With the exception of assumed mortgage loans on certain hotel properties, substantially all of the purchase price of the hotels was funded by proceeds from the Company’s best-efforts offering of Units, completed in July 2007. The Company also used the proceeds of its offering to pay 2% of the gross purchase price for these hotels, which was approximately $18.0 million, as a brokerage commission to Apple Suites Realty Group, Inc. (“ASRG”), wholly-owned by Glade M. Knight, the Company’s Chairman and Chief Executive Officer. The Company leased all of its hotels to wholly-owned taxable REIT subsidiaries under master hotel lease agreements. No hotels have been purchased since September 2008, and there are no outstanding purchase contracts for additional hotels as of June 30, 2010.
As of June 30, 2010, the Company owned 51 hotels with 6,426 rooms. The Company’s portfolio of hotels owned is unchanged since 2008. Hotel performance is impacted by many factors including economic conditions in the United States, as well as each locality. During the past two years, the overall weakness in the U.S. economy has had a considerable negative impact on both consumer and business travel. As a result, revenue in most markets in the United States has declined. Although economic conditions appear to be stabilizing and improving slightly, the Company expects revenue for the industry as a whole to continue to be below pre-recession levels until general economic conditions improve. The Company’s hotels in general have shown results consistent with industry and brand averages for the period of ownership.
Revenues
The Company’s principal source of revenue is hotel room revenue and other related revenue. For the three months ended June 30, 2010 and 2009, the Company had total revenue of $52.3 and $50.6 million, respectively, with average occupancy of 74% and 70%, ADR of $109 and $113, and RevPAR of $81 and $79 for each period. For the six months ended June 30, 2010 and 2009, the Company had total revenue of $100.5 and $98.1 million, respectively, with average occupancy of 71% and 67%, ADR of $110 and $114, and RevPAR of $78 and $77 for each period. ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR. Since the beginning of 2010 the Company has experienced an increase in demand as shown by the improved occupancy rates. However, in addition to a stabilizing economy, this improvement is a result of reduced room rates as reflected in the ADR decline. While reflecting the impact of declining economic activity, the Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for the first six months of 2010 and 2009 was 124 and 123, respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average (100) in its local market (the index excludes hotels under renovation).
Expenses
For the three month periods ended June 30, 2010 and 2009, hotel direct expenses totaled $29.4 and $29.1 million, or 56% and 58% of total revenue, respectively. Hotel direct expenses totaled $57.4 million in each of the six month periods ended June 30, 2010 and 2009, or 57% and 58% of total revenue for each respective period. Hotel direct expenses consist of operating expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees.
Results for the three and six months periods ended June 30, 2010 reflect the impact of a continuing recessionary climate at most of the Company’s hotels, and the Company’s efforts to control costs in such an economic environment. However, certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature, and cannot be curtailed or eliminated. The Company has been successful in reducing certain labor costs, food and supply costs and utility costs by continually monitoring and sharing utilization data across its hotels and management companies. With the weakened economic conditions, the Company has and will continue to work with its management companies to reduce costs as aggressively as possible while maintaining quality and service levels at each property, however it is not anticipated these reductions will offset revenue declines from pre-recessionary periods of operation.
Taxes, insurance, and other expense for the three months ended June 30, 2010 and 2009 were $3.3 and $3.8 million, or 6% and 7% of total revenue for the applicable period. For the six months ended June 30, 2010 and 2009, taxes, insurance, and other expense totaled $6.6 and $7.4 million, or 7% and 8% of total revenue for the applicable period. Decreases in these expenses for the comparable three and six month periods ending June 20, 2010 and 2009 reflect lower real estate property tax assessments at selected hotels, including the results of successful appeals of initial assessments for some locations. In addition, the Company has experienced slightly lower property insurance expense for most hotel properties, in comparison to insurance rates in effect during 2009.
General and administrative expense for the three months ended June 30, 2010 and 2009 were approximately $1.5 and $1.2 million. For the six months ended June 30, 2010 and 2009, general and administrative expenses were $2.7 and $2.3 million. The components of general and administrative expense include advisory fees, legal fees, accounting fees, reporting expenses and the Company’s share of the loss from its investment in Apple Air Holding, LLC.
Depreciation expense for the three months ended June 30, 2010 and 2009 was $8.3 million and $8.1 million. For the six months ended June 30, 2010 and 2009, depreciation expense totaled $16.6 million and $15.9 million. These amounts represent depreciation expense of the Company’s hotel buildings and related improvements, and associated furniture, fixtures and equipment, for the respective periods owned.
Interest expense during the three months ended June 30, 2010 and 2009 totaled $1.9 and $1.6 million, respectively, and $3.7 and $2.9 million for the six months ended June 30, 2010 and 2009. Interest expense
13
primarily represents interest incurred on mortgage loans assumed on acquired hotels and interest on the Company’s line of credit (originated in April 2009). As of June 30, 2010, mortgage loans were outstanding on ten of the Company’s hotel properties, totaling $104.7 million, and the outstanding balance of the line of credit was $28.5 million. Interest expense for the six month period ended June 30, 2009 is net of capitalized interest of approximately $0.4 million, associated with hotel renovations. No capitalized interest was recorded during the six month period ended June 30, 2010.
