Apple Hospitality REIT, Inc. annual report, FY2019

Apple Hospitality REIT, Inc. — 2019 Form 10-K

Reporting period: Fiscal year ended December 31, 2019; filed February 24, 2020. This is an annual filing, not a standalone fourth-quarter report. Apple Hospitality is a U.S. lodging REIT; at year-end it owned 233 hotels with 29,870 rooms across 34 states. Substantially all hotels operated under Marriott or Hilton brands, through third-party managers.

Financial and operating performance

Metric	2019	2018	Change
Total revenue	$1,266.6 million	$1,270.6 million	Down 0.3%
Net income	$171.9 million	$206.1 million	Down 16.6%
Diluted net income per share	$0.77	$0.90	Down $0.13
Cash from operating activities	$381.7 million	$404.8 million	Down 5.7%
Capital improvements	$78.7 million	$71.1 million	Up 10.7%
FFO / Modified FFO	$361.1 million / $365.9 million	$391.6 million / $395.8 million	FFO down 7.8%; MFFO down 7.6%

Revenue was nearly flat, but costs rose: hotel operating expense increased to $724.4 million from $715.9 million and rose to 57.2% of revenue from 56.3%. General and administrative expense increased 49% to $36.2 million, primarily reflecting higher incentive compensation and executive separation costs. Interest and other expense rose 19.5% to $61.2 million, including $8.2 million of finance-lease interest. Operating income was $233.8 million, down from $257.9 million. Net margin was approximately 13.6% in 2019 versus 16.2% in 2018, calculated from reported revenue and net income.

For comparable hotels, ADR increased 0.2% to $137.70, occupancy declined 0.1 percentage point to 77.1%, and RevPAR was essentially flat at $106.12. Management attributed softer operating results to flat RevPAR and increased labor costs. Fourth-quarter revenue was $290.0 million versus $295.3 million in 2018; net income was $25.5 million versus $34.2 million, and diluted EPS was $0.11 versus $0.15.

Balance sheet, debt and distributions

Year-end total assets were $4.94 billion and shareholders’ equity was $3.29 billion. Net debt on the balance sheet was $1.32 billion; the company separately reported approximately $1.33 billion of principal debt outstanding, before specified accounting adjustments.
Debt comprised approximately $455.0 million of mortgage debt and $870.9 million under unsecured credit facilities. The weighted-average interest rate, including swaps, was 3.59%. Approximately 98% of debt was effectively fixed-rate at year-end; $28.4 million remained variable-rate.
Unused capacity under the $425 million revolving facility was $374.1 million. The company reported a 27% debt-to-total-capitalization ratio and compliance with debt covenants. Cash and cash equivalents were zero; restricted cash was $34.7 million.
Operating cash flow of $381.7 million exceeded the $268.7 million of distributions paid in 2019. The annualized distribution rate remained $1.20 per share, paid monthly. The board retains discretion to change distributions; the company may use credit facilities to maintain the monthly rate.
Investment cash flow was a net use of $14.3 million, compared with $210.2 million in 2018, reflecting $121.2 million of net property-sale proceeds. Financing cash flow was a net use of $366.3 million, including distributions and net repayments on the revolving facility.

Material changes, outlook and notable items

The portfolio declined from 241 hotels and 30,812 rooms at year-end 2018 to 233 hotels and 29,870 rooms. During 2019, the company acquired three hotels for $59.3 million and sold 11 for gross proceeds of approximately $121.7 million.
Six hotel purchase contracts totaling approximately $208.8 million remained outstanding at year-end; the properties were under development and closings were conditional. A separate Boise hotel sale contract contemplated approximately $32 million in gross proceeds, subject to closing conditions.
Management forecast flat to slightly negative comparable-hotel RevPAR growth and lower operating results in 2020 versus 2019. Factors included modest expected demand growth, continued supply growth, difficult comparisons with disaster-recovery-related demand in 2019, and the New York hotel’s brand transition.
The New York Renaissance hotel became an independent boutique hotel in January 2020. Management expected operational disruption while replacing revenue associated with the brand; estimated conversion costs were approximately $1.0 million.
Management anticipated $80–$90 million of 2020 capital improvements, including renovations at approximately 25–30 properties. No development projects were then planned.
Accounting standard adoption: effective January 1, 2019, four ground leases changed from operating to finance leases under the new lease standard. The company recorded a $5.2 million cumulative-effect adjustment to equity; prior periods were not restated, limiting comparability of lease-related expense lines.
Other unusual items included $6.5 million of impairment charges in 2019 and $5.0 million of reported gains on real estate sales. General and administrative expense included approximately $2.1 million related to separation agreements with two departing executives.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; management reported effective controls. The auditor identified real-estate impairment indicators and assumptions as a critical audit matter.

Risks and contingencies

Key exposures include lodging-market cyclicality, new hotel supply and competition, labor and other operating-cost inflation, reliance on third-party managers and Marriott/Hilton brand relationships, recurring renovation needs, and seasonality. Financing risks include debt maturities, covenant compliance, interest-rate exposure and the planned transition away from LIBOR. The company also highlights potential uninsured catastrophe losses, cybersecurity, environmental and climate risks, and the need to maintain REIT qualification and distribution requirements. It reported no litigation expected by management to have a material adverse effect. One finance ground lease had an estimated payment increase of approximately $53 million reflected in its lease asset and liability; the amount and effective date remained subject to agreement with the lessor.

Investor verification points

Verify the 2020 RevPAR and operating-results outlook against subsequent reported results, particularly the effects of the New York hotel transition and disaster-related demand comparisons.
Track labor, property insurance and property-tax costs, which pressured margins despite nearly flat comparable-hotel RevPAR.
Review debt maturities, revolving-credit availability, swap expirations and the interest-rate impact of the reduced hedge coverage anticipated in 2020.
Assess whether operating cash flow continues to cover distributions, capital spending and debt service, and whether the $1.20 annual distribution remains sustainable.
Confirm whether the six conditional acquisitions and Boise sale closed, and how proceeds and purchase funding affected leverage and liquidity.
Review finance-lease accounting and the unresolved ground-lease payment estimate when comparing 2019 expenses and obligations with prior periods.
Interpret FFO, MFFO and EBITDA measures as supplemental non-GAAP metrics, not substitutes for GAAP earnings or cash available for distributions.