Apple Hospitality REIT Earnings 2019-06-30

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

Effective January 1, 2019, the Company adopted ASU No. 2016-02, Leases (Topic 842), as amended and, as a result, recorded finance ground lease assets for four of its ground leases, which are included in investment in real estate, net. See Note 9 for more information regarding the Company’s finance ground lease assets.

As of June 30, 2019, the Company owned 234 hotels with an aggregate of 30,046 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.

Hotel Acquisitions

The Company acquired two hotels during the six months ended June 30, 2019. The following table sets forth the location, brand, manager, date acquired, number of rooms and gross purchase price, excluding transaction costs, for each hotel. All dollar amounts are in thousands.

During the year ended December 31, 2018, the Company acquired five hotels including four hotels in the first six months of 2018. The following table sets forth the location, brand, manager, date acquired, number of rooms and gross purchase price, excluding transaction costs, for each hotel. All dollar amounts are in thousands.

The Company used borrowings under its 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 six months ended June 30, 2019, the amount of revenue and operating income included in the Company’s consolidated statement of operations from the date of acquisition through June 30, 2019 was approximately $3.4 million and $0.7 million, respectively. For the four hotels acquired during the six months ended June 30, 2018, the amount of revenue and operating income included in the Company’s consolidated statement of operations from the date of acquisition through June 30, 2018 was approximately $7.1 million and $2.1 million, respectively.

Hotel Purchase Contract Commitments

As of June 30, 2019, the Company had outstanding contracts for the potential purchase of five hotels for a total expected purchase price of approximately $159.2 million, which are under development and are planned to be completed and opened for business over the next 12 to 24 months from June 30, 2019, at which time closings on these hotels are expected to occur. Although the Company is working towards acquiring these hotels, there are many conditions to closing that have not yet been satisfied and there can be no assurance that closings on these hotels will occur under the outstanding purchase contracts. 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 June 30, 2019. All dollar amounts are in thousands.

The Company intends to use borrowings under its credit facilities available at closing to purchase the hotels under contract if a closing occurs.

In February 2019, the Company terminated its purchase and sale agreement with an unrelated party for the sale of 16 of its hotels and entered into two purchase and sale agreements with the same unrelated party for the sale of a total of nine hotels for a total combined gross sales price of $95.0 million.  On March 28, 2019, the Company completed the sale of the hotels, resulting in a gain of approximately $1.7 million, which is included in the Company’s consolidated statement of operations for the six months ended June 30, 2019. The nine hotels had a total carrying value of approximately $92.9 million at the time of the sale. The following table lists the nine hotels sold:

During the year ended December 31, 2018, the Company sold three hotels in two transactions with unrelated parties for a total combined gross sales price of approximately $15.8 million, resulting in a combined gain on sale of approximately $0.2 million, which is included in the Company’s consolidated statement of operations for the year ended December 31, 2018. Of the three hotels sold, two of the hotels, the Columbus, Georgia 89-room SpringHill Suites and 86-room TownePlace Suites (the “two Columbus hotels”), were sold on July 13, 2018 for a combined gross sales price of $10.0 million, resulting in no gain or loss on the sale, and one hotel, the 72-room Springdale, Arkansas Residence Inn, was sold on November 29, 2018 for a gross sales price of approximately $5.8 million, resulting in a gain of approximately $0.2 million. During the second quarter of 2018, the Company recognized impairment losses of approximately $3.1 million related to these three hotels, which is included in the Company’s consolidated statement of operations for the six months ended June 30, 2018, and consisted of approximately $0.5 million to adjust the bases of the two Columbus hotels that sold in July 2018 to their estimated fair values, which were based on the contracted sales prices, net of estimated selling costs, and approximately $2.6 million to adjust the basis of the Springdale, Arkansas Residence Inn that sold in November 2018 to its estimated fair value, which was based on the offers received at that time, net of estimated selling costs.

Excluding gain on sale of real estate, the Company’s consolidated statements of operations include operating income of approximately $1.1 million and $0.5 million for the six months ended June 30, 2019 and 2018, respectively, relating to the results of operations of the twelve hotels sold as noted above for the period of ownership. The sale of these properties does not represent a strategic shift that has, or will have, a major effect on the Company’s operations and financial results, and therefore the operating results for the period of ownership of these properties are included in income from continuing operations for the three and six months ended June 30, 2019 and 2018. The net proceeds from the sales were used to pay down borrowings on the Company’s revolving credit facility.

