Apple Hospitality REIT, Inc. - Quarter Report: 2018 March (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

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FORM 10-Q

 

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

For the quarterly period ended March 31, 2018

☐	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 001-37389

(Exact name of registrant as specified in its charter)

 

Virginia	26-1379210
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
814 East Main Street Richmond, Virginia	23219
(Address of principal executive offices)	(Zip Code)

 

(Registrant’s telephone number, including area code)

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

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

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 ☒	Accelerated filer   ☐
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)	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).    Yes  ☐    No  ☒

Number of registrant’s common shares outstanding as of May 1, 2018: 230,339,578 

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Apple Hospitality REIT, Inc.

Form 10-Q

Index

 

 

This Form 10-Q includes references to certain trademarks or service marks.  The Courtyard by Marriott®, Fairfield Inn by Marriott®, Fairfield Inn & Suites by Marriott®, Marriott® Hotels, Renaissance® Hotels, Residence Inn by Marriott®, SpringHill Suites by Marriott® and TownePlace Suites by Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates.  The Embassy Suites by Hilton®, Hampton by Hilton®, Hampton Inn & Suites by Hilton®, Hilton Garden Inn®, Home2 Suites by Hilton® and Homewood Suites by Hilton® trademarks are the property of Hilton Worldwide Holdings Inc. or one or more of its affiliates.  For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.

PART I.    FINANCIAL INFORMATION

 

Item 1.      Financial Statements

Apple Hospitality REIT, Inc.

Consolidated Balance Sheets

(in thousands, except share data)

 

See notes to consolidated financial statements.

 

Apple Hospitality REIT, Inc.

Consolidated Statements of Operations and Comprehensive Income

(Unaudited)

(in thousands, except per share data)

See notes to consolidated financial statements.

Apple Hospitality REIT, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

 

See notes to consolidated financial statements.

Apple Hospitality REIT, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

1.  Organization and Summary of Significant Accounting Policies

Organization

  

Apple Hospitality REIT, Inc., together with its wholly-owned subsidiaries (the “Company”), is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes.  The Company is a self-advised REIT that invests in income-producing real estate, primarily in the lodging sector, in the United States.  The Company’s fiscal year end is December 31.  The Company has no foreign operations or assets and its operating structure includes only one reportable segment.  The consolidated financial statements include the accounts of the Company and its subsidiaries.  All intercompany accounts and transactions have been eliminated.  Although the Company has interests in potential variable interest entities through its purchase commitments, it is not the primary beneficiary as the Company does not have any elements of power in the decision making process of these entities, and therefore does not consolidate the entities.  As of March 31, 2018, the Company owned 241 hotels with an aggregate of 30,585 rooms located in 34 states.  The Company’s common shares are listed on the New York Stock Exchange (“NYSE”) under the ticker symbol “APLE.”

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q.  Accordingly, they do not include all of the information required by United States generally accepted accounting principles (“GAAP”) for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”).  Operating results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2018.

Use of Estimates

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

Net Income Per Common Share

Basic net income per common share is computed based upon the weighted average number of shares outstanding during the period.  Diluted net income per common share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period.  Basic and diluted net income per common share were the same for each of the periods presented.

Accounting Standards Recently Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606).  The core principle of the new standard is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The standard became effective for annual and interim periods beginning after December 15, 2017.  The Company adopted this standard as of January 1, 2018 using the modified retrospective approach.  The Company evaluated each of its revenue streams under the new standard and concluded that the adoption of this standard did not impact the amount or timing of revenue recognition in the Company’s consolidated financial statements.  The Company also considered and determined that the following disaggregated revenue reflects the nature and timing of its significant revenue streams (in thousands).

 

		Three Months Ended March 31,
		2018				2017
Revenues:
Room		$	274,836			$	269,393
Food and beverage			15,710				16,733
Other			7,843				6,799
Total revenue		$	298,389			$	292,925

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash, which is intended to reduce diversity in practice in the classification and presentation of changes in restricted cash in the statement of cash flows.  The standard was effective for annual and interim periods beginning after December 15, 2017.  Under this standard, restricted cash and restricted cash equivalents are included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown in the statements of cash flows.  The Company adopted this standard as of January 1, 2018.  Amounts included in restricted cash on the Company’s consolidated balance sheets are now included with cash and cash equivalents in the Company’s consolidated statements of cash flows for all periods presented.  The adoption of this standard required retrospective revision to the statement of cash flows for the three months ended March 31, 2017.  Other than the reclassification of restricted cash balances and activity in the statements of cash flows, the adoption of the standard did not have an impact on the Company’s consolidated financial statements and related disclosures.

In February 2017, the FASB issued ASU No. 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20), Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets, which clarifies the scope of Accounting Standards Codification (“ASC”) Subtopic 610-20 and adds guidance for the derecognition of nonfinancial assets, including partial sales.  The provisions of this standard must be applied at the same time as the adoption of ASU No. 2014-09.  The Company adopted this standard as of January 1, 2018 using the modified retrospective approach.  The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and related disclosures.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities, which amends the hedge accounting model to enable entities to better portray their risk management activities in their financial statements and enhance the transparency and understandability of hedging activity.  The standard simplifies the application of hedge accounting and reduces the administrative burden of hedge documentation requirements and assessing hedge effectiveness.  The standard is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted.  The Company adopted this standard on January 1, 2018 using the modified retrospective approach.  The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and related disclosures.

