Apple Hospitality REIT, Inc. quarterly report, Q3 FY2017

Apple Hospitality REIT, Inc. — Q3 2017 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2017. Apple Hospitality is a U.S. lodging REIT; it owned 237 hotels with 30,188 rooms in 33 states at quarter-end. All hotels operated under Marriott or Hilton brands and were managed by unaffiliated operators.

Financial and operating results

Metric	Q3 2017	Q3 2016	Nine months 2017	Nine months 2016
Total revenue	$324.9 million	$276.5 million	$949.6 million	$758.6 million
Operating income	$75.2 million	$23.8 million	$205.1 million	$132.2 million
Net income	$62.8 million	$13.7 million	$184.8 million	$103.1 million
Diluted net income per share	$0.28	$0.07	$0.83	$0.57
Operating cash flow	Not presented by quarter	Not presented by quarter	$280.5 million	$238.0 million

Comparable hotel performance: Q3 RevPAR rose 1.3% to $109.77, on a 1.5% increase in ADR to $136.83 and occupancy of 80.2% versus 80.4%. For the nine months, RevPAR increased 0.8% to $107.10.
Costs and margins: Hotel operating expense was 55.3% of revenue in Q3 and 55.6% for the nine months, versus 55.5% and 55.1%, respectively. Management attributed pressure primarily to labor costs. Depreciation was $131.8 million and interest and other expense was $35.6 million for the nine months.
Supplemental operating measures: Nine-month FFO was $308.3 million and MFFO was $308.5 million; Adjusted EBITDA was $345.5 million. These are non-GAAP measures and are not substitutes for net income or cash flow.
Cash uses: Nine-month investing cash outflow was $73.0 million, including $56.8 million for hotel acquisitions and $41.4 million for capital improvements, offset in part by $28.4 million of sale proceeds. Distributions paid were $200.7 million, or $0.90 per share.

Balance sheet, debt and liquidity

At September 30, total assets were $4.914 billion, total liabilities $1.410 billion, and shareholders’ equity $3.504 billion.
Total debt carrying value was approximately $1.305 billion: $216.7 million drawn on the revolving credit facility, $656.0 million in term loans net of issuance costs, and $432.8 million in mortgage debt.
The revolving facility had $323.3 million of unused capacity and a 2.78% variable rate. Cash and cash equivalents were zero. The company reported compliance with debt covenants.
About $319.2 million, or 24% of debt, remained exposed to variable interest rates after swaps. Management estimated that a 100-basis-point rate change would affect annual net income by approximately $3.2 million.
Debt principal maturities were concentrated in 2019 ($248.4 million) and 2020 ($451.2 million). The company stated that operating cash flow, credit availability, borrowing, property sales and potential equity issuance were expected to meet anticipated needs.

Material changes and unusual items

Reported revenue increased 17.5% in Q3 and 25.2% for the nine months, but comparisons are substantially affected by the September 2016 Apple Ten merger, which added 56 hotels. The 2017 period also included three hotel acquisitions; the prior-year period included the merger and another hotel acquisition.
Reported earnings comparisons also reflect unusual items. Q3 2016 included $36.5 million of merger and litigation costs, while Q3 2017 had none. Nine-month 2017 included a $16.0 million gain on the sale of a Dallas hotel, a $7.9 million impairment charge, and a $2.6 million litigation-insurance reimbursement. Nine-month 2016 included $37.9 million of transaction and litigation costs and a $5.5 million impairment charge.
For additional context, management’s merger-adjusted pro forma presentation showed nine-month net income of $182.2 million in 2017 versus $177.0 million in 2016; pro forma revenue was approximately $949.6 million in both periods.
The company acquired three hotels for $56.4 million during the first nine months. It sold a Dallas hotel in April for approximately $56.1 million, recognizing a $16.0 million gain; it sold a Fairfax hotel in October for $41.5 million, with an estimated $0.3 million gain.
In July, the company added an $85 million unsecured term loan maturing in 2024 and used the proceeds to repay revolving borrowings. Two additional Residence Inn acquisitions closed in October for a combined approximately $81.3 million.

Outlook, risks and contingencies

Management and the lodging industry forecast low-single-digit comparable revenue growth for full-year 2017, with a similar trend expected into 2018. Management cited uneven demand, increased hotel supply in some markets and limited rate growth; it expected the company’s 2017 comparable revenue growth to be below 2016.
Labor costs and property-tax assessments were expected to continue rising. Management planned further renovations, with approximately $25 million of capital spending anticipated for the remainder of 2017. Seasonality may require use of available financing to support cash needs.
The current monthly distribution was $0.10 per share, or $1.20 annualized. The filing cautions that the board may adjust distributions and that the company is not required to maintain the current rate for REIT purposes.
Two hotels under construction remained subject to closing conditions, with an aggregate purchase price of approximately $64.8 million. The filing notes there is no assurance those transactions will close.
Hurricanes Harvey and Irma increased demand in some markets; reported hotel damage was not material. Management warned that natural disasters and insurance limits could adversely affect results.
A proposed $5.5 million settlement in the Moses litigation had preliminary court approval, with a hearing scheduled for January 2018; approval was not assured and losses could exceed the accrual. In a separate Wilchfort class action, the company said it could not reasonably estimate any potential loss. Management reported no expected additional costs or reimbursements for the resolved Apple Ten merger litigation.

Investor verification points

Separate underlying comparable hotel trends from acquisition-driven growth and one-time litigation, impairment and property-sale items.
Review the basis and sustainability of the $0.10 monthly distribution against operating cash flow, debt service and planned acquisitions and renovations.
Verify refinancing and liquidity plans for the 2019–2020 maturity concentration, variable-rate exposure and post-quarter hotel purchases and sale.
Track the remaining construction-purchase conditions, pending litigation outcomes and any changes to the estimated settlement exposure.
Assess expense trends, particularly labor and property taxes, against management’s low-single-digit growth outlook.