AMENDMENT NO. 1
APPLE REIT NINE, INC.
The Bylaws (the “Bylaws”) of Apple REIT Nine, Inc. (the “Company”) are hereby amended as follows:
“At any time the Company has no Advisor, all provisions in these Bylaws that otherwise purport to confer rights or benefits on the Advisor, or that otherwise purport to impose obligations or liabilities on the Advisor, or that otherwise assume the existence of a Company Advisor shall have no force and effect and these Bylaws shall be construed and applied as if any and all such provisions were not contained in these Bylaws.”
Capitalized terms not defined herein shall have the meaning set forth in the Company’s Bylaws.
This Amendment No. 1 to the Bylaws shall be governed by and construed in accordance with the laws of the Commonwealth of Virginia without regard to the principles thereof relating to conflicts of law or choice of law.
TERMINATION AGREEMENT
This Termination Agreement (“Agreement”), dated as of August 7, 2013, as amended, is entered into by and among Apple Seven Advisors, Inc., a Virginia corporation (“Seven Advisors”), Apple Eight Advisors, Inc., a Virginia corporation (“Eight Advisors”), Apple Nine Advisors, Inc., a Virginia corporation (“Nine Advisors”), Apple Suites Realty Group, Inc. (“ASRG,” and collectively with Seven Advisors, Eight Advisors and Nine Advisors, the “Advisors,” or individually, an “Advisor”), Apple REIT Seven, Inc., a Virginia corporation (“Apple Seven”), Apple REIT Eight, Inc., a Virginia corporation (“Apple Eight”), and Apple REIT Nine, Inc., a Virginia corporation (“Apple Nine,” and collectively with Apple Seven and Apple Eight, the “Companies,” or individually a “Company”).
WHEREAS, the Companies, Apple Seven Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Seven Acquisition Sub”), and Apple Eight Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Eight Acquisition Sub”), are entering into an Agreement and Plan of Merger, dated as of August 7, 2013 (as it may be amended or otherwise modified from time to time, the “Merger Agreement”), pursuant to which Apple Seven will merge with and into Seven Acquisition Sub (the “Apple Seven Merger”), and Apple Eight will merge with and into Eight Acquisition Sub (the “Apple Eight Merger,” and together with the Apple Eight Merger, the “Mergers,” or individually a “Merger”), with Seven Acquisition Sub and Eight Acquisition Sub continuing as the Surviving Corporations in the Mergers (all capitalized terms used but not defined herein shall have the meanings set forth in the Merger Agreement).
WHEREAS, certain of the Companies and certain of the Advisors are parties to the agreements set forth on Schedule 1 hereto (the “Related Party Agreements”).
WHEREAS, pursuant to Section 6.1(d) of the Merger Agreement, the respective obligation of each Company to effect the Mergers is partially conditioned upon the effectiveness of this Agreement as of the Effective Time.
NOW, THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree, intending to be legally bound, as follows:
1. Termination of Related Party Agreements. As of immediately before the Effective Time, the Related Party Agreements shall be terminated and shall be of no further force or effect, except as provided herein. The termination of the Related Party Agreements immediately before the Effective Time shall not affect any of the rights or obligations of any party to any such Related Party Agreement accruing prior to the Effective Time; provided, however, each Advisor and each Company acknowledges that no fees shall be payable as a result of the termination of the Related Party Agreements.
2. Representations and Warranties from the Companies. Each of the Companies, as to itself only, represents and warrants to each of the Advisors as follows:
(a) Such Company has the legal capacity, power, authority and right (contractual or otherwise) to execute and deliver this Agreement and to perform his obligations hereunder.
(b) This Agreement has been duly executed and delivered by such Company and constitutes a valid and binding obligation of such Company enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relevant to creditors’ rights and general principles of equity.
(c) The execution and delivery of this Agreement and the consummation of the transactions herein contemplated will not (i) conflict with or violate the Articles of Incorporation or Bylaws of such Company, (ii) conflict with or violate any court order, judgment or decree applicable to such Company, or (iii) conflict with or result in any breach of or constitute a default (or an event which with notice or lapse of time or both would become a default) under any contract or agreement to which such Company is a party or by which such Company is bound or affected, which conflict, violation, breach or default in the case of (ii) or (iii) would materially and adversely affect such Company’s ability to perform any of its obligations under this Agreement.
3. Representations and Warranties from the Advisors. Each Advisor, as to itself only, represents and warrants to each of the Companies as follows:
(a) Such Advisor has the legal capacity, power, authority and right (contractual or otherwise) to execute and deliver this Agreement and to perform its obligations hereunder.
(b) This Agreement has been duly executed and delivered by such Advisor and constitutes a valid and binding obligation of such Advisor enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relevant to creditors’ rights and general principles of equity.
(c) The execution and delivery of this Agreement and the consummation of the transactions herein contemplated will not (i) conflict with or violate the Articles of Incorporation or Bylaws of such Advisor, (ii) conflict with or violate any court order, judgment or decree applicable to such Advisor, or (iii) conflict with or result in any breach of or constitute a default (or an event which with notice or lapse of time or both would become a default) under any contract or agreement to which such Advisor is a party or by which such Advisor is bound or affected, which conflict, violation, breach or default in the case of (ii) or (iii) would materially and adversely affect such Advisor’s ability to perform any of its obligations under this Agreement.
4. Descriptive Headings. The descriptive headings herein are inserted for convenience only and are not intended to be part of or to affect the meaning or interpretation of this Agreement.
5. Amendment; Waivers. This Agreement shall not be amended, altered or modified except by an instrument in writing duly executed by each of the parties hereto and, with respect to Apple Seven, Apple Eight and Apple Nine, with the prior approval of each Special Committee thereof. No delay or failure on the part of any party hereto in exercising any right, power or privilege under this Agreement shall impair any such right, power or privilege or be construed as a waiver of any default or any
acquiescence thereto. No waiver shall be valid against any party hereto, unless made in writing and signed by the party against whom enforcement of such waiver is sought, and then only to the extent expressly specified therein.
6. Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other parties.
7. Entire Agreement; No Third-Party Beneficiaries. This Agreement (a) constitutes the entire agreement and supersedes all prior agreements and understandings, both written and oral, between the parties with respect to the subject matter of this Agreement and, (b) is not intended to confer upon any person other than the parties hereto any rights or remedies.
8. Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the Commonwealth of Virginia, regardless of the laws that might otherwise govern under applicable principles of conflict of laws thereof.
9. Assignment. Neither this Agreement nor any of the rights, interests or obligations under this Agreement shall be assigned or delegated, in whole or in part, by operation of law or otherwise by any party without the prior written consent of the other party. Subject to the preceding sentence, this Agreement will be binding upon, inure to the benefit of, and be enforceable by, the parties and their respective successors and assigns.
10. Enforcement. The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of the United States located in the Commonwealth of Virginia or in any Virginia state court, this being in addition to any other remedy to which they are entitled at law or in equity. In addition, each of the parties hereto (a) consents to submit itself (without making such submission exclusive) to the personal jurisdiction of any federal court located in the Commonwealth of Virginia or any Virginia state court in the event any dispute arises out of this Agreement or any of the transactions contemplated by this Agreement and (b) agrees that it will not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court. EACH OF THE PARTIES HERETO IRREVOCABLY WAIVES TRIAL BY JURY IN ANY ACTION, SUIT OR PROCEEDING WITH RESPECT TO THIS AGREEMENT.
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IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Termination Agreement, or have caused this Termination Agreement to be duly executed and delivered in their names and on their behalf, all as of the date first written above.
APPLE REIT SEVEN ADVISORS, INC.
By: /s/ Glade M. Knight______________
Name: Glade M. Knight
Title: President
APPLE REIT EIGHT ADVISORS, INC.
By: /s/ Glade M. Knight______________
Name: Glade M. Knight
Title: President
APPLE REIT NINE ADVISORS, INC.
By: /s/ Glade M. Knight______________
Name: Glade M. Knight
Title: President
APPLE SUITES REALTY GROUP, INC.
By: /s/ Glade M. Knight______________
Name: Glade M. Knight
Title: President
APPLE REIT SEVEN, INC.
By: /s/ Justin G. Knight______________
Name: Justin G. Knight
Title: President
APPLE REIT EIGHT, INC.
By: /s/ Justin G. Knight______________
Name: Justin G. Knight
Title: President
APPLE REIT NINE, INC.
By: /s/ Justin G. Knight______________
Name: Justin G. Knight
Title: President
Schedule 1
1. | Advisory Agreement between Apple REIT Seven, Inc. and Apple Seven Advisors, Inc. dated as of March 2, 2006. |
2. | Property Acquisition/Disposition Agreement between Apple REIT Seven, Inc. and Apple Suites Realty Group, Inc., dated as of March 2, 2006. |
3. | Advisory Agreement between Apple REIT Eight, Inc. and Apple Eight Advisors, Inc. dated as of May 24, 2007. |
4. | Property Acquisition/Disposition Agreement between Apple REIT Eight, Inc. and Apple Suites Realty Group, Inc., dated as of May 24, 2007. |
5. | Advisory Agreement between Apple REIT Nine, Inc. and Apple Nine Advisors, Inc. dated as of April 23, 2008. |
6. | Property Acquisition/Disposition Agreement between Apple REIT Nine, Inc. and Apple Suites Realty Group, Inc., dated as of April 23, 2008. |
SUBCONTRACT AGREEMENT
This Subcontract Agreement (the “Agreement”), dated as of August 7, 2013, as amended, is entered into by and among Apple REIT Nine, Inc., a Virginia corporation (“Apple Nine”), and Apple Ten Advisors, Inc., a Virginia corporation (“Apple Ten Advisors”).
WHEREAS, Apple Nine, Apple REIT Seven, Inc., a Virginia corporation (“Apple Seven”), Apple REIT Eight, Inc., a Virginia corporation (“Apple Eight”), Apple Seven Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Seven Acquisition Sub”), and Apple Eight Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Eight Acquisition Sub”), are entering into an Agreement and Plan of Merger, dated as of August 7, 2013 (as it may be amended or otherwise modified from time to time, the “Merger Agreement”), pursuant to which Apple Seven will merge with and into Seven Acquisition Sub (the “Apple Seven Merger”), and Apple Eight will merge with and into Eight Acquisition Sub (the “Apple Eight Merger,” and together with the Apple Eight Merger, the “Mergers,” or individually a “Merger”), with Seven Acquisition Sub and Eight Acquisition Sub continuing as the Surviving Corporations in the Mergers (all capitalized terms used but not defined herein shall have the meanings set forth in the Merger Agreement).
WHEREAS, Apple REIT Ten, Inc., a Virginia corporation (“Apple Ten”), and Apple Ten Advisors are parties to an Advisory Agreement, dated as of December 20, 2010, as amended, whereby Apple Ten has engaged Apple Ten Advisors to perform specified services to Apple Ten for specified fees (as the same may be amended from time to time in accordance with the terms thereof and this Agreement, the “Advisory Agreement”).
WHEREAS, pursuant to Section 6.1(e) of the Merger Agreement, the respective obligation of each of the Apple REITs to effect the Mergers is partially conditioned upon the effectiveness of this Agreement as of the Effective Time.
Now, THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree, intending to be legally bound, as follows:
1. The Subcontract. Effective as of the Effective Time, Apple Ten Advisors agrees to transfer all of its right, title and interest to, and Apple Nine hereby agrees to accept, all fees, expenses or other payments Apple Ten is obligated to pay under the Advisory Agreement, and Apple Nine, directly or through its Subsidiaries, agrees to perform the obligations and duties of Apple Ten Advisors under the Advisory Agreement, arising on or after the Effective Time, when and as each such performance shall be required of Apple Ten Advisors under the Advisory Agreement.
2. Further Duties of Apple Ten Advisors. Apple Ten Advisors hereby agrees that at the reasonable direction of Apple Nine it shall use its commercially reasonable efforts to perform or take such action under the Advisory Agreement, including, without limitation, demanding payment or performance from Apple Ten under the Advisory Agreement; provided, however, that Apple Ten Advisors shall not be required to (a) perform or take any action that could extend or increase its obligations under the Advisory Agreement (unless such obligations are to be performed solely by Apple Nine in connection with this Agreement), (b) incur any costs or expenses in connection with this Agreement or under the Advisory Agreement (unless reimbursed by Apple Nine), or (c) terminate the Advisory Agreement, through Section 22(c) of the Advisory Agreement or otherwise. In addition, Apple Ten Advisors agrees to deliver to Apple Nine any payments, received after the Effective Time from Apple Ten under the Advisory Agreement, as promptly as practicable (and in no event later than 5 business days) following receipt of such payments, and to keep separate from Apple Ten Advisors’ other assets such amounts until paid to Apple Nine hereunder. Apple Ten Advisors also agrees to forward any notices, documents or instruments or other information relating to the Advisory Agreement to Apple Nine promptly (and in no event later than 5 business days) after receiving such information.
3. Other Agreements. Apple Ten Advisors shall not, without the prior written consent of Apple Nine (acting at the direction of a majority of the non-management directors of Apple Nine), enter into any amendment, modification or supplement of the Advisory Agreement (including, without limitation, agreeing to any other services pursuant to Section 14 thereof) or grant any consent, waiver or release, which amendment, modification, supplement, consent, waiver or release would reasonably be expected to in any manner, directly or indirectly, enlarge, extend or prolong Apple Nine’s obligations or liabilities hereunder, release Apple Ten or its affiliates of any of its obligations or liabilities thereunder or diminish any of Apple Ten Advisors’ rights thereunder. The parties agree that Apple Ten Advisors’ right to terminate the Advisory Agreement pursuant to Section 22 thereof is not affected by the foregoing and that Apple Ten Advisors retains the right, in its sole discretion, to exercise its rights under Section 22 of the Advisory Agreement; provided, however, Apple Ten Advisors shall not terminate the Advisory Agreement unless the Property Acquisition/Disposition Agreement, dated December 10, 2010 and effective January 19, 2011 between Apple Ten and
Apple Suites Realty Group, Inc. is concurrently terminated. During the term of this Agreement, Apple Ten Advisors shall not assign any of its rights under the Advisory Agreement or enter into any other subcontract arrangement with respect to the Advisory Agreement.
4. Representations and Warranties of Apple Ten Advisors. Apple Ten Advisors represents and warrants that:
(a) Apple Ten Advisors has the legal capacity, power, authority and right (contractual or otherwise) to execute and deliver this Agreement and to perform its obligations hereunder.
(b) This Agreement has been duly executed and delivered by Apple Ten Advisors and constitutes a valid and binding obligation of Apple Ten Advisors enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relevant to creditors’ rights and general principles of equity.
(c) The execution and delivery of this Agreement and the consummation of the transactions herein contemplated will not (i) conflict with or violate the Articles of Incorporation or Bylaws of Apple Ten Advisors, (ii) conflict with or violate any court order, judgment or decree applicable to Apple Ten Advisors, or (iii) conflict with or result in any breach of or constitute a default (or an event which with notice or lapse of time or both would become a default) under any contract or agreement to which Apple Ten Advisors is a party or by which Apple Ten Advisors is bound or affected, which conflict, violation,
breach or default in the case of (ii) or (iii) would materially and adversely affect Apple Ten Advisor’s ability to perform any of its obligations under this Agreement.
(d) To the Knowledge of Apple Ten Advisors, neither Apple Ten Advisors nor Apple Ten is in breach or violation of, or default under, the Advisory Agreement. For purposes of this Agreement, “Knowledge of Apple Ten Advisors” shall mean the actual knowledge of the persons listed on Schedule 10.1(b) of the Apple Nine Disclosure Letter.
5. Representations and Warranties of Apple Nine. Apple Nine represents and warrants that:
(a) Apple Nine has the legal capacity, power, authority and right (contractual or otherwise) to execute and deliver this Agreement and to perform its obligations hereunder and under the Advisory Agreement.
(b) This Agreement has been duly executed and delivered by Apple Nine and constitutes a valid and binding obligation of Apple Nine enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency, moratorium or other similar laws relevant to creditors’ rights and general principles of equity.
(c) The execution and delivery of this Agreement, the consummation of the transactions herein contemplated, and the performance required under the Advisory Agreement by Apple Nine will not (i) conflict with or violate the Articles of Incorporation or Bylaws of Apple Nine, (ii) conflict with or violate any court order, judgment or decree applicable to Apple Nine, or (iii) conflict with or result in any breach of or constitute a default (or an event which with notice or lapse of time or both would become a default) under any contract or agreement to which Apple Nine is a party or by which Apple Nine is bound or affected, which conflict, violation, breach or default in the case of (ii) or (iii) would materially and adversely affect Apple Nine’s ability to perform any of its obligations under this Agreement or the Advisory Agreement.
6. Termination. In the event the Merger Agreement is terminated in accordance with its terms, this Agreement shall also terminate immediately upon the date on which the Merger Agreement is terminated. In addition, this Agreement and the rights and duties of the parties under this Agreement (except for outstanding payments to be made pursuant to Section 1 hereof or any indemnification claims made pursuant to Section 7 hereof) shall terminate upon the termination or expiration of the Advisory Agreement.
7. Indemnification.
(a) Apple Nine shall indemnify, defend and hold harmless Apple Ten Advisors and its affiliates and their respective officers, directors, members, employees, agents, representatives, successors and assigns from and against any liabilities, losses or damages asserted against or suffered by Apple Ten Advisors relating to, resulting from or arising out of any breach by Apple Nine of any of its covenants or agreements under this Agreement, or (ii) the Advisory Agreement on or after the Effective Time (provided such breach results primarily from a breach by Apple Nine of any of its covenants or agreements under this Agreement).
(b) Apple Ten Advisors shall indemnify, defend and hold harmless Apple Nine and its affiliates and their respective officers, directors, members, employees, agents, representatives, successors and assigns from and
against any liabilities, losses or damages asserted against or suffered by Apple Nine relating to, resulting from or arising out of any breach by Apple Ten Advisors of (i) any of its covenants or agreements under this Agreement or (ii) the Advisory Agreement on or after the Effective Time (provided such breach does not result primarily from a breach by Apple Nine of any of its covenants or agreements under this Agreement). In addition, Apple Ten Advisors agrees to seek indemnification on behalf of Apple Nine under Section 18 of the Advisory Agreement for any liabilities and losses arising from the operations of Apple Ten (including Apple Nine’s costs and expenses, including legal fees and expenses, incurred in connection with investigating and defending itself against such liabilities and losses) if the conditions set forth under Section 18 of the Advisory Agreement could be met and agrees to transfer to Apple Nine any indemnification payments made to Apple Ten Advisors pursuant to Section 18 of the Advisory Agreement upon receipt.
(c) Each party shall promptly notify the other of any claim that it may have for indemnification under this Agreement.
8. Further Assurances. The parties shall, upon the reasonable request of the other party, execute and deliver such documents and take such actions as the other party may reasonably deem necessary to effectuate the purposes of this Agreement.
9. Descriptive Headings. The descriptive headings herein are inserted for convenience only and are not intended to be part of or to affect the meaning or interpretation of this Agreement.
10. Amendment; Waivers. This Agreement shall not be amended, altered or modified except by an instrument in writing duly executed by each of the parties hereto and, with respect to Apple Nine, with the approval of the Special Committee thereof (prior to the Effective Time) or a majority of the non-management directors of the board of directors thereof (after the Effective Time). No delay or failure on the part of any party hereto in exercising any right, power or privilege under this Agreement shall impair any such right, power or privilege or be construed as a waiver of any default or any acquiescence thereto. No waiver shall be valid against any party hereto, unless made in writing and signed by the party against whom enforcement of such waiver is sought, and then only to the extent expressly specified therein.
11. Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other parties.
12. Entire Agreement; No Third-Party Beneficiaries. This Agreement (a) constitutes the entire agreement and supersedes all prior agreements and understandings, both written and oral, between the parties with respect to the subject matter of this Agreement and, (b) is not intended to confer upon any person other than the parties hereto any rights or remedies.
13. Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the Commonwealth of Virginia, regardless of the laws that might otherwise govern under applicable principles of conflict of laws thereof.
14. Assignment. Neither this Agreement nor any of the rights, interests or obligations under this Agreement shall be assigned or delegated, in whole or in part, by operation of law or otherwise by any party without the prior written consent of the other party. Subject to the preceding sentence, this Agreement will be binding upon, inure to the benefit of, and be enforceable by, the parties and their respective successors and assigns.
15. Enforcement. The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of the United States located in the Commonwealth of Virginia or in any Virginia state court, this being in addition to any other remedy to which they are entitled at law or in equity. In addition, each of the parties hereto (a) consents to submit itself (without making such submission exclusive) to the personal jurisdiction of any federal court located in the Commonwealth of Virginia or any Virginia state court in the event any dispute arises out of this Agreement or any of the transactions contemplated by this Agreement and (b) agrees that it will not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court. APPLE NINE AND APPLE TEN ADVISORS IRREVOCABLY WAIVE TRIAL BY JURY IN ANY ACTION, SUIT OR PROCEEDING WITH RESPECT TO THIS AGREEMENT.
16. Apple Ten Acknowledgement. Apple Ten acknowledges the terms of this Agreement and agrees that, as a result of this Agreement, the provisions of the Advisory Agreement for the benefit of Apple Ten Advisors (specifically excluding any rights of Apple Ten Advisors under Section 22 of the Advisory Agreement), to the extent that any such provisions relate to the subcontract effectuated by this Agreement, shall extend to Apple Nine.
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IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Subcontract Agreement, or have caused this Subcontract Agreement to be duly executed and delivered in their names and on their behalf, all as of the date first written above.
APPLE REIT NINE, INC.
By: /s/ Justin G. Knight
Name: Justin G. Knight
Title: President
APPLE TEN ADVISORS, INC.
By: /s/ Glade M. Knight
Name: Glade M. Knight
Title: President
APPLE REIT TEN, INC.
(For purposes of Section 16 only)
By: /s/ Justin G. Knight
Name: Justin G. Knight
Title: President
ASSIGNMENT AND TRANSFER AGREEMENT
This Assignment and Transfer Agreement (the “Agreement”), dated as of August 7, 2013, as amended, is entered into by and among APPLE FUND MANAGEMENT, LLC, a Virginia limited liability company (“Apple Fund”), Apple Nine Advisors, Inc., a Virginia corporation (“Advisors”) APPLE REIT NINE, INC., a Virginia corporation (“Apple Nine”).
INTRODUCTION
A. Advisors owns all of the membership interests (the “Interest”) in Apple Fund.
B. Apple Nine, Apple REIT Seven, Inc., a Virginia corporation (“Apple Seven”), Apple REIT Eight, Inc., a Virginia corporation (“Apple Eight” and together with Apple Seven and the Apple Nine, the “Apple REITs”), and Apple Seven Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Seven Acquisition Sub”), and Apple Eight Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Eight Acquisition Sub”), have entered into the Agreement and Plan of Merger dated as of August 7, 2013 (as it may be amended or otherwise modified from time to time, the “Merger Agreement”), pursuant to which Apple Seven will merge with and into Seven Acquisition Sub (the “Apple Seven Merger”), and Apple Eight will merge with and into Eight Acquisition Sub (the “Apple Eight Merger,” together with the Apple Seven Merger, the “Mergers”), with Seven Acquisition Sub and Eight Acquisition Sub continuing as the Surviving Corporations (as defined in the Merger Agreement) in the Mergers.
C. In order to induce the Apple REITs to enter into the Merger Agreement and proceed with the Mergers, Advisors and Apple Fund desire to enter into this Agreement.
D. Advisors desires to assign the Interest to Apple Nine and Apple Nine desires to accept the assignment of the Interest.
NOW, THEREFORE, in consideration of the foregoing and the representations, warranties and agreements herein contained, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows:
ARTICLE I
ASSIGNMENT OF THE INTEREST
1.1 Assignment of Interest. Advisors hereby assigns, transfers and delivers to Apple Nine, and Apple Nine hereby accepts, effective as of the Transfer Time and without further action by any party hereto or any other Person, all right, title and interest in and to the Interest, and in exchange Apple Nine shall, at the Transfer Time, pay to Advisors the cash consideration described in Section 2.1 and, in the capacity of a member (within the meaning of the Virginia Limited Liability Company Act, as amended), execute and deliver to Apple Fund a counterparty signature page to the Amended and Restated Operating Agreement of Apple Fund, dated as of October 5, 2007 (the “Joinder Signature Page”).
1.2 Acknowledgment of Apple Fund’s Assets and Liabilities. The parties hereto acknowledge that Apple Fund’s assets and liabilities as of the date of this Agreement include, but are not limited to:
(a) all rights, interests, duties and obligations under the Transfer Agreement, dated as of May 23, 2007, by and between Apple Hospitality Two, Inc., a Virginia corporation, and Apple Hospitality Five, Inc., a Virginia corporation (the “Apple Two Transfer Agreement”);
(b) all rights, interests, duties and obligations under the Assignment and Transfer Agreement, dated as of October 5, 2007, by and among Apple Fund, Apple Hospitality Five, Inc., a Virginia corporation, and Apple REIT Six, Inc., a Virginia corporation, and, solely for the purposes of Articles III, IV and V thereof, Inland American Real Estate Trust, Inc., a Maryland corporation, and Apple Six Advisors, Inc., a Virginia corporation (the “Apple Five Transfer Agreement”); and
(c) all rights, interests, duties and obligations under the Assignment and Transfer Agreement, dated as of November 29, 2012, by and among Apple Fund, Apple REIT Six, Inc., a Virginia corporation (“Apple Six”), Advisors, and, solely with respect to Sections 2.2 and 2.6 thereof, Apple Seven Advisors, Inc., Apple Eight Advisors, Inc. and Apple Ten Advisors, Inc. (the “Apple Six Transfer Agreement”; and, together with the Apple Two Transfer Agreement and the Apple Five Transfer Agreement, the “Transfer Agreements”).
