
 
FL
 
514
 
50%
 
$
24,764

 
4/1/2015
 
Resort
 
Completed
Courtyard Nashville Downtown
 
TN
 
192
 
100%
 
58,498

 
5/1/2015
 
Select-Service
 
Completed/ Planned future
Embassy Suites by Hilton Denver-Downtown/Convention Center
 
CO
 
403
 
100%
 
168,809

 
11/4/2015
 
Full-Service
 
Completed/ Planned future
2016 Acquisitions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Seattle Marriott Bellevue
 
WA
 
384
 
95.4%
 
175,921

 
1/22/2016
 
Full-Service
 
None planned
Le Méridien Arlington
 
VA
 
154
 
100%
 
54,891

 
6/28/2016
 
Full-Service
 
Completed/ Planned future
San Jose Marriott
 
CA
 
510
 
100%
 
153,814

 
7/13/2016
 
Full-Service
 
Planned future
San Diego Marriott La Jolla
 
CA
 
372
 
100%
 
136,782

 
7/21/2016
 
Full-Service
 
Completed
Renaissance Atlanta Midtown Hotel
 
GA
 
304
 
100%
 
78,782

 
8/30/2016
 
Full-Service
 
Completed
Ritz-Carlton San Francisco
 
CA
 
336
 
100%
 
272,207

 
12/30/2016
 
Full-Service
 
Planned future
2017 Acquisition
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Charlotte Marriott City Center
 
NC
 
446
 
100%
 
168,884

 
6/1/2017
 
Full-Service
 
None planned
 
 
 
 
3,615
 
 
 
$
1,293,352

 
 
 
 
 
 
Unconsolidated Hotels
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ritz-Carlton Key Biscayne (a) (c)
 
FL
 
451
 
19.3%
 
$
37,559

 
5/29/2015
 
Resort
 
Completed/ In progress
Ritz-Carlton Bacara, Santa Barbara (d)
 
CA
 
358
 
60%
 
99,386

 
9/28/2017
 
Resort
 
In progress
 
 
 
 
809
 
 
 
$
136,945

 
 
 
 
 
 
_________
(a)
Status excludes any remaining restoration work as a result of the damage sustained from Hurricane Irma.
(b)
The remaining 50% interest in this venture is owned by CWI 1. Our initial investment presented is net of $66.7 million of debt assumed at acquisition.
(c)
A 47.4% interest in this venture is owned by CWI 1. The remaining 33.3% interest is retained by the original owner. The number of rooms presented includes 149 condo-hotel units that participate in the resort rental program.
(d)
This investment represents a tenancy-in-common interest; the remaining 40% interest is owned by CWI 1.



CWI 2 9/30/2018 10-Q 28
    


Results of Operations

We evaluate our results of operations with a primary focus on our ability to generate cash flow necessary to meet our objectives of funding distributions to stockholders and increasing the value in our real estate investments. As a result, our assessment of operating results gives less emphasis to the effect of unrealized gains and losses, which may cause fluctuations in net income for comparable periods but have no impact on cash flows, and to other non-cash charges, such as depreciation.

In addition, we use other information that may not be financial in nature, including statistical information, to evaluate the operating performance of our business, such as occupancy rate, ADR and RevPAR. Occupancy rate, ADR and RevPAR are commonly used measures within the hotel industry to evaluate operating performance. RevPAR, which is calculated as the product of ADR and occupancy rate, is an important statistic for monitoring operating performance at our hotels. Our occupancy rate, ADR and RevPAR performance may be impacted by macroeconomic factors such as U.S. economic conditions, changes in regional and local labor markets, personal income and corporate earnings, business relocation decisions, business and leisure travel, new hotel construction and the pricing strategies of competitors.

The comparability of our results year over year is impacted by, among other factors, the timing of acquisition activity and of any renovation-related activity, including the restoration of certain hotels due to the impact of Hurricane Irma.



CWI 2 9/30/2018 10-Q 29
    


The following table presents our comparative results of operations (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Hotel Revenues
 
$
87,177

 
$
85,407

 
$
1,770

 
$
276,456

 
$
254,272

 
$
22,184

 
 
 
 
 
 
 
 
 
 
 
 
 
Hotel Expenses
 
71,989

 
72,157

 
(168
)
 
221,480

 
207,392

 
14,088

 
 
 
 
 
 
 
 
 
 
 
 
 
Other Operating Expenses
 
 
 
 
 
 
 
 
 
 
 
 
Asset management fees to affiliate and other expenses
 
2,790

 
2,305

 
485

 
8,279

 
6,426

 
1,853

Corporate general and administrative expenses
 
1,712

 
1,483

 
229

 
5,551

 
4,778

 
773

Loss on hurricane-related property damage
 
159

 
3,845

 
(3,686
)
 
748

 
3,845

 
(3,097
)
Acquisition-related expenses
 

 

 

 

 
4,979

 
(4,979
)
Total Other Operating Expenses
 
4,661

 
7,633

 
(2,972
)
 
14,578

 
20,028

 
(5,450
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating Income
 
10,527

 
5,617

 
4,910

 
40,398

 
26,852

 
13,546

 
 
 
 
 
 
 
 
 
 
 
 
 
Other Income and (Expenses)
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
(10,176
)
 
(9,522
)
 
(654
)
 
(30,274
)
 
(25,826
)
 
(4,448
)
Equity in (losses) earnings of equity method investments in real estate
 
(1,049
)
 
(36
)
 
(1,013
)
 
(3,440
)
 
1,461

 
(4,901
)
Loss on extinguishment of debt
 
(380
)
 
(256
)
 
(124
)
 
(380
)
 
(256
)
 
(124
)
Other income
 
365

 
58

 
307

 
551

 
135

 
416

Total Other Income and (Expenses)
 
