administrative expenses were $3.8 and $3.4 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 September 30, 2010 and 2009 was $8.3 million and $8.2 million. For the nine months ended September 30, 2010 and 2009, depreciation expense totaled $24.9 million and $24.1 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 September 30, 2010 and 2009 totaled $1.9 and $1.7 million, respectively, and $5.6 and $4.6 million for the nine months ended September 30, 2010 and 2009. Interest expense primarily represents interest incurred on mortgage loans assumed on acquired hotels, interest on the Company’s line of credit (originated in April 2009), and interest on an unsecured term loan (originated in July 2010). As of September 30, 2010, mortgage loans were outstanding on ten of the Company’s hotel properties, totaling $103.9 million, the outstanding balance of the line of credit was $24.6 million, and the Company’s unsecured term loan balance was $9.0 million. Interest expense for the nine month period ended September 30, 2009 is net of capitalized interest of approximately $0.4 million, associated with hotel renovations. No capitalized interest was recorded during the nine month period ended September 30, 2010.
The Company’s operating cash flow from the hotel properties owned and borrowings under its $30 line of credit facility are the Company’s principal sources of liquidity. With the availability of this line of credit, the Company generally maintains little cash on hand, accessing the line as necessary. As a result, cash on hand was $0 at December 31, 2009, and $296 thousand at September 30, 2010. The outstanding balance on the line of credit was approximately $24.6 million at September 30, 2010 and its interest rate was 3.15%. The Company anticipates that cash flow from operations and the line of credit facility will be adequate to meet its liquidity requirements, including required distributions to shareholders (the Company is not required to make any distributions at this time), capital expenditures and debt service. As discussed further in Subsequent Events below, the Company has obtained additional financing so that it can make distributions in excess of required amounts to maintain its REIT status. The Company intends to maintain a relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles. With the depressed financial results of the Company and the lodging industry as compared to pre-recession levels, the Company will utilize 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 distributions to required levels. If the Company was unsuccessful in the extension of debt maturing in 2011, or if it were to default on its debt, it may be unable to make distributions. 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 nine months of 2010 totaled $53.6 million and were paid monthly at a rate of $0.064167 per common share. For the same nine month period, the Company’s cash generated from operations was approximately $45.0 million. This shortfall includes a return of capital and was funded primarily by increases in the Company’s unsecured borrowings, including 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 distribution 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 September 30, 2010, the Company held $6.6 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 nine months of 2010. Two major renovation projects are planned for late 2010 into early 2011. With the depressed economic environment, the Company will only complete the most cost effective renovation projects. Total capital expenditures incurred in the first nine months of 2010 were approximately $1.4 million; the Company expects total 2010 capital improvements to be approximately $3 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. Through September 30, 2010, shareholders could 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 Program. During the nine months ended September 30, 2010, the Company redeemed approximately 2.7 million Units in the amount of $29.0 million under the program. Since the inception of the program through September 30, 2010, the Company has redeemed approximately 5.9 million Units in the amount of $62.7 million. The maximum number of Units that may be redeemed during any twelve month period is five percent of the weighted average number of Units outstanding during the twelve month period prior to redemption.
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 distributions 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 nine months ended September 30, 2010, approximately 1.7 million Units, representing $18.5 million in proceeds to the Company, were issued under the plan. During the nine months ended September 30, 2009, approximately 1.8 million Units, representing $19.7 million in proceeds to the Company, were issued under the plan. Since the inception of the plan through September 30, 2010, approximately 7.3 million Units, representing approximately $80.4 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 nine month periods ended September 30, 2010 and 2009, the Company incurred approximately $0.8 million 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 the nine month periods ended September 30, 2010 and 2009, the Company incurred approximately $1.5 million and $1.4 million in costs paid to ASA that were reimbursed to Apple REIT Six, Inc. These costs are recorded in general and administrative expense in the Company’s Consolidated Statements of Operations.
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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., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (a newly formed REIT). Members of the Company’s Board of Directors are also on the boards of Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
Subsequent Events
On October 15, 2010, the Company paid $0.064167 per common share, totaling $5.9 million, in a distribution to its common shareholders. Under the Company’s Dividend Reinvestment Plan, $2.1 million were reinvested, resulting in the issuance of 186,453 Units.
In October 2010, the Company redeemed 1,065,949 Units for approximately $11.7 million under its Unit Redemption Program.
On October 18, 2010, the Company entered into a new credit facility, to be utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. The syndicated credit facility provides for a maximum aggregate commitment by the lenders, three commercial banks, of $85 million, and has a scheduled maturity in October 2012. The applicable interest rate under the unsecured revolving credit facility is, at the Company’s option, equal to either a) LIBOR plus 3.5%, subject to a minimum LIBOR interest rate floor of 1.5%, or b) the banks’ commercial prime rate plus 3.5%. Payments of interest are due monthly under the terms of the credit agreement; the Company may make voluntary prepayments in whole or in part, at any time. The Company is required to pay a quarterly fee at an annual rate of 0.5% on the average unused balance of the credit facility. The credit facility contains representations, financial and other covenants typical for this type of commercial credit facility. At closing the Company borrowed $35.6 million under the credit facility to extinguish its then existing unsecured loans and to pay loan transaction costs, which included arrangement and commitment fees totaling 1.25% of the gross facility commitment.
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
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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.
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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 September 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 variable rate line of credit facility and variable rate term loan agreement. The Company had an outstanding balance of approximately $24.6 million on its $30 million line of credit at September 30, 2010, and had borrowed $9.0 million at September 30, 2010 under a variable rate term loan agreement. To the extent the Company utilizes the line of credit and term loan funding sources, the Company will be exposed to changes in short term interest rates. Based on the outstanding balances at September 30, 2010 under the two variable rate credit agreements, every 100 basis point change in interest rates can potentially impact the Company’s annual net income by $336 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. With the availability of the line of credit facility, the Company generally maintains little cash on hand; the Company’s cash balance at September 30, 2010 was approximately $0.3 million.
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.
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| |
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. As of September 30, 2010, shareholders could 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 board of directors reserves the right, in its sole discretion, at any time and from time to time, to 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 third quarter of 2010 (no redemptions occurred in August and September 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 |
| |
| |
| |
| |
|
July 2010 | | 989,610 | | $10.97 | | 5,896,450 | | (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.
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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). |
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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: November 5, 2010 |
|
| | |
| Glade M. Knight, | | |
| Chairman of the Board and | | |
| Chief Executive Officer | | |
| (Principal Executive Officer) | | |
| | | |
By: | /s/ BRYAN PEERY | | Date: November 5, 2010 |
|
| | |
| Bryan Peery, | | |
| Chief Financial Officer | | |
| (Principal Financial and Principal Accounting Officer) | | |
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