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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2020
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number:001-36190Commission File Number:001-36191


Extended Stay America, Inc.ESH Hospitality, Inc.
(Exact name of registrant as specified in its charter)(Exact name of registrant as specified in its charter)


DelawareDelaware
(State or other jurisdiction of
incorporation or organization)
(State or other jurisdiction of
incorporation or organization)
46-314031227-3559821
(I.R.S. Employer
Identification No.)
(I.R.S. Employer
Identification No.)
11525 N. Community House Road, Suite 10011525 N. Community House Road, Suite 100
CharlotteCharlotte
North CarolinaNorth Carolina
2827728277
(Address of principal executive offices, zip code)(Address of principal executive offices, zip code)

(980)
345-1600
(980)
345-1600
(Registrant’s telephone number, including area code)(Registrant’s telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Act:

Title of each classTrading Symbol(s)
Name of each exchange
on which registered
Common Stock, par value $0.01 per share, of Extended Stay America, Inc.STAYNasdaq Global Select Market
and Class B Common Stock, par value $0.01 per share, of ESH Hospitality, Inc., which are attached and trade together as Paired Shares





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. 
Extended Stay America, Inc.YesNo
ESH Hospitality, Inc.YesNo

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).
Extended Stay America, Inc.YesNo
ESH Hospitality, Inc.YesNo

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.
 
Extended Stay America, Inc.Large Accelerated FilerAccelerated filer
Non-accelerated filer
Smaller reporting 
company
Emerging growth company
ESH Hospitality, Inc.Large Accelerated FilerAccelerated filer
Non-accelerated filer
Smaller reporting 
company
Emerging growth company

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. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 
Extended Stay America, Inc.Yes    No  
ESH Hospitality, Inc.Yes  No
177,482,082 shares of common stock, par value $0.01 per share, of Extended Stay America, Inc., which are attached to and traded together with 177,482,082 shares of Class B common stock, par value $0.01 per share, of ESH Hospitality, Inc., and 250,493,583 shares of Class A common stock, par value $0.01 per share, of ESH Hospitality, Inc., were all outstanding as of May 1, 2020.




EXTENDED STAY AMERICA, INC.
ESH HOSPITALITY, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
 
 Page No.




ABOUT THIS COMBINED QUARTERLY REPORT
This combined quarterly report on Form 10-Q is filed by Extended Stay America, Inc., a Delaware corporation (the “Corporation”), and its controlled subsidiary, ESH Hospitality, Inc., a Delaware corporation (“ESH REIT”). Both the Corporation and ESH REIT have securities that have been registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are publicly traded and listed on The Nasdaq Global Select Market (“Nasdaq”) as Paired Shares, as defined herein. As further discussed herein, unless otherwise indicated or the context requires, the terms “Company,” “Extended Stay,” “Extended Stay America,” “we,” “our” and “us” refer to the Corporation, ESH REIT and their subsidiaries considered as a single enterprise.
As required by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation, due to the Corporation’s controlling financial interest in ESH REIT, the Corporation consolidates ESH REIT’s financial position, results of operations, comprehensive income and cash flows with those of the Corporation. The Corporation’s stand-alone financial condition and related information is discussed herein where applicable. In addition, with respect to other financial and non-financial disclosure items required by Form 10-Q, any material differences between the Corporation and ESH REIT are discussed herein.
This combined quarterly report on Form 10-Q presents the following sections or portions of sections separately for each of the Company, on a consolidated basis, and ESH REIT, where applicable:
 