(11,240
)
 
(9,756
)
 
(1,484
)
 
(33,543
)
 
(24,486
)
 
(9,057
)
 
 
 
 
 
 
 
 
 
 
 
 
 
(Loss) Income from Operations Before Income Taxes
 
(713
)
 
(4,139
)
 
3,426

 
6,855

 
2,366

 
4,489

Provision for income taxes
 
(698
)
 
(1,122
)
 
424

 
(2,351
)
 
(3,518
)
 
1,167

Net (Loss) Income
 
(1,411
)
 
(5,261
)
 
3,850

 
4,504

 
(1,152
)
 
5,656

(Income) loss attributable to noncontrolling interests
 
(1,194
)
 
3,776

 
(4,970
)
 
(5,521
)
 
983

 
(6,504
)
Net Loss Attributable to CWI 2 Stockholders
 
$
(2,605
)
 
$
(1,485
)
 
$
(1,120
)
 
$
(1,017
)
 
$
(169
)
 
$
(848
)
Supplemental Financial Measure:(a)
 
 
 
 
 
 
 
 
 
 
 
 
MFFO Attributable to CWI 2 Stockholders
 
$
11,976

 
$
11,504

 
$
472

 
$
38,567

 
$
36,346

 
$
2,221

___________
(a)
We consider MFFO, a non-GAAP measure, to be an important metric in the evaluation of our results of operations and capital resources. We evaluate our results of operations with a primary focus on the ability to generate cash flow necessary to meet our objective of funding distributions to stockholders. See Supplemental Financial Measures below for our definition of non-GAAP measures and reconciliations to their most directly comparable GAAP measures.



CWI 2 9/30/2018 10-Q 30
    


Our Same Store Hotels are comprised of our 2015 Acquisitions and 2016 Acquisitions and our Recently Acquired Hotel is our 2017 Acquisition.

The following table sets forth the average occupancy rate, ADR and RevPAR of our Consolidated Hotels for the three and nine months ended September 30, 2018 and 2017 for our Same Store Hotels.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Same Store Hotels
 
2018
 
2017
 
2018
 
2017
Occupancy Rate
 
81.2
%
 
79.9
%
 
81.2
%
 
80.1
%
ADR
 
$
239.26

 
$
234.22

 
$
243.00

 
$
235.53

RevPAR
 
194.31

 
187.22

 
197.23

 
188.75


Hotel Revenues

For the three months ended September 30, 2018 as compared to the same period in 2017, hotel revenues increased by $1.8 million primarily due to an increase in revenue from the Marriott Sawgrass Golf Resort & Spa, driven by a strong market and an increase in group bookings, partially offset by a decrease in revenue from Renaissance Atlanta Midtown Hotel, largely due to the hotel undergoing renovation during the current year period.

For the nine months ended September 30, 2018 as compared to the same period in 2017, hotel revenues increased by $22.2 million, primarily due an increase in revenue contributed by the Charlotte Marriott City Center, which we acquired on June 1, 2017, and an increase from Marriott Sawgrass Golf Resort & Spa, as discussed above.

Hotel Expenses

Room expense, food and beverage expense and other operating department costs fluctuate based on various factors, including occupancy, labor costs, utilities and insurance costs.

For the three months ended September 30, 2018 as compared to the same period in 2017, aggregate hotel operating expenses decreased by $0.2 million. The increase in expenses related to the Marriott Sawgrass Golf Resort & Spa during the current year period as a result of the increase in revenue discussed above were more than offset by a net decrease in expenses from the remaining portfolio, largely due to a decrease in expenses related to Renaissance Atlanta Midtown Hotel as a result of the current year period renovation.

For the nine months ended September 30, 2018 as compared to the same period in 2017, aggregate hotel operating expenses increased by $14.1 million, primarily due to an increase in expenses contributed by the Charlotte Marriott City Center and Marriott Sawgrass Golf Resort and Spa as a result of the increase in revenue discussed above.

Asset Management Fees to Affiliate and Other Expenses

Asset management fees to affiliate and other expenses primarily represent fees paid to our Advisor. We pay our Advisor an annual asset management fee equal to 0.55% of the aggregate Average Market Value of our Investments, as defined in our Advisory Agreement (Note 3). Our Advisor elected to receive its asset management fees in shares of our Class A common stock for each of the three and nine months ended September 30, 2018 and 2017.

For the three and nine months ended September 30, 2018 as compared to the same periods in 2017, asset management fees to affiliate and other increased by $0.5 million and $1.9 million, respectively, primarily reflecting the impact of our acquisitions of the Charlotte Marriott City Center and the Ritz-Carlton Bacara, Santa Barbara on June 1, 2017 and September 28, 2017, respectively, which increased the asset base from which our Advisor earns a fee.

Corporate General and Administrative Expenses

For the three months ended September 30, 2018 as compared to the same period in 2017, corporate general and administrative expenses increased by $0.2 million, largely due to an increase in personnel and overhead reimbursement costs, caused in part by an increase in our pro rata hotel revenue relative to CWI 1’s pro rata hotel revenue, which directly impacts the allocation of our Advisor’s expenses to us (Note 3).



CWI 2 9/30/2018 10-Q 31
    


For the nine months ended September 30, 2018 as compared to the same period in 2017, corporate general and administrative expenses increased by $0.8 million, primarily as a result of increases in professional fees of $0.4 million and overhead reimbursement costs of $0.3 million. Professional fees include legal, accounting and investor-related expenses incurred in the normal course of business.

