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Section 1: 10-Q (FORM 10-Q)

aple20180630_10q.htm

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 June 30, 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

 

APPLE HOSPITALITY REIT, INC.

(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)

 

(804) 344-8121

(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 August 1, 2018: 230,347,462

 

 

Index

 

Apple Hospitality REIT, Inc.

Form 10-Q

Index

 

 

Page Number

PART I.  FINANCIAL INFORMATION

   
     
 

Item 1.

Financial Statements (Unaudited)

   
         
   

Consolidated Balance Sheets – June 30, 2018 and December 31, 2017 

3

 
         
   

Consolidated Statements of Operations and Comprehensive Income – Three and six months ended June 30, 2018 and 2017

4

 
         
   

Consolidated Statements of Cash Flows - Six months ended June 30, 2018 and 2017

5

 
         
   

Notes to Consolidated Financial Statements

6

 
         
 

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

19

 
         
 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

35

 
         
 

Item 4.

Controls and Procedures

35

 
         

PART II.  OTHER INFORMATION 

   
     

 

Item 1.

Legal Proceedings

36

 
         
  Item 1A. Risk Factors 36  
         
 

Item 6.

Exhibits

36

 
         

Signatures

37

 

 

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® Hotels & Resorts, 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. The Hyatt House® and Hyatt Place® trademarks are the property of Hyatt Hotels Corporation 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.

 

 

Index

 

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

Apple Hospitality REIT, Inc.

Consolidated Balance Sheets

(in thousands, except share data)

 

   

June 30,

   

December 31,

 
   

2018

   

2017

 
   

(unaudited)

         

Assets

               

Investment in real estate, net of accumulated depreciation

of $818,794 and $731,284, respectively

  $ 4,858,216     $ 4,793,159  

Assets held for sale

    9,800       -  

Restricted cash-furniture, fixtures and other escrows

    32,279       29,791  

Due from third party managers, net

    61,660       31,457  

Other assets, net

    56,929       47,931  

Total Assets

  $ 5,018,884     $ 4,902,338  
                 

Liabilities

               

Revolving credit facility

  $ 218,400     $ 106,900  

Term loans

    656,860       656,279  

Mortgage debt

    496,916       459,017  

Accounts payable and other liabilities

    89,471       109,057  

Total Liabilities

    1,461,647       1,331,253  
                 

Shareholders' Equity

               

Preferred stock, authorized 30,000,000 shares; none issued

and outstanding

    -       -  

Common stock, no par value, authorized 800,000,000 shares;

issued and outstanding 230,347,462 and 229,961,548 shares, respectively

    4,594,700       4,588,188  

Accumulated other comprehensive income

    17,810       9,778  

Distributions greater than net income

    (1,055,273 )     (1,026,881 )

Total Shareholders' Equity

    3,557,237       3,571,085  
                 

Total Liabilities and Shareholders' Equity

  $ 5,018,884     $ 4,902,338  

 

See notes to consolidated financial statements.

 

3

Index

 

 

Apple Hospitality REIT, Inc.

Consolidated Statements of Operations and Comprehensive Income

(Unaudited)

(in thousands, except per share data)

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2018

   

2017

   

2018

   

2017

 

Revenues:

                               

    Room

  $ 319,022     $ 306,283     $ 593,858     $ 575,676  

    Food and beverage

    16,518       17,932       32,228       34,665  

    Other

    9,174       7,489       17,017       14,288  

Total revenue

    344,714       331,704       643,103       624,629  
                                 

Expenses:

                               

    Operating

    81,242       80,345       157,196       155,499  

    Hotel administrative

    26,558       25,217       51,660       50,053  

    Sales and marketing

    28,168       26,270       53,500       50,379  

    Utilities

    10,247       10,193       20,530       19,946  

    Repair and maintenance

    13,476       12,279       25,929       24,195  

    Franchise fees

    14,781       14,163       27,514       26,637  

    Management fees

    12,059       11,545       22,531       21,757  

    Property taxes, insurance and other

    18,681       17,821       35,910       34,748  

    Ground lease

    2,912       2,839       5,762       5,655  

    General and administrative

    6,721       6,151       13,598       12,905  

    Transaction and litigation costs (reimbursements)

    -       (2,586 )     -       (2,586 )

    Loss on impairment of depreciable real estate assets

    3,135       -       3,135       7,875  

    Depreciation

    45,743       43,893       90,583       87,660  

Total expenses

    263,723       248,130       507,848       494,723  
                                 

Operating income

    80,991       83,574       135,255       129,906  
                                 

    Interest and other expense, net

    (13,210 )     (11,849 )     (25,129 )     (23,566 )

    Gain on sale of real estate

    -       16,140       -       16,140  
                                 

Income before income taxes

    67,781       87,865       110,126       122,480  
                                 

    Income tax expense

    (151 )     (259 )     (314 )     (509 )
                                 

Net income

  $ 67,630     $ 87,606     $ 109,812     $ 121,971  
                                 

Other comprehensive income (loss):

                               

    Interest rate derivatives

    1,740       (1,175 )     8,032       370  
                                 

Comprehensive income

  $ 69,370     $ 86,431     $ 117,844     $ 122,341  
                                 

Basic and diluted net income per common share

  $ 0.29     $ 0.39     $ 0.48     $ 0.55  
                                 

Weighted average common shares outstanding - basic and diluted

    230,342       223,052       230,428       223,049  

 

See notes to consolidated financial statements.

 

4

Index

 

Apple Hospitality REIT, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

   

Six Months Ended

 
   

June 30,

 
   

2018

   

2017

 

Cash flows from operating activities:

               

Net income

  $ 109,812     $ 121,971  

Adjustments to reconcile net income to cash provided by operating activities:

               

Depreciation

    90,583       87,660  

Loss on impairment of depreciable real estate assets

    3,135       7,875  

Gain on sale of real estate

    -       (16,140 )

Other non-cash expenses, net

    3,993       3,617  

Changes in operating assets and liabilities:

               

Increase in due from third party managers, net

    (30,542 )     (26,206 )

Decrease (increase) in other assets, net

    (3,703 )     7,058  

Decrease in accounts payable and other liabilities

    (6,910 )     (30,897 )

Net cash provided by operating activities

    166,368       154,938  
                 

Cash flows from investing activities:

               

Acquisition of hotel properties, net

    (135,164 )     (18,131 )

Deposits and other disbursements for potential acquisitions

    (362 )     -  

Capital improvements

    (39,079 )     (28,866 )

Net proceeds from sale of real estate

    -       28,531  

Net cash used in investing activities

    (174,605 )     (18,466 )
                 

Cash flows from financing activities:

               

Net proceeds related to issuance of common shares

    4,677       -  

Repurchases of common shares

    (4,304 )     -  

Repurchases of common shares to satisfy employee withholding requirements

    (876 )     (432 )