2.  Investment in Real Estate

The Company’s investment in real estate consisted of the following (in thousands):

As of March 31, 2018, the Company owned 241 hotels with an aggregate of 30,585 rooms located in 34 states.

The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary (or a subsidiary thereof) under master hotel lease agreements.

Acquisitions

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(a)	The gross purchase price excludes transaction costs.

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(a)	The gross purchase price excludes transaction costs.

(b)	The Hilton Garden Inn and Home2 Suites hotels in Birmingham, AL are part of an adjoining two-hotel complex located on the same site.

The Company used borrowings under its $540 million revolving credit facility (the “revolving credit facility”) to purchase each of these hotels.  The acquisitions of these hotel properties were accounted for as an acquisition of a group of assets, with costs incurred to effect the acquisition, which were not significant, capitalized as part of the cost of the assets acquired.  For the two hotels acquired during the three months ended March 31, 2018, the amount of revenue and operating income included in the Company’s consolidated statement of operations from the date of acquisition through March 31, 2018 was approximately $2.4 million and $0.8 million, respectively.  For the hotel acquired during the three months ended March 31, 2017, the amount of revenue and operating income included in the Company’s consolidated statement of operations from the date of acquisition through March 31, 2017 was approximately $0.7 million and $0.04 million, respectively.

Hotel Contract Commitments

As of March 31, 2018, the Company had outstanding contracts for the potential purchase of two additional hotels, which were under construction, for a total purchase price of approximately $65.0 million.  The Phoenix Hampton Inn & Suites was acquired on May 2, 2018, the same day the hotel opened for business.  It is anticipated that the construction of the Orlando Home2 Suites will be completed and opened for business during the fourth quarter of 2018, at which time a closing on this hotel is expected to occur.  Although the Company is working towards acquiring this hotel, there are many conditions to closing that have not yet been satisfied and there can be no assurance that a closing on this hotel will occur under the outstanding purchase contract.  The following table summarizes the location, brand, date of purchase contract, expected number of rooms, refundable (if the seller does not meet its obligations under the contract) contract deposits paid, and gross purchase price for each of the contracts outstanding at March 31, 2018.  All dollar amounts are in thousands.

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(a)	Newly constructed hotel was acquired on May 2, 2018, the same day the hotel opened for business.

(b)

This hotel is currently under construction.  The table shows the expected number of rooms upon hotel completion and the expected franchise brand.  Assuming all conditions to closing are met, the purchase of this hotel is expected to close during the fourth quarter of 2018.  If the seller meets all of the conditions to closing, the Company is obligated to specifically perform under the contract.  As the property is under construction, at this time, the seller has not met all of the conditions to closing.

The purchase of the Phoenix Hampton Inn & Suites was funded through the Company’s revolving credit facility and it is anticipated that the purchase of the Orlando Home2 Suites will be funded similarly if a closing occurs.

Loss on Impairment of Depreciable Real Estate Assets

During the first quarter of 2017, the Company identified two properties for potential sale and in April 2017, the Company entered into separate contracts with the same unrelated party for the sale of these properties.  Due to the change in the anticipated hold period for each of these hotels, the Company reviewed the estimated undiscounted cash flows generated by each property and determined that, for each hotel, the undiscounted cash flows were less than its carrying value; therefore the Company recognized an impairment loss of approximately $7.9 million in the first quarter of 2017 to adjust the bases of these properties to their estimated fair values, which were based on the then contracted sale price, net of estimated selling costs, a Level 1 input under the fair value hierarchy.  In May 2017, both of these contracts were terminated.

3.  Debt

$965 Million Credit Facility

The Company utilizes an unsecured “$965 million credit facility” comprised of (i) a $540 million revolving credit facility with an initial maturity date of May 18, 2019 and (ii) a $425 million term loan facility with a maturity date of May 18, 2020, consisting of three term loans, all funded during 2015 (the “$425 million term loans”).  Subject to certain conditions including covenant compliance and additional fees, the revolving credit facility maturity date may be extended one year.  The Company may make voluntary prepayments in whole or in part, at any time.  Interest payments on the $965 million credit facility are due monthly and the interest rate, subject to certain exceptions, is equal to an annual rate of the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 1.50% to 2.30%, depending upon the Company’s leverage ratio, as calculated under the terms of the credit agreement.  The Company is also required to pay quarterly an unused facility fee at an annual rate of 0.20% or 0.30% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during the quarter.

$150 Million Term Loan Facility

 

On April 8, 2016, the Company entered into an unsecured $150 million term loan facility with a syndicate of commercial banks (the “$150 million term loan facility”), consisting of a $50 million term loan that will mature on April 8, 2021 (the “$50 million term loan”) and a $100 million term loan that will mature on April 8, 2023 (the “$100 million term loan,” and collectively with the $50 million term loan, the “$150 million term loans”).  The credit agreement contains requirements and covenants similar to the Company’s $965 million credit facility.  The Company may make voluntary prepayments in whole or in part, at any time, subject to certain conditions.  Interest payments on the $150 million term loan facility are due monthly and the interest rate is equal to an annual rate of the one-month LIBOR plus a margin ranging from 1.45% to 2.20% for the $50 million term loan and 1.80% to 2.60% for the $100 million term loan, depending upon the Company’s leverage ratio, as calculated under the terms of the credit agreement.  