Loss on Hurricane-Related Property Damage

During the three and nine months ended September 30, 2018, we recognized a loss on hurricane-related property damage of $0.2 million and $0.7 million, respectively, from the Marriott Sawgrass Golf Resort & Spa. For the three months ended September 30, 2018, this loss was comprised of a $0.2 million loss resulting from a change in our estimate of the total damage incurred at the property. For the nine months ended September 30, 2018, this loss was comprised of a $1.3 million loss resulting from pre-existing damage at the hotel (which was discovered as a result of the hurricane and was not covered by insurance), partially offset by a $0.6 million gain resulting from a decrease in the estimate to repair property damage at the hotel.

During both the three and nine months ended September 30, 2017, we recognized losses on hurricane-related damage of $3.8 million, representing our best estimate at the time of uninsured losses from Hurricane Irma.

We and CWI 1 maintain insurance on all of our hotels, with an aggregate policy limit of $500.0 million for both property damage and business interruption. Our insurance policies are subject to various terms and conditions, including property damage and business interruption deductibles on each hotel, which range from 2% to 5% of the insured value. We currently estimate our aggregate casualty insurance claim related to Hurricane Irma to be approximately $4.0 million, which includes estimated clean up, repair and rebuilding costs, and estimate our aggregate business interruption insurance claim to be approximately $1.0 million. As the restoration work continues to be performed, the estimated total costs will change. We believe that we maintain adequate insurance coverage on each of our hotels and are working closely with the insurance carriers and claims adjusters to obtain the maximum amount of insurance recovery provided under the policies. However, we can give no assurances as to the amounts of such claims, the timing of payments or the ultimate resolution of the claims.

We experienced a reduction in revenues as a result of Hurricane Irma. Our business interruption insurance covers lost revenue through the period of property restoration and for up to 12 months after the hotels are back to full operations. We have retained consultants to assess our business interruption claims and are currently reviewing our losses with our insurance carriers. We have not recorded revenue for covered business interruption during the nine months ended September 30, 2018. We will record revenue for covered business interruption when both the recovery is probable and contingencies have been resolved with the insurance carriers.

Acquisition-Related Expenses

For the nine months ended September 30, 2017, acquisition-related expenses were $5.0 million. We did not acquire any hotels during the three or nine months ended September 30, 2018.

Interest Expense

Our interest expense is directly impacted by the mortgage loans obtained in connection with our acquisition activity.

For the three months ended September 30, 2018 compared to the same period in 2017, interest expense increased by $0.7 million, primarily due to an increase in the weighted-average interest rate of our debt from 4.3% for the three months ended September 30, 2017 to 4.6% for the three months ended September 30, 2018.

For the nine months ended September 30, 2018 compared to the same period in 2017, interest expense increased by $4.4 million, primarily due to an increase in mortgage financing obtained related to the Ritz-Carlton San Francisco and the Charlotte Marriott City Center during the first and second quarter of 2017, respectively. Our average outstanding debt balance was $835.5 million and $752.9 million during the nine months ended September 30, 2018 and 2017, respectively. Our weighted-average interest rate was 4.6% and 4.3% during the nine months ended September 30, 2018 and 2017, respectively.



CWI 2 9/30/2018 10-Q 32
    


Equity in (Losses) Earnings of Equity Method Investments in Real Estate

Equity in (losses) earnings of equity method investments in real estate represents (losses) earnings from our equity investments in Unconsolidated Hotels recognized in accordance with each investment agreement and based upon the allocation of the investment’s net assets at book value as if the investment were hypothetically liquidated at the end of each reporting period (Note 5). We are required to periodically compare an investment’s carrying value to its estimated fair value and recognize an impairment charge to the extent that the carrying value exceeds the estimated fair value and is determined to be other than temporary. No other-than-temporary impairment charges were recognized on our equity method investments in real estate during the nine months ended September 30, 2018 or 2017.

The following table sets forth our share of equity in (losses) earnings from our Unconsolidated Hotels, which are based on the hypothetical liquidation at book value model, as well as certain amortization adjustments related to basis differentials from acquisitions of investments (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Unconsolidated Hotels
 
2018
 
2017
 
2018
 
2017
Ritz-Carlton Key Biscayne Venture
 
$
(755
)
 
$
763

 
$
1,108

 
$
2,260

Ritz-Carlton Bacara, Santa Barbara Venture (a)
 
(294
)
 
(799
)
 
(4,548
)
 
(799
)
Total equity in (losses) earnings of equity method investments in real estate
 
$
(1,049
)
 
$
(36
)
 
$
(3,440
)
 
$
1,461

___________
(a)
We acquired our 60.0% tenancy-in-common interest in this venture on September 28, 2017. The results for both the three and nine months ended September 30, 2017 represent data from its acquisition date through September 30, 2017 and include pre-opening expenses.

(Income) Loss Attributable to Noncontrolling Interests

The following table sets forth our (income) loss attributable to noncontrolling interests (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Venture
 
2018
 
2017
 
2018
 
2017
Operating Partnership — Available Cash Distribution (Note 3)
 
$
(1,691
)
 
$
(1,894
)
 
$
(3,907
)
 
$
(3,528
)
Marriott Sawgrass Golf Resort & Spa Venture (a)
 
497

 
3,255

 
(1,614
)
 
1,549

Seattle Marriott Bellevue (b)
 

 
2,415

 

 
2,962

 
 
$
(1,194
)
 
$
3,776

 
$
(5,521
)
 
$
983

___________
(a)
The results for the three and nine months ended September 30, 2018 reflect the impact of seasonality, with the hotels highest demand being during the first and second quarters. The losses attributable to noncontrolling interests during both the three and nine months ended September 30, 2017 were largely attributable to the impact of Hurricane Irma and is therefore not comparable to the three and nine months ended September 30, 2018.
(b)
At acquisition, the joint venture partner’s contribution was in the form of a net operating income guarantee reserve, which as of December 31, 2017, was substantially depleted under the HLBV method of accounting, resulting in no income or loss attributable to noncontrolling interests during the three and nine months ended September 30, 2018.