1.3 Acknowledgement and Guarantee of Apple Five Transfer Agreement. To relieve Advisors of its liabilities and obligations under the Apple Five Transfer Agreement, Apple Nine (i) formally acknowledges and unconditionally and irrevocably guarantees, from and after the Transfer Time, all liabilities and obligations of Apple Fund under the Apple Five Transfer Agreement, if any, and (ii) shall, at the Transfer Time, execute and deliver the Acknowledgement and Guarantee set forth on Exhibit A hereto.
1.4 Assignment, Acknowledgement and Guarantee of Apple Six Transfer Agreement. Advisors, effective as of the Transfer Time or at such later time as Buyer (as defined in the Apple Six Transfer Agreement) and Acquisition Sub (as defined in the Apple Six Transfer Agreement), as successor by merger to Apple Six, have consented to such assignment if such consent has not been provided at or before the Transfer Time (“Consent Time”) and without further action by any party hereto or any other Person, fully assigns to Apple Nine all of its right, interests, duties and obligations under the Apple Six Transfer Agreement and Apple Nine hereby, effective as of the later of the Transfer Time or the Consent Time and without further action by any party hereto or any other Person, accepts the foregoing assignment of the Apple Six Transfer Agreement and hereby assumes, and agrees to pay, perform and discharge when due from and after the later of the Transfer Time or the Consent Time, all obligations and liabilities (of any nature whatsoever) of Advisors arising under or relating to the Apple Six Transfer Agreement. To relieve (i) Advisors and (ii) Apple Seven Advisors, Inc., Apple Eight Advisors, Inc. and Apple Ten Advisors, Inc. (collectively, the “Other Apple Entities”) of their liabilities and obligations under the Apple Six Transfer Agreement, Apple Nine (i) formally acknowledges and unconditionally and irrevocably guarantees, from and after the later of the Transfer Time or the Consent Time, all liabilities and obligations of Apple Fund, Advisors and the Other Apple Entities under the Apple Six Transfer Agreement, if any, and (ii) shall, at the later of the Transfer Time or the Consent Time, execute and deliver the Acknowledgement and Guarantee in substantially the form set forth on Exhibit B hereto (together with Exhibit A hereto and the Joinder Signature Page, collectively the “Ancillary Documents”) with such changes as Advisors may reasonably request provided such changes are approved by the Special Committee of Apple Nine (prior to the Effective Time) or a majority of the non-management directors of the board of directors of Apple Nine (after the Effective Time). Advisors and Apple Fund hereby consent to the assignment of the Apple Six Transfer Agreement pursuant to the provisions of this Section 1.4.
ARTICLE II
TRANSFER AGREEMENT
2.1 Consideration. At the Transfer Time, Apple Nine shall pay to Advisors a total of $1.00 in cash consideration. Additional consideration for the transactions contemplated by this Agreement is provided as described in the Introduction to this Agreement.
2.2 Advisors Representations. Advisors hereby represents and warrants to Apple Nine that:
(a) Advisors is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of organization, and has corporate power and authority to own, lease and operate all of its properties and assets and to carry on its business as now being conducted.
(b) Advisors has corporate power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement by Advisors, and the consummation by it of the transactions contemplated hereby, have been duly authorized by the board of directors of Advisors and no other corporate proceedings on the part of Advisors are necessary with respect thereto. This Agreement has been duly executed and delivered by Advisors and, assuming that the other parties hereto have duly authorized, executed and delivered this Agreement, this Agreement constitutes a valid and binding obligation of Advisors, enforceable in accordance with its terms except as such enforceability may be limited by (1) bankruptcy, insolvency, reorganization, moratorium or other similar laws now or hereafter in effect relating to creditors’ rights generally or (2) general principles of equity (regardless whether enforceability is considered in a proceeding at law or in equity).
(c) The execution and delivery of this Agreement by Advisors does not, and the consummation of the transactions contemplated hereby and compliance by Advisors with the provisions of this Agreement will not, conflict with, or result in any violation of, or default (with or without notice or lapse of time, or both) under, or give rise to a right of termination, cancellation or acceleration or other rights or obligations or loss of a benefit under, or result in the creation of any pledge, claim, lien, charge, encumbrance or security interest of any kind or nature whatsoever (each, a “Lien”) upon any of the properties or assets of Advisors or any of its Subsidiaries under (A) the Articles of Incorporation, bylaws or similar organizational documents of Advisors, (B) any agreement, contract, note, loan, evidence of indebtedness, purchase order, letter of credit indenture, security or pledge agreement, mortgage, franchise agreement, undertaking, covenant not to compete, employment agreement, license, lease, instrument, obligation or commitment (whether written or oral and whether express or implied) (each, a “Contract”) or other instrument applicable to Advisors or its properties or assets or (C) any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Advisors, other than, in the case of
clause (B) or (C), any such conflicts, violations or defaults that would not, individually or in the aggregate, materially impair the ability of Advisors to perform its obligations under this Agreement.
(d) No consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity is required by or with respect to Advisors in connection with the execution or delivery of this Agreement by Advisors or the consummation by Advisors of any of the transactions contemplated hereby.
(e) No claims for indemnification or otherwise has been made by any party to any of the Transfer Agreements. Advisors is not in material breach of or material default under any such Transfer Agreement. Advisors has not received any written claim or notice of material breach of or material default under any such Transfer Agreement. To Advisor’s Knowledge, no event has occurred which individually or together with other events, would reasonably be expected to result in a material breach of or material default under any such Transfer Agreement by Advisors, the Other Apple Entities or the other parties thereto (in each case with or without notice or lapse of time or both).
(f) Advisors owns the Interest free and clear of any Lien and any other limitation or restriction on the right to sell, transfer or otherwise dispose of the Interest.
2.3 Apple Fund Representations. Apple Fund hereby represents and warrants to Apple Nine that:
(a) Apple Fund is a limited liability company duly organized, validly existing and in good standing under the laws of its jurisdiction of organization, and has limited liability company power and authority to own, lease and operate all of its properties and assets and to carry on its business as now being conducted. Apple Fund has no Subsidiaries.
(b) Apple Fund has limited liability company power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement by Apple Fund, and the consummation by it of the transactions contemplated hereby, have been duly authorized by the governing body of Apple Fund and no other limited liability company proceedings on the part of Apple Fund are necessary with respect thereto. This Agreement has been duly executed and delivered by Apple Fund and, assuming that the other parties hereto have duly authorized, executed and delivered this Agreement, this Agreement constitutes a valid and binding obligation of Apple Fund, enforceable in accordance with its terms except as such enforceability may be limited by (1) bankruptcy, insolvency, reorganization, moratorium or other similar laws now or hereafter in effect relating to creditors’ rights generally or (2) general principles of equity (regardless whether enforceability is considered in a proceeding at law or in equity).
(c) The execution and delivery of this Agreement by Apple Fund does not, and the consummation of the transactions contemplated hereby and compliance by Apple Fund with the provisions of this Agreement will not, conflict with, or result in any violation of, or default (with or without notice or lapse of time, or both) under, or give rise to a right of termination, cancellation or acceleration or other rights or obligations or loss of a benefit under, or result in the creation of any Lien upon any of the properties or assets of Apple Fund under (A) the certificate of formation, limited liability company agreement or similar organizational documents of Apple Fund, (B) any contract or other instrument applicable to Apple Fund or its properties or assets or (C) any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Apple Fund, other than, in the case of clause (B) or (C), any such conflicts, violations or defaults that would not, individually or in the aggregate, materially impair the ability of Apple Fund to perform its obligations under this Agreement.
(d) No consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity is required by or with respect to Apple Fund in connection with the execution or delivery of this Agreement by Apple Fund or the consummation by Apple Fund of any of the transactions contemplated hereby.
(e) No claims for indemnification or otherwise has been made by any party to any of the Transfer Agreements. To Apple Fund’s Knowledge, there are no pending or threatened Actions before or by any Governmental Entity against Apple Fund or any of its assets.
(f) To Apple Fund’s Knowledge, Schedule 2.3(f) hereto contains a true, complete and accurate list of all employee benefit plans, programs, policies or arrangements maintained or contributed to by Apple Fund or with respect to which Apple Fund has at any time had any Liability or potential Liability (the “Apple Fund Benefit Plans”).
(g) To Apple Fund’s Knowledge, Apple Fund has no liabilities whatsoever, whether direct or indirect, primary or secondary, or contingent, with respect to (i) any employee benefit plan, program, policy or arrangement other than the Apple Fund Benefit Plans or (ii) any prior business activities performed by Apple Fund that are unrelated to the performance of advisory services of the same type currently performed by Apple Fund. Apple Fund is not engaged in any business activities other than with respect to the performance of advisory services for Apple Seven, Apple Eight, Apple Nine and Apple REIT Ten, Inc.
2.4 Apple Nine Representations. Apple Nine hereby represents and warrants to Advisors that:
(a) Apple Nine is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of organization, and has corporate power and authority to own, lease and operate all of its properties and assets and to carry on its business as now being conducted.
(b) Apple Nine has corporate power and authority to execute and deliver this Agreement and the Ancillary Documents and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and the Ancillary Documents by Apple Nine, and the consummation by it of the transactions contemplated hereby and thereby, have been duly authorized by the board of directors of Apple Nine and no other corporate proceedings on the part of Apple Nine are necessary with respect thereto. This Agreement has been, and the Ancillary Documents will be, duly executed and delivered by Apple Nine and, assuming that the other parties hereto have duly authorized, executed and delivered this Agreement and will duly authorize, execute and deliver the Ancillary Documents, this Agreement constitutes, and the Ancillary Documents will constitute, valid and binding obligations of Apple Nine, enforceable in accordance with their terms, except as such enforceability may be limited by (1) bankruptcy, insolvency, reorganization, moratorium or other similar laws now or hereafter in effect relating to creditors’ rights generally or (2) general principles of equity (regardless whether enforceability is considered in a proceeding at law or in equity).
(c) The execution and delivery of this Agreement by Apple Nine does not, and the execution and delivery of the Ancillary Documents will not, and the consummation of the transactions contemplated hereby and thereby and compliance by Apple Nine with the provisions of this Agreement and the Ancillary Documents will not, conflict with, or result in any violation of, or default (with or without notice or lapse of time, or both) under, or give rise to a right of termination, cancellation or acceleration or other rights or obligations or loss of a benefit under, or result in the creation of any Lien upon any of the properties or assets of Apple Nine or any of its Subsidiaries under (A) the articles of incorporation, bylaws or similar organizational documents of Apple Nine, (B) any Contract or other instrument applicable to Apple Nine or its properties or assets or (C) any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Apple Nine, other than, in the case of clause (B) or (C), any such conflicts, violations or defaults that would not, individually or in the aggregate, materially impair the ability of Apple Nine to perform its obligations under this Agreement or the Ancillary Documents.
(d) No consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity is required by or with respect to Apple Nine in connection with the execution or delivery of this Agreement and the Ancillary Documents by Apple Nine or the consummation by Apple Nine of any of the transactions contemplated hereby and thereby.
2.5 Indemnification.
(a) From and after the Transfer Time, Apple Fund and Apple Nine shall jointly and severally defend, protect and indemnify Advisors and its Subsidiaries, each of the Other Apple Entities and each of their respective officers, directors, shareholders, partners, Affiliates, employees, agents, managers, members, representatives, successors and assigns or any officer, director, shareholder, partner, Affiliate, employee, agent, manager, member, representative, successor and assign of any of the foregoing and save and hold each of them harmless from and against, and pay on behalf of or reimburse each such indemnified party on demand as and when incurred, any and all Liabilities incurred by such indemnified parties or any of them as a result of, or arising out of, or relating to (i) the Apple Two Transfer Agreement, the Apple Five Transfer Agreement or the Apple Six Transfer Agreement including, without limitation, any Liabilities of Advisors or the Other Apple Entities under Section 2.6 of the Apple Six Transfer Agreement, (iii) any employee benefit plan, program, policy or arrangement maintained or contributed to by Apple Fund or with respect to which Apple Fund has at any time had any Liability or potential Liability, including (without limitation) the Apple Fund Benefit Plans, (iv) the breach or inaccuracy of any of the representations or warranties of Apple Nine set forth herein, and (vi) any breach by Apple Nine of any of its covenants or agreements contained herein.
(b) From and after the Transfer Time, Advisors shall defend, protect and indemnify Apple Nine and its officers, directors, shareholders, partners, Affiliates, employees, agents, managers, members, representatives, successors and assigns or any officer, director, shareholder, partner, Affiliate, employee, agent, manager, member, representative, successor and assign of any of the foregoing and save and hold each of them harmless from and against, and pay on behalf of or reimburse each such indemnified party on demand as and when incurred, any and all Liabilities incurred by such indemnified parties or any of them as a result of, or arising out of, or relating to the breach or inaccuracy of any of the representations or warranties of Advisors and/or Apple Fund set forth herein, and any breach by Advisors of any of its covenants or agreements contained herein.
(c) Whenever a claim shall arise for indemnification hereunder or upon receipt by an indemnified party of a written threat of a claim which such indemnified party reasonably believes may give rise to a claim for indemnification hereunder, such indemnified party shall give prompt written notice to the indemnifying parties of the claim for indemnification and the facts, in reasonable detail, constituting the basis for such claim (a “Claim Notice”); provided that failure of an indemnified party to give a prompt Claim Notice shall not release, waive or otherwise affect an indemnifying party’s obligations with respect thereto except to the extent that such indemnifying party is materially adversely affected in its ability to defend against such claim or is otherwise materially prejudiced thereby.
(d) The obligations and liabilities of the indemnifying parties to an indemnified party under this Agreement with respect to claims resulting from the assertion of Liabilities by Persons other than an indemnified party under Section 2.5(a) or (b) (including claims of a Governmental Entity for penalties, fines and assessments) (a “Third-Party Claim”) shall be subject to the following conditions:
(i) The indemnified party shall give a prompt Claim Notice to the indemnifying parties of the nature of the Third-Party Claim and the amount thereof to the extent known; provided that failure of an indemnified party to give a prompt Claim Notice shall not release, waive or otherwise affect an indemnifying party’s obligations with respect thereto except to the extent that such indemnifying party is materially adversely affected in its ability to defend against such claim or is otherwise materially prejudiced thereby.
(ii) The indemnifying parties shall be entitled to participate in the defense of such Third Party Claim. If the indemnifying parties acknowledge in writing their obligation to indemnify the indemnified party hereunder against any Liability that may result from such Third-Party Claim, then the indemnifying parties shall be entitled to assume the defense of such Third-Party Claim at their expense and through counsel selected by the indemnifying parties (which counsel shall be reasonably acceptable to the indemnified party) within 30 days of the receipt of a Claim Notice with respect to such Third-Party Claim from the indemnified party. If a Claim Notice is given to the indemnifying parties with respect to a Third-Party Claim and the indemnifying parties do not, within such 30-day period, assume the defense of such Third-Party Claim in accordance with this Section 2.5(d), the indemnifying parties will be bound by any determination made in such Third-Party Claim or any commercially reasonable compromise or settlement effected by the indemnified party. If the indemnifying parties have assumed the defense of a Third-Party Claim in accordance with this Section 2.5(d), then no compromise or settlement of such Third-Party Claim may be effected by the indemnifying parties without the indemnified party’s prior written consent unless (A) such compromise or settlement (i) includes as an unconditional term thereof the delivery by the Person(s) asserting such claim to the indemnified party of a written unconditional release from all Liabilities in respect of such Third-Party Claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act, by or on behalf of any indemnified party and (B) the sole relief provided for in such compromise or settlement is monetary damages which will be paid in full by the indemnifying parties. No Third-Party Claim which is being defended in good faith by the indemnifying parties in accordance with the terms of this Agreement shall be settled by the indemnified party without the prior written consent of the indemnifying parties (which shall not be unreasonably withheld).
(iii) In any suit, action, claim, arbitration or proceeding relating to a Third-Party Claim the defense of which has been assumed by the indemnifying parties in accordance with this Section 2.5(d): (A) the indemnified party shall have the right to be represented by advisory counsel and accountants of its own choosing at the indemnified party’s sole cost and expense, except the indemnified party shall be entitled to retain its own counsel at the expense of the indemnifying parties if (x) the indemnified party shall have been advised by counsel that there are one or more legal or equitable defenses available to it that are different from or in addition to those available to the indemnifying parties, and, in the reasonable judgment of the indemnified party, counsel for the indemnifying parties could not adequately represent the interests of the indemnified party because such interests could be in conflict with those of the indemnifying parties, (y) such Third-Party Claim involves, or is reasonably likely to have a material effect on, any matter beyond the scope of the indemnification obligation of the indemnifying parties, or (z) the indemnifying parties shall not have assumed the defense of the Third-Party Claim in a timely fashion; and (B) the indemnifying parties shall keep the indemnified party fully informed as to the status of such Third-Party Claim at all stages thereof, whether or not the indemnified party is represented by its own counsel. With respect to any Third-Party Claim (1) the indemnifying parties shall make available to the indemnified party, and its attorneys, accountants and other representatives, all books and records of the indemnifying parties relating to such Third-Party Claim; and (2) the indemnifying parties and the indemnified party, as the case may be, shall render to each other such assistance as may be reasonably required of each other and cooperate in good faith with each other in order to ensure the proper and adequate defense of any Third-Party Claim.
(e) Notwithstanding anything in this Agreement or any applicable law to the contrary, it is understood and agreed by the parties hereto that no director, officer, employee, agent, shareholder or Affiliate of the indemnifying parties shall have (i) any personal liability to an indemnified party as a result of the breach of any representation, warranty, covenant or agreement of the indemnifying parties contained herein or otherwise arising out of or in connection with the transactions contemplated hereby or (ii) any personal obligation to indemnify an indemnified party for any claims pursuant to this Agreement, and the indemnified parties will not seek recourse or commence any action against any director, officer,
employee, agent, shareholder or Affiliate of the indemnifying parties or any of their personal assets as a result of the breach of any representation, warranty, covenant or agreement of the indemnifying parties contained herein or otherwise arising out of or in connection with the transactions contemplated hereby or thereby.
(f) To the extent that the undertakings in Section 2.5(a) or (b) by the indemnifying parties may be unenforceable for any reason, such indemnifying parties shall make the maximum contribution to the payment and satisfaction of each of the Liabilities which is permissible under applicable law.
(g) For purposes of this Agreement, the term “Liabilities” shall mean any and all actions, causes of action, suits, claims, losses, costs, penalties, fees, except as set forth in Section 3.9 below, liabilities and damages and expenses (irrespective of whether any such indemnified party is a party to the action for which indemnification hereunder is sought), including reasonable attorneys’ fees and disbursements, interest and penalties and all amounts paid in investigation, defense or settlement of any of the foregoing.
ARTICLE III
GENERAL PROVISIONS
3.1 Assignment. This Agreement shall not be assigned by any party hereto by operation of law or otherwise without the prior written consent of each of the other parties hereto. Subject to the foregoing, all covenants and agreements contained in this Agreement by or on behalf of any of the parties hereto shall bind and inure to the benefit of permitted successors and permitted assigns of the parties hereto.
3.2 Termination. This Agreement shall automatically terminate upon the termination of the Merger Agreement in accordance with its terms.
3.3 Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the Commonwealth of Virginia regardless of the laws that might otherwise govern under the principals of conflict of laws thereof.
3.4 Enforcement. The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of the United States located in the Commonwealth of Virginia or in any Virginia state court, this being in addition to any other remedy to which they are entitled at law or in equity. In addition, each of the parties hereto (a) consents to submit itself (without making such submission exclusive) to the personal jurisdiction of any federal court located in the Commonwealth of Virginia or any Virginia state court in the event any dispute arises out of this Agreement or any of the transactions contemplated by this Agreement and (b) agrees that it will not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court. EACH OF THE PARTIES HERETO IRREVOCABLY WAIVES TRIAL BY JURY IN ANY ACTION, SUIT OR PROCEEDING WITH RESPECT TO THIS AGREEMENT.
3.5 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.
3.6 Services; Access; Cooperation; Further Assurances. From and after the Transfer Time, each of Apple Fund and Apple Nine (the “Cooperating Parties”) shall (and shall cause its Affiliates and representatives to) provide (or cause to be provided) to Advisors (including, for purposes of this Agreement, any successor in interest to Advisors) and its Subsidiaries and their respective representatives reasonable access to the employees of each Cooperating Party and to all books and records (including any accounting work papers, subject to the execution and delivery, if requested by outside accountants, by Advisors, as applicable, of customary confidentiality agreements relating to the access to such accounting work papers) and any other information or data relating to Apple REIT Six, a Virginia corporation (now BRE Select Hotels Corp., a Delaware corporation) that is available to a Cooperating Party, its Affiliates or representatives, to the extent reasonably requested by Advisors for any reasonable business purpose including complying with its obligations under the Apple Six Transfer Agreement, and only to the extent that Advisors pays for any reasonable third party costs and expenses incurred by a Cooperating Party in connection with providing such access; provided, however, that the Cooperating Parties shall not have any obligation to provide such access if (i) doing so would require the Cooperating Party to incur any material third party cost or expense which Advisors will not agree to reimburse, or (ii) doing so would involve a material amount of time from any employee, Affiliate or representative of the Cooperating Party, and Advisors are unwilling to pay the Cooperating Party or such Affiliate or representative of the Cooperating Party a reasonable amount to adequately compensate it for such time. Each of the parties hereto shall cooperate with each other and use its reasonable best efforts to take, or cause to be taken, all appropriate actions, and do, or cause to be done, and assist and cooperate with the other parties hereto in doing, all things, necessary, proper or advisable (including by executing
any other documents or providing any further materials and documentation) in order to fulfill the provisions of or the purpose of this Agreement, the Apple Six Transfer Agreement and the transactions contemplated hereby.
3.7 Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of this Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms.
3.8 Entire Agreement; No Third-Party Beneficiaries. This Agreement and the transactions contemplated hereby (a) constitute the entire agreement and supersede all prior agreements and understandings, both written and oral, between the parties hereto and their respective Affiliates with respect to the subject matter hereof, and (b) except as set forth in the immediately following sentence, are not intended to and shall not confer upon any Person other than the parties hereto any rights or remedies hereunder, including the right to rely upon the representations and warranties set forth herein. Notwithstanding the foregoing, each Person indemnified pursuant to Section 2.5(a) or (b) of this Agreement shall be an express third party beneficiary under this Agreement with respect to Section 2.5 of this Agreement.
3.9 No Consequential Damages. No party to this Agreement, nor any indemnified party, shall seek or be entitled to incidental, indirect or consequential damages or damages for lost profits in any claim under this Agreement, including but not limited to claims for indemnification (except to the extent such incidental, indirect or consequential damages or damages for lost profits are awarded to any third party).
3.10 Certain Definitions. For purposes of this Agreement:
(a) “Action” means any claim, action, suit, audit, assessment, arbitration or inquiry, proceeding or investigation.
(b) “Advisor’s Knowledge” shall mean the actual knowledge of Glade M. Knight.
(c) “Affiliates” means any other Person that, directly or indirectly, controls, is controlled by, or is under common control with, such first Person. For purposes of this definition, the term “control” (including the correlative terms “controlling,” “controlled by” and “under common control with”) means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, as a trustee or executor, by contract, credit agreement or otherwise.
(d) “Apple Fund’s Knowledge” shall mean the actual knowledge of any of Glade M. Knight, David S. McKenney, Justin G. Knight, Bryan Peery, Kristian Gathright and David Buckley.
(e) “Closing Date” shall mean the date of the closing of the Mergers;
(f) “Effective Time” shall have the same meaning as in the Merger Agreement.
(g) “Governmental Entity” shall mean any governmental body, whether federal, state, local, municipal, foreign or other government, or governmental or quasi-governmental authority of any nature (including any governmental agency, branch, department, official or entity and any court or other tribunal), any self-regulatory organization and any arbitral or similar forum;
(h) “Person” shall mean an individual, corporation, partnership, limited liability company, joint venture, association, trust, unincorporated organization or other entity;
(i) “Subsidiary” of a Person shall mean any corporation, partnership, limited liability company, joint venture or other legal entity of which such Person (either directly or through or together with another Subsidiary) owns any capital stock or other equity interests of such entity;
(j) “Special Committee” shall have the same meaning as in the Merger Agreement; and
(k) “Transfer Time” shall mean the time the assignments and other actions contemplated by Sections 1.1, 1.3, and 1.4 shall become effective, which time shall be on the Closing Date immediately following the Effective Time (as defined in the Merger Agreement).
3.11 Amendments and Waivers. This Agreement may not be amended except by an instrument in writing signed by each of the parties hereto and, with respect to Apple Nine, with the prior approval of the Special Committee thereof (prior to the Effective Time) or a majority of the non-management directors of the board of directors thereof (after the Effective Time). No failure or delay of any party hereto in exercising any right or remedy hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such right or power, or any course of conduct, preclude any other or further exercise thereof or the exercise of any other right or power. The rights and remedies of the parties hereto hereunder are cumulative and are not exclusive of any rights or remedies which they would otherwise have hereunder. Any agreement on the part of a party hereto to any such waiver shall be valid only if set forth in a written instrument executed and delivered by such party.
[Remainder of page intentionally left blank.]
IN WITNESS WHEREOF, Apple Fund, Advisors and Apple Nine have caused this Agreement to be signed by their respective officers thereunto duly authorized, all as of the date first written above.
APPLE FUND MANAGEMENT, LLC
By: /s/ Justin G. Knight______________
Name: Justin G. Knight
Title: Manager
APPLE NINE ADVISORS, INC.
By: /s/ Glade M. Knight______________
Name: Glade M. Knight
Title: President
APPLE REIT NINE, INC.