Part I Item 1 – Unaudited Financial Statements
Part I Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Part I Item 3 – Quantitative and Qualitative Disclosures About Market Risk
Part I Item 4 – Controls and Procedures
This combined quarterly report also includes separate Exhibit 31 and 32 certifications for each of Extended Stay America, Inc. and ESH Hospitality, Inc. in order to establish that the Chief Executive Officer and the Chief Financial Officer of each registrant has made the requisite certifications and that Extended Stay America, Inc. and ESH Hospitality, Inc. are compliant with Rule 13a-15 or Rule 15d-15 of the Exchange Act and 18 U.S.C. §1350.
We believe combining the quarterly reports on Form 10-Q of the Corporation and ESH REIT into this single report results in the following benefits:
Enhances investors’ understanding of the Corporation and ESH REIT by enabling investors, whose ownership of Paired Shares, as defined herein, gives them an ownership interest in our hotel properties through ESH REIT and in the operation, management, development and franchising of hotels and other aspects of our business through the Corporation, to view the business as a whole;
Eliminates duplicative and potentially confusing disclosure and provides a more streamlined presentation, since a substantial amount of our disclosure applies to both registrants; and
Creates time and cost efficiencies through the preparation of one combined report instead of two separate reports.


1


CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This combined quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of the federal securities laws. All statements other than statements of historical facts included in this combined quarterly report on Form 10-Q may be forward-looking, including statements regarding, among other things, our ability to meet our debt service obligations, future capital expenditures (including future acquisitions and hotel renovation programs), our distribution policies, our development, growth and franchise opportunities, anticipated benefits or use of proceeds from dispositions, our plans, objectives, goals, beliefs, business strategies, business conditions, results of operations, financial position and business outlook, business trends and future events, as well as the COVID-19 pandemic, its effects on the foregoing, government actions taken in response to the COVID-19 pandemic and actions that we have or plan to take in response to the pandemic and such effects.
When used in this combined quarterly report on Form 10-Q, the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “will,” “look forward to” and variations of such words or similar expressions are intended to identify forward-looking statements. The forward-looking statements are not historical facts, and are based upon our current expectations, beliefs, estimates and projections, and various assumptions, many of which, by their nature, are inherently uncertain and beyond our control. Our expectations, beliefs, estimates and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs, estimates and projections will be achieved and actual results may differ materially from what is expressed in or indicated by the forward-looking statements.
As disclosed in our combined annual report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 26, 2020 (the “2019 Form 10-K”) and in other filings with the SEC, including this quarterly report on Form 10-Q, there are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this combined quarterly report on Form 10-Q. You should evaluate all forward-looking statements made in this combined quarterly report on Form 10-Q in the context of these risks and uncertainties.
We caution you that the risks, uncertainties and other factors referenced above and throughout this combined quarterly report on Form 10-Q may not contain all of the risks, uncertainties and other factors that may be important to you. In addition, we cannot assure you that we will realize the results, benefits or developments that we expect or anticipate or, even if substantially realized, that they will have the results or effect on us, our business or operations in the way expected. In particular, no assurance can be given that any of our ongoing, planned or expected strategic initiatives or objectives discussed herein or in other filings with the SEC will be initiated or completed on our expected timing or at all. Estimates and forward-looking statements speak only as of the date they were made and we undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances, except as required by law.
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PART I — FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements
EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2020 AND DECEMBER 31, 2019
(In thousands, except share and per share data)
(Unaudited)

March 31,
2020
December 31,
2019
ASSETS
PROPERTY AND EQUIPMENT - Net of accumulated depreciation of $1,414,471 and $1,373,950
$3,492,821  $3,493,549  
RESTRICTED CASH14,878  14,858  
CASH AND CASH EQUIVALENTS710,131  346,812  
INTANGIBLE ASSETS - Net of accumulated amortization of $13,774 and $13,133
33,551  34,183  
GOODWILL45,192  45,192  
ACCOUNTS RECEIVABLE - Net of allowance for doubtful accounts of $1,941 and $2,749
15,427  14,020  
DEFERRED TAX ASSETS19,585  16,157  
OTHER ASSETS61,420  65,825  
TOTAL ASSETS$4,393,005  $4,030,596  
LIABILITIES AND EQUITY
LIABILITIES:
Term loan facility payable - Net of unamortized deferred financing costs and debt discount
   of $10,584 and $10,993
$617,170  $618,338  
Senior notes payable - Net of unamortized deferred financing costs and debt discount
   of $34,233 and $35,702
2,015,767  2,014,298  
Revolving credit facilities399,765    
Mandatorily redeemable preferred stock - $0.01 par value, $1,000 redemption value,
  8.0%, 350,000,000 shares authorized, 7,130,000 shares issued and outstanding
7,130  7,130  
Finance lease liabilities3,707  3,379  
Accounts payable and accrued liabilities238,582  211,181  
Total liabilities3,282,121  2,854,326  
COMMITMENTS AND CONTINGENCIES (Note 12)
EQUITY:
Common stock - $0.01 par value, 3,500,000,000 shares authorized, 177,466,325 and
  179,483,397 shares issued and outstanding
1,775  1,795  
Additional paid in capital723,285  742,397  
Accumulated deficit(63,394) (48,283) 
Accumulated other comprehensive (loss) income(512) 383  
Total Extended Stay America, Inc. shareholders’ equity661,154  696,292  
Noncontrolling interests449,730  479,978  
Total equity1,110,884  1,176,270  
TOTAL LIABILITIES AND EQUITY$4,393,005  $4,030,596  
See accompanying notes to condensed consolidated financial statements.
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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
(In thousands, except per share data)
(Unaudited)

