Apple Hospitality REIT, Inc. quarterly report, Q2 FY2014

Apple Hospitality REIT, Inc. — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 30, 2014. The company is a U.S. hotel REIT. Effective March 1, 2014, it completed mergers with Apple REIT Seven and Apple REIT Eight, became self-advised, and changed its name from Apple REIT Nine. At quarter-end, it owned 188 hotels with 23,489 rooms in 33 states. Unless otherwise noted, financial amounts below are in millions.

Financial results and operating metrics

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Revenue	$232.6	$104.6	$369.7	$197.0
Operating income (loss)	$51.7	$26.1	$(38.9)	$45.6
Net income (loss)	$43.8	$23.5	$(50.7)	$40.4
Basic and diluted EPS	$0.12	$0.13	$(0.16)	$0.22
Operating cash flow	Not presented by quarter	Not presented by quarter	$98.0	$60.2

• Q2 hotel statistics for all properties owned at June 30: occupancy 81% versus 80%, ADR $123 versus $115, and RevPAR $100 versus $92. Six-month statistics were 78% versus 76%, $122 versus $115, and $96 versus $87, respectively. These reported comparisons reflect different property counts and ownership periods.
• Comparable-hotel RevPAR increased 7% in both Q2 and the first half. Pro forma RevPAR, assuming the mergers occurred January 1, 2013, increased 8% in Q2 and 7% in the first half.
• Q2 hotel operating expenses were $128.0 million, or 55% of revenue, compared with $56.9 million, or 54%. Six-month expenses were $206.4 million, or 56%, versus $109.3 million, or 55%.
• Q2 FFO was $74.7 million and adjusted FFO was $77.3 million. Six-month FFO was $(0.2) million and adjusted FFO was $122.0 million. Adjusted EBITDA was $85.4 million for Q2 and $134.1 million for the first half. These are non-GAAP measures; the six-month figures exclude specified nonrecurring items in adjustments.

Balance sheet, debt, and liquidity

• At June 30, total assets were $3,831.4 million, including net real estate of $3,709.3 million; shareholders’ equity was $3,083.0 million. Cash and cash equivalents were only $0.8 million, and restricted cash for furniture, fixtures, and other escrows was $36.0 million.
• Total debt carrying value was approximately $704.5 million: $176.8 million under the new credit facility and $527.7 million of mortgage debt on the balance sheet. The filing separately reports mortgage principal of $520.3 million before fair-value adjustments. Estimated fair value of total debt was $715.9 million.
• The new unsecured facility is $345 million, comprising a $245 million revolver and a $100 million term loan; $176.8 million was outstanding at quarter-end, including the term loan. The revolver rate was approximately 1.76%; the term loan was effectively fixed at approximately 3.1% through a swap. The company reported compliance with applicable covenants.
• Scheduled principal maturities total $697.1 million before a $7.3 million debt fair-value adjustment; $33.9 million was due in the second half of 2014 and $93.3 million in 2015. The company cited operating cash flow and revolver availability as its main liquidity sources and expected these to meet anticipated requirements.
• First-half capital improvements and development spending totaled $28.8 million in investing cash flows. The company held $29.8 million in capital reserves, expected another $25–$35 million of existing-hotel capital spending during 2014, and budgeted approximately $36 million for two adjoining Richmond hotels, with $20.5 million incurred by June 30.

Material changes and unusual items

• The mergers added 99 continuing hotels and substantially changed the scale and composition of the company. Reported year-over-year results are not directly comparable: 2014 results include the acquired hotels only from March 1. The filing’s pro forma merger presentation reports six-month revenue of $430.5 million and net income of $71.5 million for 2014, versus $406.1 million and $67.2 million in 2013; it is illustrative and excludes merger-related costs and the preferred-share conversion expense.
• The six-month GAAP loss includes a $117.1 million noncash expense associated with conversion of Series B preferred shares to common shares. The conversion and merger transactions increased shares outstanding substantially; 373.8 million common shares were outstanding at August 1.
• Merger transaction costs were $3.9 million in the first half. Total merger-related costs were approximately $6.1 million, including costs incurred in 2013. The company also reported higher depreciation and interest expense, largely reflecting the expanded hotel portfolio and assumed or new borrowings.
• First-half distributions were $107.6 million, exceeding operating cash flow of $98.0 million; management said the shortfall, which included a return of capital, was funded with cash on hand and credit-facility borrowings. The annualized distribution rate was reduced from $0.83025 to $0.66 per share beginning with the March 2014 distribution. The company paid $0.055 per share in July.

Outlook, risks, and contingencies

• Management and the industry forecast a mid-single-digit percentage increase in 2014 revenue versus 2013, on comparable and pro forma bases. Management expects continued improvement in revenue and operating income, excluding merger costs, but cautioned that reported results may vary and that first-half results are not necessarily indicative of the full year.
• Risks cited include uncertain economic and government-spending conditions, local competition and market conditions, higher labor and benefit costs, property-tax increases, seasonal hotel demand, natural disasters and business interruption, interest-rate exposure, refinancing and covenant requirements, and the company’s continued qualification as a REIT.
• Four shareholder-related lawsuits are described, involving merger fairness, alleged disclosure and fiduciary-duty issues, and historical dividend reinvestment plan pricing. The company says it will defend the claims; it cannot reasonably predict outcomes or estimate any potential loss.
• Related-party dealings remain significant. The company noted they may not be arm’s length; following the mergers it became self-advised and also provides advisory services to Apple REIT Ten.
• The company was exposed to variable-rate debt; management estimated that a 100-basis-point rate change could affect annual net income by approximately $0.8 million based on the revolver balance at quarter-end. A $100 million term-loan swap and assumed mortgage swaps mitigate some rate exposure.

Important facts for investors to verify

• How much of reported growth reflects the March 1 mergers versus underlying comparable-hotel performance; review comparable and pro forma results alongside reported results.
• The sustainability of distributions relative to operating cash flow, FFO/AFFO, capital needs, debt service, and credit-facility restrictions.
• Near-term mortgage maturities, refinancing plans, remaining revolver availability, and covenant headroom.
• The final economic and accounting effects of the mergers, including purchase-price valuation assumptions and the noncash preferred-share conversion charge.
• Developments in the shareholder litigation and any eventual estimate or disclosure of potential exposure.