$85 Million Term Loan

On July 25, 2017, the Company entered into an unsecured $85 million term loan with a syndicate of commercial banks, with a maturity date of July 25, 2024 (the “$85 million term loan” and, together with the $425 million term loans and the $150 million term loans, the “term loans”).  The credit agreement contains requirements and covenants similar to the Company’s $965 million credit facility.  The Company may make voluntary prepayments in whole or in part, at any time, subject to certain conditions.  Interest payments on the $85 million term loan are due monthly and the interest rate is equal to an annual rate of the one-month LIBOR plus a margin ranging from 1.80% to 2.60%, depending upon the Company’s leverage ratio, as calculated under the terms of the credit agreement.

As of March 31, 2018 and December 31, 2017, the details of the Company’s revolving credit facility and term loans were as set forth below.  All dollar amounts are in thousands.

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(1)	Unamortized debt issuance costs related to the revolving credit facility totaled approximately $1.3 million and $1.7 million as of March 31, 2018 and December 31, 2017, respectively, and are included in other assets, net in the Company’s consolidated balance sheets.

(2)	Annual variable interest rate at the balance sheet date.

(3)

Effective annual interest rate at the balance sheet date which includes the effect of interest rate swaps on $322.5 million of the outstanding loan balance, resulting in an annual fixed interest rate of approximately 3.10% on this portion of the debt, subject to adjustment based on the Company’s leverage ratio, through maturity.  See Note 4 for more information on the interest rate swap agreements.  Remaining portion is variable rate debt.

(4)	Annual fixed interest rate at the balance sheet date which includes the effect of interest rate swaps on the outstanding loan balance, subject to adjustment based on the Company’s leverage ratio, through maturity.  See Note 4 for more information on the interest rate swap agreements.

The credit agreements governing the $965 million credit facility, the $150 million term loan facility and the $85 million term loan contain mandatory prepayment requirements, customary affirmative covenants, negative covenants and events of default.  The credit agreements require that the Company comply with various covenants, which include, among others, a minimum tangible net worth, maximum debt limits, minimum interest and fixed charge coverage ratios, limits on dividend payments and share repurchases and restrictions on certain investments.  The Company was in compliance with the applicable covenants at March 31, 2018.

Mortgage Debt

As of March 31, 2018, the Company had approximately $498.5 million in outstanding mortgage debt secured by 31 properties, with maturity dates ranging from June 2020 to January 2038, stated interest rates ranging from 3.55% to 6.25% and effective interest rates ranging from 3.55% to 4.97%.  The loans generally provide for monthly payments of principal and interest on an amortized basis and defeasance or prepayment penalties if prepaid.  The following table sets forth the hotel properties securing each loan, the interest rate, loan assumption or origination date, maturity date, the principal amount assumed or originated, and the outstanding balance prior to any fair value adjustments or debt issuance costs as of March 31, 2018 and December 31, 2017 for each of the Company’s debt obligations.  All dollar amounts are in thousands.

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(1)	Interest rates are the rates per the loan agreement.  For loans assumed, the Company adjusted the interest rates per the loan agreement to market rates and is amortizing the adjustments to interest expense over the life of the loan.

(2)	Outstanding principal balance is callable by lender or prepayable by the Company on August 1, 2019.

The aggregate amounts of principal payable under the Company’s total debt obligations (including mortgage debt, the revolving credit facility and term loans), for the five years subsequent to March 31, 2018 and thereafter are as follows (in thousands):

4.  Fair Value of Financial Instruments

Except as described below, the carrying value of the Company’s financial instruments approximates fair value due to the short-term nature of these financial instruments.

Debt

The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of a debt obligation with similar credit terms and credit characteristics, which are Level 3 inputs under the fair value hierarchy.  Market rates take into consideration general market conditions and maturity.  As of March 31, 2018, both the carrying value and estimated fair value of the Company’s debt were approximately $1.3 billion.  As of December 31, 2017, both the carrying value and estimated fair value of the Company’s debt were approximately $1.2 billion.  Both the carrying value and estimated fair value of the Company’s debt (as discussed above) is net of unamortized debt issuance costs related to term loans and mortgage debt for each specific year.

Derivative Instruments

Currently, the Company uses interest rate swaps to manage its interest rate risks on variable rate debt.  Throughout the terms of these interest rate swaps, the Company pays a fixed rate of interest and receives a floating rate of interest equal to the one-month LIBOR.  The swaps are designed to effectively fix the interest payments on variable rate debt instruments.  These swap instruments are recorded at fair value and are included in other assets, net, in the Company’s consolidated balance sheets.  The fair values of the Company’s interest rate swap agreements are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts, which is considered a Level 2 measurement under the fair value hierarchy.  The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.  The following table sets forth information for each of the Company’s interest rate swap agreements outstanding as of March 31, 2018 and December 31, 2017.  All dollar amounts are in thousands.