Three Months Ended
March 31,
 20202019
REVENUES:
Room revenues$254,464  $267,046  
Other hotel revenues6,768  5,303  
Franchise and management fees1,279  1,225  
262,511  273,574  
Other revenues from franchised and managed properties3,790  4,095  
Total revenues266,301  277,669  
OPERATING EXPENSES:
Hotel operating expenses145,295  137,291  
General and administrative expenses23,938  23,027  
Depreciation and amortization50,520  48,778  
219,753  209,096  
Other expenses from franchised and managed properties4,207  4,647  
Total operating expenses223,960  213,743  
OTHER INCOME2  27  
INCOME FROM OPERATIONS42,343  63,953  
OTHER NON-OPERATING EXPENSE (INCOME)703  (178) 
INTEREST EXPENSE, NET32,685  29,604  
INCOME BEFORE INCOME TAX EXPENSE8,955  34,527  
INCOME TAX EXPENSE1,110  6,123  
NET INCOME7,845  28,404  
NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS(3,291) (6,470) 
NET INCOME ATTRIBUTABLE TO EXTENDED STAY AMERICA, INC. COMMON SHAREHOLDERS$4,554  $21,934  
NET INCOME PER EXTENDED STAY AMERICA, INC. COMMON SHARE:
Basic$0.03  $0.12  
Diluted$0.03  $0.12  
WEIGHTED-AVERAGE EXTENDED STAY AMERICA, INC. COMMON SHARES OUTSTANDING:
Basic177,990  188,348  
Diluted178,171  188,576  
See accompanying notes to condensed consolidated financial statements.

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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
(In thousands)
(Unaudited)

Three Months Ended
March 31,
 20202019
NET INCOME$7,845  $28,404  
OTHER COMPREHENSIVE INCOME:
DERIVATIVE ADJUSTMENT:
INTEREST RATE CASH FLOW HEDGE LOSS, NET OF TAX
OF $(307) and $(248)
(1,747) (1,438) 
COMPREHENSIVE INCOME6,098  26,966  
COMPREHENSIVE INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS(2,439) (5,746) 
COMPREHENSIVE INCOME ATTRIBUTABLE TO EXTENDED STAY AMERICA, INC. COMMON SHAREHOLDERS$3,659  $21,220  
See accompanying notes to condensed consolidated financial statements.

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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
(In thousands, except per share data)
(Unaudited)

 Common StockAdditional
Paid in Capital
Retained EarningsAccumulated Other Comprehensive IncomeTotal Extended Stay America, Inc.
Shareholders’
Equity
Noncontrolling InterestsTotal
Equity
 SharesAmount
BALANCE - January 1, 2019188,219  $1,882  $749,219  $32,432  $2,488  $786,021  $524,618  $1,310,639  
Net income—  —  —  21,934  —  21,934  6,470  28,404  
Interest rate cash flow hedge loss, net of tax—  —  —  —  (714) (714) (724) (1,438) 
Corporation common distributions - $0.07 per common share
—  —  —  (13,250) —  (13,250) —  (13,250) 
ESH REIT common distributions - $0.15 per Class B common share
—  —  —  —  —  —  (28,398) (28,398) 
ESH REIT preferred distributions—  —  —  —  —  —  (4) (4) 
Adjustment to reflect changes in book value of noncontrolling interests—  —  475  —  —  475  (475) —  
Equity-based compensation184  2  441  —  —  443  255  698  
BALANCE - March 31, 2019188,403  $1,884  $750,135  $41,116  $1,774  $794,909  $501,742  $1,296,651  