By: /s/ Justin G. Knight______________
Name: Justin G. Knight
Title: President
Signature Page to Assignment and Transfer Agreement
Schedule 2.3(f)
Apple Fund Benefit Plans
1. | Group Benefit Insurance Plan from the Unum Life Insurance Company of America for Short Term Disability, Long Term Disability, Life and Accidental Death and Dismemberment for Apple Fund Management, LLC. |
2. | Dental Plan from Anthem Blue Cross and Blue Shield for Apple Fund Management, LLC. |
3. | Group Medical and Hospital Services Agreement from Southern Health Services, Inc. for Apple Fund Management, LLC. |
4. | Health Savings Account Administration for Apple Fund Management, LLC from Health Savings Administrators LLC. |
5. | Apple Fund Management, LLC Profit Sharing Plan administered by Employee Fiduciary Corporation and investment advisors by Mid Atlantic Management Inc. (401(k) Plan) |
6. Employee Benefits in Team Member Handbook:
· | Volunteer Service Hours |
· | Continuation Health Care (COBRA) Coverage |
· | 529 Plan – Virginia College Savings Plan |
· | Section 125 Cafeteria Plan |
· | Flexible Spending Accounts (FSA’s) |
· | Workers Compensation Insurance |
· | Employee Assistance Program (EAP) from Reliance Standard |
· | Educational Opportunities and Educational Reimbursement |
· | Industry Related Classes/Seminars |
· | Industry Participation (in trade and professional associations) |
· | Leaves of Absence including Military Leave, Family and Medical Leave, Personal Leave, Jury Duty/Serving as a Witness, Bereavement Leave and Workers Compensation Leave |
7. Bonus Program
8. | Vision insurance from Eye Med Vision Care LLC for Apple Fund Management, LLC. |
9. | Flexible benefit administration by Benefit Solutions, Inc./Your Flex for Apple Fund Management, LLC. |
10. | Severance Agreement dated October 16, 2012 between Apple Fund Management LLC and Lisa Little-Adams. |
11. Apple Hospitality Two, Inc. Executive Severance Plan dated August 23, 2005.
12. Apple Hospitality Two, Inc. Severance Plan dated August 23, 2005.
13. 2003 Incentive Plan of Apple Hospitality Five, Inc.
14. 2003 Non-Employee Directors Stock Option Plan of Apple Hospitality Five, Inc.
15. | Apple Fund Management, LLC Executive Severance Pay Plan, amended and restated as of January 1, 2009. |
16. | Apple Fund Management, LLC Severance Pay Plan, amended and restated as of January 1, 2009. |
17. | Apple REIT Six, Inc. 2004 Incentive Plan. |
18. | Apple REIT Six, Inc. 2004 Non-Employee Directors Stock Option Plan. |
EXHIBIT A
Acknowledgment and Guarantee
For valuable consideration, the sufficiency of which is hereby acknowledged, the undersigned hereby unconditionally and irrevocably guarantees all obligations of Apple Fund Management, LLC, a Virginia limited liability company (“Apple Fund”), under Article II of the Assignment and Transfer Agreement (the “Agreement”), dated as of October 5, 2007, by and among Apple Fund, Apple Hospitality Five, Inc., a Virginia corporation, and Apple REIT Six, Inc., a Virginia corporation, and, and, solely for the purposes of Articles III, IV and V of the Agreement, Inland American Real Estate Trust, Inc., a Maryland corporation, and Apple Six Advisors, Inc., a Virginia corporation. The undersigned hereby expressly waives any right to contest, notice, presentment or any other equitable or legal defense other than the satisfaction of Apple Fund’s obligations guaranteed hereby.
APPLE REIT NINE, INC.
By:
Name:
Title:
EXHIBIT B
Acknowledgment and Guarantee
For valuable consideration, the sufficiency of which is hereby acknowledged, the undersigned hereby unconditionally and irrevocably guarantees all obligations of Apple Fund Management, LLC, a Virginia limited liability company (“Apple Fund”), and Apple Nine Advisors, Inc., a Virginia corporation (“Apple Nine Advisors”), under the Assignment and Transfer Agreement (the “Agreement”), dated as of November 29, 2012, by and among Apple Fund and Apple REIT Six, Inc., a Virginia corporation, Apple Nine Advisors, and, solely with respect to Sections 2.2 and 2.6 of the Agreement, Apple Seven Advisors, Inc., Apple Eight Advisors, Inc. and Apple Ten Advisors, Inc. The undersigned hereby expressly waives any right to contest, notice, presentment or any other equitable or legal defense other than the satisfaction of Apple Fund’s and Apple Nine Advisors’ obligations guaranteed hereby.
APPLE REIT NINE, INC.
By:
Name:
Title:
EXECUTION COPY
[BANK OF AMERICA MERRILL LYNCH LETTERHEAD]
CONFIDENTIAL
August 6, 2013
Special Committee of the Board of Directors
Apple REIT Seven, Inc.
814 East Main Street
Richmond, VA 23219
Members of the Special Committee of the Board of Directors:
We understand that Apple REIT Seven, Inc., a Virginia corporation (“Apple Seven”), proposes to enter into an Agreement and Plan of Merger, to be dated as of August 7, 2013 (the “Agreement”), among Apple REIT Eight, Inc., a Virginia corporation (“Apple Eight”), Apple REIT Nine, Inc., a Virginia corporation (“Apple Nine”, and together with Apple Seven and Apple Eight, the “Apple REITs”, or each individually, an “Apple REIT”), Apple Seven Acquisition Sub, Inc., a Virginia corporation and a wholly owned subsidiary of Apple Nine (“Seven Merger Sub”), Apple Eight Acquisition Sub, Inc., a Virginia corporation and wholly owned subsidiary of Apple Nine (“Eight Merger Sub”, and together with Seven Merger Sub, the “Acquisition Subsidiaries”, or each individually, an “Acquisition Subsidiary”). Pursuant to the Agreement, among other things, Seven Merger Sub will merge with and into Apple Seven (the “Apple Seven Merger”) and Eight Merger Sub will merge with and into Apple Eight (the “Apple Eight Merger”). At the effective time of the Apple Seven Merger, each outstanding common share, no par value, of Apple Seven (“Apple Seven Common Shares”) together with the related Series A Preferred Share, no par value (the “Series A Preferred Shares”, and together with the Apple Seven Common Shares, the “Apple Seven Common Units”), of Apple Seven (other than any Merger Dissenting Shares (as defined in the Agreement) and any Apple Seven Common Units that are owned by any of the Apple REITs, the Acquisition Subsidiaries or any of their respective subsidiaries), will be converted into the right to receive 1.0 (the “Exchange Ratio”) common shares, no par value, of Apple Nine (“Apple Nine Common Shares”). Also at the effective time of the Apple Seven Merger, each issued and outstanding Series B Convertible Preferred Share, no par value, of Apple Seven shall be converted into the right to receive a number of Apple Nine Common Shares equal to (i) 24.17104 (the “Series B Conversion Ratio”) multiplied by (ii) the Exchange Ratio. The terms and conditions of the Apple Seven Merger (together with the terms and conditions of the Apple Eight Merger, the Apple Nine Merger and the related conversions of Series B Convertible Preferred Shares of each of Apple Seven and Apple Eight into Apple Nine Common Shares) are more fully set forth in the Agreement. The Apple Seven Merger and the Apple Eight Merger are expected to become effective simultaneously and are referred to herein collectively as the “Apple REIT Mergers”.
You have requested our opinion as to the fairness, from a financial point of view, to the holders of Apple Seven Common Units (other than the other Apple REITs and their respective Affiliates (as defined in the Agreement)) of the Exchange Ratio provided for in the Apple Seven Merger.
In connection with this opinion, we have, among other things:
(i) | reviewed certain publicly available business and financial information relating to each Apple REIT; |
(ii) | reviewed certain internal financial and operating information with respect to the business, operations and prospects of the Apple REITs, and their respective assets furnished to or discussed with us by Apple Seven Advisors, Inc., Apple Seven’s management company (“Apple Seven Advisors”), Apple Eight Advisors, Inc., Apple Eight’s management company (“Apple Eight Advisors”), and Apple Nine Advisors, Inc., Apple Nine’s management company (“Apple Nine Advisors”, and together with Apple Seven Advisors and Apple Eight Advisors, “Apple Advisors”), including certain financial forecasts relating to the Apple REITs prepared by Apple Advisors (such forecasts, the “Apple REIT Forecasts”); |
(iii) | reviewed certain estimates as to the amount and timing of cost savings, including through the internalization of certain management functions by the combined company (the “Cost Savings”), in each case anticipated by Apple Advisors to result from the Apple REIT Mergers; |
The Special Committee of The Board of Directors
Apple REIT Seven, Inc.
Page 2
(iv) | discussed the past and current business, operations, financial condition and prospects of the Apple REITs with members of senior management of Apple Advisors; |
(v) | reviewed the potential pro forma financial impact of the Apple REIT Mergers on the future financial performance of Apple Nine, including the potential effect on Apple Nine’s estimated funds from operations per share; |
(vi) | compared certain financial information of each Apple REIT with similar information of other companies we deemed relevant; |
(vii) | compared certain financial terms of the Apple Seven Merger to financial terms, to the extent publicly available, of other transactions we deemed relevant; |
(viii) | reviewed the relative financial contributions of each Apple REIT to the future financial performance of the combined company on a pro forma basis; |
(ix) | reviewed the August 3, 2013 draft of the Agreement; and |
(x) | performed such other analyses and studies and considered such other information and factors as we deemed appropriate. |
In arriving at our opinion, we have assumed and relied upon, without independent verification, the accuracy and completeness of the financial and other information and data publicly available or provided to or otherwise reviewed by or discussed with us and have relied upon the assurances of the management of Apple Advisors that they are not aware of any facts or circumstances that would make such information or data inaccurate or misleading in any material respect. With respect to the Apple REIT Forecasts and Cost Savings, we have been advised by Apple Advisors, and have assumed, with your consent, that they have been reasonably prepared on bases reflecting the best currently available estimates and good faith judgments of Apple Advisors as to the future financial performance of the respective Apple REITs and the other matters covered thereby. We have relied, at your direction, on the assessments of Apple Advisors as to Apple Nine’s ability to achieve the Cost Savings and have been advised by Apple Advisors, and have assumed, with your consent, that the Cost Savings will be realized in the amounts and at the times projected. We have not made, or been provided with, any independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of any of the Apple REITs, nor have we made any physical inspection of the properties or assets of any of the Apple REITs. We have not evaluated the solvency or fair value of any of the Apple REITs under any state, federal or other laws relating to bankruptcy, insolvency or similar matters. We have assumed, at your direction, that the Apple Seven Merger will be consummated in accordance with its terms, simultaneously with the Apple Eight Merger in accordance with its terms, without waiver, modification or amendment of any material term, condition or agreement and that, in the course of obtaining the necessary governmental, regulatory and other approvals, consents, releases and waivers for the Apple Seven Merger, no delay, limitation, restriction or condition, including any divestiture requirements or amendments or modifications, will be imposed that would have an adverse effect on any of the Apple REITs or the contemplated benefits of the Apple REIT Mergers. We have assumed that the Agreement will be executed by the parties thereto and will not contain materially different terms from the draft of the Agreement we reviewed. We express no opinion as to the potential outcome of the outstanding shareholder litigation captioned In re Apple REITs Litigation, filed in the United States Court of Appeals for the Second Circuit, docket number 13-1395-CV on July 26, 2013, that involves each of the Apple REITs and in which damages are alleged (the “Litigation”). In arriving at our opinion we have been directed by you to assume that the outcome of the Litigation will not have a material effect on the business, results of operations or financial condition of any Apple REIT or the combined company following the Apple REIT Mergers, and that the outcome of the Litigation will not have a disproportionate effect on the business, results of operations or financial condition of Apple Seven as compared to the other Apple REITs, taken as a whole.
We express no view or opinion as to any terms or other aspects of the Agreement or the Apple Seven Merger (other than the Exchange Ratio to the extent expressly specified herein), including, without limitation, the form or structure of the Apple Seven Merger, the Series B Conversion Ratio, or the allocation of consideration between the holders of Apple Seven Common Units and the holders of Apple Seven Series B Convertible Preferred Shares. We also express no view or opinion as to any terms or other aspects of the Apple Eight Merger, the Apple Nine Merger or the related conversions of Series B Convertible Preferred Shares of Apple Seven and Apple Eight into Apple Nine Common Shares, including, without limitation, the allocation of consideration among the shareholders of Apple Seven and Apple Eight in the Apple Seven Merger and the Apple Eight Merger, respectively. As you are aware, we were not requested to, and we did not, solicit indications of interest or proposals from third parties regarding a possible acquisition of all or any part of Apple Seven or any alternative transaction.
The Special Committee of The Board of Directors
Apple REIT Seven, Inc.
Page 3
Our opinion is limited to the fairness, from a financial point of view, of the Exchange Ratio to holders of Apple Seven Common Units (other than the other Apple REITs and their respective Affiliates) and no opinion or view is expressed with respect to any consideration received in connection with the Apple Seven Merger by the holders of any class of securities, creditors or other constituencies of any party. In addition, no opinion or view is expressed with respect to the fairness (financial or otherwise) of the amount, nature or any other aspect of any compensation to any of the officers, directors or employees of any party to the Apple Seven Merger, or class of such persons, relative to the Exchange Ratio. Furthermore, no opinion or view is expressed as to the relative merits of the Apple Seven Merger in comparison to other strategies or transactions that might be available to Apple Seven or in which Apple Seven might engage or as to the underlying business decision of Apple Seven to proceed with or effect the Apple Seven Merger. In addition, we express no opinion or recommendation as to how any shareholder should vote or act in connection with the Apple Seven Merger or any related matter.
We have acted as financial advisor to the Special Committee of the Board of Directors of Apple Seven in connection with the Apple Seven Merger and will receive a fee for our services, which is payable upon the delivery of this opinion. In addition, Apple Seven has agreed to reimburse our expenses and indemnify us against certain liabilities arising out of our engagement.
We and our affiliates comprise a full service securities firm and commercial bank engaged in securities, commodities and derivatives trading, foreign exchange and other brokerage activities, and principal investing as well as providing investment, corporate and private banking, asset and investment management, financing and financial advisory services and other commercial services and products to a wide range of companies, governments and individuals. In the ordinary course of our businesses, we and our affiliates may invest on a principal basis or on behalf of customers or manage funds that invest, make or hold long or short positions, finance positions or trade or otherwise effect transactions in equity, debt or other securities or financial instruments (including derivatives, bank loans or other obligations) of any of the Apple REITs and certain of their respective affiliates.
We and our affiliates in the past have provided, currently are providing, and in the future may provide, investment banking, commercial banking and other financial services to Apple Seven and certain of its affiliates and have received or in the future may receive compensation for the rendering of these services, including having acted or acting as lender under certain term loans and credit facilities for Apple Seven and certain of its affiliates.
In addition, we and our affiliates in the past have provided, currently are providing, and in the future may provide, investment banking, commercial banking and other financial services to Apple Seven, Apple Eight, Apple Nine and certain of their respective affiliates and have received or in the future may receive compensation for the rendering of these services, including having acted or acting as lender under certain term loans and credit facilities for Apple Eight and Apple Nine and certain of their respective affiliates.
It is understood that this letter is for the benefit and use of the Special Committee of the Board of Directors of Apple Seven (in its capacity as such) in connection with and for purposes of its evaluation of the Apple Seven Merger.
Our opinion is necessarily based on financial, economic, monetary, market and other conditions and circumstances as in effect on, and the information made available to us as of, the date hereof. It should be understood that subsequent developments may affect this opinion, and we do not have any obligation to update, revise, or reaffirm this opinion. The issuance of this opinion was approved by our Americas Fairness Opinion Review Committee.
Based upon and subject to the foregoing, including the various assumptions and limitations set forth herein, we are of the opinion on the date hereof that the Exchange Ratio provided for in the Apple Seven Merger is fair, from a financial point of view, to the holders of Apple Seven Common Units (other than the other Apple REITs and their respective Affiliates).
Very truly yours,
/s/ MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
MERRILL LYNCH, PIERCE, FENNER & SMITHINCORPORATED
August 6, 2013
Special Committee of the Board of Directors
of Apple REIT Eight, Inc.
814 East Main Street
Richmond, VA 23219
Ladies and Gentlemen:
You have requested our opinion as to the fairness, from a financial point of view, to the holders of the issued and outstanding shares of common stock, no par value, together with the related Series A preferred shares, no par value (collectively, the “Apple Eight Units”) of Apple REIT Eight, Inc., a Virginia corporation (“Apple Eight”), of the Apple Eight Unit Ratio (as defined below) in the Agreement and Plan of Merger (the “Merger Agreement”), to be entered into among Apple Eight, Apple REIT Seven, Inc., a Virginia corporation (“Apple Seven”), Apple REIT Nine, Inc., a Virginia corporation (“Apple Nine” and together with Apple Seven and Apple Eight, the “Companies”), Apple Seven Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Seven Sub”) and Apple Eight Acquisition Sub, Inc., a Virginia corporation and wholly-owned subsidiary of Apple Nine (“Eight Sub”). Pursuant to the Merger Agreement, Apple Eight will be merged with and into Eight Sub with Apple Eight continuing as the surviving entity and wholly-owned subsidiary of Apple Nine (the “Transaction”).
You have advised us that under the terms of the Merger Agreement, each of the issued and outstanding Apple Eight Units will be converted into the right to receive 0.85 (the “Apple Eight Unit Ratio”) Apple Nine common shares, no par value. The terms and conditions of the proposed Transaction are more fully set forth in the Merger Agreement.
KeyBanc Capital Markets Inc. (“KBCM”), as part of its investment banking business, is customarily engaged in the valuation of businesses and their securities in connection with mergers and acquisitions, negotiated underwritings, competitive biddings, secondary distributions of listed and unlisted securities, private placements and valuations for estate, corporate and other purposes.
In connection with rendering this opinion, we have reviewed and analyzed, among other things, the following: (i) a draft of the Merger Agreement, dated August 1, 2013, which we understand to be in substantially final form; (ii) certain publicly available information concerning the respective Companies, including the Annual Reports on Form 10–K of the respective Companies for each of the years in the five year period ended December 31, 2012, and the Quarterly Reports on Form 10–Q of the respective Companies for the quarters ended September 30, 2012 and March 31, 2013; (iii) certain other internal information, primarily financial in nature, including projections, concerning the business and operations of each of the respective Companies furnished to us by the Companies and the manager of the Companies, Apple Fund Management (“AFM”), for purposes of our analysis; (iv) certain publicly available information with respect to certain publicly traded companies that we believe to be comparable to the Companies and the trading markets for certain of such other companies’ securities; and (v) certain publicly available information concerning the nature and terms of certain other transactions that we consider relevant to our inquiry. We have also met with certain officers and employees of the Companies and AFM to discuss the business and prospects of each of the respective Companies, as well as other matters we believe relevant to our inquiry, and considered such other data and information we judged necessary to render our opinion.
In our review and analysis and in arriving at our opinion, we have assumed and relied upon the accuracy and completeness of all of the financial and other information provided to or otherwise reviewed by or discussed with us or publicly available and have assumed and relied upon the representations and warranties of the Companies, Seven Sub and Eight Sub contained in the Merger Agreement. We have not been engaged to, and have not independently attempted to, verify any of such information. We have also relied upon AFM and the management of the Companies as to the reasonableness and achievability of the financial and operating projections (and the assumptions and bases therefor) provided to us and, with your consent, we have assumed that such projections were reasonably prepared and reflect the best currently available estimates and judgments of AFM and the Companies. We have not been engaged to assess the reasonableness or achievability of such projections or the assumptions on which they were based and express no view as to such projections or assumptions. In addition, we have not conducted a physical inspection or appraisal of any of the assets, properties, facilities or liabilities of the Companies nor have we been furnished with any such evaluation or appraisal. We have also assumed that all governmental, regulatory or other consents and approvals necessary for the consummation of the Transaction will be obtained without material adverse effect on the Companies or the Transaction.
Special Committee of the Board of Directors of Apple REIT Eight, Inc. August 6, 2013 Page 2 | ![](https://capedge.com/proxy/DEFM14A/0001185185-14-000120/keylogo.jpg) |
We have not been asked to, nor do we, offer any opinion as to the material terms of the Merger Agreement or the form of the Transaction. In rendering our opinion, we have assumed, with your consent, that the Transaction will qualify as a tax-free reorganization for United States federal income tax purposes, that the final executed form of the Merger Agreement does not differ in any material respect from the draft that we have examined, that the conditions to the Transaction as set forth in the Merger Agreement would be satisfied and that the Transaction would be consummated on a timely basis in the manner contemplated by the Merger Agreement. We have not formally solicited, nor were we asked to solicit, third party interest in a transaction involving Apple Eight.
It should be noted that this opinion is based on economic and market conditions and other circumstances existing on, and information made available as of, the date hereof and does not address any matters subsequent to such date. In addition, our opinion is, in any event, limited to the fairness, as of the date hereof, from a financial point of view, of the Apple Eight Unit Ratio in the Merger Agreement and does not address the underlying business decision to effect the Transaction or any other terms of the Transaction. It should be noted that although subsequent developments may affect this opinion, we do not have any obligation, and do not intend, to update, revise or reaffirm our opinion. This opinion has been approved by a fairness committee of KBCM.
We have acted as financial advisor to Apple Eight in connection with the Transaction and will receive from Apple Eight a fee for our services, a significant portion of which is contingent upon the execution of a definitive agreement to effect the Transaction (the “Transaction Fee”). In addition, Apple Eight has agreed to reimburse us for certain expenses and to indemnify us under certain circumstances. We also will receive a fee in connection with the delivery of this opinion, which fee will not be credited against any Transaction Fee earned. We have not in the past provided investment banking services to Apple Eight. KeyBank National Association, of which KBCM is an affiliate, is lead bank and administrative agent under Apple Eight’s senior unsecured revolver, has previously provided a bridge term loan to Apple Eight, is sole lender under Apple Seven’s senior unsecured revolver and has provided CMBS financing to Apple Eight and Apple Seven.
It is understood that this opinion was prepared solely for the confidential use of the Special Committee of the Board of Directors of Apple Eight (the “Special Committee”) in its evaluation of the proposed Transaction. Our opinion does not constitute a recommendation to any stockholder of Apple Eight as to how such stockholder should vote at any stockholders’ meeting held in connection with the Transaction. In addition, we do not express any opinion as to the fairness of the amount or the nature of the compensation now paid or to be paid to any of the officers, directors or employees of any party to the Transaction, or class of such persons, relative to the Apple Eight Unit Ratio.
Based upon and subject to the foregoing and such other matters as we consider relevant, it is our opinion that as of the date hereof, the Apple Eight Unit Ratio in the Merger Agreement is fair, from a financial point of view, to the holders of the Apple Eight Units.
Very truly yours,
/s/ KEYBANC CAPITAL MARKETS INC.
KEYBANC CAPITAL MARKETS INC.
388 Greenwich Street New York, NY 10013 | ![](https://capedge.com/proxy/DEFM14A/0001185185-14-000120/citilogo.jpg) |
August 6, 2013
Special Committee of the Board of Directors
Apple REIT Nine, Inc.
814 East Main Street
Richmond, Virginia 23219
Members of the Special Committee:
You have requested our opinion as to the fairness, from a financial point of view, as of the date hereof, to Apple REIT Nine, Inc. (“Apple Nine”) of the aggregate consideration to be paid pursuant to the Mergers (the “Merger Consideration”) pursuant to the terms and subject to the conditions set forth in an Agreement and Plan of Merger (the “Merger Agreement”) proposed to be entered into among Apple Nine, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight” and, collectively with Apple Seven and Apple Nine, the “Apple REITs” or, individually, an “Apple REIT”), Apple Seven Acquisition Sub, Inc., a wholly-owned subsidiary of Apple Nine (“Seven Acquisition Sub”) and Apple Eight Acquisition Sub, Inc., a wholly-owned subsidiary of Apple Nine (“Eight Acquisition Sub”).
As more fully described in the Merger Agreement, (i) Seven Acquisition Sub will be merged with and into Apple Seven (the “Apple Seven Merger”), and (ii) (a) each issued and outstanding common share, no par value, of Apple Seven (the “Apple Seven Common Shares”) together with the related and linked Series A Preferred Share, no par value, of Apple Seven (including any fractional shares) (the “Apple Seven Series A Shares,” and together with the Apple Seven Common Shares, the “Apple Seven Units”) (other than dissenting shares or shares to be cancelled, in each case as provided in the Merger Agreement) will be converted into the right to receive 1.0 (the “Apple Seven Unit Ratio”) common shares, no par value, of Apple Nine (the “Apple Nine Common Shares”), and (b) each issued and outstanding Series B Convertible Preferred Share, no par value, of Apple Seven (the “Apple Seven Series B Shares”) will be converted into the right to receive a number of Apple Nine Common Shares equal to (1) 24.17104 multiplied by (2) the Apple Seven Unit Ratio.
In addition, as more fully described in the Merger Agreement, (i) Eight Acquisition Sub will be merged with and into Apple Eight (the “Apple Eight Merger” and together with the Apple Seven Merger, the “Mergers”), and (ii) (a) each issued and outstanding common share, no par value, of Apple Eight (the “Apple Eight Common Shares”) together with the related and linked Series A Preferred Share, no par value, of Apple Eight (including any fractional shares) (the “Apple Eight Series A Shares” and, together with the Apple Eight Common Shares, the “Apple Eight Units”) (other than dissenting shares or shares to be cancelled, in each case as provided in the Merger Agreement) will be converted into the right to receive 0.85 (the “Apple Eight Unit Ratio”) Apple Nine Common Shares, and (b) each issued and outstanding Series B Convertible Preferred Share, no par value, of Apple Eight (the “Apple Eight Series B Shares”) will be converted into the right to receive a number of Apple Nine Common Shares equal to (1) 24.17104 multiplied by (2) the Apple Eight Unit Ratio.