The Company assesses, both at inception and on an ongoing basis, the effectiveness of its qualifying cash flow hedges.  The Company elected to early adopt ASU No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities, on January 1, 2018, using the modified retrospective approach for all of its hedging relationships that existed as of that date.  As a result, effective January 1, 2018, the entire change in the fair value of the Company’s designated cash flow hedges is recorded to accumulated other comprehensive income, a component of shareholders’ equity in the Company’s consolidated balance sheets.  Prior to January 1, 2018, changes in fair value on the effective portion of all designated cash flow hedges were recorded to accumulated other comprehensive income, while changes in fair value on the ineffective portion of all designated cash flow hedges were recorded to interest and other expense, net in the Company’s consolidated statements of operations.  Since prior to January 1, 2018 there was no material ineffectiveness related to the Company’s outstanding designated cash flow hedges, the adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

The following table presents the effect of derivative instruments in cash flow hedging relationships in the Company’s consolidated statements of operations and comprehensive income for the three months ended March 31, 2018 and 2017 (in thousands):

Amounts reported in accumulated other comprehensive income will be reclassified to interest and other expense, net as interest payments are made or received on the Company’s variable-rate derivatives.  The Company estimates that approximately $3.2 million of net unrealized gains included in accumulated other comprehensive income at March 31, 2018 will be reclassified as a decrease to interest and other expense, net within the next 12 months.

5.  Related Parties

The Company has, and is expected to continue to engage in, transactions with related parties.  These transactions cannot be construed to be at arm’s length and the results of the Company’s operations may be different if these transactions were conducted with non-related parties.  There have been no changes to the contracts and relationships discussed in the 2017 Form 10-K.  Below is a summary of the significant related party relationships in effect during the three months ended March 31, 2018 and 2017.

Glade M. Knight, Executive Chairman of the Company, owns Apple Realty Group, Inc. (“ARG”), which receives support services from the Company and reimburses the Company for the cost of these services as discussed below.  Mr. Knight is also currently a partner and Chief Executive Officer of Energy 11 GP, LLC and Energy Resources 12 GP, LLC, which are the respective general partners of Energy 11, L.P. and Energy Resources 12, L.P., each of which receive support services from ARG.

The Company provides support services, including the use of the Company’s employees and corporate office, to ARG and is reimbursed by ARG for the cost of these services.  The amounts reimbursed to the Company are based on the actual costs of the services and a good faith estimate of the proportionate amount of time incurred by the Company’s employees on behalf of ARG.  Total reimbursed costs received by the Company from ARG for the three months ended March 31, 2018 and 2017 totaled approximately $0.2 million in each period, and are recorded as a reduction to general and administrative expenses in the Company’s consolidated statements of operations. 

As part of the cost sharing arrangement, certain day-to-day transactions may result in amounts due to or from the Company and ARG.  To efficiently manage cash disbursements, the Company or ARG may make payments for the other company.  Under this cash management process, each company may advance or defer up to $1 million at any time.  Each quarter, any outstanding amounts are settled between the companies.  This process allows each company to minimize its cash on hand and reduces the cost for each company.  The amounts outstanding at any point in time are not significant to either of the companies.  As of March 31, 2018 and December 31, 2017, total amounts due from ARG for reimbursements under the cost sharing structure each totaled approximately $0.3 million at each date, and are included in other assets, net in the Company’s consolidated balance sheets.

The Company, through a wholly-owned subsidiary, Apple Air Holding, LLC, owns a Learjet used primarily for acquisition, asset management, renovation and public relations purposes.  The aircraft is also leased to affiliates of the Company based on third party rates.  Leasing activity to affiliates was not significant during the reporting periods.  The Company also utilizes aircraft, owned through two entities, one of which is owned by the Company’s Executive Chairman, and the other, by its President and Chief Executive Officer, for acquisition, asset management, renovation and public relations purposes, and reimburses these entities at third party rates.  Total costs incurred for the use of these aircraft during the three months ended March 31, 2018 and 2017 were approximately $0.03 million and $0.04 million, respectively, and are included in general and administrative expenses in the Company’s consolidated statements of operations.

6.  Shareholders’ Equity

Distributions

The Company’s current annual distribution rate, payable monthly, is $1.20 per common share.  For the three months ended March 31, 2018 and 2017, the Company paid distributions of $0.30 per common share for a total of $69.1 million and $66.9 million, respectively.  Additionally, in March 2018, the Company declared a monthly distribution of $0.10 per common share, totaling $23.0 million, which was recorded as a payable as of March 31, 2018 and paid in April 2018.  As of December 31, 2017, a monthly distribution of $0.10 per common share, totaling $23.0 million, was recorded as a payable and paid in January 2018.  These accrued distributions were included in accounts payable and other liabilities in the Company’s consolidated balance sheets.

Issuance of Shares

In February 2017, the Company executed an equity distribution agreement that allows the Company to sell, from time to time, up to an aggregate of $300 million of its common shares through sales agents under an at-the-market offering program (the “ATM Program”).  Since inception of the ATM Program in February 2017 through March 31, 2018, the Company has sold approximately 7.2 million common shares at a weighted-average market sales price of approximately $19.56 per common share and received aggregate gross proceeds of approximately $139.8 million before commission and issuance costs, including the sale of approximately 0.2 million common shares during the three months ended March 31, 2018 at a weighted-average market sales price of approximately $19.73 per common share and receipt of aggregate gross proceeds of approximately $4.8 million.  The Company used the proceeds from the sale of these shares to pay down borrowings on its revolving credit facility.  No shares were issued under the ATM Program during the three months ended March 31, 2017.  As of March 31, 2018, approximately $160.2 million remained available for issuance under the ATM Program.