Summary

As of June 30, 2019 and December 31, 2018, the Company’s debt consisted of the following (in thousands):

The aggregate amounts of principal payable under the Company’s total debt obligations as of June 30, 2019 (including the revolving credit facility, term loans and mortgage debt), for the five years subsequent to June 30, 2019 and thereafter are as follows (in thousands):

The Company uses interest rate swaps to manage its interest rate risks on a portion of its 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 London Inter-Bank Offered Rate for a one-month term (“one-month LIBOR”).  The swaps are designed to effectively fix the interest payments on variable-rate debt instruments. See Note 5 for more information on the interest rate swap agreements. The Company’s total fixed-rate and variable-rate debt, after giving effect to its interest rate swaps in effect at June 30, 2019 and December 31, 2018, is set forth below. All dollar amounts are in thousands.

Credit Facilities

$850 Million Credit Facility

On July 27, 2018, the Company entered into an amendment and restatement of its then outstanding unsecured $965 million credit facility, which was repaid at closing, reducing the borrowing capacity to $850 million, reducing the annual interest rate and extending the maturity dates (the “$850 million credit facility”). The $850 million credit facility is comprised of (i) a $425 million revolving credit facility with an initial maturity date of July 27, 2022 and (ii) a $425 million term loan facility consisting of two term loans: a $200 million term loan with a maturity date of July 27, 2023, and a $225 million term loan with a maturity date of January 31, 2024, both funded at closing (the “$425 million term loan facility”).  At closing, the Company repaid the $425 million outstanding under the term loans of the $965 million credit facility with the proceeds from the $425 million term loan facility under the $850 million credit facility and borrowed approximately $196 million under the $425 million revolving credit facility to repay the outstanding balance of the extinguished revolving credit facility and to pay closing costs. Subject to certain conditions including covenant compliance and additional fees, the $425 million revolving credit facility maturity date may be extended up to one year. The Company may make voluntary prepayments in whole or in part, at any time.  Interest payments on the $850 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 plus a margin ranging from 1.35% to 2.25%, 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 0.25% on the unused portion of the $425 million revolving credit facility, based on the amount of borrowings outstanding during the quarter.

$225 Million Term Loan Facility

On August 2, 2018, the Company entered into an amendment and restatement of its then outstanding $150 million term loan facility, which was repaid at closing, increasing the borrowing capacity to $225 million, reducing the annual interest rate and extending the maturity dates (the “$225 million term loan facility”). The $225 million term loan facility is comprised of (i) a $50 million term loan with a maturity date of August 2, 2023, which was funded at closing, and (ii) a $175 million term loan with a maturity date of August 2, 2025, of which $100 million was funded at closing and the remaining $75 million was funded on January 29, 2019. At closing, the Company repaid the $150 million outstanding under the $150 million term loan facility with the proceeds from the $225 million term loan facility. The credit agreement contains requirements and covenants similar to the Company’s $850 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 $225 million term loan facility are due monthly and the interest rate, subject to certain exceptions, is equal to an annual rate of the one-month LIBOR plus a margin ranging from 1.35% to 2.50%, 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 $850 million credit facility and the $225 million term loan facility, the “credit facilities”). Although no material terms were changed, the credit agreement was amended and restated in August 2018 as a result of the refinancings noted above. The amended and restated credit agreement contains requirements and covenants similar to the Company’s $850 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. In July 2019, the Company entered into an amendment of the $85 million term loan to reduce the interest rate margin to 1.30% to 2.10% for the remainder of the term.

As of June 30, 2019 and December 31, 2018, the details of the Company’s credit facilities were as set forth below.  All dollar amounts are in thousands.

The credit agreements governing the credit facilities 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 and restrictions on certain investments.  The Company was in compliance with the applicable covenants at June 30, 2019.

Mortgage Debt

As of June 30, 2019, the Company had approximately $461.6 million in outstanding mortgage debt secured by 29 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 June 30, 2019 and December 31, 2018 for each of the Company’s mortgage debt obligations. All dollar amounts are in thousands.

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 June 30, 2019 and December 31, 2018, both the carrying value and estimated fair value of the Company’s debt were approximately $1.4 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, if in an asset position, are included in other assets, net, and, if in a liability position, are included in accounts payable and other liabilities 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 June 30, 2019 and December 31, 2018. 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 change in the fair value of the Company’s designated cash flow hedges is recorded to accumulated other comprehensive income (loss), a component of shareholders’ equity in the Company’s consolidated balance sheets. Amounts reported in accumulated other comprehensive income (loss) 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 $1.0 million of net unrealized gains included in accumulated other comprehensive income (loss) at June 30, 2019 will be reclassified as a decrease to interest and other expense, net within the next 12 months.