Concurrently with the Merger Agreement, Mr. Glade M. Knight, the Chief Executive Officer and Chairman of the Board of Directors of each of the Apple REITs, will enter into a voting agreement with each of the Apple REITs (the “Voting Agreement”), pursuant to which, Mr. Knight has agreed, among other things, to vote his (i) Apple Seven Units, (ii) Apple Eight Units, (iii) Apple Nine Common Shares, and the related and linked Series A Preferred Shares, no par value, of Apple Nine (the “Apple Nine Series A Shares” and, together with the Apple Nine Common Shares, the “Apple Nine Units”), (iv) Apple Seven Series B Shares, (v) Apple Eight Series B Shares and (vi) Series B Convertible Preferred Shares, no par value, of Apple Nine (the “Apple Nine Series B Shares” and, together with the Apple Seven Series B Shares and the Apple Eight Series B Shares, the “Series B Shares”), to approve the Merger Agreement and the Mergers and to convert each Apple Nine Series B Share into 24.17104 Apple Nine Common Shares. As described in the Merger Agreement and the Voting Agreement, Mr. Knight is currently the record owner of, and possesses sole or shared voting power over, all the Series B Shares. We understand that Mr. Knight has previously assigned certain benefits in a portion of his Series B Shares to certain persons who it is proposed will enter into conversion agreements entered into contemporaneously with the Merger Agreement (the “Conversion Agreements”), consenting to the conversion of the Apple Nine Series B Shares into common stock of Apple Nine. As described in the Merger Agreement, certain advisory and related party agreements between the Apple REITs and Mr. Knight and certain entities affiliated with Mr. Knight (other than the Apple REITs) will be terminated pursuant to a termination agreement entered into contemporaneously with the Merger Agreement (the “Termination Agreement”). We understand that the management function currently performed under such advisory and related party agreements with respect to the Apple REITs will be performed internally by Apple Nine following the Mergers and that, as described in Section 6.1(i) of the Merger Agreement, Apple Nine will provide advisory and
management services to Apple REIT Ten, Inc. pursuant to a subcontract agreement between Apple Nine and Apple Ten Advisors, Inc. to be entered into contemporaneously with the Merger Agreement (the “Subcontract Agreement” and, collectively with the Voting Agreement, the Conversion Agreements and the Termination Agreement, the “Ancillary Agreements”).
In arriving at our opinion, we reviewed a draft dated August 3, 2013 of the Merger Agreement and drafts, in each case dated August 3, 2013, of each of the Ancillary Agreements and held discussions with certain senior officers, directors and other representatives and advisors of Apple Nine and each of the other Apple REITs concerning the businesses, operations and prospects of each of the Apple REITs. We examined certain publicly available business and financial information relating to each of the Apple REITs as well as certain financial forecasts and other information and data relating to each of the Apple REITs, including on a pro forma basis for all the Apple REITS combined (“NewCo”), which were provided to or discussed with us by the management of the Apple REITs, including information relating to the potential strategic implications and operational benefits (including the amount, timing and achievability thereof) anticipated by the management of the Apple REITs to result from the Mergers. We reviewed the financial terms of the Mergers as set forth in a draft dated August 3, 2013 of the Merger Agreement in relation to, among other things: the historical and projected earnings and other operating data of each of the Apple REITs and NewCo; and the capitalization and financial condition of each of the Apple REITs and NewCo. We considered, to the extent publicly available, the financial terms of certain other transactions which we considered relevant in evaluating the Mergers and analyzed certain financial, stock market and other publicly available information relating to the businesses of other companies whose operations we considered relevant in evaluating those of (i) Apple Seven and Apple Eight, taken together, (ii) Apple Nine and (iii) NewCo. We also evaluated certain potential pro forma financial effects of the Mergers on Apple Nine. In addition to the foregoing, we conducted such other analyses and examinations and considered such other information and financial, economic and market criteria as we deemed appropriate in arriving at our opinion. The issuance of our opinion has been authorized by our fairness opinion committee.
In rendering our opinion, we have assumed and relied, without independent verification, upon the accuracy and completeness of all financial and other information and data publicly available or provided to or otherwise reviewed by or discussed with us and upon the assurances of the management of the Apple REITs that they are not aware of any relevant information that has been omitted or that remains undisclosed to us. With respect to financial forecasts and other information and data relating to the Apple REITs and NewCo provided to or otherwise reviewed by or discussed with us, we have been advised by the management of the Apple REITs that such forecasts and other information and data were reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of the Apple REITs as to the future financial performance of each of the Apple REITs and NewCo, the potential strategic implications and operational benefits anticipated to result from the Mergers and the other matters covered thereby, and have assumed, with your consent, that the financial results (including the potential strategic implications and operational benefits anticipated to result from the Mergers) reflected in such forecasts and other information and data will be realized in the amounts and at the times projected. We have assumed, with your consent, that that the final terms of the Merger Agreement and the Ancillary Agreements will not vary in any material respect from those set forth in the drafts reviewed by us and that the Mergers will be consummated in accordance with their terms, without waiver, modification or amendment of any material term, condition or agreement and that, in the course of obtaining the necessary regulatory or third party approvals, consents and releases for the Mergers, no delay, limitation, restriction or condition will be imposed that would have an adverse effect on Apple Nine, NewCo or the contemplated benefits of the Mergers. We also have assumed, with your consent, that each Merger will be treated as a tax-free reorganization for federal income tax purposes. You have advised us that the Securities and Exchange Commission (the “SEC”) is conducting a non-public investigation of each of the Apple REITs, which is focused principally on the adequacy of certain disclosures in each Apple REIT’s filings with the SEC beginning in 2008, as well as each Apple REIT’s review of certain transactions involving the Apple REITs (the “SEC Review”). We have assumed, with your consent, that the SEC Review will not result in disproportionate or material liability of Apple Nine or any of the Apple REITs and we express no opinion with respect to such investigation. You have advised us that each of the Apple REITs is a defendant, with other parties, in a purported class action alleging violations of state and federal securities laws, among other claims. You have advised us that such class action has been dismissed with prejudice, but that the plaintiffs in such class action have filed an appeal of such dismissal. We have assumed, with your consent, that such litigation will not result in disproportionate or material liability of Apple Nine or any of the Apple REITs and we express no opinion with respect to such litigation. You also have advised us, and we have assumed, that (i) the holder of the Apple Eight Series B Shares would, under the existing terms of the Apple Eight Series B Shares in accordance with the Articles of Incorporation of Apple Eight (the “Apple Eight Articles”), be entitled to convert the Apple Eight Series B Shares into Apple Eight Common Shares upon consummation of the Apple Eight Merger; (ii) the conversion of the Apple Eight Series B Shares into Apple Nine Common Shares in the Apple Eight Merger as provided in the Merger Agreement will result in the holder of the Apple Eight Series B Shares receiving exactly the same consideration as would have been received had the Apple Eight Series B Shares been converted into Apple Eight Common Shares under the Apple Eight Articles and then converted into Apple Nine Common Shares in the Apple Eight Merger; (iii) the Apple Eight Series A Shares would have been terminated without payment and without any further rights, in accordance with the Apple Eight Articles, upon the conversion of all the Apple Eight Series B Shares; (iv) the same is true with respect to the Apple Seven Series B Shares and the Apple Seven Series A Shares under the constituent documents of Apple Seven; and (v) the Apple
Nine Series A Shares will terminate without payment and without further rights upon the conversion of all the Apple Nine Series B Shares as provided in the Voting Agreement and the Conversion Agreements.
Our opinion, as set forth herein, relates to the relative values of Apple Seven and Apple Eight, taken together, and NewCo. Our opinion is limited to the fairness to Apple Nine, as of the date hereof, from a financial point of view, of the Merger Consideration. We are not expressing any opinion as to what the value of the Apple Nine Common Shares actually will be when issued pursuant to the Merger or the price at which the Apple Nine Common Shares will trade at any time. We have not made or been provided with an independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of any of the Apple REITs nor have we made any physical inspection of the properties or assets of any of the Apple REITs. We were not requested to, and we did not, participate in the negotiation or structuring of the Mergers, nor were we requested to, and we did not, solicit third party indications of interest in any possible strategic alternatives by Apple Nine. We express no view as to, and our opinion does not address, the underlying business decision of Apple Nine to effect the Mergers, the relative merits of the Mergers as compared to any alternative business strategies that might exist for Apple Nine, the effect of any other transaction in which Apple Nine might engage, any term of the Ancillary Agreements, the fairness to the holders of the Apple Nine Series B Shares of the exchange ratio applicable to the Apple Nine Series B Shares in the Mergers, the relative treatment among the holders of the Apple Nine Common Shares, the Apple Nine Series A Shares and the Apple Nine Series B Shares in the Mergers or the relative treatment of the Apple Nine Units, the Apple Seven Units and the Apple Eight Units in the Mergers. We also express no view as to, and our opinion does not address, the fairness (financial or otherwise) of the amount or nature or any other aspect of any compensation to any officers, directors or employees of any parties to the Mergers, or any class of such persons, relative to the Merger Consideration. Our opinion is necessarily based upon information available to us, and financial, stock market and other conditions and circumstances existing, as of the date hereof.
Citigroup Global Markets Inc. has acted as financial advisor to the Special Committee of the Board of Directors of Apple Nine in connection with the proposed Mergers and will receive a fee for such services, a significant portion of which is contingent upon the execution and delivery by Apple Nine of the Merger Agreement. We also will receive a fee in connection with the delivery of this opinion. We and our affiliates in the past have provided and in the future may provide investment banking and financial advisory services to one or more of the Apple REITs and their affiliates unrelated to the proposed Mergers, for which services we and such affiliates have received and expect to receive compensation, including, without limitation, having acted as financial advisor to Apple Eight in connection with its evaluation of a potential consolidation transaction with Apple REIT Six, Inc., Apple Seven and Apple Nine in 2012. We may also provide investment banking and other services to Apple Nine or NewCo in the future for additional compensation. In the ordinary course of our business, we and our affiliates may actively trade or hold the securities of the Apple REITs for our own account or for the account of our customers and, accordingly, may at any time hold a long or short position in such securities. In addition, we and our affiliates (including Citigroup Inc. and its affiliates) may maintain relationships with the Apple REITs and their respective affiliates.
Our advisory services and the opinion expressed herein are provided for the information of the Special Committee of the Board of Directors of Apple Nine in its evaluation of the proposed Mergers; provided, however, that we understand that the Special Committee of the Board of Directors may provide a copy of our opinion and the supporting materials provided to the Special Committee of the Board of Directors to the Board of Directors of Apple Nine. Our opinion is not addressed to or intended for the benefit of any other Apple REIT or the Board of Directors (or any committee thereof) of any other Apple REIT, and is not intended to be and does not constitute a recommendation to any stockholder of any of the Apple REITs as to how such stockholder should vote or act on any matters relating to the proposed Mergers.
Based upon and subject to the foregoing, our experience as investment bankers, our work as described above and other factors we deemed relevant, we are of the opinion that, as of the date hereof, the Merger Consideration is fair, from a financial point of view, to Apple Nine.
Very truly yours,
/s/ CITIGROUP GLOBAL MARKETS INC.
CITIGROUP GLOBAL MARKETS INC.
Article 15 of the Virginia Stock Corporation Act (§§ 13.1-729 – 741.1 of the Code of Virginia)
Article 15. Appraisal Rights and Other Remedies
§ 13.1-729. Definitions
In this article:
“Affiliate” means a person who directly or indirectly through one or more intermediaries controls, is controlled by, or is under common control with another person or is a senior executive officer thereof.
“Beneficial shareholder” means a person who is the beneficial owner of shares held in a voting trust or by a nominee on the beneficial owner’s behalf.
“Corporation” means the issuer of the shares held by a shareholder demanding appraisal and, for matters covered by §§ 13.1-734 through 13.1-740, includes the surviving entity in a merger.
“Fair value” means the value of the corporation’s shares determined:
a. Immediately before the effectuation of the corporate action to which the shareholder objects;
b. Using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal; and
c. Without discounting for lack of marketability or minority status except, if appropriate, for amendments to the articles pursuant to subdivision A 5 of § 13.1-730.
“Interest” means interest from the effective date of the corporate action until the date of payment, at the average rate currently paid by the corporation on its principal bank loans or, if none, at a rate that is fair and equitable under all the circumstances.
“Interested transaction” means a corporate action described in subsection A of § 13.1-730, other than a merger pursuant to § 13.1-719 or 13.1-719.1, involving an interested person in which any of the shares or assets of the corporation are being acquired or converted. As used in this definition:
1. “Beneficial owner” means any person who, directly or indirectly, through any contract, arrangement, or understanding, other than a revocable proxy, has or shares the power to vote, or to direct the voting of, shares; except that a member of a national securities exchange is not deemed to be a beneficial owner of securities held directly or indirectly by it on behalf of another person solely because the member is the record holder of the securities if the member is precluded by the rules of the exchange from voting without instruction on contested matters or matters that may affect substantially the rights or privileges of the holders of the securities to be voted. When two or more persons agree to act together for the purpose of voting their shares of the corporation, each member of the group formed thereby is deemed to have acquired beneficial ownership, as of the date of the agreement, of all voting shares of the corporation beneficially owned by any member of the group.
2. “Interested person” means a person, or an affiliate of a person, who at any time during the one-year period immediately preceding approval by the board of directors of the corporate action:
a. Was the beneficial owner of 20% or more of the voting power of the corporation, excluding any shares acquired pursuant to an offer for all shares having voting power if the offer was made within one year prior to the corporate action for consideration of the same kind and of a value equal to or less than that paid in connection with the corporate action;
b. Had the power, contractually or otherwise, to cause the appointment or election of 25% or more of the directors to the board of directors of the corporation; or
c. Was a senior executive officer or director of the corporation or a senior executive officer of any affiliate thereof, and that senior executive officer or director will receive, as a result of the corporate action, a financial benefit not generally available to other shareholders as such, other than:
(1) Employment, consulting, retirement, or similar benefits established separately and not as part of or in contemplation of the corporate action;
(2) Employment, consulting, retirement, or similar benefits established in contemplation of, or as part of, the corporate action that are not more favorable than those existing before the corporate action or, if more favorable, that have been approved on behalf of the corporation in the same manner as is provided in § 13.1-691; or
(3) In the case of a director of the corporation who will, in the corporate action, become a director of the acquiring entity in the corporate action or one of its affiliates, rights and benefits as a director that are provided on the same basis as those afforded by the acquiring entity generally to other directors of such entity or such affiliate.
“Preferred shares” means a class or series of shares whose holders have preference over any other class or series of shares with respect to distributions.
“Record shareholder” means the person in whose name shares are registered in the records of the corporation or the beneficial owner of shares to the extent of the rights granted by a nominee certificate on file with the corporation.
“Senior executive officer” means the chief executive officer, chief operating officer, chief financial officer and anyone in charge of a principal business unit or function.
“Shareholder” means both a record shareholder and a beneficial shareholder.
§ 13.1-730. Right to appraisal
A. A shareholder is entitled to appraisal rights, and to obtain payment of the fair value of that shareholder’s shares, in the event of any of the following corporate actions:
1. Consummation of a merger to which the corporation is a party (i) if shareholder approval is required for the merger by § 13.1-718, except that appraisal rights shall not be available to any shareholder of the corporation with respect to shares of any class or series that remain outstanding after consummation of the merger, or (ii) if the corporation is a subsidiary and the merger is governed by § 13.1-719;
2. Consummation of a share exchange to which the corporation is a party as the corporation whose shares will be acquired, except that appraisal rights shall not be available to any shareholder of the corporation with respect to any class or series of shares of the corporation that is not exchanged;
3. Consummation of a disposition of assets pursuant to § 13.1-724 if the shareholder is entitled to vote on the disposition;
4. An amendment of the articles of incorporation with respect to a class or series of shares that reduces the number of shares of a class or series owned by the shareholder to a fraction of a share if the corporation has the obligation or right to repurchase the fractional share so created; or
5. Any other amendment to the articles of incorporation, or any other merger, share exchange or disposition of assets to the extent provided by the articles of incorporation, bylaws or a resolution of the board of directors.
B. Notwithstanding subsection A, the availability of appraisal rights under subdivisions A 1 through A 4 shall be limited in accordance with the following provisions:
1. Appraisal rights shall not be available for the holders of shares of any class or series of shares that is:
a. A covered security under § 18(b)(1)(A) or (B) of the federal Securities Act of 1933, as amended;
b. Traded in an organized market and has at least 2,000 shareholders and a market value of at least $20 million, exclusive of the value of such shares held by the corporation’s subsidiaries, senior executives, directors and beneficial shareholders owning more than 10 percent of such shares; or
c. Issued by an open end management investment company registered with the United States Securities and Exchange Commission under the Investment Company Act of 1940 and may be redeemed at the option of the holder at net asset value.
2. The applicability of subdivision 1 of this subsection shall be determined as of:
a. The record date fixed to determine the shareholders entitled to receive notice of the meeting of shareholders to act upon the corporate action requiring appraisal rights; or
b. The day before the effective date of such corporate action if there is no meeting of shareholders.
3. Subdivision 1 of this subsection shall not be applicable and appraisal rights shall be available pursuant to subsection A for the holders of any class or series of shares who are required by the terms of the corporate action requiring appraisal rights to accept for such shares anything other than cash or shares of any class or any series of shares of any corporation, or any other proprietary interest of any other entity, that satisfies the standards set forth in subdivision 1 of this subsection at the time the corporate action becomes effective.
4. Subdivision 1 of this subsection shall not be applicable and appraisal rights shall be available pursuant to subsection A for the holders of any class or series of shares where the corporate action is an interested transaction.
C. Notwithstanding any other provision of this section, the articles of incorporation as originally filed or any amendment thereto may limit or eliminate appraisal rights for any class or series of preferred shares, but any such limitation or elimination contained in an amendment to the articles of incorporation that limits or eliminates appraisal rights for any of such shares that are outstanding immediately prior to the effective date of such amendment or that the corporation is or may be required to issue or sell thereafter pursuant to any conversion, exchange or other right existing immediately before the effective date of such amendment shall not apply to any corporate action that becomes effective within one year of that date if such action would otherwise afford appraisal rights.
§ 13.1-731. Assertion of rights by nominees and beneficial owners
A. A record shareholder may assert appraisal rights as to fewer than all the shares registered in the record shareholder’s name but owned by a beneficial shareholder only if the record shareholder objects with respect to all shares of the class or series owned by the beneficial shareholder and notifies the corporation in writing of the name and address of each beneficial shareholder on whose behalf appraisal rights are being asserted. The rights of a record shareholder who asserts appraisal rights for only part of the shares held of record in the record shareholder’s name under this subsection shall be determined as if the shares as to which the record shareholder objects and the record shareholder’s other shares were registered in the names of different record shareholders.
B. A beneficial shareholder may assert appraisal rights as to shares of any class or series held on behalf of the shareholder only if such shareholder:
1. Submits to the corporation the record shareholder’s written consent to the assertion of such rights no later than the date referred to in subdivision B 2 b of § 13.1-734; and
2. Does so with respect to all shares of the class or series that are beneficially owned by the beneficial shareholder.
§ 13.1-732. Notice of appraisal rights
A. Where any corporate action specified in subsection A of § 13.1-730 is to be submitted to a vote at a shareholders’ meeting, the meeting notice shall state that the corporation has concluded that shareholders are, are not or may be entitled to assert appraisal rights under this article.
If the corporation concludes that appraisal rights are or may be available, a copy of this article and a statement of the corporation’s position as to the availability of appraisal rights shall accompany the meeting notice sent to those record shareholders entitled to exercise appraisal rights.
B. In a merger pursuant to § 13.1-719, the parent corporation shall notify in writing all record shareholders of the subsidiary who are entitled to assert appraisal rights that the corporate action became effective. Such notice shall be sent within 10 days after the corporate action became effective and include the materials described in § 13.1-734.
C. Where any corporate action specified in subsection A of § 13.1-730 is to be approved by written consent of the shareholders pursuant to § 13.1-657:
1. Written notice that appraisal rights are, are not, or may be available must be given to each record shareholder from whom a consent is solicited at the time consent of such shareholder is first solicited and, if the corporation has concluded that appraisal rights are or may be available, must be accompanied by a copy of this article; and
2. Written notice that appraisal rights are, are not, or may be available must be delivered together with the notice to nonconsenting and nonvoting shareholders required by subsections E and F of § 13.1-657, may include the materials described in § 13.1-734, and, if the corporation has concluded that appraisal rights are or may be available, must be accompanied by a copy of this article.
D. Where corporate action described in subsection A of § 13.1-730 is proposed, or a merger pursuant to § 13.1-719 is effected, the notice referred to in subsection A or C, if the corporation concludes that appraisal rights are or may be available, and in subsection B shall be accompanied by:
1. The annual financial statements specified in subsection A of § 13.1-774 of the corporation that issued the shares that may be subject to appraisal, which shall be as of a date ending not more than 16 months before the date of the notice and shall comply with subsection B of § 13.1-774; provided that, if such annual financial statements are not reasonably available, the corporation shall provide reasonably equivalent financial information; and
2. The latest available quarterly financial statements of such corporation, if any.
E. A public corporation, or a corporation that ceased to be a public corporation as a result of the corporate action specified in subsection A of § 13.1-730, may fulfill its responsibilities under subsection D by delivering the specified financial statements, or otherwise making them available, in any manner permitted by the applicable rules and regulations of the U.S. Securities and Exchange Commission if the corporation was a public corporation as of the date of the specified financial statements.
F. The right to receive the information described in subsection D may be waived in writing by a shareholder before or after the corporate action.
§ 13.1-733. Notice of intent to demand payment
A. If a corporate action specified in subsection A of § 13.1-730 is submitted to a vote at a shareholders’ meeting, a shareholder who wishes to assert appraisal rights with respect to any class or series of shares:
1. Must deliver to the corporation before the vote is taken written notice of the shareholder’s intent to demand payment if the proposed action is effectuated; and
2. Must not vote, or cause or permit to be voted, any shares of such class or series in favor of the proposed action.
B. If a corporate action specified in subsection A of § 13.1-730 is to be approved by less than unanimous written consent, a shareholder who wishes to assert appraisal rights with respect to any class or series of shares may not sign a consent in favor of the proposed action with respect to that class or series of shares.
C. A shareholder who fails to satisfy the requirements of subsection A or subsection B is not entitled to payment under this article.
§ 13.1-734. Appraisal notice and form
A. If proposed corporate action requiring appraisal rights under § 13.1-730 becomes effective, the corporation shall deliver an appraisal notice and the form required by subdivision B 1 to all shareholders who satisfied the requirements of § 13.1-733. In the case of a merger under § 13.1-719, the parent corporation shall deliver an appraisal notice and form to all record shareholders who may be entitled to assert appraisal rights.
B. The appraisal notice shall be sent no earlier than the date the corporate action specified in subsection A of § 13.1-730 became effective and no later than 10 days after such date and shall:
1. Supply a form that (i) specifies the first date of any announcement to shareholders made prior to the date the corporate action became effective of the principal terms of the proposed corporate action, (ii) if such announcement was made, requires the shareholder asserting appraisal rights to certify whether beneficial ownership of those shares for which appraisal rights are asserted was acquired before that date, and (iii) requires the shareholder asserting appraisal rights to certify that such shareholder did not vote for or consent to the transaction;
2. State:
a. Where the form must be sent and where certificates for certificated shares must be deposited and the date by which those certificates must be deposited, which date may not be earlier than the date for receiving the required form under subdivision 2 b of this subsection;
b. A date by which the corporation must receive the form which date may not be fewer than 40 nor more than 60 days after the date the subsection A appraisal notice and form were sent, and state that the shareholder shall have waived the right to demand appraisal with respect to the shares unless the form is received by the corporation by such specified date;
c. The corporation’s estimate of the fair value of the shares;
d. That, if requested in writing, the corporation will provide, to the shareholder so requesting, within 10 days after the date specified in subdivision 2 b of this subsection, the number of shareholders who returned the form by the specified date and the total number of shares owned by them; and
e. The date by which the notice to withdraw under § 13.1-735.1 must be received, which date must be within 20 days after the date specified in subdivision 2 b of this subsection; and
3. Be accompanied by a copy of this article.
§ 13.1-735. Repealed by Acts 2005, c. 765
§ 13.1-735.1. Perfection of rights; right to withdraw
A. A shareholder who receives notice pursuant to § 13.1-734 and who wishes to exercise appraisal rights must complete, sign, and return the form sent by the corporation and, in the case of certificated shares, deposit the shareholder’s certificates in accordance with the terms of the notice by the date referred to in the notice pursuant to subdivision B 2 b of § 13.1-734. If the form requires the shareholder to certify whether the beneficial owner of such shares acquired beneficial ownership of the shares before the date required to be set forth in the notice pursuant to subdivision B 1 of § 13.1-734, and the shareholder fails to make the certification, the corporation may elect to treat the shareholder’s shares as after-acquired shares under § 13.1-738. Once a shareholder deposits that shareholder’s certificates or, in the case of uncertificated shares, returns the signed form, that shareholder loses all rights as a shareholder, unless the shareholder withdraws pursuant to subsection B.
B. A shareholder who has complied with subsection A may nevertheless decline to exercise appraisal rights and withdraw from the appraisal process by so notifying the corporation in writing by the date set forth in the appraisal notice pursuant to subdivision B 2 e of § 13.1-734. A shareholder who fails to withdraw from the appraisal process may not thereafter withdraw without the corporation’s written consent.