Share Repurchases

During the first three months of 2018, the Company purchased, under its $475 million share repurchase program (the “Share Repurchase Program”), approximately 0.3 million of its common shares at a weighted-average market purchase price of approximately $16.89 per common share for an aggregate purchase price of approximately $4.3 million.  The Company did not purchase any common shares under its Share Repurchase Program during the first three months of 2017.  In March 2018, the Company established a new written trading plan as part of the Share Repurchase Program that provides for share repurchases in open market transactions that is intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended.  Repurchases under the Share Repurchase Program have been funded, and the Company intends to fund future repurchases, with availability under its revolving credit facility.  As of March 31, 2018, approximately $463.2 million remained available for repurchase under the Share Repurchase Program.  The Share Repurchase Program may be suspended or terminated at any time by the Company and will end in July 2018 if not terminated earlier.

7.  Compensation Plans

The Company annually establishes an incentive plan for its executive management.  Under the incentive plan for 2018 (the “2018 Incentive Plan”), participants are eligible to receive a bonus based on the achievement of certain 2018 performance measures, consisting of operational performance metrics (including targeted Modified Funds from Operations per share, Comparable Hotels revenue per available room growth and Adjusted Hotel EBITDA Margin growth) and shareholder return metrics (including shareholder return relative to a peer group and total shareholder return, over one-year, two-year and three-year periods).  The components of the operational performance metrics and shareholder return metrics are equally weighted and the two metrics each account for 50% of the total target incentive compensation.  The range of potential aggregate payouts under the 2018 Incentive Plan is $0 - $20 million.  Based on performance through March 31, 2018, the Company has accrued approximately $1.9 million as a liability for potential executive bonus payments under the 2018 Incentive Plan, which is included in accounts payable and other liabilities in the Company’s consolidated balance sheet as of March 31, 2018 and in general and administrative expenses in the Company’s consolidated statement of operations for the three months ended March 31, 2018.  Approximately 25% of awards under the 2018 Incentive Plan, if any, will be paid in cash, and 75% will be issued in stock under the Company’s 2014 Omnibus Incentive Plan, approximately two-thirds of which will vest at the end of 2018 and one-third of which will vest in December 2019.  Under the incentive plan for 2017 (the “2017 Incentive Plan”), the Company recorded approximately $2.0 million in general and administrative expenses in the Company’s consolidated statement of operations for the three months ended March 31, 2017. 

Share Based Compensation Awards

During the first quarters of 2018 and 2017, the Company issued 367,333 and 101,305 common shares earned under the 2017 Incentive Plan and the incentive plan for 2016 (the “2016 Incentive Plan”) (net of 48,533 and 19,667 common shares surrendered to satisfy tax withholding obligations) at $16.92 and $19.10 per share, or approximately $7.0 million and $2.3 million in share based compensation, including the surrendered shares, respectively.  Of the total shares issued under the 2017 Incentive Plan, 223,421 shares were unrestricted at the time of issuance, and the remaining 143,912 restricted shares will vest on December 14, 2018.  Of the total shares issued under the 2016 Incentive Plan, 60,028 shares were unrestricted at the time of issuance, and the remaining 41,277 restricted shares vested on December 15, 2017, of which 13,129 common shares were surrendered to satisfy tax withholding obligations.  Of the total 2017 share based compensation, approximately $5.8 million was recorded as a liability as of December 31, 2017, which was included in accounts payable and other liabilities in the Company’s consolidated balance sheet and the remaining $1.2 million, which is subject to vesting on December 14, 2018, will be recognized as compensation expense proportionately throughout 2018.  Of the total 2016 share based compensation, approximately $0.4 million, which vested on December 15, 2017, was recognized as compensation expense proportionately throughout 2017.  For the three months ended March 31, 2018 and 2017, the Company recognized approximately $0.3 million and $0.1 million, respectively, of share based compensation expense related to the unvested restricted share awards.

 

8.  Legal Proceedings

Moses, et al. v. Apple Hospitality REIT, Inc., et al.

As previously disclosed in the 2017 Form 10-K, on April 22, 2014, a purported shareholder of Apple REIT Seven, Inc. (“Apple Seven”) and Apple REIT Eight, Inc. (“Apple Eight”), filed a class action against the Company and several individual directors on behalf of all then-existing shareholders and former shareholders of Apple Seven and Apple Eight, who purchased additional shares under the Dividend Reinvestment Plans (“DRIP”) of Apple Seven, Apple Eight and the Company between July 17, 2007 and February 12, 2014 (the “2014 DRIP litigation”).  In January 2017, the parties reached an agreement in principle to settle the litigation which the court approved by order dated March 27, 2018.  In January 2018, the Company funded the settlement amount of $5.5 million, which was included in accounts payable and other liabilities in the Company’s consolidated balance sheet as of December 31, 2017, and in transaction and litigation costs (reimbursements) in the Company’s consolidated statement of operations for the year ended December 31, 2016.

Wilchfort, et al. v. Apple Hospitality REIT, Inc., et al.