 Common StockAdditional
Paid in Capital
Accumulated DeficitAccumulated Other Comprehensive (Loss) IncomeTotal Extended Stay America, Inc.
Shareholders’
Equity
Noncontrolling InterestsTotal
Equity
 SharesAmount
BALANCE - January 1, 2020179,483  $1,795  $742,397  $(48,283) $383  $696,292  $479,978  $1,176,270  
Net income—  —  —  4,554  —  4,554  3,291  7,845  
Interest rate cash flow hedge loss, net of tax—  —  —  —  (895) (895) (852) (1,747) 
Repurchase of Corporation common stock and ESH REIT Class B common stock (Paired Shares)(2,237) (22) —  (19,665) —  (19,687) (11,406) (31,093) 
Corporation common distributions - $0.09 per common share
—  —  (15,981) —  —  (15,981) —  (15,981) 
ESH REIT common distributions - $0.14 per Class B common share
—  —  —  —  —  —  (24,842) (24,842) 
ESH REIT preferred distributions—  —  —  —  —  —  (4) (4) 
Adjustment to reflect changes in book value of noncontrolling interests—  —  (3,319) —  —  (3,319) 3,319  —  
Equity-based compensation220  2  188  —  —  190  246  436  
BALANCE - March 31, 2020177,466  $1,775  $723,285  $(63,394) $(512) $661,154  $449,730  $1,110,884  
See accompanying notes to condensed consolidated financial statements.
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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
(In thousands)
(Unaudited)

Three Months Ended
March 31,
 20202019
OPERATING ACTIVITIES:
Net income$7,845  $28,404  
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization50,520  48,778  
Foreign currency transaction loss (gain)703  (178) 
Amortization of deferred financing costs and debt discount2,052  1,996  
Loss on disposal of property and equipment3,343  1,376  
Equity-based compensation1,126  2,109  
Deferred income tax benefit(3,122) (50) 
Changes in assets and liabilities:
Accounts receivable, net(1,407) (1,586) 
Other assets1,760  3,208  
Accounts payable and accrued liabilities29,465  17,982  
Net cash provided by operating activities92,285  102,039  
INVESTING ACTIVITIES:
Purchases of property and equipment(34,452) (45,197) 
Development in process payments(19,769) (7,982) 
Payment for intangible assets(358) (2,109) 
Proceeds from insurance and related recoveries956  156  
Net cash used in investing activities(53,623) (55,132) 
FINANCING ACTIVITIES:
Principal payments on term loan facility(1,577) (2,842) 
Proceeds from revolving credit facilities399,765    
Payments of deferred financing costs(17)   
Principal payments on finance leases(37) (29) 
Tax withholdings related to restricted stock unit settlements(815) (1,571) 
Repurchase of Corporation common stock and ESH REIT Class B common stock (Paired Shares)(31,093)   
Corporation common distributions(16,177) (13,334) 
ESH REIT common distributions(25,222) (28,562) 
Net cash provided by (used in) financing activities324,827  (46,338) 
CHANGES IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH DUE TO CHANGES IN FOREIGN CURRENCY EXCHANGE RATES(150) 31  
NET INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH363,339  600  
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - Beginning of period361,670  303,336  
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - End of period$725,009  $303,936  
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash payments for interest, excluding modification, prepayment and other penalties, net of capitalized interest of $859 and $313
$5,455  $12,028  
Cash (refunds) payments for income taxes, net of refunds of $18 and $0
$(18) $341  
Operating cash payments for finance leases$59  $61  
Operating cash payments for operating leases$714  $690  
NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital expenditures included in accounts payable and accrued liabilities$22,400  $24,555  
Additions to finance lease right-of-use assets and liabilities$364  $109  
Corporation common distributions included in accounts payable and accrued liabilities$238  $274  
ESH REIT common distributions included in accounts payable and accrued liabilities$387  $629  
See accompanying notes to condensed consolidated financial statements.
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EXTENDED STAY AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2020 AND DECEMBER 31, 2019 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2020 AND 2019
(Unaudited)