C. A shareholder who does not sign and return the form and, in the case of certificated shares, deposit that shareholder’s share certificates where required, each by the date set forth in the notice described in subsection B of § 13.1-734, shall not be entitled to payment under this article.
§ 13.1-736. Repealed by Acts 2005, c. 765
§ 13.1-737. Payment
A. Except as provided in § 13.1-738, within 30 days after the form required by subsection B 2 b of § 13.1-734 is due, the corporation shall pay in cash to those shareholders who complied with subsection A of § 13.1-735.1 the amount the corporation estimates to be the fair value of their shares plus interest.
B. The payment to each shareholder pursuant to subsection A shall be accompanied by:
1. The (i) annual financial statements specified in subsection A of § 13.1-774 of the corporation that issued the shares to be appraised, which shall be as of a date ending not more than 16 months before the date of payment and shall comply with subsection B of § 13.1-774; provided that, if such annual financial statements are not available, the corporation shall provide reasonably equivalent information, and (ii) the latest available quarterly financial statements of such corporation, if any;
2. A statement of the corporation’s estimate of the fair value of the shares, which estimate shall equal or exceed the corporation’s estimate given pursuant to subdivision B 2 c of § 13.1-734; and
3. A statement that shareholders described in subsection A have the right to demand further payment under § 13.1-739 and that if any such shareholder does not do so within the time period specified therein, such shareholder shall be deemed to have accepted such payment in full satisfaction of the corporation’s obligations under this article.
C. A public corporation, or a corporation that ceased to be a public corporation as a result of the corporate action specified in subsection A of § 13.1-730, may fulfill its responsibilities under subdivision B 1 by delivering the specified financial statements, or otherwise making them available, in any manner permitted by the applicable rules and regulations of the U.S. Securities and Exchange Commission if the corporation was a public corporation as of the date of the specified financial statements.
§ 13.1-738. After-acquired shares
A. A corporation may elect to withhold payment required by § 13.1-737 from any shareholder who was required to, but did not certify that beneficial ownership of all of the shareholder’s shares for which appraisal rights are asserted was acquired before the date set forth in the appraisal notice sent pursuant to subdivision B 1 of § 13.1-734.
B. If the corporation elected to withhold payment under subsection A, it shall, within 30 days after the form required by subdivision B 2 b of § 13.1-734 is due, notify all shareholders who are described in subsection A:
1. Of the information required by subdivision B 1 of § 13.1-737;
2. Of the corporation’s estimate of fair value pursuant to subdivision B 2 of § 13.1-737 and its offer to pay such value plus interest;
3. That they may accept the corporation’s estimate of fair value plus interest in full satisfaction of their demands or demand for appraisal under § 13.1-739;
4. That those shareholders who wish to accept such offer must so notify the corporation of their acceptance of the corporation’s offer within 30 days after receiving the offer; and
5. That those shareholders who do not satisfy the requirements for demanding appraisal under § 13.1-739 shall be deemed to have accepted the corporation’s offer.
C. Within 10 days after receiving a shareholder’s acceptance pursuant to subsection B, the corporation shall pay in cash the amount it offered under subdivision B 2 to each shareholder who agreed to accept the corporation’s offer in full satisfaction of the shareholder’s demand.
D. Within 40 days after sending the notice described in subsection B, the corporation shall pay in cash the amount it offered to pay under subdivision B 2 to each shareholder described in subdivision B 5.
§ 13.1-739. Procedure if shareholder dissatisfied with payment or offer
A. A shareholder paid pursuant to § 13.1-737 who is dissatisfied with the amount of the payment must notify the corporation in writing of that shareholder’s stated estimate of the fair value of the shares and demand payment of that estimate plus interest (less any payment under § 13.1-737). A shareholder offered payment under § 13.1-738 who is dissatisfied with that offer must reject the offer and demand payment of the shareholder’s estimate of the fair value of the shares plus interest.
B. A shareholder who fails to notify the corporation in writing of that shareholder’s demand to be paid the shareholder’s stated estimate of the fair value plus interest under subsection A within 30 days after receiving the corporation’s payment or offer of payment under § 13.1-737 or 13.1-738, respectively, waives the right to demand payment under this section and shall be entitled only to the payment made or offered pursuant to those respective sections.
§ 13.1-740. Court action
A. If a shareholder makes a demand for payment under § 13.1-739 that remains unsettled, the corporation shall commence a proceeding within 60 days after receiving the payment demand and petition the court to determine the fair value of the shares and accrued interest. If the corporation does not commence the proceeding within the 60-day period, it shall pay in cash to each shareholder the amount the shareholder demanded pursuant to § 13.1-737 plus interest.
B. The corporation shall commence the proceeding in the circuit court of the city or county where the corporation’s principal office, or, if none in the Commonwealth, where its registered office, is located. If the corporation is a foreign corporation without a registered office in the Commonwealth, it shall commence the proceeding in the circuit court of the city or county in the Commonwealth where the principal office, or, if none in the Commonwealth, where the registered office of the domestic corporation merged with the foreign corporation was located at the time the transaction became effective.
C. The corporation shall make all shareholders, whether or not residents of the Commonwealth, whose demands remain unsettled parties to the proceeding as in an action against their shares, and all parties shall be served with a copy of the petition. Nonresidents may be served by registered or certified mail or by publication as provided by law.
D. The corporation may join as a party to the proceeding any shareholder who claims to have demanded an appraisal but who has not, in the opinion of the corporation, complied with the provisions of this article. If the court determines that a shareholder has not complied with the provisions of this article, that shareholder shall be dismissed as a party.
E. The jurisdiction of the court in which the proceeding is commenced under subsection B is plenary and exclusive. The court may appoint one or more persons as appraisers to receive evidence and recommend a decision on the question of fair value. The appraisers shall have the powers described in the order appointing them, or in any amendment to it. The shareholders demanding appraisal are entitled to the same discovery rights as parties in other civil proceedings. There shall be no right to a jury trial.
F. Each shareholder made a party to the proceeding is entitled to judgment (i) for the amount, if any, by which the court finds the fair value of the shareholder’s shares plus interest exceeds the amount paid by the corporation to the shareholder for such shares or (ii) for the fair value plus interest of the shareholder’s shares for which the corporation elected to withhold payment under § 13.1-738.
§ 13.1-741. Court costs and counsel fees
A. The court in an appraisal proceeding commenced under § 13.1-740 shall determine all costs of the proceeding, including the reasonable compensation and expenses of appraisers appointed by the court. The court shall assess the costs against the corporation, except that the court may assess costs against all or some of the shareholders demanding appraisal, in amounts the court finds equitable, to the extent the court finds such shareholders acted arbitrarily, vexatiously or not in good faith with respect to the rights provided by this article.
B. The court in an appraisal proceeding may also assess the fees and expenses of counsel and experts for the respective parties, in amounts the court finds equitable:
1. Against the corporation and in favor of any or all shareholders demanding appraisal if the court finds the corporation did not substantially comply with the requirements of § 13.1-732, 13.1-734, 13.1-737 or 13.1-738; or
2. Against either the corporation or a shareholder demanding appraisal, in favor of any other party, if the court finds that the party against whom the fees and expenses are assessed acted arbitrarily, vexatiously or not in good faith with respect to the rights provided by this article.
C. If the court in an appraisal proceeding finds that the services of counsel for any shareholder were of substantial benefit to other shareholders similarly situated, and that the fees for those services should not be assessed against the corporation, the court may award to such counsel reasonable fees to be paid out of the amounts awarded the shareholders who were benefited.
D. To the extent the corporation fails to make a required payment pursuant to § 13.1-737, 13.1-738 or 13.1-739, the shareholder may sue directly for the amount owed and, to the extent successful, shall be entitled to recover from the corporation all costs and expenses of the suit, including counsel fees.
§ 13.1-741.1. Limitations on other remedies for fundamental transactions
A. Except for action taken before the Commission pursuant to § 13.1-614 or as provided in subsection B, the legality of a proposed or completed corporate action described in subsection A of § 13.1-730 may not be contested, nor may the corporate action be enjoined, set aside or rescinded, in a legal or equitable proceeding by a shareholder after the shareholders have approved the corporate action.
B. Subsection A does not apply to a corporate action that:
1. Was not authorized and approved in accordance with the applicable provisions of:
a. Article 11 (§ 13.1-705 et seq.), Article 12 (§ 13.1-715.1 et seq.), or Article 13 (§ 13.1-723 et seq.);
b. The articles of incorporation or bylaws; or
c. The resolutions of the board of directors authorizing the corporate action;
2. Was procured as a result of fraud, a material misrepresentation, or an omission of a material fact necessary to make statements made, in light of the circumstances in which they were made, not misleading;
3. Is an interested transaction, unless it has been authorized, approved or ratified by the board of directors in the same manner as is provided in subsection B of § 13.1-691 and has been authorized, approved or ratified by the shareholders in the same manner as is provided in subsection C of § 13.1-691 as if the interested transaction were a director’s conflict of interests transaction; or
4. Is adopted or taken by less than unanimous consent of the voting shareholders pursuant to § 13.1-657 if:
a. The challenge to the corporate action is brought by a shareholder who did not consent and as to whom notice of the adoption or taking of the corporate action was not effective at least 10 days before the corporate action was effected; and
b. The proceeding challenging the corporate action is commenced within 10 days after notice of the adoption or taking of the corporate action is effective as to the shareholder bringing the proceeding.
C. Any remedial action with respect to corporate action described in subsection A of § 13.1-730 shall not limit the scope of, or be inconsistent with, any provision of § 13.1-614.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): September 9, 2013
Apple REIT Seven, Inc.
(Exact name of registrant as specified in its charter)
Virginia | | 000-52585 | | 20-2879175 |
(State or other jurisdiction of incorporation) | | (Commission File Number) | | (I.R.S. Employer Identification Number) |
| | |
814 East Main Street, Richmond, Virginia | | 23219 |
(Address of principal executive offices) | | (Zip Code) |
(804) 344-8121
(Registrant’s telephone number, including area code)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
o | Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
o | Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
o | Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
| |
o | Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
Apple REIT Seven, Inc. (which is referred to below as the “Company”) is filing this report in accordance with Item 8.01 and Item 9.01 of Form 8-K.
The Company is re-issuing, in an updated format, its historical consolidated financial statements for the years ended December 31, 2012, 2011, and 2010, in connection with the requirements of United States generally accepted accounting principles (“GAAP”). GAAP provisions require, among other things, that the primary assets and liabilities and the results of operations of the Company’s real properties which have been sold or are held for sale, be classified as discontinued operations and segregated in the Company’s Consolidated Statements of Operations and Balance Sheets. In compliance with GAAP, the Company has presented the net operating results and the assets and liabilities of those properties held for sale through June 30, 2013, as discontinued operations. Under the Securities and Exchange Commission ("SEC") requirements, the same reclassification of continuing and discontinued operations as prescribed by GAAP is required for all previously issued annual financial statements for each of the three years shown in the Company’s last Annual Report on Form 10-K, if those financials are incorporated or included in subsequent filings with the SEC made under the Securities Act of 1933, even though those financial statements relate to periods prior to the date of the reclassification. This reclassification has no effect on the Company’s reported shareholders’ equity, cash flows or net income.
This Current Report on Form 8-K updates Items 6, 7, 8 and 15 (Schedule III), of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (the “Form 10-K”), to reflect the primary assets and liabilities and the results of operations of the Company’s real properties which are held for sale at June 30, 2013, as discontinued operations. The updated financial information is attached to this Current Report on Form 8-K as Exhibit 99.1. All other items of the Company’s Form 10-K remain unchanged. No attempt has been made to update matters in the Form 10-K except to the extent expressly provided above.
Item 9.01 Financial Statements and Exhibits
(d) Exhibits
Exhibit No. | | Description |
| | |
23.1 | | Consent of Independent Registered Public Accounting Firm |
| | |
99.1 | | Updated financial information for the years ended December 31, 2012, 2011, and 2010 |
| | |
101 | | The following materials from the Company's Form 8-K updating its Annual Report on Form 10-K for the year ended December 31, 2012, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Shareholders' Equity, (iv) the Consolidated Statements of Cash Flows, and (v) related notes to these financial statements, tagged as blocks of text and in detail (FURNISHED HEREWITH). |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
| | | |
Apple REIT Seven, Inc. | |
| | |
By: | | /s/ Glade M. Knight | |
| | Glade M. Knight, Chief Executive Officer | |
| | September 9, 2013 | |
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the Registration Statement (Form S-3 No. 333-179005) of Apple REIT Seven, Inc. and in the related Prospectus of our report dated March 6, 2013 (except for Note 11, as to which the date is September 9, 2013), with respect to the consolidated financial statements and schedule of Apple REIT Seven, Inc., included in this Current Report on Form 8-K.
/s/ Ernst & Young
Richmond, Virginia
September 9, 2013
Exhibit 99.1
Updated Financial Information
Index
| | | Page |
| Item 6. | Selected Financial Data | 2 |
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 3 |
| Item 8. | Financial Statements and Supplementary Data | 17 |
| Item 15. (2) | Financial Statement Schedule - Schedule III – Real Estate and Accumulated Depreciation | 38 |
This Report includes references to certain trademarks or service marks. The SpringHill Suites® by Marriott, TownePlace Suites® by Marriott, Fairfield Inn® by Marriott, Courtyard® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Homewood Suites® by Hilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites® trademarks are the property of Hilton Worldwide or one or more of its affiliates. For convenience, the applicable trademark or servicemark symbol has been omitted but will be deemed to be included wherever the above-referenced terms are used.
The following table sets forth selected financial data for the five years ended December 31, 2012, 2011, 2010, 2009 and 2008. Certain information in the table has been derived from the Company’s audited financial statements and notes thereto. Additionally, certain information in the table has been reclassified to conform to the current year presentation in accordance with Accounting Standards Codification Topic 205-20, Presentation of Financial Statements – Discontinued Operations, as described in Note 11 to the Consolidated Financial Statements included in this Report. This data should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, the Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Report.
| | For the Year | | | For the Year | | | For the Year | | | For the Year | | | For the Year | |
| | Ended | | | Ended | | | Ended | | | Ended | | | Ended | |
(in thousands except per share and statistical data) | | December 31, 2012 | | | December 31, 2011 | | | December 31, 2010 | | | December 31, 2009 | | | December 31, 2008 | |
Revenues: | | | | | | | | | | | | | | | |
Room revenue | | $ | 191,437 | | | $ | 184,179 | | | $ | 176,802 | | | $ | 169,690 | | | $ | 190,421 | |
Other revenue | | | 20,609 | | | | 20,203 | | | | 19,350 | | | | 17,644 | | | | 18,840 | |
Total revenue | | | 212,046 | | | | 204,382 | | | | 196,152 | | | | 187,334 | | | | 209,261 | |
| | | | | | | | | | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | | | | | | | | | |
Hotel operating expenses | | | 122,799 | | | | 119,232 | | | | 114,108 | | | | 111,227 | | | | 121,545 | |
Taxes, insurance and other | | | 12,951 | | | | 12,321 | | | | 12,003 | | | | 13,495 | | | | 13,358 | |
General and administrative | | | 7,194 | | | | 4,989 | | | | 5,177 | | | | 4,554 | | | | 5,757 | |
Depreciation | | | 33,922 | | | | 33,533 | | | | 32,603 | | | | 31,866 | | | | 27,894 | |
Gain from settlement of contingency | | | - | | | | - | | | | (3,099 | ) | | | - | | | | - | |
Interest expense, net | | | 10,573 | | | | 9,822 | | | | 7,639 | | | | 6,089 | | | | 3,558 | |
Total expenses | | | 187,439 | | | | 179,897 | | | | 168,431 | | | | 167,231 | | | | 172,112 | |
Income from continuing operations | | | 24,607 | | | | 24,485 | | | | 27,721 | | | | 20,103 | | | | 37,149 | |
Income (loss) from discontinued operations | | | (6,421 | ) | | | 528 | | | | 597 | | | | 610 | | | | 914 | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | | | $ | 20,713 | | | $ | 38,063 | |
| | | | | | | | | | | | | | | | | | | | |
Per Share: | | | | | | | | | | | | | | | | | | | | |
Income from continuing operations per common share | | $ | 0.27 | | | $ | 0.27 | | | $ | 0.30 | | | $ | 0.21 | | | $ | 0.40 | |
Income (loss) from discontinued operations per common share | | | (0.07 | ) | | | - | | | | 0.01 | | | | 0.01 | | | | 0.01 | |
Net income per common share | | $ | 0.20 | | | $ | 0.27 | | | $ | 0.31 | | | $ | 0.22 | | | $ | 0.41 | |
Distributions paid per common share | | $ | 0.77 | | | $ | 0.77 | | | $ | 0.77 | | | $ | 0.81 | | | $ | 0.88 | |
Weighted-average common shares outstanding - basic | | | | | | | | | | | | | | | | | |
and diluted | | | 90,891 | | | | 91,435 | | | | 92,627 | | | | 93,472 | | | | 92,637 | |
| | | | | | | | | | | | | | | | | | | | |
Balance Sheet Data (at end of period): | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 20,609 | |
Investment in real estate, net | | $ | 802,326 | | | $ | 846,377 | | | $ | 872,169 | | | $ | 902,293 | | | $ | 920,688 | |
Total assets | | $ | 835,503 | | | $ | 865,141 | | | $ | 891,967 | | | $ | 923,887 | | | $ | 967,844 | |
Notes payable | | $ | 198,123 | | | $ | 174,847 | | | $ | 148,017 | | | $ | 117,787 | | | $ | 109,275 | |
Shareholders' equity | | $ | 624,463 | | | $ | 677,980 | | | $ | 733,300 | | | $ | 792,257 | | | $ | 845,753 | |
Net book value per share | | $ | 6.87 | | | $ | 7.44 | | | $ | 7.97 | | | $ | 8.47 | | | $ | 9.04 | |
| | | | | | | | | | | | | | | | | | | | |
Other Data: | | | | | | | | | | | | | | | | | | | | |
Cash Flow From (Used In): | | | | | | | | | | | | | | | | | | | | |
Operating activities | | $ | 60,806 | | | $ | 60,035 | | | $ | 59,915 | | | $ | 55,460 | | | $ | 69,025 | |
Investing activities | | $ | (12,134 | ) | | $ | (6,882 | ) | | $ | (2,310 | ) | | $ | (10,926 | ) | | $ | (127,519 | ) |
Financing activities | | $ | (48,672 | ) | | $ | (53,153 | ) | | $ | (57,605 | ) | | $ | (65,143 | ) | | $ | (63,334 | ) |
Number of hotels owned at end of period (including hotels held for sale) | | | 51 | | | | 51 | | | | 51 | | | | 51 | | | | 51 | |
Average Daily Rate (ADR) (a)(f) | | $ | 115 | | | $ | 111 | | | $ | 109 | | | $ | 112 | | | $ | 122 | |
Occupancy (f) | | | 73 | % | | | 73 | % | | | 71 | % | | | 67 | % | | | 71 | % |
| | For the Year | | | For the Year | | | For the Year | | | For the Year | | | For the Year | |
| | Ended | | | Ended | | | Ended | | | Ended | | | Ended | |
(in thousands except per share and statistical data) | | December 31, 2012 | | | December 31, 2011 | | | December 31, 2010 | | | December 31, 2009 | | | December 31, 2008 | |
Revenue Per Available Room (RevPAR) (b)(f) | | $ | 84 | | | $ | 81 | | | $ | 78 | | | $ | 75 | | | $ | 87 | |
Total Rooms Sold (c)(f) | | | 1,665,345 | | | | 1,654,622 | | | | 1,618,571 | | | | 1,517,333 | | | | 1,565,617 | |
Total Rooms Available (d)(f) | | | 2,271,458 | | | | 2,265,767 | | | | 2,265,767 | | | | 2,264,691 | | | | 2,191,467 | |
| | | | | | | | | | | | | | | | | | | | |
Modified Funds From Operations Calculation (e): | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | | | $ | 20,713 | | | $ | 38,063 | |
Loss on impairment of hotels held for sale | | | 6,640 | | | | - | | | | - | | | | - | | | | - | |
Depreciation of real estate owned | | | 34,557 | | | | 34,160 | | | | 33,174 | | | | 32,425 | | | | 28,434 | |
Funds from operations | | | 59,383 | | | | 59,173 | | | | 61,492 | | | | 53,138 | | | | 66,497 | |
Gain from settlement of contingency | | | - | | | | - | | | | (3,099 | ) | | | - | | | | - | |
Modified funds from operations | | $ | 59,383 | | | $ | 59,173 | | | $ | 58,393 | | | $ | 53,138 | | | $ | 66,497 | |
(a) Total room revenue divided by number of rooms sold. | | | | | | | | |
(b) ADR multiplied by occupancy percentage. | | | | | | | | | | |
(c) Represents actual number of room nights sold during period. | | | | | | | | |
(d) Represents number of rooms owned by the Company multiplied by the number of nights in the period. | | | |
(e) Funds from operations (FFO) is defined as net income (computed in accordance with generally accepted accounting principles - GAAP) excluding gains and losses from sales of depreciable property, or loss on impairment of hotels held for sale, plus depreciation and amortization. Modified funds from operations (MFFO) excludes any gain or loss from the settlement of a contingency. The Company considers FFO and MFFO in evaluating property acquisitions and its operating performance and believes that FFO and MFFO should be considered along with, but not as an alternative to, net income and cash flows as a measure of the Company's activities in accordance with GAAP. The Company considers FFO and MFFO as supplemental measures of operating performance in the real estate industry, and along with the other financial measures included in this Report, including net income, cash flow from operating activities, financing activities and investing activities, they provide investors with an indication of the performance of the Company. The Company's definition of FFO and MFFO are not necessarily the same as such terms that are used by other companies. FFO and MFFO are not necessarily indicative of cash available to fund cash needs. |
(f) From continuing operations. | | | | | | | | | | |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets, or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission and Item 1A in this report. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
Overview
Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”), was formed to invest in income-producing real estate in the United States. The Company was initially capitalized on May 26, 2005, with its first investor closing on March 15, 2006. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007. The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. As of December 31, 2012, the Company owned 51 hotels, including three hotels held for sale, within different markets in the United States. The Company’s first hotel was acquired on April 27, 2006 and the last hotel was purchased in September 2008. Accordingly, the results of operations include only the results of operations of the hotels for the period owned. Exclusive of interest income, the Company had no operating revenues before the first hotel acquisition in April 2006.
Hotel Operations
Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned. With the significant decline in economic conditions throughout the United States over the 2008 through 2010 time period, overall performance of the Company’s hotels has not met expectations since acquisition. Beginning in 2011 and continuing throughout 2012, the hotel industry and Company’s revenues have shown improvement from the significant decline in the industry during 2008 through 2010. Although there is no way to predict future general economic conditions, and there are several key factors that continue to negatively affect economic recovery in the United States and add to general market uncertainty, including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the uncertainty surrounding the fiscal policy of the United States, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012.
In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”), and market yield which compares an individual hotel’s results to other hotels in its local market, and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.
The Company continually monitors the profitability of its properties and attempts to maximize shareholder value by timely disposal of properties. In January 2013, the Company committed to sell three underperforming assets, the Fairfield Inns in Dothan, Alabama, Columbus, Georgia and Tallahassee, Florida. Due to the change in anticipated hold period of these assets, the estimated undiscounted cash flow for these properties was estimated to be less than their carrying value; therefore the Company recognized a loss of $6.6 million in the fourth quarter of 2012 to adjust the basis of the properties to their estimated fair market value. The net assets of the hotels have been classified as held for sale in the Company’s Consolidated Balance Sheet as of December 31, 2012 and the results of operations for these properties have been reclassified to discontinued operations in the Company’s Consolidated Statements of Operations for each of the three years in the period ended December 31, 2012.
The following is a summary of the Company’s results from continuing operations:
| | Years Ended December 31, | |
(in thousands, except statistical data) | | 2012 | | | Percent of Revenue | | | 2011 | | | Percent of Revenue | | | Percent Change | |
| | | | | | | | | | | | | | | |
Total revenue | | $ | 212,046 | | | | 100 | % | | $ | 204,382 | | | | 100 | % | | | 4 | % |
Hotel operating expenses | | | 122,799 | | | | 58 | % | | | 119,232 | | | | 58 | % | | | 3 | % |
Taxes, insurance and other expense | | | 12,951 | | | | 6 | % | | | 12,321 | | | | 6 | % | | | 5 | % |
General and administrative expense | | | 7,194 | | | | 3 | % | | | 4,989 | | | | 2 | % | | | 44 | % |
| | | | | | | | | | | | | | | | | | | | |
Depreciation | | | 33,922 | | | | | | | | 33,533 | | | | | | | | 1 | % |
Interest expense, net | | | 10,573 | | | | | | | | 9,822 | | | | | | | | 8 | % |
| | | | | | | | | | | | | | | | | | | | |
Number of hotels | | | 48 | | | | | | | | 48 | | | | | | | | 0 | % |
Average Market Yield (1) | | | 124 | | | | | | | | 127 | | | | | | | | -2 | % |
ADR | | $ | 115 | | | | | | | $ | 111 | | | | | | | | 4 | % |
Occupancy | | | 73 | % | | | | | | | 73 | % | | | | | | | 0 | % |
RevPAR | | $ | 84 | | | | | | | $ | 81 | | | | | | | | 4 | % |
| | | | | | | | | | | | | | | | | | | | |
(1) Calculated from data provided by Smith Travel Research, Inc.® Excludes hotels under renovation. | | | | | | | | | |
Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Hotels Owned
The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 51 hotels the Company owned at December 31, 2012. All dollar amounts are in thousands.