As previously disclosed in the 2017 Form 10-K, on February 24, 2017, a purported shareholder of Apple REIT Six, Inc. (“Apple Six”), Apple Seven and Apple Eight, filed a class action against, among others, the Company and the former individual directors of Apple Six, Apple Seven and Apple Eight, including Mr. Glade Knight (“the Apple REIT Defendants”), on behalf of all then-existing shareholders and former shareholders of Apple Six, Apple Seven and Apple Eight, who purchased additional shares under Apple Six’s, Apple Seven’s and Apple Eight’s DRIP between July 17, 2007 and December 2012 (in the case of Apple Six shareholders) or June 30, 2013 (in the case of Apple Seven and Apple Eight shareholders).  On May 1, 2018, all of the Apple REIT Defendants were dismissed from the complaint without prejudice by the plaintiff.

9.  Subsequent Events

In April 2018, the Company paid approximately $23.0 million, or $0.10 per outstanding common share, in distributions to its common shareholders.

In April 2018, the Company declared a regular monthly cash distribution of $0.10 per common share for the month of May 2018.  The distribution is payable on May 15, 2018.

On May 2, 2018, the Company closed on the purchase of a newly constructed 210-room Hampton Inn & Suites in Phoenix, Arizona, the same day the hotel opened for business.  The gross purchase price was approximately $44.3 million.

 

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

Forward-Looking Statements

This Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements are typically identified by use of statements that include phrases such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential,” “outlook,” “strategy,” and similar expressions that convey the uncertainty of future events or outcomes.  Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.  Such factors include, but are not limited to, the ability of the Company to effectively acquire and dispose of properties; the ability of the Company to successfully integrate pending transactions and implement its operating strategy; changes in general political, economic and competitive conditions and specific market conditions; adverse changes in the real estate and real estate capital markets; financing risks; the outcome of current and future litigation, including any legal proceedings that have been or may be instituted against the Company or others; regulatory proceedings or inquiries; and changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a REIT.  Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Quarterly Report will prove to be accurate.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved.  In addition, the Company’s qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code.  Readers should carefully review the risk factors described in the Company’s filings with the Securities and Exchange Commission (“SEC”), including but not limited to those discussed in the section titled “Risk Factors” in the 2017 Form 10-K.  Any forward-looking statement that the Company makes speaks only as of the date of this Quarterly Report.  The Company undertakes no obligation to publicly update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.

The following discussion and analysis should be read in conjunction with the Company’s Unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Quarterly Report on Form 10-Q, as well as the information contained in the 2017 Form 10-K.

Overview

The Company is a Virginia corporation that has elected to be treated as a REIT for federal income tax purposes.  The Company is self-advised and invests in income-producing real estate, primarily in the lodging sector, in the United States.  As of March 31, 2018, the Company owned 241 hotels with an aggregate of 30,585 rooms located in urban, high-end suburban and developing markets throughout 34 states.  All of the Company’s hotels operate under Marriott or Hilton brands.  The hotels are operated and managed under separate management agreements with 23 hotel management companies, none of which are affiliated with the Company.  The Company’s common shares are listed on the NYSE under the ticker symbol “APLE.”

2018 Hotel Portfolio Activities

The Company continually monitors market conditions and attempts to maximize shareholder value by investing in properties that it believes provide superior value over the long term.  Consistent with this strategy and the Company’s focus on investing in select-service hotels, the Company acquired two hotels for an aggregate purchase price of approximately $63.0 million during the first three months of 2018: a 119-room Hampton Inn & Suites in Atlanta, Georgia and a 144-room Hampton Inn & Suites in Memphis, Tennessee.  On May 2, 2018, the same day the hotel opened for business, the Company acquired a 210-room Hampton Inn & Suites in Phoenix, Arizona for approximately $44.3 million.  As of May 2, 2018, the Company also had outstanding contracts for the potential purchase of three hotels that were under construction for a total purchase price of approximately $67.4 million, including  a 128-room Home2 Suites in Orlando, Florida which is planned to be completed and opened for business in the fourth quarter of 2018, and a combined 224-room dual-branded Hampton Inn & Suites and Home2 Suites by Hilton property in Cape Canaveral, Florida which is planned to be completed and opened for business in 2020.  The Company utilized its revolving credit facility to fund the completed acquisitions and plans to utilize the revolving credit facility for any additional acquisitions.

See Note 2 titled “Investment in Real Estate” and Note 9 titled “Subsequent Events” in the Company’s Unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Quarterly Report on Form 10-Q, for additional information concerning these transactions.

Hotel Operations

Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the Company’s hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned.  Over the past several years, the lodging industry and the Company have experienced modest revenue growth.  Moderate improvements in the general U.S. economy have been partially offset by increased supply in many markets.  With modest revenue growth, the Company has produced stable operating results during the first three months of 2018 on a comparable basis (as defined below) with expense increases generally offsetting revenue growth.  There is no way to predict future economic conditions, and there continue to be additional factors that could negatively affect the lodging industry and the Company, including but not limited to, increased hotel supply in certain markets, labor uncertainty both for the economy as a whole and the lodging industry in particular, global volatility and government fiscal policies.  The Company, on a comparable basis, and industry are forecasting a low single digit percentage increase in revenue for the full year of 2018 as compared to 2017.  The anticipated low growth is primarily due to inconsistent demand in certain markets and increased hotel supply meeting demand growth in others, limiting the Company’s ability to increase rates.