1. BUSINESS, ORGANIZATION AND BASIS OF CONSOLIDATION
Extended Stay America, Inc. (the “Corporation”) was incorporated in the state of Delaware on July 8, 2013. ESH Hospitality, Inc. (“ESH REIT”) was formed as a limited liability company in the state of Delaware on September 16, 2010 and was converted to a corporation on November 5, 2013. The Corporation owns, and is expected to continue to own, all of the issued and outstanding Class A common stock of ESH REIT, which, as of March 31, 2020, represents 59% of the outstanding common stock of ESH REIT. Due to its controlling interest in ESH REIT, the Corporation consolidates the financial position, results of operations, comprehensive income and cash flows of ESH REIT. The term, “the Company,” as used herein refers to the Corporation and its consolidated subsidiaries, including ESH REIT.
A “Paired Share” consists of one share of common stock, par value $0.01 per share, of the Corporation, that is attached to and trades as a single unit with one share of Class B common stock, par value $0.01 per share, of ESH REIT. Each outstanding share of Corporation common stock is attached to and trades with one share of ESH REIT Class B common stock.
The Company is an integrated owner/operator of Extended Stay America-branded hotels and is also engaged in franchising and managing extended stay hotels for third parties in the U.S. As of March 31, 2020 and December 31, 2019, the Company owned and operated 558 and 557 hotel properties, respectively, in 40 U.S. states, consisting of approximately 62,100 and 61,900 rooms, respectively, and franchised or managed 74 and 73 hotel properties for third parties, respectively, consisting of approximately 7,600 and 7,500 rooms, respectively. As of March 31, 2020, all 632 system-wide hotels were operated under the Extended Stay America brand.
Owned hotel properties are owned by subsidiaries of ESH REIT and are operated by subsidiaries of the Corporation (the “Operating Lessees”) pursuant to leases between ESH REIT and the Operating Lessees. The hotels are managed by ESA Management LLC (“ESA Management”), a subsidiary of the Corporation, which also manages 25 hotels on behalf of third parties. The Extended Stay America brand is owned by ESH Hospitality Strategies LLC (“ESH Strategies”), also a subsidiary of the Corporation. ESH Strategies licenses the brand and intellectual property to its subsidiaries, which license them to the Operating Lessees and third parties.
As of March 31, 2020 and December 31, 2019, the Corporation had 177.5 million shares and 179.5 million shares of common stock outstanding, respectively. As of March 31, 2020 and December 31, 2019, ESH REIT’s common equity consisted of the following: (i) 250.5 million shares of Class A common stock outstanding (59% and 58%, respectively, of its common equity), all of which were owned by the Corporation, and (ii) 177.5 million shares and 179.5 million shares of Class B common stock outstanding, respectively (41% and 42%, respectively, of its common equity).
Paired Share Repurchase Program—In December 2015, the Boards of Directors of the Corporation and ESH REIT authorized a combined Paired Share repurchase program. As a result of several increases in authorized amounts and program extensions, the combined Paired Share repurchase program currently authorizes the Corporation and ESH REIT to purchase up to $550 million in Paired Shares through December 31, 2020. Repurchases may be made at management’s discretion from time to time in the open market, in privately negotiated transactions or by other means (including through Rule 10b5-1 trading plans). As of March 31, 2020, the Corporation and ESH REIT had repurchased and retired 28.6 million Paired Shares for $283.0 million and $166.4 million, including transaction fees, respectively, and $101.1 million remained available under the combined Paired Share repurchase program.
Basis of Consolidation
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”) and include the financial position, results of operations, comprehensive income, changes in equity and cash flows of the Corporation and its consolidated subsidiaries, including ESH REIT. Third-party equity interests in consolidated subsidiaries are presented as noncontrolling interests. Despite the fact that each share of Corporation common stock is paired on a one-for-one basis with each share of ESH REIT Class B common stock, the Corporation does not own ESH REIT Class B common stock; therefore, ESH REIT Class B common stock represents a
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third-party equity interest. As such, the rights associated with ESH REIT Class B common stock, along with other third-party equity interests in ESH REIT, are presented as noncontrolling interests in the accompanying condensed consolidated financial statements. Changes in ownership interests in a consolidated subsidiary that do not result in a loss of control are accounted for as equity transactions. All intercompany accounts and transactions have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Interim Presentation—Certain information and footnote disclosures normally included in financial statements presented in accordance with U.S. GAAP have been condensed or omitted in the accompanying condensed consolidated financial statements. The Company believes the disclosures made are adequate to prevent the information presented from being misleading. However, the condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2019 included in the combined annual report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 26, 2020.