Distributions paid to common shareholders

    (138,204 )     (133,811 )

Net proceeds from revolving credit facility

    111,500       31,300  

Proceeds from mortgage debt

    44,000       -  

Payments of mortgage debt

    (6,068 )     (34,590 )

Financing costs

    -       (120 )

Net cash provided by (used in) financing activities

    10,725       (137,653 )
                 

Net change in cash, cash equivalents and restricted cash

    2,488       (1,181 )
                 

Cash, cash equivalents and restricted cash, beginning of period

    29,791       29,425  
                 

Cash, cash equivalents and restricted cash, end of period

  $ 32,279     $ 28,244  
                 

Supplemental cash flow information:

               

Interest paid

  $ 24,448     $ 23,532  
                 

Supplemental disclosure of noncash investing and financing activities:

               

    Accrued distribution to common shareholders

  $ 23,020     $ 22,301  

    Mortgage debt assumed by buyer upon sale of real estate

  $ -     $ 27,073  
                 

Reconciliation of cash, cash equivalents and restricted cash:

               

Cash and cash equivalents, beginning of period

  $ -     $ -  

Restricted cash-furniture, fixtures and other escrows, beginning of period

    29,791       29,425  

    Cash, cash equivalents and restricted cash, beginning of period

  $ 29,791     $ 29,425  
                 

Cash and cash equivalents, end of period

  $ -     $ -  

Restricted cash-furniture, fixtures and other escrows, end of period

    32,279       28,244  

    Cash, cash equivalents and restricted cash, end of period

  $ 32,279     $ 28,244  

 

See notes to consolidated financial statements.

5

Index

 

 

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 June 30, 2018, the Company owned 243 hotels with an aggregate of 30,929 rooms located in 34 states, including two hotels with an aggregate of 175 rooms classified as held for sale, which were sold to an unrelated party in July 2018. 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 and six months ended June 30, 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.

 

Reclassifications

 

Certain line items in the consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2017, and the consolidated statements of cash flows for the six months ended June 30, 2017 have been reclassified to conform to the current year presentation. Reclassifications had no effect on previously reported net income or shareholders’ equity.

 

6

Index

 

 

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 presenting revenue disaggregated by rooms, food and beverage, and other in its consolidated statements of operations and comprehensive income reflects the nature and timing of its significant revenue streams and has reclassified prior period amounts to conform to the current period presentation.

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments, which is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The standard was effective for annual and interim periods beginning after December 15, 2017. The Company adopted this standard as of January 1, 2018, and the adoption did not have a material impact on the Company’s consolidated financial statements and related disclosures.

 

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 six months ended June 30, 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.

 

7

Index

 

 

Accounting Standards Recently Issued

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets as right-of-use assets and lease liabilities, as well as making targeted changes to lessor accounting. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. Leases with a term of 12 months or less will be accounted for similar to the existing guidance today for operating leases. The standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which includes amendments that affect narrow aspects of the guidance issued in ASU No. 2016-02, and ASU No. 2018-11, Leases (Topic 842) Targeted Improvements, which gives entities another option for transition and provides lessors with a practical expedient. Under ASU No. 2018-11, entities are provided an additional (and optional) transition method to adopt Topic 842 by recognizing a cumulative-effect adjustment to the opening balance of retained earnings for the effects of initially applying Topic 842 in the period of adoption. Consequently, an entity’s reporting for comparative periods presented in the consolidated financial statements in which the entity adopts the new lease requirements would continue in accordance with current GAAP, Leases (Topic 840), including disclosures. The standard is effective for annual and interim periods beginning after December 15, 2018 with early adoption permitted. The Company expects to adopt this standard as of January 1, 2019. The Company is the lessee on certain ground leases and hotel equipment leases, which represents a majority of the Company’s current operating lease payments, and expects to record right of use assets and lease liabilities for these leases under the new standard. The Company is also a lessor in certain retail lease agreements related to its real estate, however, it does not anticipate any material change to the accounting for these leasing arrangements. The Company is continuing to evaluate the impact this standard will have on its consolidated financial statements and related disclosures.

 

2.  Investment in Real Estate

 

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

 

   

June 30,

   

December 31,

 
   

2018

   

2017

 
                 

Land

  $ 736,137     $ 720,465  

Building and Improvements

    4,479,362       4,362,929  

Furniture, Fixtures and Equipment

    448,548       428,734  

Franchise Fees

    12,963       12,315  
      5,677,010       5,524,443  

Less Accumulated Depreciation

    (818,794 )     (731,284 )

Investment in Real Estate, net

  $ 4,858,216     $ 4,793,159  

 

As of June 30, 2018, the Company owned 243 hotels with an aggregate of 30,929 rooms located in 34 states, including two hotels with an aggregate of 175 rooms classified as held for sale, which were sold to an unrelated party in July 2018.

 

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

 

Acquisitions

 

The Company acquired four hotels during the first six months of 2018. The following table sets forth the location, brand, manager, date acquired, number of rooms and gross purchase price for each hotel. All dollar amounts are in thousands.

 

8

Index

 

 

City

 

State

 

Brand

 

Manager

 

Date Acquired

 

Rooms

   

Gross Purchase Price (1)

 

Atlanta/Downtown

 

GA

 

Hampton

 

McKibbon

 

2/5/2018

    119     $ 24,000  

Memphis

 

TN

 

Hampton

 

Crestline

 

2/5/2018

    144       39,000  

Phoenix

 

AZ

 

Hampton

 

North Central

 

5/2/2018

    210       44,300  

Atlanta/Perimeter Dunwoody

 

GA

 

Hampton

 

LBA

 

6/28/2018

    132       29,500  
                        605     $ 136,800  

(1) The gross purchase price excludes transaction costs.

 

During the year ended December 31, 2017, the Company acquired six hotels including one in the first six months of 2017. The following table sets forth the location, brand, manager, date acquired, number of rooms and gross purchase price for each hotel. All dollar amounts are in thousands.

 

City

 

State

 

Brand

 

Manager

 

Date Acquired

 

Rooms

   

Gross Purchase

Price (1)

 

Fort Worth

 

TX

 

Courtyard

 

LBA

 

2/2/2017

    124     $ 18,034  

Birmingham (2)

 

AL

 

Hilton Garden Inn

 

LBA

 

9/12/2017

    104       19,162  

Birmingham (2)

 

AL

 

Home2 Suites

 

LBA

 

9/12/2017

    106       19,276  

Portland

 

ME

 

Residence Inn

 

Pyramid

 

10/13/2017

    179       55,750  

Salt Lake City

 

UT

 

Residence Inn

 

Huntington

 

10/20/2017

    136       25,500  

Anchorage

 

AK

 

Home2 Suites

 

Stonebridge

 

12/1/2017

    135       24,048  
                        784     $ 161,770  

 


(1) The gross purchase price excludes transaction costs.