As of March 31, 2018, the Company owned 241 hotels with a total of 30,585 rooms as compared to 236 hotels with a total of 30,203 rooms as of March 31, 2017, however, results of operations are included only for the period of ownership for hotels acquired or disposed of during the current reporting period and prior year.  During the three months ended March 31, 2018, the Company acquired two existing hotels (both on February 5, 2018).  During 2017, the Company acquired three newly constructed hotels (one on February 2, 2017 and two on September 12, 2017) and three existing hotels (one on October 13, 2017, one on October 20, 2017 and one on December 1, 2017), and sold two hotels (one on April 20, 2017 and one on October 5, 2017).  As a result, the comparability of results for the three months ended March 31, 2018 and 2017 as discussed below is impacted by these transactions.

In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”) and revenue per available room (“RevPAR”), and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.

The following is a summary of the results from operations of the Company’s hotels for their respective periods of ownership by the Company.

 

The following table reflects certain operating statistics for the Company’s 241 hotels owned as of March 31, 2018 (“Comparable Hotels”).  The Company defines metrics from Comparable Hotels as results generated by the 241 hotels owned as of the end of the reporting period.  For the hotels acquired during the current reporting period and prior year, the Company has included, as applicable, results of those hotels for periods prior to the Company’s ownership using information provided by the properties’ prior owners at the time of acquisition and not adjusted by the Company.  This information has not been audited, either for the periods owned or prior to ownership by the Company.  For dispositions, results have been excluded for the Company’s period of ownership.

The following table reflects certain operating statistics for the Company’s 233 hotels owned by the Company as of January 1, 2017 and during the entirety of the reporting periods being compared (“Same Store Hotels”).  This information has not been audited.

As discussed above, hotel performance is impacted by many factors, including the economic conditions in the United States as well as each individual locality.  Economic indicators in the United States have generally been favorable, which has been partially offset by increased supply in many of the Company’s markets.  As a result, the Company’s revenue and operating results for its Comparable Hotels and Same Store Hotels experienced modest growth during the first quarter of 2018 as compared to 2017.  The Company expects continued modest improvement in both revenue and operating results for its Comparable Hotels in 2018 as compared to 2017.  The Company’s hotels in general have shown results consistent with industry and brand averages for the period of ownership.  During the first quarter of 2018, revenue growth from the leisure travel sector of the industry was estimated to be stronger than from the business travel sector as a result of the shift of the Easter holiday to March and April in 2018.  With a greater proportion of its revenue generated from business travel as compared to leisure travel, the Company’s growth was slightly below industry averages.

The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue.  For the three months ended March 31, 2018 and 2017, the Company had total revenue of $298.4 million and $292.9 million, respectively.  For the three months ended March 31, 2018 and 2017, respectively, Comparable Hotels achieved combined average occupancy of 74.6% and 74.5%, ADR of $134.43 and $133.25 and RevPAR of $100.23 and $99.31.  ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.

During the first quarter of 2018, the Company experienced a modest increase in ADR and stable occupancy, resulting in a 0.9% increase in RevPAR for Comparable Hotels compared to the first quarter of 2017.  Markets with above average growth in the first quarter of 2018 for the Company and industry included Fort Worth, Texas, Knoxville, Tennessee, Norfolk/Virginia Beach, Virginia and South Florida.  Markets that were below average for the Company and industry included Austin, Texas, Kansas City, Missouri, Omaha, Nebraska and Washington, D.C.   

Hotel operating expense consists of direct room operating expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees.  For the three months ended March 31, 2018 and 2017, respectively, hotel operating expense totaled $172.3 million and $168.5 million or 57.8% and 57.5% of total revenue for each respective period.  For the Company’s Comparable Hotels, hotel operating expense as a percentage of revenue increased approximately 50 basis points for the three months ended March 31, 2018 as compared to the same period in 2017.  Increases in labor costs as a percentage of revenue during the first quarter of 2018 as compared to the same period in 2017 was the primary cause of the increased hotel operating expense.  The Company anticipates continued increases in labor costs due to government regulations surrounding wages, healthcare and other benefits, other wage-related initiatives and lower unemployment rates.  Although operating expenses will increase as revenue increases, the Company will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.

Property taxes, insurance, and other expense for the three months ended March 31, 2018 and 2017 totaled $17.2 million and $16.9 million, respectively, or 5.8% of total revenue for each respective period, and for Comparable Hotels, 5.8% of total revenue for each respective period.  For the Company’s Comparable Hotels, real estate taxes increased slightly during the first three months of 2018 compared to the first three months of 2017, with tax increases at certain locations due to the reassessment of property values by localities related to the improved economy, partially offset by decreases at other locations due to successful appeals of tax assessments.  With the economy continuing to improve, the Company anticipates continued increases in property tax assessments during the remainder of 2018.  The Company will continue to appeal tax assessments in certain jurisdictions to attempt to minimize tax increases as warranted.  Additionally, due to increased losses in 2017 for property insurance carriers, the Company’s property insurance costs are anticipated to increase slightly as a percentage of revenue for the full year of 2018 as compared to 2017.

Ground lease expense for the three months ended March 31, 2018 and 2017 was $2.9 million and $2.8 million, respectively.  Ground lease expense primarily represents the expense incurred by the Company to lease land for 14 of its hotel properties.

General and administrative expense for the three months ended March 31, 2018 and 2017 was $6.9 million and $6.8 million, respectively, or 2.3% of total revenue for each respective period.  The principal components of general and administrative expense are payroll and related benefit costs, legal fees, accounting fees and reporting expenses.