Modified Funds from Operations

MFFO is a non-GAAP measure that we use to evaluate our business. For a definition of MFFO and a reconciliation to net income attributable to CWI 2 stockholders, see Supplemental Financial Measures below.

For the three and nine months ended September 30, 2018 as compared to the same periods in 2017, MFFO increased by $0.5 million and $2.2 million, respectively, primarily as a result of a net increase from hotel operations, including the impact from our 2017 investments, partially offset by an increase in asset management fees, corporate general and administrative expenses and interest expense, as discussed above.



CWI 2 9/30/2018 10-Q 33
    


Liquidity and Capital Resources

Our principal demands for funds will be for the payment of operating expenses, interest and principal on current and future indebtedness and distributions to stockholders. Liquidity is affected adversely by unanticipated costs and greater-than-anticipated operating expenses. We expect to meet our liquidity requirements from cash generated from operations. To the extent that these funds are insufficient to satisfy our cash flow requirements, additional funds may be provided from asset sales, long- and/or short-term borrowings, proceeds from mortgage financings or refinancings.

Sources and Uses of Cash During the Period

We have fully invested the proceeds from our initial public offering. We use the cash flow generated from hotel operations to meet our normal recurring operating expenses, service debt and fund distributions to our shareholders. Our cash flows fluctuate from period to period due to a number of factors, including the financial and operating performance of our hotels, the timing of purchases or dispositions of hotels, the timing and characterization of distributions from equity method investments in hotels and seasonality in the demand for our hotels. Also, hotels we invest in may undergo renovations, during which they may experience disruptions, possibly resulting in reduced revenue and operating income. Despite these fluctuations, we believe that we will continue to generate sufficient cash from operations and from our equity method investments to meet our normal recurring short-term and long-term liquidity needs. We may also use existing cash resources, proceeds available under our Working Capital Facility, through its expiration, as amended, which is currently expected to occur on December 31, 2019 (Note 3), the proceeds of mortgage loans, asset sales, and distributions reinvested in our common stock through our DRIP. We assess our ability to access capital on an ongoing basis. Our sources and uses of cash during the period are described below.

Operating Activities

For the nine months ended September 30, 2018 as compared to the same period in 2017, net cash provided by operating activities increased by $8.5 million. Net cash provided by operating activities during the nine months ended September 30, 2017 reflected the $7.2 million acquisition fee paid to our Advisor related to the acquisition of the Ritz-Carlton San Francisco on December 30, 2016, which was paid in the first quarter of 2017. The remaining increase for the nine months ended September 30, 2018 as compared to the same period in 2017 was largely attributable to net cash flow from operations generated by our 2017 Acquisition.

Investing Activities

During the nine months ended September 30, 2018, net cash used in investing activities was $6.5 million, primarily as a result of funding $11.2 million of capital expenditures for our Consolidated Hotels, partially offset by distributions received from equity investments in excess of equity income totaling $5.2 million.

Financing Activities

Net cash used in financing activities for the nine months ended September 30, 2018 was $37.2 million, primarily as a result of scheduled payments and prepayments of mortgage financing totaling $47.5 million substantially made in connection with the refinancing of the Renaissance Atlanta Midtown senior mortgage and mezzanine loans during the third quarter of 2018 (Note 8), cash distributions paid to stockholders of $32.9 million, redemptions of our common stock pursuant to our redemption plan totaling $13.1 million, as described below, and distributions to noncontrolling interests totaling $7.4 million, partially offset by the proceeds of $49.0 million from the refinancing of the Renaissance Atlanta Midtown loans and the reinvestment of distributions in shares of our common stock through our DRIP, net of distribution and shareholder servicing fee payments, totaling $15.5 million.
 
Distributions

Our objectives are to generate sufficient cash flow over time to provide stockholders with distributions and to seek investments with potential for capital appreciation throughout varying economic cycles. For the nine months ended September 30, 2018, we paid distributions to stockholders, excluding distributions paid in shares of our common stock, totaling $32.9 million, which were comprised of cash distributions of $12.9 million and distributions that were reinvested in shares of our common stock by stockholders through our DRIP of $20.0 million. From Inception through September 30, 2018, we declared distributions, excluding distributions paid in shares of our common stock, to stockholders totaling $98.7 million, which were comprised of cash distributions of $37.8 million and distributions that were reinvested in shares of our common stock by stockholders through our DRIP of $60.9 million.


CWI 2 9/30/2018 10-Q 34
    



We believe that FFO, a non-GAAP measure, is the most appropriate metric to evaluate our ability to fund distributions to stockholders. For a discussion of FFO, see Supplemental Financial Measures below. Over the life of our company, the regular quarterly cash distributions we pay are expected to be principally sourced from our FFO or our Cash flow from operations. However, we have funded a portion of our cash distributions to date using net proceeds from our public offering and there can be no assurance that our FFO or our Cash flow from operations will be sufficient to cover our future distributions. We fully covered total distributions declared for the nine months ended September 30, 2018 using FFO and funded all of these distributions from Net cash provided by operating activities. We expect that, in the future, if distributions cannot be fully sourced from net cash provided by operating activities, they may be sourced from other sources of cash, such as financings, borrowings, or sales of assets.

Redemptions

We maintain a quarterly redemption program pursuant to which we may, at the discretion of our board of directors, redeem shares of our common stock from stockholders seeking liquidity. During the nine months ended September 30, 2018, we redeemed 443,002 shares of our Class A common stock (representing 82 requests), at an average share price of $10.59, and 798,933 shares of our Class T common stock (representing 144 requests), at an average share price of $10.56. As of the date of this Report, we have fulfilled all of the valid redemption requests that we received during the nine months ended September 30, 2018. We funded all share redemptions during the nine months ended September 30, 2018 with proceeds from the sale of shares of our common stock pursuant to our DRIP.