Liquidity and Capital Resources
The Company’s operating cash flow from the hotel properties owned and borrowings under its line of credit facility are the Company’s principal sources of liquidity. To minimize its outstanding balance on its line of credit, the Company maintains minimal cash balances. The Company anticipates that cash flow from operations and credit availability will be adequate to meet substantially all of its anticipated liquidity requirements, including required distributions to shareholders, capital expenditures and debt service. The Company is pursuing additional financing so that it can make distributions in excess of distributions required to maintain its REIT status. Historically, the Company has maintained a relatively stable monthly dividend rate instead of raising and lowering the distribution with varying economic cycles. With the depressed financial results of the Company and the lodging industry, the Company will attempt to utilize additional financing to achieve this objective. Although the Company has relatively low levels of debt, there can be no assurances it will be successful with this strategy and may need to reduce its distribution to levels required to maintain its REIT status. The Company’s bylaws require board review and approval of any debt financing obtained by the Company.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions in the first six months of 2010 totaled $35.8 million and were paid monthly at a rate of $0.064167 per common share. For the same six month period, the Company’s cash generated from operations was approximately $25.3 million. This shortfall includes a return of capital and was funded primarily by additional borrowings under the Company’s line of credit facility. The Company intends to continue paying distributions on a monthly basis. However, since there can be no assurance of the ability of the Company’s properties to provide income at this level, there can be no assurance as to the classification or duration of distributions at the current monthly rate. In consideration of the weakness in economic conditions throughout the United States, the Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company. In April 2009, the Board of Directors approved a reduction in the Company’s annual distribution rate from $0.88 to $0.77 per common share. The reduction of the dividend was effective beginning with the May 15, 2009 distribution.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, an amount between 2% to 5% of gross revenues of the applicable hotel, provided that such amount may be used for the Company’s capital expenditures with respect to the applicable hotel. The Company expects that this amount will be adequate to fund required repair, replacement, and refurbishments and to maintain the Company’s hotels in a competitive condition. As of June 30, 2010, the Company held $6.1 million in restricted cash accounts for capital improvement purposes as required by certain loan or hotel management agreements. The Company substantially completed significant renovations to one hotel property during the first six months of 2010. No major renovation projects were in progress at June 30, 2010. With the depressed economic environment, the Company will only complete the most cost effective renovation projects. Total capital expenditures incurred in the first six months of 2010 were approximately $0.9 million; the Company expects total 2010 capital improvements to be approximately $5 million.
In 2007, the Company instituted a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to the lesser of: (1) the purchase price per Unit that the shareholder actually paid for the Unit, or (2) $11.00 per unit. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption
14
Program. During the six months ended June 30, 2010, the Company redeemed approximately 1.7 million Units in the amount of $18.1 million under the program. Since the inception of the program through June 30, 2010, the Company has redeemed approximately 4.9 million Units in the amount of $51.8 million. The Company has increased the maximum number of Units that may be redeemed to five percent (from three percent) of the weighted average number of Units outstanding during a year.
In 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a convenient and cost effective way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of the proceeds from this plan may include purchasing Units under the Company’s Unit Redemption Program, enhancing properties, satisfying financing obligations and other expenses, increasing working capital, funding various corporate operations, and acquiring hotels. During the six months ended June 30, 2010, approximately 1.1 million Units, representing $12.3 million in proceeds to the Company, were issued under the plan. During the six months ended June 30, 2009, approximately 1.2 million Units, representing $13.5 million in proceeds to the Company, were issued under the plan. Since the inception of the plan through June 30, 2010, approximately 6.7 million Units, representing approximately $74.2 million in proceeds to the Company, have been issued.
Related Party Transactions
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be at arm’s length, and the results of the Company’s operations may be different than if conducted with non-related parties.
The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“ASA”), pursuant to which ASA provides management services to the Company. An annual fee ranging from .1% to .25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services. During each of the six month periods ended June 30, 2010 and 2009, the Company incurred approximately $507 thousand and $509 thousand in fees related to the advisory agreement with ASA. These fees are recorded in general and administrative expense in the Company’s Consolidated Statements of Operations.
Through a contractual arrangement with Apple REIT Six, Inc., ASA provides the Company with support services. The Company reimburses ASA for the cost of the services provided by Apple REIT Six, Inc. ASA in turn reimburses Apple REIT Six, Inc. During each of the six month periods ended June 30, 2010 and 2009, the Company incurred approximately $1.0 million and $0.9 million in costs paid to ASA that were reimbursed to Apple REIT Six, Inc. These reimbursed costs are recorded in general and administrative expense in the Company’s Consolidated Statements of Operations.
ASA is 100% owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Members of the Company’s Board of Directors are also on the boards of Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc.
Subsequent Events
On July 15, 2010, the Company paid $0.064167 per common share, totaling $6.0 million, in a dividend distribution to its common shareholders. Under the Company’s Dividend Reinvestment Plan, $2.0 million were reinvested, resulting in the issuance of 185,515 Units.