The Company did not experience any loss on impairment of depreciable real estate assets for the three months ended March 31, 2018.  Loss on impairment of depreciable real estate assets was approximately $7.9 million for the three months ended March 31, 2017, and related to two properties that the Company identified for potential sale during the first quarter of 2017.  See Note 2 titled “Investment in Real Estate” in the Company’s Unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Quarterly Report on Form 10-Q, for additional information concerning this impairment loss.

Depreciation expense for the three months ended March 31, 2018 and 2017 was $44.8 million and $43.8 million, respectively.  Depreciation expense primarily represents expense of the Company’s hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment) for their respective periods owned.  The increase was primarily due to the increase in the number of properties owned as a result of the acquisition of two hotels in February 2018 and six hotels in 2017 and renovations completed throughout 2018 and 2017.

Interest and other expense, net for the three months ended March 31, 2018 and 2017 was $11.9 million and $11.7 million, respectively, and is net of approximately $0.5 million in each respective period, of interest capitalized associated with renovation projects.  Although average outstanding debt was less in the first quarter of 2018 as compared to the first quarter of 2017, interest expense increased slightly as a result of an increase in the Company’s effective interest rate during the first quarter of 2018 as compared to 2017, due to (a) the issuance of longer term fixed-rate debt subsequent to March 31, 2017, which was used to reduce the Company’s revolving credit facility, resulting in a higher average interest rate than the variable-rate borrowings repaid, and (b) an increase in interest rates on the Company’s variable-rate debt, with the one-month LIBOR increasing from 0.98% at March 31, 2017 to 1.88% at March 31, 2018.  While approximately 79% of the Company’s outstanding debt was effectively fixed rate at March 31, 2018, the Company does expect interest costs to continue to increase for the remainder of 2018 due to increased rates for its remaining variable rate debt.

Non-GAAP Financial Measures

The Company considers the following non-GAAP financial measures useful to investors as key supplemental measures of its operating performance: Funds from Operations (“FFO”), Modified FFO (“MFFO”), Earnings before Interest, Income Taxes, Depreciation and Amortization (“EBITDA”), and Adjusted EBITDA (“Adjusted EBITDA”).  These non-GAAP financial measures should be considered along with, but not as alternatives to, net income, cash flow from operations or any other operating GAAP measure.  FFO, MFFO, EBITDA and Adjusted EBITDA are not necessarily indicative of funds available to fund the Company’s cash needs, including its ability to make cash distributions.  Although FFO, MFFO, EBITDA and Adjusted EBITDA, as calculated by the Company, may not be comparable to FFO, MFFO, EBITDA and Adjusted EBITDA as reported by other companies that do not define such terms exactly as the Company defines such terms, the Company believes these supplemental measures are useful to investors when comparing the Company’s results between periods and with other REITs.

The Company calculates and presents FFO in accordance with standards established by the National Association of Real Estate Investment Trusts (“Nareit”), which defines FFO as net income (computed in accordance with GAAP), excluding gains or losses from sales of real estate, extraordinary items as defined by GAAP, and the cumulative effect of changes in accounting principles, plus real estate related depreciation, amortization and impairments, and adjustments for unconsolidated partnerships and joint ventures.  Historical cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes predictably over time.  Since real estate values instead have historically risen or fallen with market conditions, most real estate industry investors consider FFO to be helpful in evaluating a real estate company’s operations.  The Company further believes that by excluding the effects of these items, FFO is useful to investors in comparing its operating performance between periods and between REITs that report FFO using the Nareit definition.  FFO as presented by the Company is applicable only to its common shareholders, but does not represent an amount that accrues directly to common shareholders.

The Company further adjusts FFO for the exclusion of non-cash straight-line ground lease expense as this expense does not reflect the underlying performance of the related hotels.  The Company presents MFFO when evaluating its performance because it believes that it provides further useful supplemental information to investors regarding its ongoing operating performance.

The following table reconciles the Company’s GAAP net income to FFO and MFFO for the three months ended March 31, 2018 and 2017 (in thousands).

EBITDA is a commonly used measure of performance in many industries and is defined as net income excluding interest, income taxes, depreciation and amortization.  The Company believes EBITDA is useful to investors because it helps the Company and its investors evaluate the ongoing operating performance of the Company by removing the impact of its capital structure (primarily interest expense) and its asset base (primarily depreciation and amortization).  In addition, certain covenants included in the agreements governing the Company’s indebtedness use EBITDA, as defined in the specific credit agreement, as a measure of financial compliance.

The Company considers the exclusion of certain additional items from EBITDA useful, including: (i) the loss on impairment of depreciable real estate assets as this item does not represent ongoing operations and (ii) the exclusion of non-cash straight-line ground lease expense as this expense does not reflect the underlying performance of the related hotels.

The following table reconciles the Company’s GAAP net income to EBITDA and Adjusted EBITDA for the three months ended March 31, 2018 and 2017 (in thousands).

Hotels Owned

 

As of March 31, 2018, the Company owned 241 hotels with an aggregate of 30,585 rooms located in 34 states.  The following tables summarize the number of hotels and rooms by brand and by state:

 

The following table summarizes the location, brand, manager, date acquired or completed and number of rooms for each of the 241 hotels the Company owned as of March 31, 2018.