(2) The hotels in Birmingham, AL are part of an adjoining dual-branded complex located on the same site.

 

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 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. For the hotel acquired during the six months ended June 30, 2017, the amount of revenue and operating income included in the Company’s consolidated statement of operations from the date of acquisition through June 30, 2017 was approximately $1.9 million and $0.4 million, respectively.

 

Hotel Contract Commitments

 

As of June 30, 2018, the Company had outstanding contracts for the potential purchase of five hotels for a total purchase price of approximately $130.8 million. All five hotels are under development and are planned to be completed and opened for business over the next nine to 30 months from June 30, 2018, 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 closing 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, 2018. All dollar amounts are in thousands.

 

9

Index

 

 

 

Location (1)

 

Brands

 

Date of Purchase Contract

 

Rooms

   

Refundable Deposits

   

Gross Purchase Price

 

Orlando, FL

 

Home2 Suites

 

1/18/2017

    128     $ 3     $ 20,736  

Cape Canaveral, FL (2)

 

Hampton and Home2 Suites

 

4/11/2018

    224       3       46,704  

Tempe, AZ (3)

 

Hyatt House and Hyatt Place

 

6/13/2018

    254       360       63,341  
                  606     $ 366     $ 130,781  

(1) These hotels are currently under development. The table shows the expected number of rooms upon hotel completion and the expected franchise brands. Assuming all conditions to closing are met, the purchases of these hotels are expected to occur over the next nine to 30 months from June 30, 2018. If the seller meets all of the conditions to closing, the Company is obligated to specifically perform under the contract. As the properties are under development, at this time, the seller has not met all of the conditions to closing.

(2) These hotels are part of an adjoining combined 224-room, dual-branded complex that will be located on the same site.

(3) These hotels are part of an adjoining combined 254-room, dual-branded complex that will be located on the same site.

 

The Company intends to use borrowings under its revolving credit facility to purchase the hotels under contract if a closing occurs. 

 

Loss on Impairment of Depreciable Real Estate Assets

 

During the second quarter of 2018, the Company identified three properties for potential sale: the Columbus, Georgia SpringHill Suites and TownePlace Suites (the “two Columbus hotels”) and the Springdale, Arkansas Residence Inn. In May 2018, the Company entered into separate contracts with the same unrelated party for the sale of the two Columbus hotels. As further discussed in Note 3, the Company completed the sale of the two Columbus hotels in July 2018 and classified the hotels as assets held for sale as of June 30, 2018. As a result, the Company recognized an impairment loss of approximately $0.5 million in the second quarter of 2018, representing the difference between the carrying values of the two Columbus hotels and the contracted sales prices, net of estimated selling costs, which are Level 1 inputs under the fair value hierarchy. The Company has committed to sell the Springdale, Arkansas Residence Inn and has received offers from unrelated parties that it is pursuing. Due to the change in the anticipated hold period for this hotel, the Company reviewed the estimated undiscounted cash flows to be generated by the property and determined that the undiscounted cash flows were less than its carrying value; therefore the Company recognized an impairment loss of approximately $2.6 million in the second quarter of 2018 to adjust the basis of this property to its estimated fair value, which was based on the offers received, net of estimated selling costs, which is a Level 2 input under the fair value hierarchy.

 

The two Columbus hotels were previously identified for potential sale during the first quarter of 2017, at which time the Company recognized an impairment loss of approximately $7.9 million to adjust the bases of these properties to their estimated fair values, which were based on the then contracted sales prices, which were terminated in May 2017, net of estimated selling costs, a Level 1 input under the fair value hierarchy.

 

3.  Assets Held for Sale and Dispositions

 

Assets Held for Sale

 

In May 2018, the Company entered into separate purchase and sale agreements with the same unrelated party for the sale of its 89-room SpringHill Suites and its 86-room TownePlace Suites hotels in Columbus, Georgia for a total combined gross sales price of $10.0 million. Since the buyer under the contracts had completed its due diligence and had made a non-refundable deposit, as of June 30, 2018, the Company classified the two Columbus hotels as held for sale at their estimated fair values which, as discussed in Note 2, were based on the contracted sales prices, net of estimated selling costs, resulting in an impairment loss during the second quarter of 2018. On July 13, 2018, the Company completed the sale of the hotels.

 

10

Index

 

 

2017 Dispositions

 

In December 2016, the Company entered into a purchase and sale agreement with an unrelated party for the sale of its 224-room Hilton hotel in Dallas, Texas for a gross sales price of approximately $56.1 million, as amended. On April 20, 2017, the Company completed the sale resulting in a gain of approximately $16.1 million, which is included in the Company’s consolidated statements of operations for the three and six months ended June 30, 2017. The hotel had a carrying value totaling approximately $39.0 million at the date of sale. Under the contract, at closing, the mortgage loan secured by the Dallas, Texas Hilton hotel was assumed by the buyer with the buyer receiving a credit for the amount assumed, which was approximately $27.1 million at the date of sale.

 

The Company’s consolidated statements of operations include operating income (loss) of approximately $(0.4) million and $0.3 million for the three months ended June 30, 2018 and 2017, respectively, and approximately $(0.4) million and $(6.5) million for the six months ended June 30, 2018 and 2017, respectively, relating to the results of operations of the three hotels noted above (the two Columbus hotels classified as held for sale as of June 30, 2018 and sold in July 2018, and the Dallas, Texas Hilton sold in April 2017). 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, 2018 and 2017. The net proceeds from the sales were used to pay down borrowings on the Company’s revolving credit facility. 

 

4.  Debt

 

$965 Million Credit Facility 

 

Prior to the Company’s debt refinancing in July 2018 as discussed below, the Company utilized 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”).  Interest payments on the $965 million credit facility were due monthly and the interest rate, subject to certain exceptions, was 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 was 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

 

Prior to the Company’s debt refinancing in August 2018 as discussed below, the Company utilized an unsecured $150 million term loan facility (the “$150 million term loan facility”), consisting of a $50 million term loan with a maturity date of April 8, 2021 (the “$50 million term loan”) and a $100 million term loan with a maturity date of April 8, 2023 (the “$100 million term loan,” and collectively with the $50 million term loan, the “$150 million term loans”).  The credit agreement contained requirements and covenants similar to the Company’s $965 million credit facility.  Interest payments on the $150 million term loan facility were due monthly and the interest rate was 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.  

 

11

Index

 

$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. In conjunction with the Company’s debt refinancing discussed below, the requirements and covenants under the $85 million term loan agreement were amended to be similar to the refinanced facilities’ credit agreements.

 

As of June 30, 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.