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price | |
Houston | | TX | | Residence Inn | | Western | | 4/27/06 | | | 129 | | | $ | 13,600 | |
San Diego | | CA | | Hilton Garden Inn | | Inn Ventures | | 5/9/06 | | | 200 | | | | 34,500 | |
Brownsville | | TX | | Courtyard | | Western | | 6/19/06 | | | 90 | | | | 8,550 | |
Stafford | | TX | | Homewood Suites | | Western | | 8/15/06 | | | 78 | | | | 7,800 | |
Auburn | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 101 | | | | 10,185 | |
Huntsville | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 101 | | | | 10,285 | |
Montgomery | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 97 | | | | 10,385 | |
Montgomery | | AL | | Homewood Suites | | LBA | | 8/17/06 | | | 91 | | | | 10,660 | |
Troy | | AL | | Hampton Inn | | LBA | | 8/17/06 | | | 82 | | | | 6,130 | |
Seattle | | WA | | Residence Inn | | Inn Ventures | | 9/1/06 | | | 234 | | | | 56,173 | |
Sarasota | | FL | | Homewood Suites | | Hilton | | 9/15/06 | | | 100 | | | | 13,800 | |
Hattiesburg | | MS | | Courtyard | | LBA | | 10/5/06 | | | 84 | | | | 9,455 | |
Huntsville | | AL | | Homewood Suites | | LBA | | 10/27/06 | | | 107 | | | | 11,606 | |
Omaha | | NE | | Courtyard | | Marriott | | 11/4/06 | | | 181 | | | | 23,100 | |
Cincinnati | | OH | | Homewood Suites | | White | | 12/1/06 | | | 76 | | | | 7,100 | |
Rancho Bernardo | | CA | | Courtyard | | Dimension | | 12/12/06 | | | 210 | | | | 36,000 | |
New Orleans | | LA | | Homewood Suites | | Dimension | | 12/15/06 | | | 166 | | | | 43,000 | |
Ronkonkoma | | NY | | Hilton Garden Inn | | White | | 12/15/06 | | | 164 | | | | 27,000 | |
Tupelo | | MS | | Hampton Inn | | LBA | | 1/23/07 | | | 96 | | | | 5,245 | |
Miami | | FL | | Homewood Suites | | Dimension | | 2/21/07 | | | 159 | | | | 24,300 | |
Highlands Ranch | | CO | | Residence Inn | | Dimension | | 2/22/07 | | | 117 | | | | 19,000 | |
Cranford | | NJ | | Homewood Suites | | Dimension | | 3/7/07 | | | 108 | | | | 13,500 | |
Mahwah | | NJ | | Homewood Suites | | Dimension | | 3/7/07 | | | 110 | | | | 19,500 | |
Highlands Ranch | | CO | | Hilton Garden Inn | | Dimension | | 3/9/07 | | | 128 | | | | 20,500 | |
Prattville | | AL | | Courtyard | | LBA | | 4/24/07 | | | 84 | | | | 9,304 | |
Lakeland | | FL | | Courtyard | | LBA | | 4/24/07 | | | 78 | | | | 9,805 | |
Tallahassee* | | FL | | Fairfield Inn | | LBA | | 4/24/07 | | | 79 | | | | 6,647 | |
Columbus* | | GA | | Fairfield Inn | | LBA | | 4/24/07 | | | 79 | | | | 7,333 | |
Agoura Hills | | CA | | Homewood Suites | | Dimension | | 5/8/07 | | | 125 | | | | 25,250 | |
Memphis | | TN | | Homewood Suites | | Hilton | | 5/15/07 | | | 140 | | | | 11,100 | |
Dothan* | | AL | | Fairfield Inn | | LBA | | 5/16/07 | | | 63 | | | | 4,584 | |
Vancouver | | WA | | SpringHill Suites | | Inn Ventures | | 6/1/07 | | | 119 | | | | 15,988 | |
San Diego | | CA | | Residence Inn | | Dimension | | 6/13/07 | | | 121 | | | | 32,500 | |
Provo | | UT | | Residence Inn | | Dimension | | 6/13/07 | | | 114 | | | | 11,250 | |
Macon | | GA | | Hilton Garden Inn | | LBA | | 6/28/07 | | | 101 | | | | 10,660 | |
San Antonio | | TX | | TownePlace Suites | | Western | | 6/29/07 | | | 106 | | | | 11,925 | |
Alexandria | | VA | | Courtyard | | Marriott | | 7/13/07 | | | 178 | | | | 36,997 | |
San Diego | | CA | | Hampton Inn | | Dimension | | 7/19/07 | | | 177 | | | | 42,000 | |
Addison | | TX | | SpringHill Suites | | Marriott | | 8/10/07 | | | 159 | | | | 12,500 | |
Boise | | ID | | SpringHill Suites | | Inn Ventures | | 9/14/07 | | | 230 | | | | 21,000 | |
San Antonio | | TX | | TownePlace Suites | | Western | | 9/27/07 | | | 123 | | | | 13,838 | |
Trussville | | AL | | Courtyard | | LBA | | 10/4/07 | | | 84 | | | | 9,510 | |
Kirkland | | WA | | Courtyard | | Inn Ventures | | 10/23/07 | | | 150 | | | | 31,000 | |
Huntsville | | AL | | TownePlace Suites | | LBA | | 12/10/07 | | | 86 | | | | 8,927 | |
Tucson | | AZ | | Residence Inn | | Western | | 1/17/08 | | | 124 | | | | 16,640 | |
Richmond | | VA | | Marriott | | White | | 1/25/08 | | | 410 | | | | 53,300 | |
Columbus | | GA | | SpringHill Suites | | LBA | | 3/6/08 | | | 85 | | | | 9,675 | |
Dothan | | AL | | Residence Inn | | LBA | | 4/16/08 | | | 84 | | | | 9,669 | |
El Paso | | TX | | Homewood Suites | | Western | | 4/23/08 | | | 114 | | | | 15,390 | |
Columbus | | GA | | TownePlace Suites | | LBA | | 5/22/08 | | | 86 | | | | 8,428 | |
Miami | | FL | | Courtyard | | Dimension | | 9/5/08 | | | 118 | | | | 15,000 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | 6,426 | | | $ | 901,594 | |
* Hotels are reported as held for sale.
Management and Franchise Agreements
Each of the 48 hotels included in the Company’s continuing operations are operated and managed, under separate management agreements, by affiliates of one of the following companies: Dimension Development Company (“Dimension”), Hilton Worldwide (“Hilton”), Inn Ventures, Inc. (“Inn Ventures”), Larry Blumberg & Associates (“LBA”), Marriott International, Inc. (“Marriott”), Western International (“Western”), or White Lodging Services Corporation (“White”). The agreements generally provide for initial terms ranging from one to twenty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.1 million, $6.8 million and $6.5 million, respectively, in management fees for continuing operations.
Dimension, Inn Ventures, LBA, Western, and White are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage (as well as the two hotels managed by Promus Hotels, Inc., which is an affiliate of Hilton) were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements provide for initial terms ranging between 10 to 20 years. Fees associated with the Hilton agreements generally include the payment of royalty fees and program fees based on room revenues. The Marriott franchise agreements provide for an initial term of between six and 20 years. Fees associated with the Marriott agreements include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $8.8 million, $8.4 million and $8.0 million, respectively, in franchise fees for continuing operations.
Results of Operations for Years 2012 and 2011
As of December 31, 2012 the Company’s continuing operations consisted of 48 hotels with 6,205 rooms. Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy had a considerable negative impact on both consumer and business travel. However, economic conditions have shown evidence of improvement during the past two years. As a result, the Company expects improvement in revenue and operating income in 2013 as compared to 2012. The Company’s hotels in general have shown results consistent with its local markets and brand averages for the period of ownership.
Revenues
The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue. For the years ended December 31, 2012 and 2011, the Company had total hotel revenue from continuing operations of $212.0 million and $204.4 million, respectively. For the year ended December 31, 2012, the hotels achieved combined average occupancy of approximately 73%, ADR of $115 and RevPAR of $84. For the year ended December 31, 2011, the hotels achieved combined average occupancy of approximately 73%, ADR of $111 and RevPAR of $81. 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 over prior recessionary periods of 2008 and 2009. While occupancy for 2012 is stable with the prior year, the Company has been able to modestly increase average room rates. Signifying a stabilizing economy, the Company experienced an increase in ADR of 4% during 2012 as compared to the prior year. Although the Company realized modest revenue growth, its RevPAR growth rate of approximately 4% was behind the overall industry growth rate, which was approximately 7%, as compared to 2011. The below average growth is due primarily to factors specific to the individual markets where the Company’s hotels are located. Several of the Company’s markets are heavily dependent upon the government sector which has had a declining demand in certain markets. Overall, with steady demand and room rate improvement, the Company is forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012. Although impacted by increased supply in certain markets, the Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for 2012 and 2011 was 124 and 127. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue.
Expenses
Hotel operating expenses consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the years ended
December 31, 2012 and 2011, hotel operating expenses from continuing operations totaled $122.8 million and $119.2 million, representing 58% of total hotel revenue for each period. Hotel operational expenses for 2012 reflect the impact of modest increases in revenues at most of the Company’s hotels and the Company’s efforts to control costs. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utilities by continually monitoring and sharing utilization data across its hotels and management companies. Although operating expenses will increase as occupancy and revenue increases, the Company has and will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
Taxes, insurance, and other expenses from continuing operations for the years ended December 31, 2012 and 2011 were $13.0 million and $12.3 million, representing 6% of total hotel revenue for each period. Taxes have increased due to reassessment of property values by localities resulting from the improved economy. Insurance rates increased in 2012 due to property and casualty carriers’ losses world-wide in the past year. With the improved economy, the Company anticipates continued increases in property tax assessments in 2013 and a moderate increase in insurance rates.
General and administrative expense from continuing operations for the years ended December 31, 2012 and 2011 was $7.2 million and $5.0 million, representing 3% and 2% of total hotel revenue. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expenses. Total advisory fees incurred by the Company increased by approximately $0.5 million in 2012 as compared to the prior year due to the Company reaching the middle tier of the fee range under the advisory agreement. During the years ended December 31, 2012 and 2011, the Company incurred approximately $1.6 million and $0.9 million, respectively, in legal costs related to the legal matters discussed herein and continued costs responding to requests from the staff of the Securities and Exchange Commission (“SEC”). The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company’s Consolidated Balance Sheets, Consolidated Statements of Operations or Consolidated Statements of Cash Flows. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution. As discussed below under Related Parties, the Company shares legal counsel with the other Apple REIT Companies. Total costs for these legal matters across all of the Apple REIT Companies was $7.3 million in 2012. The Company anticipates it will continue to incur significant legal costs at least during the first half of 2013 related to these matters. Also during the fourth quarter of 2011 the Company began to incur costs associated with its evaluation of a potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Total costs incurred during 2012 and 2011 were approximately $0.7 million and $0.1 million. In May 2012, it was determined by the Board of Directors of the Company and the Board of Directors of each of the other Apple REITs not to move forward with the potential consolidation transaction at that time.
Depreciation expense from continuing operations for the years ended December 31, 2012 and 2011 was $33.9 million and $33.5 million. Depreciation expense represents the expense of the Company’s hotel buildings and related improvements, and associated personal property (furniture, fixtures and equipment) for their respective periods owned.
Interest expense, net, from continuing operations for the years ended December 31, 2012 and 2011 was $10.6 million and $9.8 million. Interest expense primarily arose from mortgage debt outstanding on certain properties, in addition to interest on borrowings under the Company’s unsecured credit facilities. Interest expense for the years ended December 31, 2012 and 2011 was reduced by capitalized interest of approximately $0.3 million and $0.2 million in conjunction with hotel renovations. As of December 31, 2012, the Company had debt outstanding of $198.1 million compared to $174.8 million at December 31, 2011. For the years ended December 31, 2012 and 2011, interest expense increased from 2011 primarily due to an increase in the average outstanding balance of the Company’s debt. The increase in overall debt outstanding during 2012 is to fund working capital needs, while maintaining a relatively stable distribution rate to Unit holders during a low-growth economic period.
Results of Operations for Years 2011 and 2010
Revenues
For the years ended December 31, 2011 and 2010, the Company had total hotel revenue from continuing operations of $204.4 million and $196.2 million. For the year ended December 31, 2011, the hotels achieved average occupancy of 73%, ADR of $111 and RevPAR of $81. For the year ended December 31, 2010, the hotels achieved average occupancy of 71%, ADR of $109 and RevPAR of $78. Since the beginning of 2010, the Company experienced an increase in demand, as shown by the improvement in average occupancy of 3% in 2011 as compared to 2010. In addition, also signifying a
stabilizing economy, the Company experienced an increase in ADR of 2% in 2011 as compared to 2010. The Company’s average Market Yield for both 2011 and 2010 was 127, and excluded hotels under renovation.
Expenses
For the years ended December 31, 2011 and 2010, hotel operating expenses from continuing operations totaled $119.2 million and $114.1 million, representing 58% of total hotel revenue for each period. Hotel operational expenses for 2011 reflect the impact of modest increases in revenues and occupancy at most of the Company’s hotels, and the Company’s efforts to control costs in a challenging and relatively flat to low-growth economic environment during 2011.
Taxes, insurance, and other expenses from continuing operations for the years ended December 31, 2011 and 2010 were $12.3 million and $12.0 million, representing 6% of total hotel revenue for each period. Increases in these expenses for 2011 versus the prior year reflect higher real estate property tax assessments due to the improved economy.
General and administrative expense from continuing operations for the years ended December 31, 2011 and 2010 was $5.0 million and $5.2 million, representing 2% and 3% of total hotel revenue. During 2011 and 2010, the Company incurred approximately $900,000 and $500,000, respectively in legal costs related to the legal matters discussed herein and costs related to responding to requests from the staff of the SEC as discussed above. Also, during the fourth quarter of 2011, the Company incurred costs totaling $90,000 associated with its evaluation of a potential consolidation transaction with the other Apple REITs as discussed above.
Depreciation expense from continuing operations for the years ended December 31, 2011 and 2010 was $33.5 million and $32.6 million, respectively. Depreciation expense represents the expense of the Company’s hotel buildings and related improvements, and associated personal property (furniture, fixtures and equipment) for their respective periods owned.
Interest expense, net from continuing operations for the years ended December 31, 2011 and 2010 was $9.8 million and $7.6 million, respectively. Interest expense primarily arose from mortgage debt outstanding on certain properties, in addition to interest on borrowings under the Company’s credit facility. As of December 31, 2011, the Company had debt outstanding of $174.8 million compared to $148.0 million at December 31, 2010. The increase in interest expense from 2010 was due to an increase in the average outstanding balance of the Company’s debt. The increase in overall debt outstanding during 2011 was to fund working capital needs, while maintaining a relatively stable distribution rate to Unit holders during a low-growth economic period.
Gain from settlement of contingency
The Company recorded other income of $3.1 million in November 2010 arising from the de-recognition of a liability for taxes, previously assumed at purchase in January 2008 of the full service Marriott hotel in Richmond, VA. The de-recognition was a non-cash transaction and had no impact on the Company’s net cash provided by operating activities for the year ended December 31, 2010. The taxing authority to whom the tax liability was due, refinanced the debt related to the tax and therefore extinguished the Company’s liability.
Related Parties
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions in 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price with addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of this contract totaled approximately $18.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees were incurred during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“A7A”) pursuant to which A7A provides management services to the Company. A7A provides these management services through an affiliate called Apple Fund Management, LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee
ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.5 million, $1.0 million and $1.0 million for the years ended December 31, 2012, 2011 and 2010. At December 31, 2012, $0.5 million of the 2012 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. The increase in 2012 is due to the Company reaching the middle tier of the fee range under the advisory agreement, due to improved operating results.
In addition to the fees payable to A7A, the Company reimbursed A7A or paid directly to AFM on behalf of A7A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A7A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each Company’s level of business activity and the extent to which each Company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, Apple Nine Advisors, Inc. entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, Apple Nine Advisors, Inc. and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to Apple Nine Advisors, Inc., if it occurs, will have no impact on the Company’s advisory agreement with A7A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
A7A and ASRG are 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. 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.
Included in other assets, net on the Company’s consolidated balance sheet, is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and
renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.9 million as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, the services received by the Company are shared as applicable across the Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services.
Series B Convertible Preferred Stock
In May 2005 the Company issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with A7A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $50 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to issuance of 240,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the
Series B convertible preferred shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred at December 31, 2012, expense would have ranged from $0 to $63.8 million (assumes $11 per common share fair market value) which represents approximately 5.8 million shares of common stock.
Liquidity and Capital Resources
Contractual Commitments
The following is a summary of the Company’s significant contractual obligations as of December 31, 2012:
| | | | | | Amount of Commitments Expiring per Period |
(000’s) | | | Total | | | Less than 1 Year | | | 2-3 Years | | | 4-5 Years | | | Over 5 Years |
Debt (including interest of $39.9 million) | | | $ | 237,354 | | | $ | 39,810 | | | $ | 97,797 | | | $ | 31,729 | | | $ | 68,018 | |
Ground Leases | | | | 97,111 | | | | 1,052 | | | | 2,300 | | | | 2,325 | | | | 91,434 | |
| | | $ | 334,465 | | | $ | 40,862 | | | $ | 100,097 | | | $ | 34,054 | | | $ | 159,452 | |
Capital Resources
In August 2012, the Company entered into a new $40 million unsecured credit facility with a commercial bank that is utilized for working capital, hotel renovations and other general corporate funding purposes, including the payment of redemptions and distributions. The outstanding principal is required to be paid by the maturity date of August 30, 2014. Interest payments are due monthly and the interest rate is equal to the LIBOR (London Interbank Offered Rate for a one-month term) plus 3.25%. The Company is also required to pay a quarterly fee at an annual rate of 0.35% on the average unused balance of the credit facility. With the availability of the Company’s credit facility, the Company generally maintains little cash on hand, accessing the facility as necessary. As a result, cash on hand was $0 at December 31, 2012 and 2011. The outstanding balance on the credit facility as of December 31, 2012 was $35.6 million and its annual interest rate was 3.46%.
At closing, the Company borrowed approximately $24.5 million under the credit facility to repay the outstanding balance and extinguish its prior $85 million credit facility and to pay transaction costs. Loan origination costs totaled approximately $0.3 million and are being amortized as interest expense through the August 2014 maturity date. The credit facility contains the following quarterly financial covenants (capitalized terms are defined in the loan agreements):
● | Tangible Net Worth must exceed $325 million; |
● | Total Debt to Asset Value must not exceed 50%; |
● | Cumulative 12 month Distributions and Redemptions, net of proceeds from the Company’s Dividend Reinvestment Program, must not exceed $84 million, and quarterly Distributions will not exceed $0.193 per share, unless such cumulative Net Distributions are less than total Funds From Operations for the period; |
● | Loan balance must not exceed 45% of the Unencumbered Asset Value; |
● | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
● | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at December 31, 2012.
In August 2012, the Company entered into four mortgage loan agreements with a commercial bank, secured by four hotel properties for a total of $63.0 million. At closing, the Company used proceeds from each loan to reduce the outstanding balance on the Company’s prior credit facility and pay transaction costs. Combined total loan origination costs of approximately $0.3 million are being amortized as interest expense through the September 2022 maturity date for each loan. The following table summarizes the hotel property securing each loan, the interest rate, loan origination date, maturity date and principal amount originated under each loan agreement. All dollar amounts are in thousands.
Hotel Location | | Brand | | Interest Rate | | Loan Origination Date | | Maturity Date | | Principal Originated | |
Hattiesburg, MS | | Courtyard | | | 5.00 | % | 8/24/2012 | | 9/1/2022 | | $ | 5,900 | |
Rancho Bernardo, CA | | Courtyard | | | 5.00 | % | 8/24/2012 | | 9/1/2022 | | | 15,500 | |
Kirkland, WA | | Courtyard | | | 5.00 | % | 8/24/2012 | | 9/1/2022 | | | 12,500 | |
Seattle, WA | | Residence Inn | | | 4.96 | % | 8/30/2012 | | 9/1/2022 | | | 29,100 | |
Total | | | | | | | | | | | $ | 63,000 | |
The Company has three secured mortgage notes payable that mature in 2013. The Company extinguished one of the loans in February 2013 through a short-term increase in its line of credit and intends to refinance the extinguished loan and the other maturing loans with long term loans.
Capital Uses
In October 2012, the Company extinguished through payment of the outstanding principal, two mortgage notes payable. The mortgage loans for the Tallahassee, Florida Fairfield Inn and the Lakeland, Florida Courtyard, originally assumed at acquisition of the hotels, had principal balances at pay-off of approximately $3.0 million and $3.6 million, respectively.
The Company’s principal sources of liquidity are the operating cash flow generated from the Company’s properties and its $40 million revolving credit facility. The Company anticipates that cash flow from operations, its current revolving credit facility and other available credit will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions. The Company intends to maintain a relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles. The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions, capital improvements, ramp-up of new properties and varying economic cycles. With the depressed financial results of the Company and lodging industry as compared to pre-recession levels, the Company has and will, if necessary, 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 distributions to required levels. If the Company were to default or be unable to refinance debt maturing in the future, it may be unable to make distributions.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions in 2012 totaled $70.0 million and were paid monthly at a rate of $0.064167 per common share. Total 2012 dividends paid equaled $0.77 per common share. For the same period the Company’s cash generated from operations was approximately $60.8 million. This shortfall includes a return of capital and was funded primarily by borrowings on the credit facility. Since a portion of distributions has been funded with borrowed funds, the Company’s ability to maintain its current intended rate of distribution will be primarily based on the ability of the Company’s properties to generate cash from operations at this level, the Company’s ability to utilize currently available financing, or the Company’s ability to obtain additional financing. Since there can be no assurance of the Company’s ability to obtain additional financing or that the properties owned by the Company will provide income at this level, there can be no assurance as to the classification or duration of distributions at the current rate. The Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make additional adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company.
In April 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 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 more than three years. 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. Since inception of the program through December 31, 2012, the Company has redeemed approximately 11.5 million Units representing $124.2 million, including 1.6 million Units in the amount of $17.8 million, 2.9 million Units in the amount of $32.0 million, and 3.7 million Units in the amount of $40.7 million redeemed during 2012, 2011, and 2010. As contemplated in the program, beginning with the January 2011 redemption, the scheduled redemption date for the first quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 1,137,969 | | | | 728,135 | | | | 409,834 | |
April 2011 | | | 1,303,574 | | | | 728,883 | | | | 574,691 | |
July 2011 | | | 5,644,778 | | | | 732,160 | | | | 4,912,618 | |
October 2011 | | | 11,332,625 | | | | 727,980 | | | | 10,604,645 | |
January 2012 | | | 12,885,635 | | | | 455,093 | | | | 12,430,542 | |
April 2012 | | | 12,560,001 | | | | 441,458 | | | | 12,118,543 | |
July 2012 | | | 12,709,508 | | | | 364,299 | | | | 12,345,209 | |
October 2012 | | | 13,003,443 | | | | 363,755 | | | | 12,639,688 | |
As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent. Currently, the Company plans to redeem under its Redemption Program approximately 1-2% of weighted average Units during 2013.
In July 2007 the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of 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. The Company has registered 15 million Units for potential issuance under the plan. During the years ended December 31, 2012, 2011 and 2010, approximately 1.5 million Units, representing $16.0 million in proceeds to the Company, 2.0 million Units representing $22.0 million in proceeds to the Company, and 2.2 million Units representing $24.6 million in proceeds to the Company, were issued under the plan. Since inception of the plan through December 31, 2012, approximately 11.3 million Units, representing $124.5 million in proceeds to the Company, were issued under the plan.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and under certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. 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 December 31, 2012, the Company held $9.3 million in reserve for capital expenditures. In 2012 and 2011, the Company invested approximately $7.4 million and $8.4 million in capital expenditures and anticipates investing approximately $20 million during 2013. Due to the recent recessionary low-growth economic environment, the Company invested a slightly lower than normal amount in capital expenditures in 2012 and 2011. The Company currently does not have any existing or planned projects for new developments.
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 historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.
Critical Accounting Policies
The following contains a discussion of what the Company believes to be critical accounting policies. These items should be read to gain a further understanding of the principles used to prepare the Company’s financial statements. These principles include application of judgment; therefore, changes in judgments may have a significant impact on the Company’s reported results of operations and financial condition.
Capitalization Policy
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; and (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
Impairment Losses Policy
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that recently opened, were recently renovated or experienced other short-term business disruption. Since the Company’s planned initial hold period for each property is 39 years the Company’s ongoing analysis and annual recoverability analysis have not identified any impairment losses and no impairment losses have been recorded to date other than the impairment on three properties discussed below. If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value. During December 2012, the Company identified three properties that it would consider selling in the next year due to anticipated returns for needed capital investment being below returns for other investment opportunities. In January 2013 management committed to a marketing effort to sell these properties. Since the Company’s anticipated hold period for these properties was reduced, the estimated undiscounted cash flows for these properties was estimated to be less than their carrying value; therefore the Company adjusted the carrying value of the properties to their estimated fair market value, which resulted in an impairment loss of $6.6 million.
Subsequent Events
In January 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 111,782 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 386,558 Units in the amount of $4.2 million. As contemplated in the Program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 3% of the total 13.4 million requested Units to be redeemed, with approximately 13.0 million requested Units not redeemed.
In January 2013, the Company entered into two mortgage loan agreements with a commercial real estate lender. The loans are separately secured by the Company’s Huntsville, Alabama Homewood Suites and Prattville, Alabama Courtyard hotels, and will amortize based on a 25 year term with a balloon payment due at maturity in February 2023. Interest is payable monthly on the outstanding balance of each loan at an annual rate of 4.12%. The total proceeds of $15.3 million under the two loan agreements were used to reduce the outstanding balance on the Company’s $40.0 million credit facility, and to pay loan origination and other transaction costs of approximately $0.2 million.