The accompanying condensed consolidated financial statements reflect all adjustments (consisting only of normal and recurring items) necessary to present fairly the Company’s financial position as of March 31, 2020 and the results of the Company’s operations, comprehensive income, changes in equity and cash flows for the three months ended March 31, 2020 and 2019. Interim results are not necessarily indicative of full year performance because of the impact of seasonal, short-term or other market variations, as well as the impact of acquisitions, dispositions, hotel renovations and financing or other capital transactions.
Use of Estimates—The preparation of the accompanying condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and amounts of revenues and expenses during the reporting period. Management used significant estimates to determine the estimated useful lives of tangible assets, as well as in the assessment of tangible and intangible assets for impairment, estimated liabilities for insurance reserves and income taxes. Actual results could differ from those estimates.
Property and Equipment—Property and equipment additions are recorded at cost. Major improvements that extend the life or utility of property or equipment are capitalized and depreciated over a period equal to the shorter of the estimated useful life of the improvement or the remaining estimated useful life of the asset. Ordinary repairs and maintenance are charged to expense as incurred. Depreciation and amortization are recorded on a straight-line basis over estimated useful lives which range from 2 to 49 years.
Management assesses long-lived assets for potential impairment quarterly, as well as when events or changes in circumstances indicate the carrying amount of an asset or group of assets may not be recoverable. The identification of events or changes in circumstances that indicate the carrying value of assets may not be recoverable requires judgment. The Company reviews for impairment indicators at the lowest level of identifiable cash flows based on quantitative, qualitative and certain industry-related factors. Quantitative factors include, but are not limited to, hotel property EBITDA, EBITDA margins and EBITDA multiples, and serve to screen assets with historical, current or projected operating cash flow losses or deterioration. Qualitative factors include a change in physical condition, economic environment, regulatory environment or primary use, including the evaluation of the asset for disposition.
Recoverability of property and equipment is measured by a comparison of the carrying amount of a hotel property or group of hotel properties to the estimated future undiscounted cash flows expected to be generated by the hotel property or group of hotel properties. Impairment is recognized when estimated future undiscounted cash flows, including expected proceeds from disposition, are less than the carrying value of the hotel property or group of hotel properties. To the extent that a hotel property or group of hotel properties is impaired, the excess carrying amount over estimated fair value is recognized as an impairment charge. Fair value is determined based upon the discounted cash flows of the hotel property or group of hotel properties, bids, quoted market prices or independent appraisals, as considered necessary.
The estimation and evaluation of future cash flows, in particular the holding period for real estate assets and asset composition and/or concentration within real estate portfolios, relies on judgments and assumptions regarding holding period, current and future operating performance and current and future market conditions. It is possible that such judgments and/or estimates will change; in particular, the effects of the COVID-19 pandemic could cause economic and market conditions to continue to deteriorate, and if this occurs, or if the Company's expected holding period for real estate assets changes, the Company may recognize impairment charges or losses on sale in future periods reflecting either changes in estimate, circumstance or the estimated market value of assets. Based on market conditions and the Company's plans with respect to its hotel properties as of March 31, 2020, the Company believes that the carrying amounts of the hotel properties are recoverable
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and no impairment charges were recorded during the three months ended March 31, 2020. However, actual results are subject to a high degree of uncertainty due to the volatility of macroeconomic trends and the evolving nature of the COVID-19 pandemic.
Intangible Assets and Goodwill—Intangible assets include trademarks, corporate customer relationships and licenses related to certain internal-use software. Corporate customer relationships and software licenses are amortized using the straight-line method over their estimated useful lives; the estimated useful life of customer relationships is 20 years, and the estimated useful life of software licenses is the remaining non-cancellable term of each respective contract. Trademarks are not amortized. Goodwill represents the purchase price in excess of the fair value of net assets acquired in conjunction with the acquisition of the Company's predecessor in 2010.