 

       

As of June 30, 2018

       

As of December 31, 2017

       
   

Maturity Date

 

Outstanding Balance

   

Interest Rate

       

Outstanding Balance

   

Interest Rate

       

Revolving credit facility (1)

 

5/18/2019

  $ 218,400       3.64 %   (2)   $ 106,900       3.11 %   (2)  

Term loans

                                             
$425 million term loans   5/18/2020     425,000       3.21 %   (3)     425,000       3.09 %   (3)  

$50 million term loan

 

4/8/2021

    50,000       2.54 %   (4)     50,000       2.54 %   (4)  

$100 million term loan

 

4/8/2023

    100,000       3.13 %   (4)     100,000       3.13 %   (4)  

$85 million term loan

 

7/25/2024

    85,000       3.76 %   (4)     85,000       3.76 %   (4)  

Total term loans at stated value

    660,000                   660,000                

Unamortized debt issuance costs

    (3,140 )                 (3,721 )              

Total term loans

    656,860                   656,279                
                                               

Total revolving credit facility and term loans

  $ 875,260                 $ 763,179                

(1) Unamortized debt issuance costs related to the revolving credit facility totaled approximately $1.1 million and $1.7 million as of June 30, 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. See Note 5 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. See Note 5 for more information on the interest rate swap agreements.

 

At June 30, 2018, the credit agreements governing the $965 million credit facility, the $150 million term loan facility and the $85 million term loan contained mandatory prepayment requirements, customary affirmative covenants, negative covenants and events of default.  The credit agreements required 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, 2018.

 

12

Index

 

2018 Debt Refinancing

 

On July 27, 2018, the Company entered into an amendment and restatement of its $965 million credit facility, reducing the borrowing capacity to $850 million 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.  At closing, the Company repaid the outstanding $425 million term loans under the $965 million credit facility with the proceeds from the $425 million term loan facility and borrowed approximately $196 million under the $425 million revolving credit facility to repay the outstanding balance on its $540 million 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 credit agreement for the $850 million credit facility contains requirements and covenants similar to the previous credit agreement for the $965 million credit facility. 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.

 

Also, on August 2, 2018, the Company entered into an amendment and restatement of its $150 million term loan facility, increasing the borrowing capacity to $225 million 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 drawn at closing and the remaining $75 million may be drawn by the Company no later than January 31, 2019. At closing, the Company repaid the $150 million term loans under the $150 million term loan facility. The credit agreement contains requirements and covenants similar to the $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.  

 

A summary of the 2018 debt refinancing is set forth below. All dollar amounts are in thousands.

 

   

2018 Refinancing

 

Prior to Refinancing

       

Maturity

           

Maturity

   
   

Capacity

 

Date

 

Interest Rate

 

Capacity

 

Date

 

Interest Rate

Revolving credit facility

  $ 425,000  

7/27/2022

 

LIBOR + 1.40% - 2.25%

  $ 540,000  

5/18/2019

 

LIBOR + 1.55% - 2.30%

Term loan

    200,000  

7/27/2023

 

LIBOR + 1.35% - 2.20%

    425,000  

5/18/2020

 

LIBOR + 1.50% - 2.25%

Term loan

    225,000  

1/31/2024

 

LIBOR + 1.35% - 2.20%

             

   Facility total

    850,000             965,000        

Term loan

    50,000  

8/2/2023

 

LIBOR + 1.35% - 2.20%

    50,000  

4/8/2021

 

LIBOR + 1.45% - 2.20%

Term loan

    175,000  

8/2/2025

 

LIBOR + 1.65% - 2.50%

    100,000  

4/8/2023

 

LIBOR + 1.80% - 2.60%

   Facility total

    225,000             150,000        

Total

  $ 1,075,000           $ 1,115,000        

 

Mortgage Debt

 

As of June 30, 2018, the Company had approximately $495.4 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 June 30, 2018 and December 31, 2017 for each of the Company’s mortgage debt obligations. All dollar amounts are in thousands.

 

13

Index

 

 

Location

 

Brand

 

Interest

Rate (1)

 

Loan Assumption or Origination Date

 

Maturity Date

 

Principal Assumed

or Originated

   

Outstanding balance

as of June 30, 2018

   

Outstanding balance as of December 31, 2017

 

San Juan Capistrano, CA

 

Residence Inn

    4.15 %    

9/1/2016

 

6/1/2020

  $ 16,210     $ 15,604     $ 15,774  

Colorado Springs, CO

 

Hampton

    6.25 %    

9/1/2016

 

7/6/2021

    7,923       7,686       7,754  

Franklin, TN

 

Courtyard

    6.25 %    

9/1/2016

 

8/6/2021

    14,679       14,242       14,368  

Franklin, TN

 

Residence Inn

    6.25 %    

9/1/2016

 

8/6/2021

    14,679       14,242       14,368  

Grapevine, TX

 

Hilton Garden Inn

    4.89 %    

8/29/2012

 

9/1/2022

    11,810       10,258       10,412  

Collegeville/Philadelphia, PA

 

Courtyard

    4.89 %    

8/30/2012

 

9/1/2022

    12,650       10,987       11,152  

Hattiesburg, MS

 

Courtyard

    5.00 %    

3/1/2014

 

9/1/2022

    5,732       5,136       5,212  

Rancho Bernardo/San Diego, CA

 

Courtyard

    5.00 %    

3/1/2014

 

9/1/2022

    15,060       13,492       13,692  

Kirkland, WA

 

Courtyard

    5.00 %    

3/1/2014

 

9/1/2022

    12,145       10,881       11,042  

Seattle, WA

 

Residence Inn

    4.96 %    

3/1/2014

 

9/1/2022

    28,269       25,310       25,687  

Anchorage, AK

 

Embassy Suites

    4.97 %    

9/13/2012

 

10/1/2022

    23,230       20,261       20,560  

Somerset, NJ

 

Courtyard

    4.73 %    

3/1/2014

 

10/6/2022

    8,750       7,813       7,932  

Tukwila, WA

 

Homewood Suites

    4.73 %    

3/1/2014

 

10/6/2022

    9,431       8,421       8,549  

Prattville, AL

 

Courtyard

    4.12 %    

3/1/2014

 

2/6/2023

    6,596       5,849       5,943  

Huntsville, AL

 

Homewood Suites

    4.12 %    

3/1/2014

 

2/6/2023

    8,306       7,365       7,483  

San Diego, CA

 

Residence Inn

    3.97 %    

3/1/2014

 

3/6/2023

    18,600       16,467       16,733  

Miami, FL

 

Homewood Suites

    4.02 %    

3/1/2014

 

4/1/2023

    16,677       14,786       15,022  

Syracuse, NY

 

Courtyard

    4.75 %    

10/16/2015

 

8/1/2024

 (2)   11,199       10,498       10,637  

Syracuse, NY

 

Residence Inn

    4.75 %    

10/16/2015

 

8/1/2024

 (2)   11,199       10,498       10,637  

New Orleans, LA

 