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 and six months ended June 30, 2019 and 2018 (in thousands):

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 2018 Form 10-K. Below is a summary of the significant related party relationships in effect during the six months ended June 30, 2019 and 2018.

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 allocated by the Company to ARG for the six months ended June 30, 2019 and 2018 totaled approximately $0.6 million and $0.5 million, respectively, 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 June 30, 2019 and December 31, 2018, total amounts due from ARG for reimbursements under the cost sharing structure totaled approximately $0.3 million and $0.4 million, respectively, 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, which leasing activity 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 six months ended June 30, 2019 and 2018 were approximately $0.05 million for each respective period, and are included in general and administrative expenses in the Company’s consolidated statements of operations.

Distributions 

The Company’s current annual distribution rate, payable monthly, is $1.20 per common share. For the three months ended June 30, 2019 and 2018, the Company paid distributions of $0.30 per common share for a total of $67.2 million and $69.1 million, respectively. For the six months ended June 30, 2019 and 2018, the Company paid distributions of $0.60 per common share for a total of $134.3 and $138.2 million, respectively. Additionally, in June 2019, the Company declared a monthly distribution of $0.10 per common share, totaling $22.4 million, which was recorded as a payable as of June 30, 2019 and paid in July 2019. As of December 31, 2018, a monthly distribution of $0.10 per common share, totaling $22.4 million, was recorded as a payable and paid in January 2019. These accrued distributions were included in accounts payable and other liabilities in the Company’s consolidated balance sheets.

Share Repurchases

In May 2019, the Company’s Board of Directors approved an extension of its existing share repurchase program (the “Share Repurchase Program”), authorizing share repurchases up to an aggregate of $360 million. The Share Repurchase Program may be suspended or terminated at any time by the Company and will end in July 2020 if not terminated earlier. The Company has a 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. During the first quarter of 2019 and 2018, the Company purchased, under its Share Repurchase Program, approximately 0.3 million of its common shares in each respective period, at a weighted-average market purchase price of approximately $14.93 and $16.89 per common share for an aggregate purchase price, including commissions, of approximately $4.1 million and $4.3 million, respectively. No shares were repurchased during the second quarter of 2019 and 2018. Repurchases under the Share Repurchase Program have been funded, and the Company intends to fund future repurchases, with availability under its credit facilities.

The Company annually establishes an incentive plan for its executive management.  Under the incentive plan for 2019 (the “2019 Incentive Plan”), participants are eligible to receive a bonus based on the achievement of certain 2019 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 operational performance metrics are equally weighted and account for 50% of the total target incentive compensation. The shareholder return metrics are weighted 75% for relative shareholder return metrics and 25% for total shareholder return metrics, and account for 50% of the total target incentive compensation.  At June 30, 2019, the range of potential aggregate payouts under the 2019 Incentive Plan was $0 - $18 million.  Based on performance through June 30, 2019, the Company has accrued approximately $4.7 million as a liability for potential executive bonus payments under the 2019 Incentive Plan, which is included in accounts payable and other liabilities in the Company’s consolidated balance sheet as of June 30, 2019. Compensation expense recognized by the Company under the 2019 Incentive Plan is included in general and administrative expenses in the Company’s consolidated statements of operations and totaled approximately $2.5 million and $4.7 million for the three and six months ended June 30, 2019, respectively. Approximately 25% of awards under the 2019 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 2019 and one-third of which will vest in December 2020. Under the incentive plan for 2018 (the “2018 Incentive Plan”), the Company recorded approximately $1.8 million and $3.7 million in general and administrative expenses in the Company’s consolidated statements of operations for the three and six months ended June 30, 2018, respectively. 

During the six months ended June 30, 2019, the Company incurred a one-time separation payment of $0.5 million in connection with the retirement of the Company’s Executive Vice President and Chief Legal Officer which, pursuant to the separation and general release agreement executed in March 2019, was paid in April 2019 and was included in general and administrative expenses in the Company’s consolidated statement of operations for the six months ended June 30, 2019.

Share-Based Compensation Awards

The following table sets forth information pertaining to the share-based compensation issued under the 2018 Incentive Plan and the incentive plan for 2017 (the “2017 Incentive Plan”).