Summary of Financing

The table below summarizes our non-recourse debt, net (dollars in thousands):
 
September 30, 2018
 
December 31, 2017
Carrying Value
 
 
 
Fixed rate (a)
$
484,998

 
$
484,631

Variable rate (a):
 
 
 
Amount subject to interest rate cap, if applicable
248,840

 
247,245

Amount subject to interest rate swap
99,653

 
99,453

 
348,493

 
346,698

 
$
833,491

 
$
831,329

Percent of Total Debt
 
 
 
Fixed rate
58
%
 
58
%
Variable rate
42
%
 
42
%
 
100
%
 
100
%
Weighted-Average Interest Rate at End of Period
 
 
 
Fixed rate
4.3
%
 
4.3
%
Variable rate (b)
4.8
%
 
4.6
%
_________
(a)
Aggregate debt balance includes deferred financing costs totaling $3.4 million and $4.1 million as of September 30, 2018 and December 31, 2017, respectively.
(b)
The impact of our derivative instruments are reflected in the weighted-average interest rates.

Most of our mortgage loan agreements contain “lock-box” provisions, which permit the lender to access or sweep a hotel’s excess cash flow and would be triggered under limited circumstances, including the failure to maintain minimum debt service coverage ratios. If a provision were triggered, we would generally be permitted to spend an amount equal to our budgeted hotel operating expenses, taxes, insurance and capital expenditure reserves for the relevant hotel. The lender would then hold all excess cash flow after the payment of debt service in an escrow account until certain performance hurdles are met.



CWI 2 9/30/2018 10-Q 35
    


Cash Resources

At September 30, 2018, our cash resources consisted of cash and cash equivalents totaling $74.1 million, of which $11.3 million was designated as hotel operating cash. We also had the $25.0 million Working Capital Facility, all of which remained available to be drawn as of the date of this Report. Our cash resources can be used for working capital needs, debt service and other commitments, such as renovation commitments as noted below, as well as to fund future investments.

Cash Requirements

During the next 12 months, we expect that our cash requirements will include paying distributions to our stockholders, reimbursing our Advisor for costs incurred on our behalf, fulfilling our renovation commitments (Note 9), funding hurricane-related repair and remediation costs in excess of insurance proceeds received, funding lease commitments and making scheduled mortgage loan principal payments, including a scheduled balloon payment of $88.0 million on one mortgage loan, as well as other normal recurring operating expenses. We currently intend to refinance the scheduled balloon payment, although there can be no assurance that we will be able to do so on favorable terms, if at all.

We expect to use cash generated from operations, the Working Capital Facility, through its expiration on December 31, 2019, and mortgage financing to fund these cash requirements, in addition to amounts held in escrow to fund our renovation commitments.

Capital Expenditures and Reserve Funds

With respect to our hotels that are operated under management or franchise agreements with major national hotel brands and for most of our hotels subject to mortgage loans, we are obligated to maintain furniture, fixtures and equipment reserve accounts for future capital expenditures at these hotels, sufficient to cover the cost of routine improvements and alterations at the hotels. The amount funded into each of these reserve accounts is generally determined pursuant to the management agreements, franchise agreements and/or mortgage loan documents for each of the respective hotels and typically ranges between 3% and 5% of the respective hotel’s total gross revenue. At September 30, 2018 and December 31, 2017$19.4 million and $16.5 million, respectively, was held in furniture, fixtures and equipment reserve accounts for future capital expenditures.

Off-Balance Sheet Arrangements and Contractual Obligations

The table below summarizes our debt, off-balance sheet arrangements, and other contractual obligations (primarily our capital commitments) at September 30, 2018, and the effect that these arrangements and obligations are expected to have on our liquidity and cash flow in the specified future periods (in thousands):
 
Total
 
Less than
1 year
 
1-3 years
 
3-5 years
 
More than
5 years
Non-recourse debt — principal (a)
$
836,900

 
$
91,185

 
$
269,123

 
$
476,592

 
$

Interest on borrowings (b)
106,021

 
37,059

 
49,545

 
19,417

 

Contractual capital commitments (c)
16,372

 
12,522

 
3,050

 
800

 

Annual distribution and shareholder servicing fee (d)
11,756

 
5,862

 
5,894

 

 

Lease commitments (e)
1,267

 
543

 
724

 

 

Asset retirement obligation, net (f)
99

 

 

 

 
99

 
$
972,415

 
$
147,171

 
$
328,336

 
$
496,809

 
$
99

___________
(a)
Excludes deferred financing costs totaling $3.4 million.
(b)
For variable-rate debt, interest on borrowings is calculated using the capped or swapped interest rate, when in effect.
(c)
Capital commitments represent our remaining contractual renovation commitments at our Consolidated Hotels, which does not reflect any renovation work to be undertaken as a result of Hurricane Irma (Note 9).
(d)
Represents the estimated liability for the present value of the future distribution and shareholder servicing fees in connection with our Class T common stock (Note 3).
(e)
Lease commitments consist of our share of future rents payable pursuant to the Advisory Agreement for the purpose of leasing office space used for the administration of real estate entities.
(f)
Represents the estimated future obligation for the removal of asbestos and environmental waste in connection with two of our hotels upon the retirement of the asset.


CWI 2 9/30/2018 10-Q 36
    



Supplemental Financial Measures

In the real estate industry, analysts and investors employ certain non-GAAP supplemental financial measures in order to facilitate meaningful comparisons between periods and among peer companies. Additionally, in the formulation of our goals and in the evaluation of the effectiveness of our strategies, we use FFO and MFFO, which are non-GAAP measures defined by our management. We believe that these measures are useful to investors to consider because they may assist them to better understand and measure the performance of our business over time and against similar companies. A description of FFO and MFFO, and reconciliations of these non-GAAP measures to the most directly comparable GAAP measures, are provided below.