Homewood Suites

    4.36 %    

7/17/2014

 

8/11/2024

    27,000       24,578       24,919  

Westford, MA

 

Residence Inn

    4.28 %    

3/18/2015

 

4/11/2025

    10,000       9,263       9,386  

Denver, CO

 

Hilton Garden Inn

    4.46 %    

9/1/2016

 

6/11/2025

    34,118       32,625       33,046  

Oceanside, CA

 

Courtyard

    4.28 %    

9/1/2016

 

10/1/2025

    13,655       13,206       13,332  

Omaha, NE

 

Hilton Garden Inn

    4.28 %    

9/1/2016

 

10/1/2025

    22,682       21,935       22,145  

Boise, ID

 

Hampton

    4.37 %    

5/26/2016

 

6/11/2026

    24,000       23,220       23,422  

Burbank, CA

 

Courtyard

    3.55 %    

11/3/2016

 

12/1/2026

    25,564       24,585       24,917  

San Diego, CA

 

Courtyard

    3.55 %    

11/3/2016

 

12/1/2026

    25,473       24,497       24,828  

San Diego, CA

 

Hampton

    3.55 %    

11/3/2016

 

12/1/2026

    18,963       18,237       18,483  

Burbank, CA

 

SpringHill Suites

    3.94 %    

3/9/2018

 

4/1/2028

    28,470       28,358       -  

Santa Ana, CA

 

Courtyard

    3.94 %    

3/9/2018

 

4/1/2028

    15,530       15,469       -  

San Jose, CA

 

Homewood Suites

    4.22 %    

12/22/2017

 

1/1/2038

    30,000       29,598       30,000  
                          $ 528,600       495,367       457,435  

Unamortized fair value adjustment of assumed debt

                        3,879       4,330  

Unamortized debt issuance costs

                        (2,330 )     (2,748 )

    Total

                            $ 496,916     $ 459,017  

(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.

 

14

Index

 

The aggregate amounts of principal payable under the Company’s total debt obligations as of June 30, 2018 (including mortgage debt, the revolving credit facility and term loans), for the five years subsequent to June 30, 2018 and thereafter are as follows (in thousands):

 

2018 (July - December)

  $ 6,595  

2019

    252,205  

2020

    453,349  

2021

    97,586  

2022

    109,252  

Thereafter

    454,780  
      1,373,767  

Unamortized fair value adjustment of assumed debt

    3,879  

Unamortized debt issuance costs related to term loans and mortgage debt

    (5,470 )

Total

  $ 1,372,176  

 

5.  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 June 30, 2018, both the carrying value and estimated fair value of the Company’s debt were approximately $1.4 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, 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, 2018 and December 31, 2017. All dollar amounts are in thousands.

 

   

Notional

                Fair Value Asset (Liability)  

Hedge Type

 

Amount at

June 30, 2018

 

Origination

Date

 

Maturity Date

 

Swap Fixed

Interest Rate

   

June 30,

2018

   

December 31,

2017

 

Cash flow hedge

  $ 212,500  

5/21/2015

 

5/18/2020

    1.58 %   $ 3,915     $ 2,033  

Cash flow hedge

    110,000  

7/2/2015

 

5/18/2020

    1.62 %     1,946       951  

Cash flow hedge

    50,000  

4/7/2016

 

3/31/2021

    1.09 %     2,119       1,544  

Cash flow hedge

    100,000  

4/7/2016

 

3/31/2023

    1.33 %     6,352       4,098  

Cash flow hedge

    75,000  

5/31/2017

 

6/30/2024

    1.96 %     3,308       1,043  

Cash flow hedge

    10,000  

8/10/2017

 

6/30/2024

    2.01 %     415       109  

Cash flow hedge (1)

    50,000  

6/1/2018

 

6/30/2025

    2.89 %     (245 )     -  
    $ 607,500                   $ 17,810     $ 9,778  

 

(1) In June 2018 the Company entered into a forward interest rate swap agreement with a commercial bank, which beginning January 31, 2019 will effectively fix the interest rate on $50 million of the Company's variable rate debt.

 

15

Index

 

 

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 tables present 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, 2018 and 2017 (in thousands):

 

   

Net Unrealized Gain (Loss)

Recognized in Other

Comprehensive Income (Loss)

   

Net Unrealized Gain (Loss) Reclassified

from Accumulated Other Comprehensive

Income to Interest and Other Expense, net

 
   

Three Months Ended June 30,

   

Three Months Ended June 30,

 
   

2018

   

2017

   

2018

   

2017

 

Interest rate derivatives in cash flow hedging relationships

  $ 2,252     $ (1,733 )   $ 512     $ (558 )

 

   

Net Unrealized Gain (Loss)

Recognized in Other

Comprehensive Income (Loss)

   

Net Unrealized Gain (Loss) Reclassified

from Accumulated Other Comprehensive

Income to Interest and Other Expense, net

 
   

Six Months Ended June 30,

   

Six Months Ended June 30,

 
   

2018

   

2017

   

2018

   

2017

 

Interest rate derivatives in cash flow hedging relationships

  $ 8,600     $ (1,010 )   $ 568     $ (1,380 )

 

 

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 $4.5 million of net unrealized gains included in accumulated other comprehensive income at June 30, 2018 will be reclassified as a decrease to interest and other expense, net within the next 12 months.

 

6.  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 six months ended June 30, 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 allocated by the Company to ARG for the six months ended June 30, 2018 and 2017 totaled approximately $0.5 million and $0.3 million, respectively, and are recorded as a reduction to general and administrative expenses in the Company’s consolidated statements of operations. 

 

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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, 2018 and December 31, 2017, total amounts due from ARG for reimbursements under the cost sharing structure each totaled approximately $0.3 million, 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 six months ended June 30, 2018 and 2017 were approximately $0.05 million and $0.1 million, respectively, and are included in general and administrative expenses in the Company’s consolidated statements of operations.

 

7.  Shareholders Equity

 

Distributions 

 

The Company’s current annual distribution rate, payable monthly, is $1.20 per common share. For the three months ended June 30, 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. For the six months ended June 30, 2018 and 2017, the Company paid distributions of $0.60 per common share for a total of $138.2 million and $133.8 million, respectively. Additionally, in June 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 June 30, 2018 and paid in July 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 June 30, 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 six months ended June 30, 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 six months ended June 30, 2017. As of June 30, 2018, approximately $160.2 million remained available for issuance under the ATM Program.

 

Share Repurchases

 

In May 2018, the Board of Directors approved an extension of the Company’s existing share repurchase program (the “Share Repurchase Program”), authorizing share repurchases up to an aggregate of $464 million. The Share Repurchase Program may be suspended or terminated at any time by the Company and will end in July 2019 if not terminated earlier. In March 2018, the Company established 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 six months of 2018, the Company purchased, under its 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 six months of 2017. Repurchases under the Share Repurchase Program have been funded, and the Company intends to fund future repurchases, with availability under its revolving credit facility.