Definite-lived intangible assets are reviewed for impairment quarterly and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Indefinite-lived intangible assets, including goodwill, are reviewed for impairment quarterly, and the Company tests for impairment more frequently if events or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company has two reportable operating segments, owned hotels and franchise and management. There is no goodwill associated with our franchise and management segment. Management analyzes goodwill associated with all owned hotels when analyzing for potential impairment. The Company first assesses qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount.
As of March 31, 2020, the Company believes that the carrying amount of its intangible assets, including goodwill, are recoverable and there are no changes in circumstances that would more likely than not reduce the fair value of its reporting units below their carrying amount; therefore, no impairment charges were recorded during the three months ended March 31, 2020. However, if the effects of the COVID-19 pandemic cause economic and market conditions to continue to deteriorate, in particular if the market price of the Company's Paired Shares further declines, these events could result in impairment charges in the future. Actual results are subject to a high degree of uncertainty due to the volatility of macroeconomic trends and the evolving nature of the COVID-19 pandemic.
Revenue from Owned and Operated HotelsRevenue generated from owned and operated hotels consists of room and other hotel revenues recognized when services are provided. When a reservation is made, the Company deems that the parties have approved a contract in accordance with customary business practices and are committed to perform their respective obligations. At such time, each party’s rights regarding the services to be transferred are identified, payment terms are specified, the contract has commercial substance and, in most instances, it is probable the Company will collect substantially all consideration to which it will be entitled in exchange for services.
Each room night consumed by a guest with a cancellable reservation represents a contract whereby the Company has a performance obligation to provide the room night at an agreed upon price. For cancellable reservations, the Company recognizes revenue as each performance obligation (i.e., each room night) is met. Such contract is renewed if the guest continues their stay. For room nights consumed by a guest with a non-cancellable reservation, the entire reservation period represents the contract term whereby the Company has a performance obligation to provide the room night or nights at an agreed upon price. For non-cancellable reservations, the Company recognizes revenue over the term of the performance period (i.e., the reservation period) as room nights are consumed. For these reservations, the room rate is typically fixed over the reservation period. The Company uses an output method based on performance completed to date (i.e., room nights consumed) to determine the amount of revenue it recognizes on a daily basis if the length of a non-cancellable reservation exceeds one night since consumption of room nights indicates when services are transferred to the guest. In certain instances, variable consideration may exist with respect to the transaction price, such as discounts, coupons and price concessions made upon guest checkout.
In evaluating its performance obligation, the Company bundles the obligation to provide the guest the room itself with other obligations (such as free WiFi, grab and go breakfast, access to on-site laundry facilities and parking), as the other obligations are not distinct and separable because the guest cannot benefit from the additional amenities without the consumed room night. The Company’s obligation to provide the additional items or services is not separately identifiable from the fundamental contractual obligation (i.e., providing the room and its contents). The Company has no performance obligations once a guest’s stay is complete.
Certain revenues are generated through third-party intermediaries or distribution channels (i.e., online travel agents). Regardless of the basis on which the Company is compensated (i.e., gross or net), the Company is responsible for fulfilling the promise to provide the hotel room and related services to the guest and retains inventory risk. Since the Company controls the inventory and services provided and because third-party intermediaries are typically not contractually required to guarantee room night consumption, the Company is the principal in these transactions. As such, the Company is required to record