In July 2010, the Company redeemed 989,610 Units for approximately $10.9 million under its Unit Redemption Program.
In July 2010, the Company entered into a variable rate term loan agreement with a banking institution, under which the Company borrowed $9.0 million. The interest rate of the loan is equal to the daily LIBOR interest rate plus 2.25 percentage points. The loan has a maturity date of December 31, 2010, and can be repaid
15
before maturity with no penalty. Proceeds of the loan will be used by the Company for general working capital purposes, including the payment of redemptions and distributions.
Impact of Inflation
Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation. Competitive pressures may, however, limit the operators’ ability to raise room rates. Currently the Company is not experiencing any material impact from inflation.
Business Interruption
Being in the real estate industry, the Company is exposed to natural disasters on both a local and national scale. Although management believes there is adequate insurance to cover this exposure, there can be no assurance that such events will not have a material adverse effect on the Company’s financial position or results of operations.
Seasonality
The hotel industry is seasonal in nature. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. As a result, there may be quarterly fluctuations in results of operations. The Company may utilize short-term borrowings in certain periods in order to offset these fluctuations in revenues and to make distributions to shareholders.
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (“FASB”) issued a pronouncement (Accounting Standards Update No. 2009-17) which amends its guidance surrounding a company’s analysis to determine whether any of its variable interests constitute controlling financial interests in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics: (a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity’s economic performance. The new pronouncement also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and enhanced disclosure about an enterprise’s involvement with a variable interest entity. This pronouncement was adopted by the Company in the first quarter of 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
16
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of June 30, 2010, the Company’s financial instruments were not exposed to significant market risk due to interest rate risk, foreign currency exchange risk, commodity price risk or equity price risk. The Company will be exposed to interest rate risk due to possible changes in short term interest rates as it invests its cash or borrows under its line of credit facility. The Company had an outstanding balance of approximately $28.5 million on its $30 million line of credit at June 30, 2010, and to the extent it utilizes the line of credit, the Company will be exposed to changes in short term interest rates. Based on the outstanding balance at June 30, 2010, every 100 basis point change in interest rates can potentially impact the Company’s annual net income by $285 thousand, subject to the conditions of the interest rate floor provisions of the line of credit facility, and with all other factors remaining the same. The Company’s cash balance at June 30, 2010 was not material.
Item 4. Controls and Procedures
Senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective and that there have been no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Since that evaluation process was completed there have been no significant changes in internal controls or in other factors that could significantly affect these controls.
17
| |
PART II. | OTHER INFORMATION |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unit Redemption Program
The Company has instituted a Unit Redemption Program to provide its shareholders who have held their Units for at least one year with the benefit of limited interim liquidity, by presenting for redemption all or any portion of their Units. If Units are held for the required one-year period, the Units may be redeemed for a purchase price equal to 92% of the price paid per Unit if the Units have been owned less than three years, or 100% of the price paid per Unit if the Units have been owned for three years or more. The board of directors reserves the right, in its sole discretion, at any time and from time to time, to waive the one-year holding period, reject any request for redemption, change the purchase price for redemptions or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. The following is a summary of redemptions during the second quarter of 2010 (no redemptions occurred in May and June 2010):
| | | | | | | | |
Issuer Purchases of Equity Securities |
| | | | | | | | |
| | (a) | | (b) | | (c) | | (d) |
Period | | Total Number
of Units
Purchased | | Average Price Paid
per Unit | | Total Number of
Units Purchased as
Part of Publicly
Announced Plans
or Programs | | Maximum Number
of Units that May
Yet Be Purchased
Under the Plans or
Programs |
| |
| |
| |
| |
|
April 2010 | | 906,094 | | $ 10.80 | | 4,906,840 | | (1) |
(1) The maximum number of Units that may be redeemed in any 12 month period is limited to five percent (5.0%) of the weighted average number of Units outstanding from the beginning of the 12 month period.
18
Item 6. Exhibits
| | |
Exhibit
Number | | Description |
| |
|
| | |
3.1 | | Amended and Restated Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.3 to amendment no. 3 to the Registrant’s registration statement on Form S-11 (SEC File No. 333-125546) effective March 3, 2006). |
| | |
3.2 | | Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to the Registrant’s registration statement on Form S-11 (SEC File No. 333-125546) effective March 3, 2006). |
| | |
31.1 | | Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH). |
| | |
31.2 | | Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH). |
| | |
32.1 | | Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH). |
19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | |
APPLE REIT SEVEN, INC. | | |
| | | |
By: | /s/ GLADE M. KNIGHT | | Date: August 3, 2010 |
|
| | |
| Glade M. Knight, | | |
| Chairman of the Board and | | |
| Chief Executive Officer | | |
| (Principal Executive Officer) | | |
| | | |
By: | /s/ BRYAN PEERY | | Date: August 3, 2010 |
|
| | |
| Bryan Peery, | | |
| Chief Financial Officer | | |
| (Principal Financial and Principal Accounting Officer) | | |
20
