Apple Hospitality REIT, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; filed November 7, 2016. The company is a U.S. lodging REIT. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where indicated.
Business context and reporting period
At quarter-end, Apple Hospitality owned 236 hotels with 30,299 rooms in 33 states, operating under Marriott or Hilton brands. On September 1, it completed its merger with Apple REIT Ten, adding 56 hotels and 7,209 rooms. The merger consideration was approximately $1.0 billion, including 48.7 million shares valued at $956.1 million and $93.6 million cash. Because the acquired hotels were consolidated only from September 1, reported year-over-year results are not directly comparable; the merger materially expanded the portfolio and share count.
Financial and operating results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $276.5m | $240.6m | $758.6m | $685.3m |
| Operating income | $23.8m | $56.4m | $132.2m | $144.9m |
| Net income | $13.7m | $47.0m | $103.1m | $135.1m |
| Basic and diluted EPS | $0.07 | $0.27 | $0.57 | $0.74 |
| Operating margin | 8.6% | 23.5% | 17.4% | 21.1% |
| Net margin | 5.0% | 19.5% | 13.6% | 19.7% |
Revenue rose 14.9% in the quarter and 10.7% year to date, reflecting portfolio changes as well as hotel performance. GAAP profit fell substantially, primarily due to merger-related transaction costs, including litigation-related costs, and a $5.5 million impairment charge. Q3 transaction costs were $36.5 million versus $0.8 million a year earlier; nine-month costs were $37.9 million versus $7.9 million. The prior-year nine-month comparison also included a $15.4 million real estate sale gain.
Comparable-hotel RevPAR increased 1.5% in Q3 and 3.0% year to date. Q3 comparable ADR rose 1.7% to $134.75, while occupancy edged down to 80.1% from 80.3%. For the nine months, ADR rose 3.2% to $134.90 and occupancy was 78.5% versus 78.7%. Adjusted EBITDA was $104.1 million in Q3 and $283.2 million for the first nine months; Modified FFO was $93.7 million and $253.4 million, respectively. These are company-defined non-GAAP measures and are not substitutes for GAAP results or cash available for distributions.
Net cash provided by operating activities was $238.0 million for the first nine months, versus $205.2 million in 2015. Investing activities used $162.6 million, including $93.6 million merger cash consideration, $24.0 million for the Atlanta hotel, and $47.5 million for capital improvements and development costs. Financing activities used $75.3 million, including $161.9 million of distributions paid. Cash and cash equivalents were zero at September 30.
Debt and liquidity
Total debt carrying value was approximately $1.349 billion at September 30, up from approximately $998 million at December 31, 2015. This comprised $302.1 million outstanding on the $540 million revolving facility, $570.7 million in term loans (net of issuance costs), and $476.4 million in mortgage debt. The revolver had approximately $237.9 million of unused capacity. The company reported compliance with applicable debt covenants. Approximately $404.6 million, or 30% of total debt, was subject to variable rates after swaps; management estimated that a 100-basis-point rate change would affect annual net income by about $4.0 million.
Operating cash flow and revolver availability are the principal liquidity sources. Management stated these, together with additional borrowing capacity, were expected to meet anticipated needs, including debt service, acquisitions, renovations, distributions and repurchases. The annualized distribution rate was $1.20 per share, payable monthly; the company cautioned that the rate is discretionary and could be reduced if liquidity or financing conditions warrant.
Material changes, outlook, risks and unusual items
- Merger and integration: Apple Ten substantially increased the portfolio, debt and share count. Preliminary acquired-asset and liability valuations remained subject to change; no goodwill was recorded.
- Outlook: Management and the industry forecast low-single-digit comparable revenue growth for full-year 2016, slightly below the prior-quarter forecast, with the trend expected to continue into 2017. Management expected comparable hotel performance to improve for the remainder of 2016, but at a slower pace than in recent years.
- Operating pressures: Management cited uneven demand and increased room supply in some markets as constraints on rate growth. Labor costs, including wage and benefit pressures, and property-tax reassessments could raise expenses. Hotel results are seasonal, typically stronger in Q2 and Q3.
- Impairment and planned dispositions: The company recorded a $5.5 million impairment on its Chesapeake, Virginia Marriott after identifying it for sale. In October, it contracted to sell that hotel and a Dallas Hilton for combined gross proceeds of about $66.3 million; closings were conditional. If completed, management estimated a combined net gain of about $11.4 million and intended to use net proceeds to reduce revolver borrowings.
- Litigation: The Quinn merger-related case reached a $32 million settlement agreement in principle on November 2, subject to court approval. The settlement amount was recorded in liabilities and transaction costs; management anticipated $10–$15 million from insurance and other parties, but had not recognized it because amounts were not agreed. A separate Moses shareholder claim remained unresolved, and the company said it could not estimate any possible loss.
- Other commitments and subsequent events: Three hotel purchase contracts totaled $56.5 million, with expected closings in the first half of 2017 subject to conditions. Subsequent to quarter-end, the company contracted to pursue a Phoenix hotel for $44.1 million and entered a $70 million, fixed-rate mortgage at 3.55% maturing in 2026; proceeds reduced revolver borrowings.
- Key risks: Hotel-market and economic conditions, supply growth, labor costs, financing and interest-rate exposure, execution of acquisitions and sales, litigation, REIT qualification, and potential tax consequences if Apple Ten did not qualify as a REIT or the merger failed to qualify as a tax-free reorganization.
Most important facts for investors to verify
- How reported and comparable hotel operating performance evolves after the Apple Ten portfolio is fully included, particularly RevPAR, occupancy and ADR trends.
- Final purchase-price allocation for Apple Ten and the company’s ability to integrate the 56 acquired hotels.
- Whether the $32 million Quinn settlement receives court approval and whether the anticipated $10–$15 million recovery is realized.
- Debt maturities, refinancing needs, revolver availability, variable-rate exposure and covenant compliance.
- Whether planned hotel sales and purchase commitments close, and the resulting proceeds, gains or funding needs.
- Whether operating cash flow can support distributions, capital spending and any share repurchases without materially increasing leverage.