FFO and MFFO

Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts, or NAREIT, has promulgated a non-GAAP measure known as FFO, which we believe to be an appropriate supplemental measure, when used in addition to and in conjunction with results presented in accordance with GAAP, to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental non-GAAP measure. FFO is not equivalent to nor a substitute for net income or loss as determined under GAAP.

We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004. The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property, impairment charges on real estate, and depreciation and amortization from real estate assets; and after adjustments for unconsolidated partnerships and jointly owned investments. Adjustments for unconsolidated partnerships and jointly owned investments are calculated to reflect FFO. NAREITs definition of FFO does not distinguish between the conventional method of equity accounting and the hypothetical liquidation at book value method of accounting for unconsolidated partnerships and jointly owned investments.

The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, especially if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances in order to maintain the value disclosed. We believe that, since real estate values historically rise and fall with market conditions, including inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using historical accounting for depreciation may be less informative. Historical accounting for real estate involves the use of GAAP. Any other method of accounting for real estate such as the fair value method cannot be construed to be any more accurate or relevant than the comparable methodologies of real estate valuation found in GAAP. Nevertheless, we believe that the use of FFO, which excludes the impact of real estate-related depreciation and amortization, as well as impairment charges of real estate-related assets, 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, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income. In particular, we believe it is appropriate to disregard impairment charges, as this is a fair value adjustment that is largely based on market fluctuations and assessments regarding general market conditions, which can change over time. An asset will only be evaluated for impairment if certain impairment indicators exist. For real estate assets held for investment and related intangible assets in which an impairment indicator is identified, we follow a two-step process to determine whether an asset is impaired and to determine the amount of the charge. First, we compare the carrying value of the property’s asset group to the estimated future net undiscounted cash flow that we expect the property’s asset group will generate, including any estimated proceeds from the eventual sale of the property’s asset group. It should be noted, however, the property’s asset group’s estimated fair value is primarily determined using market information from outside sources such as broker quotes or recent comparable sales. In cases where the available market information is not deemed appropriate, we perform a future net cash flow analysis discounted for inherent risk associated with each asset to determine an estimated fair value. While impairment charges are excluded from the calculation of FFO described above, due to the fact that impairments are based on estimated future undiscounted cash flows and the relatively limited term of our operations, it could be difficult to recover any impairment charges. However, FFO and MFFO, as described below, 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 the operating performance of the company. The method utilized to evaluate the value and performance of real estate under GAAP should be construed as a more relevant measure 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.

Changes in the accounting and reporting promulgations under GAAP (for acquisition fees and expenses from a capitalization/depreciation model to an expensed-as-incurred model) were put into effect in 2009. These changes to GAAP accounting for real


CWI 2 9/30/2018 10-Q 37
    


estate subsequent to the establishment of NAREITs definition of FFO have prompted an increase in cash-settled expenses, such as acquisition fees that are typically accounted for as operating expenses. Management believes these fees and expenses do not affect our overall long-term operating performance. Publicly-registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation. While other start-up entities may also experience significant acquisition activity during their initial years, we believe that non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after acquisition activity ceases. We intend to begin the process of achieving a liquidity event (i.e., listing of our common stock on a national exchange, a merger or sale of our assets or another similar transaction) not later than six years following the conclusion of our initial public offering, which occurred in July 2017. Thus, we intend to have a limited life. Due to the above factors and other unique features of publicly registered, non-listed REITs, the Institute for Portfolio Alternatives (formerly known as the Investment Program Association), or the IPA, an industry trade group, has standardized a measure known as MFFO, which the IPA has recommended as a supplemental measure for publicly registered non-listed REITs and which we believe to be another appropriate non-GAAP measure to reflect the operating performance of a non-listed REIT having the characteristics described above. MFFO is not equivalent to our net income or loss as determined under GAAP, and MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to operate with a limited life and targeted exit strategy, as currently intended. We believe that, because MFFO excludes costs that we consider more reflective of investing activities and other non-operating items included in FFO and also excludes acquisition fees and expenses that affect our operations only in periods in which properties are acquired, 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 in place. By providing MFFO, we believe we are presenting useful information that assists investors and analysts to better assess the sustainability of our operating performance after our offering has been completed and once essentially all of our properties have been acquired. We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry. Further, we believe MFFO is useful in comparing the sustainability of our operating performance, with the sustainability of the operating performance of other real estate companies that are not as involved in acquisition activities. MFFO should only be used to assess the sustainability of a companys operating performance after a companys offering has been completed and properties have been acquired, as it excludes acquisition costs that have a negative effect on a companys operating performance during the periods in which properties are acquired.

We define MFFO consistent with the IPA’s Practice Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations, or the Practice Guideline, issued by the IPA in November 2010. This Practice Guideline defines MFFO as FFO further adjusted for the following items, included in the determination of GAAP net income, as applicable: acquisition fees and expenses; accretion of discounts and amortization of premiums on debt investments; where applicable, payments of loan principal made by our equity investees accounted for under the hypothetical liquidation model where such payments reduce our equity in earnings of equity method investments in real estate, nonrecurring impairments of real estate-related investments (i.e., infrequent or unusual, not reasonably likely to recur in the ordinary course of business); mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, 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 Hotels, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, unrealized gains and losses on hedges, derivatives or securities holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses that are unrealized and may not ultimately be realized.

Our MFFO calculation complies with the IPA’s Practice Guideline described above. In calculating MFFO, we exclude acquisition-related expenses, fair value adjustments of derivative financial instruments and the adjustments of such items related to noncontrolling interests. Under GAAP, acquisition fees and expenses are characterized as operating expenses in determining operating net income. These expenses are paid in cash by a company. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by the company, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to such property. Further, under GAAP, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income in determining cash flow from operating activities. We account for certain of our equity investments using the hypothetical liquidation model which is based on distributable cash as defined in the operating agreement.

