Apple Hospitality REIT, Inc. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The filing provides quarterly data, including fourth-quarter results, but is an annual report rather than a standalone Q4 filing. Unless noted, financial results cover the company before the March 1, 2014 mergers with Apple REIT Seven and Apple REIT Eight.
Business context
Apple Hospitality REIT owned 89 hotels with 11,371 rooms in 27 states at year-end 2013. It operates as a U.S. hotel REIT, primarily investing in branded select-service and extended-stay properties managed under third-party agreements. After the subsequent mergers, the company reported 188 continuing hotels and 23,490 rooms in 33 states and changed its name from Apple REIT Nine, Inc.
Financial and operating performance
| Metric | 2013 | 2012 |
|---|---|---|
| Total revenue | $388.0 million | $365.6 million |
| Operating income | $82.7 million | $76.6 million |
| Income from continuing operations | $81.9 million | $68.7 million |
| Net income | $115.2 million | $75.5 million |
| Net income per common share | $0.63 | $0.41 |
| Cash from operating activities | $137.4 million | $123.0 million |
| Cash and cash equivalents at year-end | $18.1 million | $9.0 million |
| Notes payable at year-end | $162.6 million | $166.8 million |
| Shareholders’ equity at year-end | $1,311.8 million | $1,346.1 million |
Hotel operating expenses were $220.2 million, or 57% of revenue, in 2013, unchanged as a share of revenue. Operating income was about 21.3% of revenue, compared with about 21.0% in 2012. Occupancy improved to 74% from 72%, ADR to $115 from $111, and RevPAR to $85 from $80. Average Market Yield increased to 122 from 120.
Modified funds from operations (MFFO) was $135.7 million, compared with $131.6 million; FFO was $136.7 million versus $128.2 million. The company cautions that FFO and MFFO are supplemental measures, are not necessarily comparable with other companies’ definitions, and do not necessarily represent cash available for needs.
For Q4 2013, revenue was $90.8 million versus $86.7 million in Q4 2012. Income from continuing operations was $23.3 million versus $13.1 million; reported net income was $56.6 million versus $13.1 million, reflecting the $33.3 million discontinued-operations gain recognized in Q4 2013.
Material changes and unusual items
- Net income included a $33.3 million gain on the 2012 sale of 110 Fort Worth-area parcels, recognized after the buyer repaid a $60 million note in November 2013. The company also recognized $9.0 million of deferred interest income in Q4 2013.
- Operating cash flow of $137.4 million was below the $151.6 million of 2013 monthly distributions. Management said the shortfall was funded with cash on hand, credit-facility borrowings and proceeds from repayment of the note receivable. The $0.75-per-unit special distribution in 2012 makes that year’s total distributions of $291.1 million non-comparable with 2013.
- The March 1, 2014 mergers added roughly 180 million common shares and $385.1 million of mortgage debt. The company became self-advised; its Series B preferred shares converted into common shares, and Series A preferred shares were terminated. The filing estimated a $104–$128 million noncash expense in Q1 2014 related to the conversion, subject to final fair value.
- On March 3, 2014, the company replaced its $50 million credit facility with a $345 million unsecured facility ($245 million revolver and $100 million term loan), and borrowed $150 million to repay the acquired companies’ credit-facility balances and pay closing costs. The term loan is hedged with an interest-rate swap; facility covenants include limits affecting distributions.
Liquidity, distributions and outlook
At December 31, 2013, the company had $18.1 million of cash and no borrowings on its then-existing $50 million credit facility. Management expected operating cash flow and post-merger credit availability to cover debt service, improvements, development, distributions and repurchases. Existing debt had maturities from 2014 onward; the filing reported $57.3 million of principal due in 2015 and $39.8 million in 2016.
The company forecast a mid-single-digit percentage increase in 2014 revenue compared with 2013, on both a comparable and pro forma post-merger basis. It expected to spend $15–$20 million on existing-hotel capital improvements in 2014 on a standalone basis, or approximately $50–$60 million as the combined company. The Richmond Courtyard and Residence Inn development was expected to cost about $36 million in total and be completed by year-end 2014; $8.9 million had been incurred by year-end 2013.
Beginning with the March 2014 distribution, the stated annual rate was reduced from $0.83025 to $0.66 per common share. Distributions remain subject to board approval and cash availability; the company is not required to maintain the prior rate for REIT qualification. The credit facility generally restricts distributions to 100% of annual FFO, subject to REIT requirements.
Risks, contingencies and governance
- Hotel results are exposed to economic weakness, reduced business and leisure travel, local competition and new room supply, labor and operating-cost increases, seasonality, renovations, and natural disasters or other losses that may exceed insurance coverage.
- The hotel portfolio is concentrated in one industry; real estate and the company’s shares are illiquid. There was no established public trading market. The dividend reinvestment and unit redemption programs were suspended in 2013, with approximately 12.1 million unfulfilled redemption requests reported after the last redemption date.
- Two securities matters remained unresolved: an appeal of a dismissed class action and a separate merger-related shareholder class action. The company said it could not estimate the likelihood or range of loss.
- In February 2014, the SEC settled its investigation with the company, related REITs and associated parties. The company did not admit or deny the allegations; the settlement required no company penalty, though civil penalties applied to certain individuals and advisors. The order cited historical disclosure and control deficiencies and had no impact on the company’s financial statements.
- Related-party arrangements included advisory, brokerage and cost-sharing transactions involving entities owned by the CEO. The filing states these arrangements were not necessarily at arm’s length. Merger completion ended the company’s prior advisory agreements.
Ernst & Young issued an unqualified opinion on the financial statements and on internal control over financial reporting; management also concluded controls were effective at December 31, 2013.
Investor verification priorities
- Verify the final purchase-price allocation, acquired debt and integration results for the Apple Seven and Apple Eight mergers, including the final value and accounting for the estimated $104–$128 million conversion expense.
- Assess whether the post-merger $0.66 annual distribution is supported by recurring operating cash flow, after capital spending and debt service, rather than one-time proceeds or borrowings.
- Reconcile 2013 net income and Q4 earnings to recurring hotel operations, excluding the parcel-sale gain and deferred interest.
- Review post-merger leverage, debt maturities, floating-rate exposure, credit-facility covenant headroom and the distribution restrictions.
- Monitor the litigation appeal and merger-related suit, SEC settlement implications, related-party governance, and the absence of a public trading market or active redemption mechanism.