In February 2013, the Company extinguished through pay-off a mortgage note payable jointly secured by the San Diego, California Residence Inn and the Provo, Utah Residence Inn. The note payable had a scheduled maturity in April 2013, and was originally assumed upon acquisition of the two hotels in 2007. The mortgage note payable had a principal balance at pay-off of approximately $18.3 million, an interest rate of 6.55%, and was extinguished without premium or discount to the balance outstanding. Funds for the debt extinguishment were provided by borrowings under the Company’s amended unsecured credit facility. The Company entered into an amendment to its unsecured credit facility, also in February 2013, which increased the maximum aggregate commitment by the lender from $40.0 million to $55.0 million. Under the amendment the increase is effective until the earlier of completing its planned financing of the San Diego, California Residence Inn or April 2013. All other terms of the credit facility remain the same, including the payment of a quarterly fee on the average unused balance of the credit facility at an annual rate of 0.35%.
The Company’s Board of Directors approved a reduction in the Company’s projected distribution rate from an annual rate of $0.77 per common share to $0.66 per common share. The change is effective with the distribution planned for April 2013. The distribution will continue to be paid monthly.
In February 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 110,000 Units were reinvested under the Company’s Dividend Reinvestment Plan.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Apple REIT Seven, Inc.
We have audited the accompanying consolidated balance sheets of Apple REIT Seven, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Apple REIT Seven, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Apple REIT Seven, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 6, 2013 (not provided herein) expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Richmond, Virginia
March 6, 2013, except for Note 11,
as to which the date is September 9, 2013
APPLE REIT SEVEN, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)
| | As of December 31, | |
| | 2012 | | | 2011 | |
| | | | | | |
Assets | | | | | | |
Investment in real estate, net of accumulated depreciation of $179,491 and $148,257, respectively | | $ | 802,326 | | | $ | 846,377 | |
Hotels held for sale | | | 10,300 | | | | 0 | |
Restricted cash-furniture, fixtures and other escrows | | | 11,354 | | | | 7,141 | |
Due from third party managers, net | | | 6,798 | | | | 6,426 | |
Other assets, net | | | 4,725 | | | | 5,197 | |
Total Assets | | $ | 835,503 | | | $ | 865,141 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Credit facilities | | $ | 35,600 | | | $ | 64,700 | |
Mortgage debt | | | 162,523 | | | | 110,147 | |
Accounts payable and accrued expenses | | | 12,917 | | | | 12,314 | |
Total Liabilities | | | 211,040 | | | | 187,161 | |
| | | | | | | | |
Shareholders' Equity | | | | | | | | |
Preferred stock, authorized 15,000,000 shares; none issued and outstanding | | | 0 | | | | 0 | |
Series A preferred stock, no par value, authorized 200,000,000 shares; issued and outstanding 90,941,959 and91,109,651 shares, respectively | | | 0 | | | | 0 | |
Series B convertible preferred stock, no par value, authorized 240,000 shares; issued and outstanding 240,000 shares | | | 24 | | | | 24 | |
Common stock, no par value, authorized 200,000,000 shares; issued and outstanding 90,941,959 and 91,109,651 shares, respectively | | | 898,821 | | | | 900,555 | |
Distributions greater than net income | | | (274,382 | ) | | | (222,599 | ) |
Total Shareholders' Equity | | | 624,463 | | | | 677,980 | |
| | | | | | | | |
Total Liabilities and Shareholders' Equity | | $ | 835,503 | | | $ | 865,141 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
| | | | | | | | | |
Revenues: | | | | | | | | | |
Room revenue | | $ | 191,437 | | | $ | 184,179 | | | $ | 176,802 | |
Other revenue | | | 20,609 | | | | 20,203 | | | | 19,350 | |
Total revenue | | | 212,046 | | | | 204,382 | | | | 196,152 | |
| | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | |
Operating expense | | | 56,581 | | | | 54,999 | | | | 52,264 | |
Hotel administrative expense | | | 15,617 | | | | 15,527 | | | | 14,685 | |
Sales and marketing | | | 16,640 | | | | 15,804 | | | | 15,157 | |
Utilities | | | 8,555 | | | | 8,725 | | | | 8,539 | |
Repair and maintenance | | | 9,489 | | | | 8,954 | | | | 8,949 | |
Franchise fees | | | 8,823 | | | | 8,436 | | | | 8,007 | |
Management fees | | | 7,094 | | | | 6,787 | | | | 6,507 | |
Taxes, insurance and other | | | 12,951 | | | | 12,321 | | | | 12,003 | |
General and administrative | | | 7,194 | | | | 4,989 | | | | 5,177 | |
Depreciation expense | | | 33,922 | | | | 33,533 | | | | 32,603 | |
Gain from settlement of contingency | | | 0 | | | | 0 | | | | (3,099 | ) |
Total expenses | | | 176,866 | | | | 170,075 | | | | 160,792 | |
| | | | | | | | | | | | |
Operating income | | | 35,180 | | | | 34,307 | | | | 35,360 | |
| | | | | | | | | | | | |
Interest expense, net | | | (10,573 | ) | | | (9,822 | ) | | | (7,639 | ) |
| | | | | | | | | | | | |
Income from continuing operations | | | 24,607 | | | | 24,485 | | | | 27,721 | |
Income (loss) from discontinued operations | | | (6,421 | ) | | | 528 | | | | 597 | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | |
| | | | | | | | | | | | |
Basic and diluted net income (loss) per common share | | | | | | | | | | | | |
From continuing operations | | $ | 0.27 | | | $ | 0.27 | | | $ | 0.30 | |
From discontinued operations | | | (0.07 | ) | | | 0.00 | | | | 0.01 | |
Total basic and diluted net income per common share | | $ | 0.20 | | | $ | 0.27 | | | $ | 0.31 | |
| | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 90,891 | | | | 91,435 | | | | 92,627 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands except per share data)
| | | | | | | | Series B Convertible | | | Distributions | | | | |
| | Common Stock | | | Preferred Stock | | | Greater than | | | | |
| | Number of Shares | | | Amount | | | Number of Shares | | | Amount | | | Net income | | | Total | |
| | | | | | | | | | | | | | | | | | |
Balance at December 31, 2009 | | | 93,522 | | | $ | 926,419 | | | | 240 | | | $ | 24 | | | $ | (134,186 | ) | | $ | 792,257 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 2,239 | | | | 24,745 | | | | 0 | | | | 0 | | | | 0 | | | | 24,745 | |
Common shares redeemed | | | (3,733 | ) | | | (40,680 | ) | | | 0 | | | | 0 | | | | 0 | | | | (40,680 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 28,318 | | | | 28,318 | |
Cash distributions declared and paid to shareholders ($.77 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (71,340 | ) | | | (71,340 | ) |
Balance at December 31, 2010 | | | 92,028 | | | | 910,484 | | | | 240 | | | | 24 | | | | (177,208 | ) | | | 733,300 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 1,999 | | | | 22,098 | | | | 0 | | | | 0 | | | | 0 | | | | 22,098 | |
Common shares redeemed | | | (2,917 | ) | | | (32,027 | ) | | | 0 | | | | 0 | | | | 0 | | | | (32,027 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 25,013 | | | | 25,013 | |
Cash distributions declared and paid to shareholders ($.77 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (70,404 | ) | | | (70,404 | ) |
Balance at December 31, 2011 | | | 91,110 | | | | 900,555 | | | | 240 | | | | 24 | | | | (222,599 | ) | | | 677,980 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 1,457 | | | | 16,098 | | | | 0 | | | | 0 | | | | 0 | | | | 16,098 | |
Common shares redeemed | | | (1,625 | ) | | | (17,832 | ) | | | 0 | | | | 0 | | | | 0 | | | | (17,832 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 18,186 | | | | 18,186 | |
Cash distributions declared and paid to shareholders ($.77 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (69,969 | ) | | | (69,969 | ) |
Balance at December 31, 2012 | | | 90,942 | | | $ | 898,821 | | | | 240 | | | $ | 24 | | | $ | (274,382 | ) | | $ | 624,463 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
| | | | | | | | | |
Cash flows from operating activities: | | | | | | | | | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | |
Adjustments to reconcile net income to cash provided by | | | | | | | | | | | | |
Depreciation, including discontinued operations | | | 34,557 | | | | 34,160 | | | | 33,174 | |
Loss on impairment of hotels held for sale | | | 6,640 | | | | 0 | | | | 0 | |
Gain from settlement of contingency | | | 0 | | | | 0 | | | | (3,099 | ) |
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net | | | 256 | | | | 491 | | | | 665 | |
Changes in operating assets and liabilities: | | | | | | | | | | | | |
Increase in due from third party managers, net | | | (372 | ) | | | (597 | ) | | | (190 | ) |
Decrease (increase) in other assets | | | 145 | | | | 1 | | | | (33 | ) |
Increase in accounts payable and accrued expenses | | | 1,394 | | | | 967 | | | | 1,080 | |
Net cash provided by operating activities | | | 60,806 | | | | 60,035 | | | | 59,915 | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Capital improvements | | | (8,237 | ) | | | (7,671 | ) | | | (4,234 | ) |
Additions to ownership interest in non-hotel properties | | | 0 | | | | (101 | ) | | | (125 | ) |
Net decrease (increase) in capital improvement reserves | | | (3,897 | ) | | | 890 | | | | 2,049 | |
Net cash used in investing activities | | | (12,134 | ) | | | (6,882 | ) | | | (2,310 | ) |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net proceeds related to issuance of Units | | | 16,004 | | | | 21,987 | | | | 24,745 | |
Redemptions of Units | | | (17,832 | ) | | | (32,027 | ) | | | (40,680 | ) |
Distributions paid to common shareholders | | | (69,969 | ) | | | (70,404 | ) | | | (71,340 | ) |
Net proceeds from (payments on) extinguished credit facility | | | (64,700 | ) | | | 19,800 | | | | 33,390 | |
Net proceeds from existing credit facility | | | 35,600 | | | | 0 | | | | 0 | |
Proceeds from mortgage debt | | | 63,000 | | | | 10,500 | | | | 0 | |
Payments on mortgage debt | | | (10,021 | ) | | | (2,874 | ) | | | (2,563 | ) |
Deferred financing costs | | | (754 | ) | | | (135 | ) | | | (1,157 | ) |
Net cash used in financing activities | | | (48,672 | ) | | | (53,153 | ) | | | (57,605 | ) |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | 0 | | | | 0 | | | | 0 | |
| | | | | | | | | | | | |
Cash and cash equivalents, beginning of period | | | 0 | | | | 0 | | | | 0 | |
| | | | | | | | | | | | |
Cash and cash equivalents, end of period | | $ | 0 | | | $ | 0 | | | $ | 0 | |
| | | | | | | | | | | | |
Supplemental information: | | | | | | | | | | | | |
Interest paid | | $ | 10,881 | | | $ | 9,959 | | | $ | 7,980 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC.
Notes to Consolidated Financial Statements
Note 1
Organization and Summary of Significant Accounting Policies
Organization
Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”) is a Virginia corporation formed to invest in income-producing real estate in the United States. Initial capitalization occurred on May 26, 2005 and operations began on April 27, 2006 when the Company acquired its first hotel. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007. The Company’s fiscal year end is December 31. The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. As of December 31, 2012, the Company owned 51 hotels located in 18 states with an aggregate of 6,426 rooms.
The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The REIT Modernization Act, effective January 1, 2001, permits real estate investment trusts to establish taxable businesses to conduct certain previously disallowed business activities. The Company has formed wholly-owned taxable REIT subsidiaries (collectively, the “Lessee”), which lease all of the Company’s hotels.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments with original maturities of three months or less. The fair market value of cash and cash equivalents approximates their carrying value. Balances held may at times exceed federal depository insurance limits.
Restricted Cash
Restricted cash includes reserves for debt service, real estate taxes, and insurance, and reserves for furniture, fixtures, and equipment replacements of up to 5% of property revenue for certain hotels, as required by certain management or mortgage debt agreement restrictions and provisions.
Investment in Real Estate and Related Depreciation
Real estate is stated at cost, net of depreciation. Repair and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements are capitalized. Depreciation is computed using the straight-line method over average estimated useful lives of the assets, which are 39 years for buildings, 18 years for franchise fees, ten years for major improvements and three to seven years for furniture, fixtures and equipment.
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; and (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that recently opened, were recently renovated or experienced other short-term business disruption. The Company’s planned
initial hold period for each property is 39 years. The Company’s ongoing analysis and annual recoverability analysis have not identified any impairment losses and no impairment losses have been recorded to date, other than the loss on impairment of three properties discussed below. If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.
During December 2012, the Company identified three properties that it would consider selling in the next year due to anticipated returns for needed capital investment being below returns for other investment opportunities. In January 2013, the Company began the process of marketing these three underperforming assets, the Fairfield Inns in Dothan, Alabama, Columbus, Georgia and Tallahassee, Florida. Due to the change in anticipated hold period of the assets, the estimated undiscounted cash flow for these properties was estimated to be less than their carrying value; therefore the Company recognized a loss of $6.6 million in the fourth quarter of 2012 to adjust the basis of the properties to their estimated fair market value. The estimated fair value of the three properties is based on third party pricing estimates, including specific market analysis and management estimates of market capitalization rates. These estimates incorporate significant unobservable inputs and therefore are considered Level 3 inputs under the fair value hierarchy.
Revenue Recognition
Hotel revenue is recognized as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel’s services.
Comprehensive Income
The Company recorded no comprehensive income other than net income during the periods reported.
Earnings Per Common Share
Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the year. Diluted earnings per common share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the year. There were no potential common shares with a dilutive effect for the years ended December 31, 2012, 2011 or 2010. As a result, basic and dilutive outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares.
Federal Income Taxes
The Company is operated as, and has elected to be taxed as, a REIT under Sections 856 to 860 of the Internal Revenue Code. Earnings and profits, which will determine the taxability of distributions to shareholders, will differ from income reported for financial reporting purposes primarily due to the differences for federal income tax purposes in the estimated useful lives used to compute depreciation. Distributions in 2012 of $0.77 per share for tax purposes was 43% ordinary income and 57% return of capital. The characterization of 2011 distributions of $0.77 per share for tax purposes was 52% ordinary income and 48% return of capital. The characterization of 2010 distributions of $0.77 per share for tax purposes was 51% ordinary income and 49% return of capital.
The Lessee, as a taxable REIT subsidiary of the Company, is subject to federal and state income taxes. The taxable REIT subsidiary had taxable income for the year ended December 31, 2012 and incurred a loss for the years ended December 31, 2011 and 2010. Due to the availability of net operating losses from prior years the Company did not have any federal tax expense in 2012. No operating loss benefit has been recorded in the consolidated balance sheet since realization is uncertain due to the history of operating losses. The total net operating loss carry forward for federal income tax purposes was approximately $25.9 million as of December, 31, 2012. The net operating losses begin to expire in 2026. There are no material differences between the book and tax cost basis of the Company’s assets except for the $6.6 million impairment loss recorded for book purposes. As of December 31, 2012, the tax years that remain subject to examination by major tax jurisdictions generally include 2009 to 2012.
Sales and Marketing Costs
Sales and marketing costs are expensed when incurred. These costs represent the expense for franchise advertising and reservation systems under the terms of the hotel management and franchise agreements and general and administrative expenses that are directly attributable to advertising and promotion.
Use of Estimates
The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Note 2
Investment in Real Estate
The Company’s investment in real estate consisted of the following (in thousands):
| | December 31, 2012 | | | December 31, 2011 | |
Land | | $ | 88,961 | | | $ | 90,429 | |
Building and Improvements | | | 818,249 | | | | 832,798 | |
Furniture, Fixtures and Equipment | | | 71,935 | | | | 68,585 | |
Franchise Fees | | | 2,672 | | | | 2,822 | |
| | | | | | | | |
| | | 981,817 | | | | 994,634 | |
Less Accumulated Depreciation | | | (179,491 | ) | | | (148,257 | ) |
| | | | | | | | |
Investment in Real Estate, net | | $ | 802,326 | | | $ | 846,377 | |
Hotels Owned
As of December 31, 2012, the Company owned 51 hotels, including three hotels held for sale, located in 18 states, consisting of the following:
Brand | | Total by Brand | | | Number of Rooms | |
Homewood Suites | | | 12 | | | | 1,374 | |
Courtyard | | | 10 | | | | 1,257 | |
Residence Inn | | | 7 | | | | 923 | |
Hilton Garden Inn | | | 7 | | | | 892 | |
SpringHill Suites | | | 4 | | | | 593 | |
TownePlace Suites | | | 4 | | | | 401 | |
Hampton Inn | | | 3 | | | | 355 | |
Fairfield Inn | | | 3 | | | | 221 | |
Marriott | | | 1 | | | | 410 | |
Total | | | 51 | | | | 6,426 | |
Note 3
Credit Facility and Mortgage Debt
In August 2012, the Company entered into a new $40 million unsecured credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. Interest payments are due monthly and the interest rate is equal to the LIBOR (London Interbank Offered Rate for a one-month term) plus 3.25%. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part, at any time. The Company is also required to pay a quarterly fee at an annual rate of 0.35% on the average unused balance of the credit facility. The Company’s prior $85 million unsecured credit facility, originated in October 2010, had an interest rate equal to one-month LIBOR plus 3.5%, subject to a minimum LIBOR interest rate floor of 1.5%, and was subject to a fee on the average unused balance of the facility an annualized rate of 0.50%. The credit facility matures in August 2014. At closing, the Company borrowed approximately $24.5 million under the credit facility to repay the outstanding balance and extinguish the prior $85 million credit facility and pay transaction costs. The balance outstanding under the credit facility on December 31, 2012 was $35.6 million, at an annual interest rate of approximately 3.46%. Loan origination costs totaled approximately $0.3 million and are being amortized as interest expense through the August 2014 maturity date. The credit facility contains the following quarterly financial covenants (capitalized terms are defined in the loan agreements):
● | Tangible Net Worth must exceed $325 million; |
● | Total Debt to Asset Value must not exceed 50%; |
● | Cumulative 12 month Distributions and Redemptions, net of proceeds from the Company’s Dividend Reinvestment Program, cannot exceed $84 million and quarterly Distributions cannot exceed $0.193 per share, unless such cumulative Net Distributions are less than total Funds From Operations for the period; |
● | Loan balance must not exceed 45% of the Unencumbered Asset Value; |
● | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
● | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at December 31, 2012.
In conjunction with the acquisition of several hotel properties, the Company assumed mortgage notes payable outstanding, secured by the applicable hotel property. In August 2012, the Company entered into four mortgage loan agreements with a commercial bank, secured by four hotel properties, for a total of $63.0 million. Scheduled payments of interest and principal are due monthly. At closing, the Company used proceeds from each loan to reduce the outstanding balance on the Company’s prior credit facility and pay transaction costs. Combined total loan origination costs of approximately $0.3 million are being amortized as interest expense through the September 2022 maturity date for each loan. In addition, on February 28, 2011, the Company entered into a mortgage loan agreement, secured by the Company’s Houston, Texas Residence Inn property, for $10.5 million. Scheduled payments of interest and principal are due monthly. At closing, the Company used proceeds from the loan for general corporate purposes, including the reduction in the outstanding balance of the Company’s former revolving credit facility. The following table summarizes the hotel property securing each loan, the interest rate, maturity date, the principal amount assumed or originated, and the outstanding balance as of December 31, 2012 and 2011. All dollar amounts are in thousands.
Location | | Brand | | Interest Rate (1) | | Acquisition or Loan Origination Date | | Maturity Date | | Principal Assumed or Originated | | | Outstanding balance as of December 31, 2012 | | | Outstanding balance as of December 31, 2011 | |
Omaha, NE | | Courtyard | | | 6.79 | % | 11/4/2006 | | 1/1/2014 | | $ | 12,658 | | | $ | 10,922 | | | $ | 11,258 | |
New Orleans, LA | | Homewood Suites | | | 5.85 | % | 12/15/2006 | | 10/1/2014 | | | 17,144 | | | | 14,872 | | | | 15,307 | |
Tupelo, MS | | Hampton Inn | | | 5.90 | % | 1/23/2007 | | 3/1/2016 | | | 4,110 | | | | 3,316 | | | | 3,470 | |
Miami, FL | | Homewood Suites | | | 6.50 | % | 2/21/2007 | | 7/1/2013 | | | 9,820 | | | | 8,405 | | | | 8,687 | |
Highlands Ranch, CO | | Residence Inn | | | 5.94 | % | 2/21/2007 | | 6/1/2016 | | | 11,550 | | | | 10,710 | | | | 10,883 | |
Tallahassee, FL | | Fairfield Inn | | | 6.80 | % | 4/24/2007 | | 1/11/2013 | | | 3,494 | | | | 0 | | | | 3,099 | |
Lakeland, FL | | Courtyard | | | 6.80 | % | 4/24/2007 | | 1/11/2013 | | | 4,210 | | | | 0 | | | | 3,734 | |
San Diego, CA | | Residence Inn | | | 6.55 | % | 6/12/2007 | | 4/1/2013 | | | 15,804 | | | | 13,589 | | | | 14,053 | |
Provo, UT | | Residence Inn | | | 6.55 | % | 6/12/2007 | | 4/1/2013 | | | 5,553 | | | | 4,775 | | | | 4,938 | |
Richmond, VA | | Marriott | | | 6.95 | % | 1/25/2008 | | 9/1/2014 | | | 25,298 | | | | 22,376 | | | | 23,054 | |
Houston, TX | | Residence Inn | | | 5.71 | % | 2/28/2011 | | 3/1/2016 | | | 10,500 | | | | 10,170 | | | | 10,363 | |
Hattiesburg, MS | | Courtyard | | | 5.00 | % | 8/24/2012 | | 9/1/2022 | | | 5,900 | | | | 5,871 | | | | 0 | |
Rancho Bernardo, CA | | Courtyard | | | 5.00 | % | 8/24/2012 | | 9/1/2022 | | | 15,500 | | | | 15,424 | | | | 0 | |
Kirkland, WA | | Courtyard | | | 5.00 | % | 8/24/2012 | | 9/1/2022 | | | 12,500 | | | | 12,439 | | | | 0 | |
Seattle, WA | | Residence Inn | | | 4.96 | % | 8/30/2012 | | 9/1/2022 | | | 29,100 | | | | 28,956 | | | | 0 | |
Total | | | | | | | | | | | $ | 183,141 | | | $ | 161,825 | | | $ | 108,846 | |
________ | | | | | | | | | | | | | | | | | | | | | |
(1) These rates are the rates per the loan agreement. At acquisition, the Company adjusted the interest rateson the loans assumed to market rates and is amortizing the adjustments to interest expense over the life of the loan. |
In October 2012, the Company extinguished through payment of the outstanding principal two mortgage notes payable. The mortgage loans for the Tallahassee, Florida Fairfield Inn and the Lakeland, Florida Courtyard, originally assumed at acquisition of the hotels, had principal balances at pay-off of approximately $3.0 million and $3.6 million, respectively. Each mortgage loan had an interest rate of 6.80%, a stated maturity date in January 2013, and was extinguished without premium or discount to the balance outstanding.
The aggregate amounts of principal payable under the Company’s debt obligations, for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
2013 | | $ | 30,153 | |
2014 | | | 84,148 | |
2015 | | | 2,036 | |
2016 | | | 23,898 | |
2017 | | | 1,559 | |
Thereafter | | | 55,631 | |
| | | 197,425 | |
Fair Value Adjustment of Assumed Debt | | | 698 | |
Total | | $ | 198,123 | |
A fair value adjustment was recorded upon the assumption of above market rate mortgage loans in connection with several of the Company’s hotel acquisitions. These fair value adjustments will be amortized into interest expense over the remaining term of the related indebtedness using a method approximating the effective interest rate method. The effective interest rates on the applicable debt obligations assumed ranged from 5.40% to 6.24% at the date of assumption. The total adjustment resulted in a reduction to interest expense of $603,000, $597,000, and $597,000 in each of the years 2012, 2011 and 2010. The unamortized balance of the fair value adjustment was $0.7 million at December 31, 2012 and $1.3 million at December 31, 2011.
The Company incurred loan origination costs related to the assumption of the mortgage obligations on purchased hotels, upon the origination of its current corporate unsecured credit facility and on the former corporate line of credit facilities extinguished in 2012 and 2010, and upon the origination of four mortgage loans in 2012 and one mortgage loan in 2011. Such costs are amortized over the period to maturity of the applicable mortgage loan or credit facility, or to termination of the applicable credit agreement, as an addition to interest expense. Amortization of such costs totaled $764,000 in 2012, $799,000 in 2011 and $351,000 in 2010, and is included in interest expense.
The mortgage loan assumed on the Richmond, Virginia Marriott hotel has a stated maturity date of September 1, 2014. As a condition of the mortgage loan, the maturity date of the note payable may be accelerated by the lender should the Company be required to expand the hotel, under terms of the ground lease on the hotel property. The Company is under no such requirement as of December 31, 2012.
Note 4
Fair Value of Financial Instruments
The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit terms and credit characteristics which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. As of December 31, 2012, the carrying value and estimated fair value of the Company’s debt was approximately $198.1 million and $204.1 million. As of December 31, 2011, the carrying value and estimated fair value of the Company’s debt was $174.8 million and $175.6 million. The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.
Note 5
Related Parties
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions in 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price with addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of
this contract totaled approximately $18.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees were incurred during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“A7A”) pursuant to which A7A provides management services to the Company. A7A provides these management services through an affiliate called Apple Fund Management, LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.5 million $1.0 million and $1.0 million for the years ended December 31, 2012, 2011 and 2010. At December 31, 2012, $0.5 million of the 2012 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. The increase in 2012 is due to the Company reaching the middle tier of the fee range under the advisory agreement, due to improved operating results.
