Apple Hospitality REIT, Inc. quarterly report, Q2 FY2016

Apple Hospitality REIT, Inc. — Q2 2016 Form 10-Q

Reporting period: Three and six months ended June 30, 2016. The company is a U.S. lodging REIT; at quarter-end it owned 179 hotels with 22,961 rooms across 32 states.

Financial performance and position

Metric	Q2 2016	Q2 2015	First half 2016	First half 2015
Revenue	$257.6 million	$234.4 million	$482.1 million	$444.7 million
Operating income	$64.6 million	$52.2 million	$108.4 million	$88.5 million
Net income	$54.7 million	$44.2 million	$89.4 million	$88.1 million
Diluted EPS	$0.31	$0.24	$0.51	$0.47

Q2 revenue rose 9.9% and net income rose 23.7% year over year. Operating margin increased to approximately 25.1% from 22.3%.
First-half revenue rose 8.4%; operating income increased 22.5%. Net income edged up 1.5%, with comparison affected by a $15.4 million real-estate sale gain in first-half 2015. First-half operating margin was approximately 22.5%, versus 19.9%.
Comparable-hotel RevPAR increased 5.1% in Q2 and 4.5% in the first half. For Q2, ADR was $138.16, up 4.7%, and occupancy was 82.2%, versus 81.9%.
First-half operating cash flow was $136.7 million, versus $116.8 million. Investing cash use was $34.4 million and financing cash use was $80.7 million. Cash and cash equivalents ended at $21.6 million.
At June 30, total liabilities were $1.100 billion, including approximately $1.023 billion of debt carrying value; shareholders’ equity was $2.626 billion. Cash plus unused revolving-credit capacity of approximately $384.4 million provided liquidity.
First-half interest and other expense rose to $18.4 million from $15.0 million. Approximately 25% of debt was exposed to variable rates after swaps; management estimated that a 100-basis-point rate change would affect annual net income by about $2.6 million.
Distributions paid in the first half totaled $104.7 million, or $0.60 per share. The stated annual distribution rate was $1.20 per share, payable monthly; a further $17.5 million distribution was accrued at quarter-end and paid in July.

Material changes and capital allocation

Hotel count increased from 174 at June 30, 2015 to 179, while the company made no hotel acquisitions or dispositions in the first half of 2016. Prior-year results included hotel purchases and the sale of 19 properties, affecting period comparability.
The company entered a new $150 million term-loan facility in April and borrowed $50 million initially; it could draw the remaining $100 million by October 5, 2016. Proceeds were intended to reduce revolver borrowings and support repayment of upcoming mortgage maturities.
First-half capital improvements and development costs in the cash-flow statement were $35.5 million. Management separately reported approximately $28.8 million invested in capital expenditures and expected another $20–$30 million of spending in the second half.
The board extended the share-repurchase authorization through July 2017, with up to $475 million authorized. The program may be suspended or terminated; first-half 2016 repurchases were limited.

Outlook, risks and notable items

Management and the lodging industry forecast low- to mid-single-digit revenue growth for comparable hotels in full-year 2016 versus 2015, and expected further improvement in comparable-hotel revenue and operating income. Management noted growth expectations were below 2015’s achieved rate.
Operating risks cited include increased hotel supply in some markets, labor availability and wage/benefit costs, property-tax increases, economic and market uncertainty, seasonality, and natural disasters or business interruption. Renovations took approximately 51,000 room nights out of service in the first half.
The proposed Apple REIT Ten merger remained subject to shareholder approvals and other closing conditions. The amended terms contemplated approximately 48.7 million new company shares and $93.4 million cash consideration, plus assumption of Apple Ten debt of approximately $262 million. Current holders were expected to own about 78% of the combined company. The company expected a third-quarter close if conditions were met; completion was not assured.
A July 19, 2016 shareholder lawsuit sought, among other relief, to enjoin the merger vote. A court hearing on the injunction motion was scheduled for August 26; the company said it considered the allegations meritless and intended to defend vigorously. Failure to complete the merger could involve additional costs and, in certain circumstances, a $25 million termination fee.
Merger-related costs of approximately $1.2 million were incurred in the first half; total costs were estimated at approximately $4 million. The filing also disclosed related-party arrangements involving company leadership and Apple Ten.
Approximately $4.8 million of hedge losses in accumulated other comprehensive loss was expected to be reclassified to interest expense within 12 months. The company reported compliance with debt covenants at June 30.

Most important facts for investors to verify

Whether both companies’ shareholders approved the Apple Ten merger, whether the litigation affected its timing or terms, and the final share issuance, cash requirement and assumed debt.
Upcoming debt maturities, refinancing plans and the availability and cost of revolver and term-loan funding.
Whether comparable RevPAR growth and margins held up as management’s full-year outlook implied, particularly given labor, tax and supply pressures.
The sustainability of the $1.20 annual distribution relative to recurring operating cash flow, capital spending and merger-related funding needs.
The distinction between GAAP earnings and supplemental non-GAAP measures such as FFO, MFFO and Adjusted EBITDA; these measures are not substitutes for cash available for distributions.