Our management uses MFFO and the adjustments used to calculate it in order to evaluate our performance against other non-listed REITs, which have limited lives with short and defined acquisition periods and targeted exit strategies shortly thereafter.


CWI 2 9/30/2018 10-Q 38
    


As noted above, MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to operate in this manner. We believe that MFFO and the adjustments used to calculate it allow us to present our performance in a manner that takes into account certain characteristics unique to non-listed REITs, such as their limited life, defined acquisition period and targeted exit strategy, and is therefore a useful measure for investors. For example, acquisition costs are generally funded from the proceeds of our offering and other financing sources and not from operations. By excluding expensed acquisition costs, the use of MFFO provides information consistent with managements analysis of the operating performance of the properties. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such changes that may reflect anticipated and unrealized gains or losses, we believe MFFO provides useful supplemental information.

Presentation of this information is intended to provide useful information to investors as they compare the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income 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. FFO and MFFO should be reviewed in conjunction with other GAAP measurements as an indication of our performance.

Neither the SEC, NAREIT nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, the SEC, NAREIT or another regulatory body may decide to standardize the allowable adjustments across the non-listed REIT industry and we would have to adjust our calculation and characterization of FFO and MFFO accordingly.

FFO and MFFO were as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net loss attributable to CWI 2 stockholders
$
(2,605
)
 
$
(1,485
)
 
$
(1,017
)
 
$
(169
)
Adjustments:
 
 
 
 
 
 
 
Depreciation and amortization of real property
11,480

 
11,665

 
34,384

 
32,187

Proportionate share of adjustments for partially-owned entities — FFO adjustments
2,658

 
(838
)
 
4,496

 
(2,621
)
Total adjustments
14,138

 
10,827

 
38,880

 
29,566

FFO attributable to CWI 2 stockholders (as defined by NAREIT)
11,533

 
9,342

 
37,863

 
29,397

Loss on hurricane-related property damage (a)
159

 
3,845

 
748

 
3,845

Loss on extinguishment of debt
380

 
256

 
380

 
256

Other rent adjustments
(17
)
 
(17
)
 
(50
)
 
(209
)
Acquisition expenses (b)

 

 

 
4,979

Proportionate share of adjustments for partially owned entities — MFFO adjustments
(79
)
 
(1,922
)
 
(374
)
 
(1,922
)
Total adjustments
443

 
2,162

 
704

 
6,949

MFFO attributable to CWI 2 stockholders
$
11,976

 
$
11,504

 
$
38,567

 
$
36,346

___________
(a)
We excluded the hurricane loss because of the non-recurring nature of the adjustment.


CWI 2 9/30/2018 10-Q 39
    


(b)
In evaluating investments in real estate, management differentiates between the costs to acquire the investment and the operations derived from the investment. Such information would be comparable only for non-listed REITs that have made no acquisitions in the periods presented and have other similar operating characteristics. By excluding expensed acquisition costs, management believes MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management’s analysis of the investing and operating performance of our properties. Acquisition fees and expenses include payments to our Advisor or third parties. Acquisition fees and expenses under GAAP are considered operating expenses and as expenses included in the determination of net income from continuing operations, both of which are performance measures under GAAP. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to the property.


CWI 2 9/30/2018 10-Q 40
    


Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market Risk

We currently have limited exposure to financial market risks, including changes in interest rates. We currently have no foreign operations and are not exposed to foreign currency fluctuations.

Interest Rate Risk

The values of our real estate and related fixed-rate debt obligations are subject to fluctuations based on changes in interest rates. The value of our real estate is also subject to fluctuations based on local and regional economic conditions, which may affect our ability to refinance property-level mortgage debt when balloon payments are scheduled (if we do not choose to repay the debt when due). Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond our control. An increase in interest rates would likely cause the fair value of our assets to decrease.

We are exposed to the impact of interest rate changes primarily through our borrowing activities. To limit this exposure, we have attempted to obtain mortgage financing on a long-term, fixed-rate basis. However, from time to time, we or our joint investment partners have obtained, and may in the future obtain, variable-rate mortgage loans, and, as a result, we have entered into, and may continue to enter into, interest rate swap agreements or interest rate cap agreements with counterparties. See Note 7 for additional information on our interest rate swaps and caps.

At September 30, 2018, all of our long-term debt bore interest at fixed rates or was subject to an interest rate cap or swap. Our debt obligations are more fully described in Note 8 and Summary of Financing in Item 2 above. The following table presents principal cash outflows for our Consolidated Hotels based upon expected maturity dates of our debt obligations outstanding at September 30, 2018 and excludes deferred financing costs (in thousands):
 
2018 (Remainder)
 
2019
 
2020
 
2021
 
2022
 
Thereafter
 
Total
 
Fair Value
Fixed-rate debt
$

 
$
2,630

 
$
4,321

 
$
4,498

 
$
395,710

 
$
79,741

 
$
486,900

 
$
474,832

Variable-rate debt
$

 
$
168,265

 
$
132,735

 
$
49,000

 
$

 
$

 
$
350,000

 
$
350,500


The estimated fair value of our fixed-rate debt and our variable-rate debt that currently bears interest at fixed rates or has effectively been converted to a fixed rate through the use of an interest rate swap, or that has been subject to an interest rate cap, is affected by changes in interest rates. A decrease or increase in interest rates of 1.0% would change the estimated fair value of this debt at September 30, 2018 by an aggregate increase of $17.4 million or an aggregate decrease of $21.7 million, respectively. Annual interest expense on our variable-rate debt that is subject to an interest rate cap at September 30, 2018 would increase or decrease by $2.3 million for each respective 1.0% change in annual interest rates.