 

17

Index

 

8.  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 June 30, 2018, the Company has accrued approximately $3.7 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 June 30, 2018. Compensation expense recognized by the Company under the 2018 Incentive Plan is included in general and administrative expense in the Company’s consolidated statements of operations and totaled approximately $1.8 million and $3.7 million for the three and six months ended June 30, 2018, respectively.  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 $1.4 million and $3.5 million in general and administrative expenses in the Company’s consolidated statements of operations for the three and six months ended June 30, 2017, respectively. 

 

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 June 30, 2018 and 2017, the Company recognized approximately $0.3 million and $0.1 million, respectively, and for the six months ended June 30, 2018 and 2017, the Company recognized approximately $0.6 million and $0.2 million, respectively, of share based compensation expense related to the unvested restricted share awards.

 

9.  Subsequent Events           

 

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

 

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

 

On July 13, 2018, the Company completed the sale of its two Columbus hotels for a total combined gross sales price of $10.0 million. The Company used the net proceeds from the sale to pay down borrowings on its revolving credit facility. See Note 3 for additional information.

 

In July and August 2018, the Company refinanced its $965 million credit facility and its $150 million term loan facility. See Note 4 for additional information on the Company’s debt refinancing.

 

18

Index

 

 

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; litigation risks; 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 June 30, 2018, the Company owned 243 hotels with an aggregate of 30,929 rooms located in urban, high-end suburban and developing markets throughout 34 states, including two hotels with an aggregate of 175 rooms classified as held for sale, which were sold to an unrelated party in July 2018. 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 four hotels for an aggregate purchase price of approximately $136.8 million during the first six months of 2018: a 119-room Hampton Inn & Suites in downtown Atlanta, Georgia; a 144-room Hampton Inn & Suites in Memphis, Tennessee; a 210-room Hampton Inn & Suites in downtown Phoenix, Arizona; and a 132-room Hampton Inn & Suites in Atlanta Perimeter Dunwoody, Georgia. The Company also had outstanding contracts for the potential purchase of five hotels that are under development for a total purchase price of approximately $130.8 million, which are planned to be completed and opened for business over the next nine to 30 months from June 30, 2018, at which time closings on these hotels are expected to occur. The Company utilized its revolving credit facility to fund the completed acquisitions and plans to utilize the revolving credit facility for any additional acquisitions.

 

19

Index

 

For its existing portfolio, the Company monitors each property’s profitability, market conditions and capital requirements and attempts to maximize shareholder value by disposing of properties when it believes that superior value can be provided by the proceeds from the sale of the property.  Accordingly, during the second quarter of 2018, the Company identified three properties for potential sale: the two Columbus hotels and the Springdale, Arkansas Residence Inn. In May 2018, the Company entered into separate contracts with the same unrelated party for the sale of the two Columbus hotels and, as a result, recognized an impairment loss of approximately $0.5 million in the second quarter of 2018. In July 2018, the Company completed the sale of its two Columbus hotels, which were classified as held for sale as of June 30, 2018, for a total combined gross sales price of $10.0 million. The net proceeds from the sales of these hotels were used to pay down borrowings on the Company’s revolving credit facility. Additionally, the Company has committed to sell the Springdale, Arkansas Residence Inn and has received offers from unrelated parties that it is pursuing and, as a result, recognized an impairment loss of approximately $2.6 million in the second quarter of 2018 on this hotel. 

 

See Note 2 titled “Investment in Real Estate” and Note 3 titled “Assets Held for Sale and Dispositions” 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 six 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 June 30, 2018, the Company owned 243 hotels with a total of 30,929 rooms as compared to 235 hotels with a total of 29,978 rooms as of June 30, 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 six months ended June 30, 2018, the Company acquired one newly constructed hotel on May 2, 2018 and three existing hotels (two on February 5, 2018 and one on June 28, 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 and six months ended June 30, 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.

 

20

Index

 

 

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

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,  

 

(in thousands, except statistical data)

 

2018

   

Percent of

Revenue

   

2017

   

Percent of

Revenue

   

Percent

Change

   

2018

   

Percent of

Revenue

   

2017

   

Percent of

Revenue

   

Percent

Change

 
                                                                                 

Total revenue

  $ 344,714       100.0 %   $ 331,704       100.0 %     3.9 %   $ 643,103       100.0 %   $ 624,629       100.0 %     3.0 %

Hotel operating expense

    186,531       54.1 %     180,012       54.3 %     3.6 %     358,860       55.8 %     348,466       55.8 %     3.0 %

Property taxes, insurance and other expense

    18,681       5.4 %     17,821       5.4 %     4.8 %     35,910       5.6 %     34,748       5.6 %     3.3 %

Ground lease expense

    2,912       0.8 %     2,839       0.9 %     2.6 %     5,762       0.9 %     5,655       0.9 %     1.9 %

General and administrative expense

    6,721       1.9 %     6,151       1.9 %     9.3 %     13,598       2.1 %     12,905       2.1 %     5.4 %
                                                                                 

Transaction and litigation costs (reimbursements)

    -               (2,586 )             n/a       -               (2,586 )             n/a  

Loss on impairment of depreciable real estate assets

    3,135               -               n/a       3,135               7,875               n/a  

Depreciation expense

    45,743               43,893               4.2 %     90,583               87,660               3.3 %

Interest and other expense, net

    13,210               11,849               11.5 %     25,129               23,566               6.6 %

Gain on sale of real estate

    -               16,140               n/a       -               16,140               n/a  

Income tax expense

    151               259               -41.7 %     314               509               -38.3 %
                                                                                 

Number of hotels owned at end of period

    243               235               3.4 %     243               235               3.4 %

ADR

  $ 139.58             $ 137.56               1.5 %   $ 137.09             $ 135.58               1.1 %

Occupancy

    81.7 %             81.5 %             0.2 %     78.2 %             78.0 %             0.3 %

RevPAR

  $ 114.09             $ 112.10               1.8 %   $ 107.20             $ 105.70               1.4 %

 

Comparable Hotels Operating Results

 

The following table reflects certain operating statistics for the Company’s 241 hotels owned and held for use as of June 30, 2018 (“Comparable Hotels”). The Company defines metrics from Comparable Hotels as results generated by the 241 hotels owned and held for use as of the end of the reporting period. These metrics do not include the results generated by the two Columbus hotels, which were held for sale as of June 30, 2018 and sold on July 13, 2018. 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 and assets held for sale, results have been excluded for the Company’s period of ownership.