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revenue at an amount equal to the price charged to the guest (i.e., on a gross basis). Third-party intermediaries that pay the Company directly (i.e., on a net basis) typically charge the guest additional fees, blend the room offering with other offerings at amounts which are not allocable and may adjust the price without the Company’s approval. As such, the Company is unable to calculate the room rate charged to the guest. Since any estimate the Company would make has significant uncertainty that ultimately would not be resolved, despite its role as principal, in these instances the Company records revenue equal to the amount paid by the third-party intermediaries (i.e., the net amount).
Revenue from Franchise and Management FeesRevenue generated from franchise and management fees consists of the following:
Franchise fees, which consist of an initial fee and an ongoing royalty fee based on a percentage of a hotel’s monthly revenue in exchange for the access to and use of the Company’s brand name and other intellectual property. Initial fees are deferred and recognized over the expected contract or customer life. Royalty fees are recognized over time as franchisees derive value from the license to use the intellectual property.
Management fees, which consist of an ongoing base fee calculated as a percentage of a hotel’s monthly revenue in exchange for on-site hotel management services. Management fees are recognized over time as third-party hotel owners derive value from on-site personnel and related services.
Other revenues from franchised and managed properties, which include the reimbursement of costs incurred on behalf of third-party hotel owners on a direct and an indirect basis, as follows:
Direct costs incurred with respect to management and franchise agreements include on-site hotel personnel and incremental reservation and distribution costs for which the Company is reimbursed on a dollar-for-dollar basis. Since the Company employs the hotel personnel and has discretion over reservation and distribution costs, it is the principal with respect to these services and revenue is recognized on a gross basis.
Indirect costs incurred with respect to franchise agreements include costs associated with certain shared system-wide platforms (i.e., system services), such as marketing, technology infrastructure, central reservations, national sales and revenue management systems. The Company is reimbursed for indirect costs through a system service fee, or program fee, based on a percentage of a hotel’s monthly revenue. System service fees are recognized over time as franchisees derive value from the license to use these processes and systems. The Company has discretion over how it spends system service fees and is the principal with respect to these services. Revenue is recognized on a gross basis; expense is recognized as incurred. Over time, the Company manages system services to break-even, but the timing of system service fee revenues will typically not align with expenses incurred to operate the programs.
The promise to provide access to the Company’s intellectual property is combined with the promise to provide system services to form a single performance obligation since the promises generally accompany one another. Hotel management services form a single performance obligation. As noted above, each identified performance obligation is considered to be a series of services transferred over time. Revenue is recognized on an output method based on performance completed to date. The Company recognizes revenue in the amount to which it has a right to bill third parties under their respective franchise or management agreements, as it has a right to consideration in an amount that corresponds directly with the third parties’ hotel revenues. Franchise, management and system service fees are characterized as variable consideration and vary from period to period. In the event that fees include variables that extend beyond the current period, the Company uses the most likely amount method to determine the amount of revenue to record based on a reasonable revenue forecast for the applicable hotel. In most instances, the Company does not have constraining estimates, as third-party hotel revenues are typically available and obtained monthly.
Recently Issued Accounting Standards
Reference Rate Reform—In March 2020, the FASB issued an accounting standards update that provides optional expedients and exceptions for applying U.S. GAAP to contract modifications and hedging relationships that reference LIBOR, subject to meeting certain criteria. The Company adopted this update on March 12, 2020, and the update is effective through December 31, 2022, during which time the Company may elect to apply the optional expedients and exceptions offered under the standard. The Company's variable rate debt and interest rate swap are tied to rates that reference LIBOR (see Notes 7 and 8). As of March 31, 2020, the Company had not applied any of these optional expedients or exceptions. The adoption of this update did not, and is not expected to, have a material effect on the Company's condensed consolidated financial statements.
Income Taxes—In December 2019, the FASB issued an accounting standards update which simplifies the accounting for income taxes. The update amends several topics including interim period accounting for enacted changes in tax law and year-
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