CWI 2 9/30/2018 10-Q 41
    


Item 4. Controls and Procedures.

Disclosure Controls and Procedures

Our disclosure controls and procedures include internal controls and other procedures designed to provide reasonable assurance that information required to be disclosed in this and other reports filed under the Exchange Act is recorded, processed, summarized and reported within the required time periods specified in the SEC’s rules and forms; and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures. It should be noted that no system of controls can provide complete assurance of achieving a company’s objectives and that future events may impact the effectiveness of a system of controls.

Our Chief Executive Officer and Chief Financial Officer, after conducting an evaluation, together with members of our management, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2018, have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were effective as of September 30, 2018 at a reasonable level of assurance.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



CWI 2 9/30/2018 10-Q 42
    


PART II — OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities.

Unregistered Sales of Equity Securities
 
During the three months ended September 30, 2018, we issued 234,643 shares of Class A common stock to our Advisor as consideration for asset management fees. These shares were issued at our most recently published NAV of $11.11 per share. Since none of these transactions were considered to have involved a “public offering” within the meaning of Section 4(a)(2) of the Securities Act, the shares issued were deemed to be exempt from registration. In acquiring our shares, our Advisor represented that such interests were being acquired by it for investment purposes and not with a view to the distribution thereof.

All prior sales of unregistered securities have been reported in our previously filed quarterly reports on Form 10-Q and annual reports on Form 10-K.

Issuer Purchases of Equity Securities

The following table provides information with respect to repurchases of our common stock during the three months ended September 30, 2018:
 
 
Class A
 
Class T
 
 
 
 
2018
 
Total number of shares purchased (a)
 
Average price paid per share
 
Total number of shares purchased (a)
 
Average price paid per share
 
Total number of shares purchased as part of publicly announced plans or programs
 
Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
July
 
775

 
$
10.57

 

 
$

 
N/A
 
N/A
August
 

 

 

 

 
N/A
 
N/A
September
 
85,726

 
10.58

 
252,299

 
10.55

 
N/A
 
N/A
Total
 
86,501

 
 
 
252,299

 
 
 
 
 
 
___________
(a)
Represents shares of our Class A and Class T common stock repurchased under our redemption plan, pursuant to which we may elect to redeem shares at the request of our stockholders who have held their shares for at least one year from the date of their issuance, subject to certain exceptions, conditions and limitations. The maximum amount of shares purchasable by us in any period depends on a number of factors and is at the discretion of our board of directors. We generally receive fees in connection with share redemptions. The average price paid per share will vary depending on the number of redemption requests that were made during the period, the number of redemption requests that qualify for special circumstances, and the most recently published NAVs.



CWI 2 9/30/2018 10-Q 43
    


Item 6. Exhibits.

The following exhibits are filed with this Report. Documents other than those designated as being filed herewith are incorporated herein by reference.
Exhibit No.

 
Description
 
Method of Filing
10.1

 
First Amendment to the Loan Agreement, between W. P. Carey, as Lender, as CWI 2 OP, LP, as Borrower, effective September 30, 2018
 
Filed herewith
 
 
 
 
 
31.1

 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Filed herewith
 
 
 
 
 
31.2

 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Filed herewith
 
 
 
 
 
32

 
Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
Filed herewith
 
 
 
 
 
101.INS

 
XBRL Instance Document
 
Filed herewith
 
 
 
 
 
101.SCH

 
XBRL Taxonomy Extension Schema Document
 
Filed herewith
 
 
 
 
 
101.CAL

 
XBRL Taxonomy Extension Calculation Linkbase Document
 
Filed herewith
 
 
 
 
 
101.DEF

 
XBRL Taxonomy Extension Definition Linkbase Document
 
Filed herewith
 
 
 
 
 
101.LAB

 
XBRL Taxonomy Extension Label Linkbase Document
 
Filed herewith
 
 
 
 
 
101.PRE

 
XBRL Taxonomy Extension Presentation Linkbase Document
 
Filed herewith




CWI 2 9/30/2018 10-Q 44
    


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.
 
 
 
Carey Watermark Investors 2 Incorporated
Date:
November 13, 2018
 
 
 
 
By:
/s/ Mallika Sinha
 
 
 
Mallika Sinha
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial Officer)
 
 
 
 
Date:
November 13, 2018
 
 
 
 
By:
/s/ Noah K. Carter
 
 
 
Noah K. Carter
 
 
 
Chief Accounting Officer
 
 
 
(Principal Accounting Officer)




CWI 2 9/30/2018 10-Q 45
    


EXHIBIT INDEX

The following exhibits are filed with this Report. Documents other than those designated as being filed herewith are incorporated herein by reference.
Exhibit No.

 
Description
 
Method of Filing
10.1

 
First Amendment to the Loan Agreement, between W. P. Carey, as Lender, as CWI 2 OP, LP, as Borrower, effective September 30, 2018
 
 
 
 
 
 
31.1

 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
31.2

 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
32

 
Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
101.INS

 
XBRL Instance Document
 
Filed herewith
 
 
 
 
 
101.SCH

 
XBRL Taxonomy Extension Schema Document
 
Filed herewith
 
 
 
 
 
101.CAL

 
XBRL Taxonomy Extension Calculation Linkbase Document
 
Filed herewith
 
 
 
 
 
101.DEF

 
XBRL Taxonomy Extension Definition Linkbase Document
 
Filed herewith
 
 
 
 
 
101.LAB

 
XBRL Taxonomy Extension Label Linkbase Document
 
Filed herewith
 
 
 
 
 
101.PRE

 
XBRL Taxonomy Extension Presentation Linkbase Document
 
Filed herewith





CWI 2 9/30/2018 10-Q 46