 

21

Index

 

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2018

   

2017

   

Percent Change

   

2018

   

2017

   

Percent Change

 
                                                 

ADR

  $ 139.83     $ 138.22       1.2 %   $ 137.39     $ 135.95       1.1 %

Occupancy

    81.8 %     81.7 %     0.1 %     78.3 %     78.2 %     0.1 %

RevPAR

  $ 114.38     $ 112.88       1.3 %   $ 107.52     $ 106.31       1.1 %

 

Same Store Operating Results

 

The following table reflects certain operating statistics for the Company’s 231 hotels owned and held for use 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.

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2018

   

2017

   

Percent Change

   

2018

   

2017

   

Percent Change

 
                                                 

ADR

  $ 139.28     $ 137.60       1.2 %   $ 137.01     $ 135.50       1.1 %

Occupancy

    82.1 %     81.8 %     0.4 %     78.5 %     78.3 %     0.3 %

RevPAR

  $ 114.29     $ 112.53       1.6 %   $ 107.51     $ 106.10       1.3 %

 

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 half of 2018 as compared to 2017. Due to the increase in revenue and operating income in the second half of 2017 related to the increase in demand from restoration and recovery efforts in Houston and Florida resulting from hurricanes Harvey and Irma, the Company expects flat to modest improvement in both revenue and operating results for its Comparable Hotels for the second half of 2018 as compared to the same period in 2017. The Company’s hotels in general have shown results consistent with industry and brand averages for the period of ownership.

 

Revenues

 

The Company’s principal source of revenue is hotel revenue consisting of room, food and beverage, and other related revenue. For the three months ended June 30, 2018 and 2017, the Company had total revenue of $344.7 million and $331.7 million, respectively. For the six months ended June 30, 2018 and 2017, the Company had total revenue of $643.1 million and $624.6 million, respectively. For the three months ended June 30, 2018 and 2017, respectively, Comparable Hotels achieved combined average occupancy of 81.8% and 81.7%, ADR of $139.83 and $138.22 and RevPAR of $114.38 and $112.88. For the six months ended June 30, 2018 and 2017, respectively, Comparable Hotels achieved combined average occupancy of 78.3% and 78.2%, ADR of $137.39 and $135.95 and RevPAR of $107.52 and $106.31. ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.

 

Compared to the same periods in 2017, during the second quarter and first half of 2018, the Company experienced a modest increase in ADR and stable occupancy, resulting in a 1.3% and 1.1% increase in RevPAR for Comparable Hotels, respectively. Markets/areas with above average growth in the second quarter and first half of 2018 for the Company and industry included Fort Worth, Texas, Knoxville, Tennessee, Tucson, Arizona, Southeastern Texas and South Florida. Markets that were below average for the Company and industry included Boston, Massachusetts, Denver, Colorado, Kansas City, Missouri, St. Louis, Missouri and Seattle, Washington.  

 

22

Index

 

Hotel Operating Expense

 

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 June 30, 2018 and 2017, respectively, hotel operating expense totaled $186.5 million and $180.0 million or 54.1% and 54.3% of total revenue for each respective period.  For the six months ended June 30, 2018 and 2017, respectively, hotel operating expense totaled $358.9 million and $348.5 million or 55.8% of total revenue for each respective period.  For the Company’s Comparable Hotels, hotel operating expense as a percentage of revenue increased approximately 10 and 30 basis points, respectively, for the three and six months ended June 30, 2018 as compared to the same periods in 2017. Increases in labor costs as a percentage of revenue during the first half of 2018 as compared to the same period in 2017 were the primary cause of the increased Comparable Hotels 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 

 

Property taxes, insurance, and other expense for the three months ended June 30, 2018 and 2017 totaled $18.7 million and $17.8 million, respectively, or 5.4% of total revenue for each respective period, and for Comparable Hotels, 5.4% and 5.3% of total revenue for each respective period. For the six months ended June 30, 2018 and 2017, property taxes, insurance, and other expense totaled $35.9 million and $34.7 million, respectively, or 5.6% of total revenue for each respective period, and for Comparable Hotels, 5.6% and 5.5% of total revenue for each respective period. For the Company’s Comparable Hotels, real estate taxes increased slightly during the first half of 2018 compared to the first half 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 have increased slightly as a percentage of revenue for the first six months of 2018 as compared to the first six months of 2017 and are anticipated to increase for the remainder of 2018.

 

Ground Lease Expense 

 

Ground lease expense for the three months ended June 30, 2018 and 2017 was $2.9 million and $2.8 million, respectively. For the six months ended June 30, 2018 and 2017, ground lease expense was $5.8 million and $5.7 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 

 

General and administrative expense for the three months ended June 30, 2018 and 2017 was $6.7 million and $6.2 million, respectively, or 1.9% of total revenue for each respective period. For the six months ended June 30, 2018 and 2017, general and administrative expense was $13.6 million and $12.9 million, respectively, or 2.1% 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.

 

Transaction and Litigation Costs (Reimbursements)

 

During the three and six months ended June 30, 2017, transaction and litigation costs (reimbursements) each totaled $(2.6) million which primarily related to additional proceeds received from the Company’s directors and officers insurance carriers in connection with a legal settlement that occurred in 2017 related to the Company’s merger with Apple REIT Ten, Inc. in 2016.

 

Loss on Impairment of Depreciable Real Estate Assets 

 

Loss on impairment of depreciable real estate assets was $3.1 million for both the three and six months ended June 30, 2018, and $7.9 million for the six months ended June 30, 2017, which consisted of impairment charges for the two Columbus hotels (in 2018 and 2017) and the Springdale, Arkansas Residence Inn (in 2018). 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 these impairment losses.

 

23

Index

 

Depreciation Expense 

 

Depreciation expense for the three months ended June 30, 2018 and 2017 was $45.7 million and $43.9 million, respectively. For the six months ended June 30, 2018 and 2017, depreciation expense was $90.6 million and $87.7 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 four hotels in the first half of 2018 and six hotels in 2017 and renovations completed throughout 2018 and 2017.

 

Interest and Other Expense, net 

 

Interest and other expense, net for the three months ended June 30, 2018 and 2017 was $13.2 million and $11.8 million, respectively. For the six months ended June 30, 2018 and 2017, interest and other expense, net was $25.1 million and $23.6 million, respectively, and is net of $0.5 million and $0.6 million of interest capitalized associated with renovation projects, for each respective period.  Although average outstanding debt was slightly less in the first half of 2018 as compared to the first half of 2017, interest expense increased as a result of an increase in the Company’s effective interest rate during the first half of 2018 as compared to 2017, due to (a) the issuance of longer term fixed-rate debt subsequent to June 30, 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 1.22% at June 30, 2017 to 2.09% at June 30, 2018. While approximately 77% of the Company’s outstanding debt was effectively fixed rate at June 30, 2018, the Company does expect interest costs to continue to increase for the remainder of 2018 due to expected increased borrowings and increased rates for its remaining variable rate debt. However, the impact from higher interest rates and increased borrowings will be partially mitigated by the Company’s 2018 debt refinancing, resulting in lower spreads charged on outstanding borrowings under its revolving credit facility and $575 million of its outstanding term loans by 10 to 15 basis points, depending on the Company’s leverage ratio. See Note 4 titled “Debt” 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 the Company’s debt refinancing.

