Apple Hospitality REIT, Inc. quarterly report, Q2 FY2011

Business context and reporting period

The supplied filing is Apple REIT Nine, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2011—not a filing identified as Apple Hospitality REIT, Inc. Apple REIT Nine elected REIT status and reported two segments: hotel investments and a long-term ground lease. At June 30, it owned 86 hotels with 10,982 rooms in 27 states, plus approximately 410 acres across 111 Fort Worth-area sites leased for natural-gas production.

Key financial metrics

Amounts below are in millions except per-share data and hotel statistics.

• Q2 operating margin was approximately 24.1% versus 13.5% a year earlier; six-month operating margin was approximately 22.2% versus 12.9%. Net margin was approximately 22.7% versus 13.0% for Q2, and 21.2% versus 12.5% for the six-month periods.
• At June 30, cash and cash equivalents were $67.7 million, total assets $1.749 billion, notes payable $125.6 million, total liabilities $137.2 million, and shareholders’ equity $1.612 billion. Debt carrying value was $125.6 million; estimated fair value was $128.3 million. The filing does not provide a clear current ratio or other current-liquidity breakdown.
• Six-month investing cash use was $147.6 million, principally $130.7 million for acquisitions and $10.0 million for capital improvements. Financing used $59.2 million, including $80.0 million of shareholder distributions; $29.4 million of net proceeds related to Unit issuance partly offset financing outflows.
• The annualized distribution rate was $0.88 per common share, paid monthly. Six-month distributions totaled $80.0 million, exceeding operating cash flow of $50.4 million.

Material changes versus the prior comparable period

• Revenue and earnings rose sharply, but comparisons are substantially affected by portfolio expansion: the company had 86 hotels at June 30, 2011 versus 44 a year earlier. It acquired nine hotels during the first half of 2011 and opened a newly constructed 155-room hotel.
• Reported hotel revenue increased to $84.4 million for Q2 and $156.4 million for the first half, versus $35.6 million and $62.1 million, respectively. Rental revenue was essentially unchanged at $5.3 million for Q2 and $10.7 million for the first half.
• Hotel operating expenses declined as a share of hotel revenue: 56% versus 59% in Q2 and 57% versus 61% for the six-month period. Depreciation increased to $24.7 million for the first half from $12.5 million, reflecting the larger portfolio; net interest expense also increased.
• Cash declined by $156.4 million from year-end 2010 to $67.7 million, principally reflecting acquisitions, distributions, and other cash uses.

Outlook, risks, contingencies, and unusual items

• Management reported improving hotel demand and room rates and anticipated mid-single-digit revenue growth for comparable hotels during the remainder of 2011 versus 2010. Management cautioned that it did not expect revenue and operating income to return to pre-recession levels. These are forward-looking expectations, not guarantees.
• Comparable hotel statistics improved: Q2 occupancy was 74% versus 68%, ADR $107 versus $103, and RevPAR $79 versus $70. For the first half, occupancy was 70% versus 65%, ADR $108 versus $102, and RevPAR $76 versus $66.
• Three hotels under construction were subject to potential purchase contracts totaling $51.2 million, with closing conditions outstanding. The company expected to fund any completed purchases with cash on hand. It reported $9.0 million in capital reserves, approximately $6.0 million of first-half capital spending, and anticipated a further $13.0 million for the remainder of 2011.
• Management said cash and expected property cash flow should cover operating costs, debt service, capital improvements, and anticipated 2011 distributions. However, distributions have partly been funded from offering proceeds; maintaining the distribution rate depends in part on investing proceeds in income-producing properties, and continuation or tax classification of distributions at that rate is not assured.
• Three putative securities class actions were filed in June 2011. The company disputed the claims and intended to defend them, but could not predict outcomes or estimate possible losses. It also disclosed regulatory inquiries and stated it expected significant legal costs to continue at least through the remainder of 2011.
• Related-party exposure is notable: ASRG, owned by the CEO, receives a 2% fee on gross real-estate purchase or sale prices. The company incurred $3.3 million of ASRG fees in the first half of 2011 and reported approximately $32.4 million of such fees since inception. The filing says related-party arrangements are not necessarily arm’s length.
• After quarter-end, the company reported a contract to potentially sell its Fort Worth land and improvements for $198.4 million. The sale was not reported as completed; a purchaser partner was also a director of Apple REIT Ten. In July, redemptions totaled approximately $16.0 million, fulfilling about 41% of requested redemptions.
• Hotel seasonality, economic and competitive conditions, natural disasters, tenant performance under the ground lease, litigation and regulatory actions, and execution of acquisition plans are identified risks. Management reported disclosure controls were effective as of June 30, 2011.

Important facts for investors to verify

• Confirm the issuer identity: the filing supplied is for Apple REIT Nine, Inc., while the request names Apple Hospitality REIT, Inc.
• Assess how much of reported growth reflects acquisitions and newly opened hotels rather than comparable-property performance.
• Verify the sustainability and funding sources of the $0.88 annualized distribution, given distributions exceeded first-half operating cash flow.
• Review the status and potential financial impact of the three lawsuits, regulatory inquiries, and related legal expenses.
• Check the outcome of the proposed $198.4 million land sale, the three pending hotel purchase contracts, and the July redemption activity.
• Examine debt terms and repayment needs, related-party fees and governance, and the tenant and concentration risks associated with the Fort Worth ground lease.