Apple Hospitality REIT, Inc. quarterly report, Q1 FY2014

Apple Hospitality REIT, Inc. — Q1 2014 Form 10-Q

Reporting period: Three months ended March 31, 2014. Dollar amounts below are in millions unless noted. Apple Hospitality REIT is a U.S. hotel-owning REIT. On March 1, it completed mergers with Apple REIT Seven and Apple REIT Eight, becoming self-advised and expanding to 188 hotels with 23,489 rooms across 33 states. Because the acquired hotels contributed only one month of results, reported year-over-year comparisons are not representative of a full-period portfolio comparison.

Financial and operating results

Metric	Q1 2014	Q1 2013
Total revenue	$137.2	$92.4
Operating income (loss)	$(90.5)	$19.5
Net income (loss)	$(94.5)	$16.9
Net income (loss) per common share	$(0.38)	$0.09
Cash provided by operations	$22.9	$23.3
Capital improvements and development cash spending	$11.8	$3.3

• Reported revenue increased 48.5%, but the increase largely reflects the mergers. On an unaudited pro forma basis assuming the mergers took effect January 1, 2013, revenue was $198.3 versus $188.3, and net income was $27.0 versus $24.8. The pro forma results exclude $2.0 of merger costs and the $117.1 non-cash preferred-share conversion expense.
• The $117.1 non-cash expense arose when the Company’s Series B preferred shares converted to common shares upon termination of the advisory agreements. It drove the reported quarterly loss; the cash flow statement adds the expense back to net loss.
• Comparable hotels’ RevPAR rose 7% to $88, with ADR up 5% to $121 and occupancy at 72%, up one percentage point. Pro forma statistics for all 188 hotels showed RevPAR up 5% to $85, ADR up 3% to $119 and occupancy up one percentage point to 72%.
• Hotel operating expenses were 57% of revenue in both reported periods. The filing does not provide a clear comparable-property operating margin or a company-wide adjusted earnings measure.

Balance sheet, debt and liquidity

• At March 31, total assets were $3,845.6, including net real estate of $3,722.3; total liabilities were $742.1 and shareholders’ equity was $3,103.6.
• Debt carrying value was approximately $703.9: $544.8 of mortgage debt and $150.5 outstanding under the new credit facility. Mortgage debt was secured by 50 properties; maturities ranged from September 2014 to October 2032. The filing reports estimated debt fair value of $708.1.
• The new unsecured facility totals $345: a $245 revolving facility and a $100 term loan. The revolver had $50.5 outstanding, with a stated variable rate of about 1.75%; the term loan was effectively fixed at about 3.1% through March 2019 by an interest-rate swap. The revolver matures in March 2018, with a conditional one-year extension option. The facility may be increased to $700 subject to conditions.
• Cash and cash equivalents were zero at quarter-end; restricted cash was $37.0. The Company said operating cash flow and revolving-facility availability were expected to meet anticipated liquidity needs. The filing does not give a single unrestricted-cash liquidity cushion beyond these reported balances and facility terms.
• Operating cash flow of $22.9 was below the $45.9 of distributions paid during the quarter; the Company 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. Management noted the Company was not required to distribute at the then-current rate to satisfy REIT requirements.
• The Company reported compliance with its credit-facility covenants at March 31 and expected to remain compliant for the rest of 2014.

Material changes, outlook and risks

• The mergers added 99 hotels and were accounted for as business combinations. The estimated share consideration was approximately $1.8 billion, based on about 180 million shares valued at $10.10 each. Purchase-price allocation remained preliminary and was expected to be finalized during 2014; final fair values could differ significantly.
• The Company became self-advised and its former advisory agreements were terminated. It anticipated total merger costs of approximately $5.8, including $2.0 incurred in Q1 and $3.1 in 2013; it expected a further $0.7 during 2014, excluding possible litigation-defense costs.
• Management forecast a mid-single-digit percentage increase in 2014 revenue versus 2013 on both comparable and pro forma bases, and expected continued improvement in revenue and operating income excluding merger costs. This was a forecast, not quantified earnings guidance. Management cited harsh weather and reduced government spending as headwinds, as well as potential labor-benefit and property-tax cost increases.
• The Company was developing adjoining Courtyard and Residence Inn hotels in Richmond, expected to open by year-end 2014. Total expected project cost was about $36; $13.0 had been incurred by March 31. It also anticipated $40–$50 of 2014 capital spending on existing hotels.
• Ground leases assumed in the mergers had estimated payments totaling $322.5, including $295.6 thereafter. Hotel seasonality typically results in higher occupancy and revenue in the second and third quarters. Management also cautioned that economic conditions, hotel competition, financing, REIT qualification, natural disasters and litigation could affect results.
• Litigation remains uncertain. An appellate court affirmed dismissal of securities and unjust-enrichment claims in the earlier consolidated case but remanded certain state-law claims for further proceedings. Additional shareholder class actions concern the mergers and historical dividend-reinvestment-plan share prices. The Company said it could not reasonably predict outcomes or estimate potential losses.
• After quarter-end, the Company paid $20.6 in April distributions and $2.3 to shareholders exercising appraisal rights. The Company stated disclosure controls were effective at March 31, 2014.

Important facts for investors to verify

• Final merger purchase-price allocation and the fair values assigned to acquired assets and assumed liabilities.
• Underlying hotel performance and margins on a full-period, comparable basis, separating merger-driven scale increases from organic growth.
• Cash available after distributions, capital spending and debt service; near-term mortgage maturities; and availability under the revolving facility subject to covenants.
• The sustainability and funding of the $0.66 annualized distribution rate, given quarterly distributions exceeded operating cash flow.
• Progress, total cost and completion timing for the Richmond development and planned hotel renovations.
• Developments in the shareholder litigation, potential defense costs and any eventual loss exposure, which the filing does not quantify.