 

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.

 

FFO and MFFO

 

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 certain additional items including (i) the exclusion of transaction and litigation costs (reimbursements), as these costs do 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 Company presents MFFO when evaluating its performance because it believes that it provides further useful supplemental information to investors regarding its ongoing operating performance.

 

24

Index

 

The following table reconciles the Company’s GAAP net income to FFO and MFFO for the three and six months ended June 30, 2018 and 2017 (in thousands).

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2018

   

2017

   

2018

   

2017

 

Net income

  $ 67,630     $ 87,606     $ 109,812     $ 121,971  

Depreciation of real estate owned

    45,502       43,664       90,112       87,201  

Gain on sale of real estate

    -       (16,140 )     -       (16,140 )

Loss on impairment of depreciable real estate assets

    3,135       -       3,135       7,875  

Amortization of favorable and unfavorable leases, net

    148       168       354       333  

Funds from operations

    116,415       115,298       203,413       201,240  

Transaction and litigation costs (reimbursements)

    -       (2,586 )     -       (2,586 )

Non-cash straight-line ground lease expense

    898       938       1,802       1,877  

Modified funds from operations

  $ 117,313     $ 113,650     $ 205,215     $ 200,531  

 

EBITDA and Adjusted EBITDA

 

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 exclusion of transaction and litigation costs (reimbursements), gains or losses from sales of real estate, and the loss on impairment of depreciable real estate assets, as these items do 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 and six months ended June 30, 2018 and 2017 (in thousands).

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2018

   

2017

   

2018

   

2017

 

Net income

  $ 67,630     $ 87,606     $ 109,812     $ 121,971  

Depreciation

    45,743       43,893       90,583       87,660  

Amortization of favorable and unfavorable leases, net

    148       168       354       333  

Interest and other expense, net

    13,210       11,849       25,129       23,566  

Income tax expense

    151       259       314       509  

EBITDA

    126,882       143,775       226,192       234,039  

Transaction and litigation costs (reimbursements)

    -       (2,586 )     -       (2,586 )

Gain on sale of real estate

    -       (16,140 )     -       (16,140 )

Loss on impairment of depreciable real estate assets

    3,135       -       3,135       7,875  

Non-cash straight-line ground lease expense

    898       938       1,802       1,877  

Adjusted EBITDA

  $ 130,915     $ 125,987     $ 231,129     $ 225,065  

 

Hotels Owned

 

As of June 30, 2018, the Company owned 243 hotels with an aggregate of 30,929 rooms located in 34 states, including two hotels with an aggregate of 175 rooms classified as held for sale, which were sold to an unrelated party in July 2018. The following tables summarize the number of hotels and rooms by brand and by state:

 

25

Index

 

Number of Hotels and Guest Rooms by Brand

 
   

Number of

   

Number of

 

Brand

 

Hotels

   

Rooms

 

Hilton Garden Inn

    42       5,807  

Courtyard

    40       5,460  

Hampton

    40       5,029  

Residence Inn

    34       4,011  

Homewood Suites

    34       3,831  

SpringHill Suites

    17       2,248  

TownePlace Suites

    12       1,196  

Fairfield Inn

    11       1,300  

Home2 Suites

    8       910  

Marriott

    2       616  

Embassy Suites

    2       316  

Renaissance

    1       205  

    Total

    243       30,929  

 

 

Number of Hotels and Guest Rooms by State

 
   

Number of

   

Number of

 

State

 

Hotels

   

Rooms

 

Alabama

    15       1,434  

Alaska

    2       304  

Arizona

    12       1,644  

Arkansas

    4       408  

California

    27       3,807  

Colorado

    4       567  

Florida

    23       2,851  

Georgia

    8       847  

Idaho

    2       416  

Illinois

    8       1,420  

Indiana

    4       479  

Iowa

    3       301  

Kansas

    4       422  

Louisiana

    4       541  

Maine

    1       179  

Maryland

    2       233  

Massachusetts

    4       466  

Michigan

    1       148  

Minnesota

    2       244  

Mississippi

    2       168  

Missouri

    4       544  

Nebraska

    4       621  

New Jersey

    5       629  

New York

    4       550  

North Carolina

    12       1,337  

Ohio

    2       252  

Oklahoma

    4       545  

Pennsylvania

    3       391  

South Carolina

    5       538  

Tennessee

    13       1,502  

Texas

    34       4,072  

Utah

    3       393  

Virginia

    14       2,067  

Washington

    4       609  

    Total

    243       30,929  

 

 

26

Index

 

 

The following table summarizes the location, brand, manager, date acquired or completed and number of rooms for each of the 243 hotels the Company owned as of June 30, 2018.

 

City

 

State

 

Brand

 

Manager

 

Date

Acquired or

Completed

 

Rooms

 

Anchorage

 

AK

 

Embassy Suites

 

Stonebridge

 

4/30/2010

  169  

Anchorage

 

AK

 

Home2 Suites

 

Stonebridge

 

12/1/2017

  135  

Auburn

 

AL

 

Hilton Garden Inn

 

LBA

 

3/1/2014

  101  

Birmingham

 

AL

 

Courtyard

 

LBA

 

3/1/2014

  84  

Birmingham

 

AL

 

Hilton Garden Inn

 

LBA

 

9/12/2017

  104  

Birmingham

 

AL

 

Home2 Suites

 

LBA

 

9/12/2017

  106  

Birmingham

 

AL

 

Homewood Suites

 

McKibbon

 

3/1/2014

  95  

Dothan

 

AL

 

Hilton Garden Inn

 

LBA

 

6/1/2009

  104  

Dothan

 

AL

 

Residence Inn

 

LBA

 

3/1/2014

  84  

Huntsville

 

AL

 

Hampton

 

LBA

 

9/1/2016

  98  

Huntsville

 

AL

 

Hilton Garden Inn

 

LBA

 

3/1/2014

  101  

Huntsville

 

AL

 

Home2 Suites

 

LBA

 

9/1/2016

  77  

Huntsville

 

AL

 

Homewood Suites

 

LBA

 

3/1/2014

  107  

Mobile

 

AL

 

Hampton

 

McKibbon

 

9/1/2016

  101  

Montgomery

 

AL

 

Hilton Garden Inn

 

LBA

 

3/1/2014

  97  

Montgomery

 

AL

 

Homewood Suites

 

LBA

 

3/1/2014

  91  

Prattville

 

AL

 

Courtyard

 

LBA

 

3/1/2014

  84  

Rogers

 

AR

 

Hampton

 

Raymond

 

8/31/2010