In addition to the fees payable to A7A, the Company reimbursed A7A or paid directly to AFM on behalf of A7A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A7A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each Company’s level of business activity and the extent to which each Company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, Apple Nine Advisors, Inc. entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, Apple Nine Advisors, Inc. and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to Apple Nine Advisors, Inc., if it occurs, will have no impact on the Company’s advisory agreement with A7A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
A7A and ASRG are 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. 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.
Included in other assets, net on the Company’s consolidated balance sheet, is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.9 million as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, the services received by the Company are shared as applicable across the Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the legal matters discussed herein for all of the Apple REIT Companies was approximately $7.3 million in 2012, of which $1.6 million was allocated to the Company.
Note 6
Shareholders’ Equity
Best-efforts Offering
The Company concluded its best-efforts offering of Units on July 17, 2007. The Company registered its Units on Registration Statement Form S-11 (File No. 333-125546). The Company began its best-efforts offering (the “Offering”) of Units on March 15, 2006, the same day the Registration Statement was declared effective by the Securities and Exchange Commission. Each Unit consists of one common share and one Series A preferred share.
Series A Preferred Shares
The Series A preferred shares have no voting rights and no conversion rights. In addition, the Series A preferred shares are not separately tradable from the common shares to which they relate. The Series A preferred shares do not have any distribution rights except a priority distribution upon the sale of the Company’s assets. The priority distribution (“Priority Distribution”) is equal to $11.00 per Series A preferred share, and will be paid before any distribution will be made to the holders of any other shares. Upon the Priority Distribution, the Series A preferred shares will have no other distribution rights.
Series B Convertible Preferred Stock
The Company has issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with A7A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $50 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to issuance of 240,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B convertible preferred shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred at December 31, 2012, expense would have ranged from $0 to $63.8 million (assumes $11 per common share fair market value) which represents approximately 5.8 million shares of common stock.
Preferred Shares
The Company’s articles of incorporation authorize issuance of up to 15 million additional preferred shares. No preferred shares other than the Series A preferred shares and the Series B convertible preferred shares (discussed above) have been issued. The Company believes that the authorization to issue additional preferred shares benefits the Company and its shareholders by permitting flexibility in financing additional growth, giving the Company additional financing options in corporate planning and in responding to developments in business, including financing of additional acquisitions and other general corporate purposes. Having authorized preferred shares available for issuance in the future gives the Company the ability to respond to future developments and allows preferred shares to be issued without the expense and delay of a special shareholders’ meeting. At present, the Company has no specific financing or acquisition plans involving the issuance of additional preferred shares and the Company does not propose to fix the characteristics of any series of preferred shares in anticipation of issuing preferred shares other than the Series A preferred shares and Series B convertible preferred shares discussed above. The Company cannot now predict whether or to what extent, if any, additional preferred shares will be used or if so used what the characteristics of a particular series may be. The voting rights and rights to distributions of the holders of common shares will be subject to the prior rights of the holders of any subsequently-issued preferred shares. Unless otherwise required by applicable law or regulation, the preferred shares would be issuable without further authorization by holders of the common shares and on such terms and for such consideration as may be determined by the Board of Directors. The preferred shares could be issued in one or more series having varying voting rights, redemption and conversion features, distribution (including liquidating distribution) rights and preferences, and other rights, including rights of approval of specified transactions. A series of preferred shares could be given rights that are superior to rights of holders of common shares and a series having preferential distribution rights could limit common share distributions and reduce the amount holders of common shares would otherwise receive on dissolution.
Unit Redemption Program
In April 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 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 more than three years. 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. Since inception of the program through December 31, 2012, the Company has redeemed approximately 11.5 million Units representing $124.2 million, including 1.6 million Units in the amount of $17.8 million in
2012, 2.9 million Units in the amount of $32.0 million in 2011 and 3.7 million Units in the amount of $40.7 million in 2010. As contemplated in the program, beginning with the January 2011 redemption, the scheduled redemption date for the first quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 1,137,969 | | | | 728,135 | | | | 409,834 | |
April 2011 | | | 1,303,574 | | | | 728,883 | | | | 574,691 | |
July 2011 | | | 5,644,778 | | | | 732,160 | | | | 4,912,618 | |
October 2011 | | | 11,332,625 | | | | 727,980 | | | | 10,604,645 | |
January 2012 | | | 12,885,635 | | | | 455,093 | | | | 12,430,542 | |
April 2012 | | | 12,560,001 | | | | 441,458 | | | | 12,118,543 | |
July 2012 | | | 12,709,508 | | | | 364,299 | | | | 12,345,209 | |
October 2012 | | | 13,003,443 | | | | 363,755 | | | | 12,639,688 | |
As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.
Dividend Reinvestment Plan
In July 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of 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. The Company has registered 15 million Units for potential issuance under the plan. During the years ended December 31, 2012, 2011 and 2010, approximately 1.5 million Units, representing $16.0 million in proceeds to the Company, 2.0 million Units representing $22.0 million in proceeds to the Company, and 2.2 million Units representing $24.6 million in proceeds to the Company, were issued under the plan. Since inception of the plan through December 31, 2012, approximately 11.3 million Units, representing $124.5 million in proceeds to the Company, were issued under the plan.
Distributions
The Company’s annual distribution rate as of December 31, 2012 was $0.77 per common share, payable monthly. For the years ended December 31, 2012, 2011 and 2010, the Company made distributions of $0.77 per common share each year, for a total of $70.0 million, $70.4 million and $71.3 million, respectively.
Note 7
Stock Option Plans
In 2006 the Board of Directors approved a Non-Employee Directors Stock Option Plan (the “Directors Plan”) whereby directors, who are not employees of the Company or affiliates, automatically receive the option to purchase Units. Under the Directors Plan, the number of Units authorized for issuance is equal to 45,000 plus 1.8% of the number of Units sold in excess of the minimum offering of 4,761,905 Units. This plan currently relates to the initial public offering of 91,125,541 Units. The maximum number of Units authorized under the Directors Plan as of December 31, 2012 is 1,599,545.
Also in 2006, the Board of Directors approved an Incentive Stock Option Plan (the “Incentive Plan”) whereby incentive awards may be granted to certain personnel of the Company or affiliates. Under the Incentive Plan, the number of Units authorized for issuance is equal to 35,000 plus 4.625% of the number of Units sold in the initial offering in excess of 4,761,905. This plan also currently relates to the initial public offering of 91,125,541 Units. The maximum number of Units that can be issued under the Incentive Plan as of December 31, 2012 is 4,029,318.
Both plans generally provide, among other things, that options be granted at exercise prices not lower than the market value of the Units on the date of grant. The options expire 10 years from the date of the grant. During 2012, 2011 and 2010, the Company granted options to purchase 72,672, 73,204 and 74,224 Units, respectively, under the Directors Plan. All of the options issued vested at the date of issuance, and have an exercise price of $11 per Unit. The Company has granted no options under the Incentive Plan as of December 31, 2012. Activity in the Company’s stock option plans during 2012, 2011 and 2010 is summarized in the following table:
| | Year ended | | | Year ended | | | Year ended | |
| | December 31, 2012 | | | December 31, 2011 | | | December 31, 2010 | |
Outstanding, beginning of year: | | | 367,698 | | | | 294,494 | | | | 220,270 | |
Granted | | | 72,672 | | | | 73,204 | | | | 74,224 | |
Exercised | | | 0 | | | | 0 | | | | 0 | |
Expired or canceled | | | 0 | | | | 0 | | | | 0 | |
Outstanding, end of year: | | | 440,370 | | | | 367,698 | | | | 294,494 | |
Exercisable, end of year: | | | 440,370 | | | | 367,698 | | | | 294,494 | |
The weighted-average exercise price of outstanding options: | | $ | 11.00 | | | $ | 11.00 | | | $ | 11.00 | |
Compensation expense associated with the issuance of stock options was approximately $95,000 in 2012, $111,000 in 2011 and $117,000 in 2010.
Note 8
Management and Franchise Agreements
Each of the 48 hotels included in the Company’s continuing operations are operated and managed, under separate management agreements, by affiliates of one of the following companies (indicates the number of hotels managed): Marriott International, Inc. (“Marriott”) (3), Dimension Development Company (“Dimension”) (12), Hilton Worldwide (“Hilton”) (2), Western International (“Western”) (7), Larry Blumberg & Associates (“LBA”) (16), White Lodging Services Corporation (“White”) (3), or Inn Ventures, Inc. (“Inn Ventures”) (5). The agreements generally provide for initial terms ranging from one to twenty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.1 million, $6.8 million and $6.5 million in management fees for continuing operations.
Dimension, Western, LBA, White, and Inn Ventures are not affiliated with either Marriott or Hilton, and as a result, these hotels (as well as the two hotels managed by Promus Hotels, Inc., which is an affiliate of Hilton) were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for initial terms ranging between 10 to 20 years. Fees associated with the Hilton agreements generally include the payment of royalty fees and program fees based on room revenues. The Marriott franchise agreements provide for an initial term of between six and 20 years. Fees associated with the Marriott agreements include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010 the Company incurred approximately $8.8 million, $8.4 million and $8.0 million in franchise fees for continuing operations.
Note 9
Gain from Settlement of Contingency
The Company recorded other income of $3.1 million in November 2010 arising from the de-recognition of a liability for taxes, previously assessed by the Broad Street Community Development Authority of Richmond, VA (“CDA”). Upon the Company’s purchase in January 2008 of the full service Marriott hotel in Richmond, VA (“MRV”), the Company assumed all remaining obligations of the MRV under a multi-year minimum tax assessment on hotels operating within the CDA’s jurisdiction. The MRV was obligated for minimum annual tax payments to the CDA of $257,000, which related to the 2003 issuance by the CDA of tax-exempt revenue bonds with maturities extending through 2033. Annual tax payments to the CDA were effective through the earlier of a) a period extending through 2033, or b) payment or defeasance in full of all applicable CDA revenue bonds. In November 2010, the CDA provided for the full defeasance or redemption of the applicable CDA revenue bonds. Accordingly, the CDA announced that assessments and collections of the prior tax have ceased as of November 2010. The Company’s net present value of the previously required minimum annual tax assessments, originally projected to extend through 2033, was $3.1 million at the date of the CDA’s bond defeasance and redemption in November 2010.
Note 10
Commitments
The Company leases the underlying land for six hotel properties and one hotel parking lot as of December 31, 2012. These land leases have remaining terms available to the Company ranging from 15 to 93 years, excluding any potential option periods to extend the initial lease term.
The initial term for the land lease for the Residence Inn in Seattle, WA extends through February 2049, with an additional three consecutive 10-year extensions available to the Company (the lessee under the assumed lease). The lease is subject to various payment adjustments during the lease term, including potential periodic increases in lease payments based on the appraised market value of the underlying land at time of adjustment. Based on an assessment of the fair value of the assumed land lease at the date of the hotel acquisition, the Company recorded an initial land lease liability. This liability is being amortized over the life of the lease, and is included in accrued expenses on the Company’s consolidated balance sheet; the amount of the liability at December 31, 2012 and 2011 was approximately $2.0 million and $2.1 million.
The initial term for the land lease for the full-service Marriott hotel in Richmond, VA extends through December 2102. The lease is subject to payment adjustments, based on the Consumer Price Index, at stated intervals during its term. A fair value adjustment was recorded by the Company upon the assumption of the below market rate ground lease. This favorable lease asset will be amortized over the remaining term of the ground lease. The unamortized balance of the land lease’s fair value adjustment was approximately $0.9 million at December 31, 2012 and 2011, and is included in other assets, net on the Company’s consolidated balance sheet. Upon assumption of the MRV land lease, the Company also assumed certain contingent responsibilities of the hotel’s predecessor owner, with respect to the third-party lessor of the land. Dependent on conditions which include the hotel exceeding stated revenue per available room (“RevPAR”) thresholds for a trailing twelve month period (with thresholds adjusting upward by 3% annually), the Company may be obligated to construct an addition to the MRV hotel containing a minimum of 209 rooms. As of December 31, 2012, there is no requirement to commence an expansion of the MRV hotel.
The Company also assumed land leases pertaining to the Columbus, GA Fairfield Inn; Macon, GA Hilton Garden Inn; Columbus, GA TownePlace Suites; Huntsville, AL Homewood Suites; and the Miami, FL Courtyard hotel properties. Based on an assessment of each of these leases, no material land lease liability, or favorable lease asset, was assumed at date of acquisition.
The aggregate amounts of the estimated minimum lease payments pertaining to the Company’s land leases, for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
| | Total | |
2013 | | $ | 1,052 | |
2014 | | | 1,141 | |
2015 | | | 1,159 | |
2016 | | | 1,159 | |
2017 | | | 1,166 | |
Thereafter | | | 91,434 | |
| | | | |
Total | | $ | 97,111 | |
Note 11
Discontinued Operations
In accordance with Accounting Standards Codification Topic 205-20, Presentation of Financial Statements – Discontinued Operations (“Topic 205-20”), the results of operations for properties designated as held-for-sale are classified as discontinued operations for all periods presented. Properties classified as real estate held for sale generally represent hotels that are actively marketed or contracted for sale with the closing expected to occur within the next twelve months. The application of Topic 205-20 does not have an impact on net income. The application of Topic 205-20 results in the reclassification of the operating results of all properties classified as held for sale through June 30, 2013, within the consolidated statements of operations for the years ended December 31, 2012, 2011 and 2010, and the reclassification of the assets and liabilities within the consolidated balance sheets as of December 31, 2012.
In January 2013, the Company committed to sell three properties, the Fairfield Inns in Dothan, Alabama, Columbus, Georgia, and Tallahassee, Florida, and began the process of marketing efforts. As a result, the operating results of these properties have been reclassified to “Income from discontinued operations” in the Company’s consolidated statements of operations and the assets and liabilities of these properties have been reclassified to “Hotels held for sale” in the Company’s consolidated balance sheet as of December 31, 2012.
The following table sets forth the components of income (loss) from discontinued operations for the years ended December 31, 2012, 2011 and 2010 (in thousands):
| | 2012 | | | 2011 | | | 2010 | |
| | | | | | | | | |
Total revenue | | $ | 3,899 | | | $ | 4,497 | | | $ | 4,379 | |
Hotel operating expenses | | | 2,720 | | | | 2,916 | | | | 2,786 | |
Property taxes, insurance and other | | | 187 | | | | 233 | | | | 226 | |
Depreciation expense | | | 635 | | | | 627 | | | | 571 | |
Interest expense, net | | | 138 | | | | 193 | | | | 199 | |
Loss on impairment of hotels held for sale | | | 6,640 | | | | 0 | | | | 0 | |
Income (loss) from discontinued operations | | $ | (6,421 | ) | | $ | 528 | | | $ | 597 | |
Note 12
Industry Segments
The Company owns hotel properties throughout the United States that generate rental and other property related income. The Company separately evaluates the performance of each of its hotel properties. However, because each of the hotels has similar economic characteristics, facilities, and services, and each hotel is not individually significant, the properties have been aggregated into a single operating segment. All segment disclosures are included in, or can be derived from the Company’s consolidated financial statements.
Note 13
Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc. et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those
who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company’s consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Note 14
Quarterly Financial Data (Unaudited)
The following is a summary of quarterly results of operations for the years ended December 31, 2012 and 2011.
2012 (in thousands except per share data) | | First Quarter | | | Second Quarter | | Third Quarter | | | Fourth Quarter | |
Revenues | | $ | 51,426 | | | $ | 55,146 | | | $ | 55,824 | | | $ | 49,650 | |
Income from continuing operations | | $ | 5,387 | | | $ | 8,043 | | | $ | 7,327 | | | $ | 3,850 | |
Income (loss) from discontinued operations | | $ | 143 | | | $ | 96 | | | $ | (28 | ) | | $ | (6,632 | ) |
Net income (loss) | | $ | 5,530 | | | $ | 8,139 | | | $ | 7,299 | | | $ | (2,782 | ) |
Basic and diluted net income (loss) per common share | | $ | 0.06 | | | $ | 0.09 | | | $ | 0.08 | | | $ | (0.03 | ) |
Distributions declared and paid per common share | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | |
2011 (in thousands except per share data) | | First Quarter | | | Second Quarter | | Third Quarter | | | Fourth Quarter | |
Revenues | | $ | 48,294 | | | $ | 53,754 | | | $ | 54,685 | | | $ | 47,649 | |
Income from continuing operations | | $ | 5,000 | | | $ | 7,598 | | | $ | 8,273 | | | $ | 3,614 | |
Income from discontinued operations | | $ | 189 | | | $ | 147 | | | $ | 164 | | | $ | 28 | |
Net income | | $ | 5,189 | | | $ | 7,745 | | | $ | 8,437 | | | $ | 3,642 | |
Basic and diluted net income per common share | | $ | 0.06 | | | $ | 0.08 | | | $ | 0.09 | | | $ | 0.04 | |
Distributions declared and paid per common share | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | |
Income from discontinued operations and net income for the fourth quarter of 2012 includes a loss on impairment of hotels held for sale of $6.6 million, representing a net loss of $(0.07) per basic and diluted income per common share.
Note 15
Subsequent Events
In January 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 111,782 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 386,558 Units in the amount of $4.2 million. As contemplated in the Program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 3% of the total 13.4 million requested Units to be redeemed, with approximately 13.0 million requested Units not redeemed.
In January 2013, the Company entered into two mortgage loan agreements with a commercial real estate lender. The loans are separately secured by the Company’s Huntsville, Alabama Homewood Suites and Prattville, Alabama Courtyard hotels, and will amortize based on a 25 year term with a balloon payment due at maturity in February 2023. Interest is payable monthly on the outstanding balance of each loan at an annual rate of 4.12%. The total proceeds of $15.3 million under the two loan agreements were used to reduce the outstanding balance on the Company’s $40.0 million credit facility, and to pay loan origination and other transaction costs of approximately $0.2 million.
In February 2013, the Company extinguished through pay-off a mortgage note payable jointly secured by the San Diego, California Residence Inn and the Provo, Utah Residence Inn. The note payable had a scheduled maturity in April 2013, and was originally assumed upon acquisition of the two hotels in 2007. The mortgage note payable had a principal balance at pay-off of approximately $18.3 million, an interest rate of 6.55%, and was extinguished without premium or discount to the balance outstanding. Funds for the debt extinguishment were provided by borrowings under the Company’s amended unsecured credit facility. The Company entered into an amendment to its unsecured credit facility, also in February 2013, which increased the maximum aggregate commitment by the lender from $40.0 million to $55.0 million. Under the amendment the increase is effective until the earlier of completing its planned financing of the San Diego, California Residence Inn or April 2013. All other terms of the credit facility remain the same, including the payment of a quarterly fee on the average unused balance of the credit facility at an annual rate of 0.35%.
The Company’s Board of Directors approved a reduction in the Company’s projected distribution rate from an annual rate of $0.77 per common share to $0.66 per common share. The change is effective with the distribution planned for April 2013. The distribution will continue to be paid monthly.
In February 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 110,000 Units were reinvested under the Company’s Dividend Reinvestment Plan.
Real Estate and Accumulated Depreciation
As of December 31, 2012
(dollars in thousands)
| | | | | | | | | | Subsequently | | | | | | | | | | | | | | |
| | | | | | | | Initial Cost | | Capitalized | | | | | | | | | | | | | | |
| | | | | | | | | | Bldg./ | | Bldg | | Total | | Acc | | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Brand | | Encumbrances | | Land | | FF&E /Other | | Imp. & FF&E | | Gross Cost (1) | | Deprec | | | Construction | | Acquired | | Life | | Rooms | |
Montgomery | | AL | | Homewood Suites | | $ | 0 | | $ | 972 | | $ | 10,038 | | $ | 446 | | $ | 11,456 | | $ | (2,300 | ) | | 2004 | | Aug-06 | | 3 - 39 yrs. | | 91 | |
Montgomery | | AL | | Hilton Garden Inn | | | 0 | | | 761 | | | 9,964 | | | 1,618 | | | 12,343 | | | (2,337 | ) | | 2003 | | Aug-06 | | 3 - 39 yrs. | | 97 | |
Troy | | AL | | Hampton Inn | | | 0 | | | 497 | | | 5,872 | | | 335 | | | 6,704 | | | (1,399 | ) | | 2003 | | Aug-06 | | 3 - 39 yrs. | | 82 | |
Auburn | | AL | | Hilton Garden Inn | | | 0 | | | 639 | | | 9,883 | | | 1,521 | | | 12,043 | | | (2,848 | ) | | 2001 | | Aug-06 | | 3 - 39 yrs. | | 101 | |
Huntsville | | AL | | Hilton Garden Inn | | | 0 | | | 736 | | | 9,891 | | | 240 | | | 10,867 | | | (2,251 | ) | | 2005 | | Aug-06 | | 3 - 39 yrs. | | 101 | |
Huntsville | | AL | | Homewood Suites | | | 0 | | | 1,086 | | | 10,895 | | | 228 | | | 12,209 | | | (2,457 | ) | | 2006 | | Oct-06 | | 3 - 39 yrs. | | 107 | |
Prattville | | AL | | Courtyard | | | 0 | | | 1,163 | | | 8,414 | | | 92 | | | 9,669 | | | (1,730 | ) | | 2007 | | Apr-07 | | 3 - 39 yrs. | | 84 | |
Trussville | | AL | | Courtyard | | | 0 | | | 1,082 | | | 8,750 | | | 81 | | | 9,913 | | | (1,615 | ) | | 2007 | | Oct-07 | | 3 - 39 yrs. | | 84 | |
Huntsville | | AL | | TownePlace Suites | | | 0 | | | 800 | | | 8,388 | | | 31 | | | 9,219 | | | (1,499 | ) | | 2007 | | Dec-07 | | 3 - 39 yrs. | | 86 | |
Dothan | | AL | | Residence Inn | | | 0 | | | 816 | | | 9,102 | | | 22 | | | 9,940 | | | (1,680 | ) | | 2008 | | Apr-08 | | 3 - 39 yrs. | | 84 | |
Tucson | | AZ | | Residence Inn | | | 0 | | | 995 | | | 15,963 | | | 76 | | | 17,034 | | | (2,759 | ) | | 2008 | | Jan-08 | | 3 - 39 yrs. | | 124 | |
San Diego | | CA | | Hilton Garden Inn | | | 0 | | | 5,009 | | | 30,357 | | | 2,407 | | | 37,773 | | | (6,982 | ) | | 2004 | | May-06 | | 3 - 39 yrs. | | 200 | |
Rancho Bernardo | | CA | | Courtyard | | | 15,424 | | | 4,658 | | | 32,282 | | | 804 | | | 37,744 | | | (6,199 | ) | | 1987 | | Dec-06 | | 3 - 39 yrs. | | 210 | |
Agoura Hills | | CA | | Homewood Suites | | | 0 | | | 4,501 | | | 21,444 | | | 123 | | | 26,068 | | | (3,836 | ) | | 2007 | | May-07 | | 3 - 39 yrs. | | 125 | |
San Diego | | CA | | Residence Inn | | | 13,589 | | | 7,334 | | | 26,235 | | | 2,461 | | | 36,030 | | | (4,767 | ) | | 1999 | | Jun-07 | | 3 - 39 yrs. | | 121 | |
San Diego | | CA | | Hampton Inn | | | 0 | | | 5,683 | | | 37,949 | | | 2,810 | | | 46,442 | | | (7,047 | ) | | 2001 | | Jul-07 | | 3 - 39 yrs. | | 177 | |
Highlands Ranch | | CO | | Residence Inn | | | 10,710 | | | 2,339 | | | 17,339 | | | 865 | | | 20,543 | | | (3,166 | ) | | 1996 | | Feb-07 | | 3 - 39 yrs. | | 117 | |
Highlands Ranch | | CO | | Hilton Garden Inn | | | 0 | | | 2,510 | | | 18,553 | | | 207 | | | 21,270 | | | (3,570 | ) | | 2007 | | Mar-07 | | 3 - 39 yrs. | | 128 | |
Sarasota | | FL | | Homewood Suites | | | 0 | | | 1,778 | | | 12,284 | | | 772 | | | 14,834 | | | (2,925 | ) | | 2005 | | Sep-06 | | 3 - 39 yrs. | | 100 | |
Miami | | FL | | Homewood Suites | | | 8,405 | | | 3,206 | | | 22,161 | | | 2,205 | | | 27,572 | | | (4,987 | ) | | 2000 | | Feb-07 | | 3 - 39 yrs. | | 159 | |
Lakeland | | FL | | Courtyard | | | 0 | | | 1,549 | | | 8,844 | | | 743 | | | 11,136 | | | (1,667 | ) | | 2000 | | Apr-07 | | 3 - 39 yrs. | | 78 | |
Miami | | FL | | Courtyard | | | 0 | | | 0 | | | 15,463 | | | 185 | | | 15,648 | | | (2,487 | ) | | 2008 | | Sep-08 | | 3 - 39 yrs. | | 118 | |
Macon | | GA | | Hilton Garden Inn | | | 0 | | | 0 | | | 10,115 | | | 98 | | | 10,213 | | | (2,032 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | 101 | |
Columbus | | GA | | SpringHill Suites | | | 0 | | | 1,188 | | | 8,758 | | | 25 | | | 9,971 | | | (1,553 | ) | | 2008 | | Mar-08 | | 3 - 39 yrs. | | 85 | |
Columbus | | GA | | TownePlace Suites | | | 0 | | | 0 | | | 8,643 | | | 28 | | | 8,671 | | | (1,586 | ) | | 2008 | | May-08 | | 3 - 39 yrs. | | 86 | |
Boise | | ID | | SpringHill Suites | | | 0 | | | 2,015 | | | 19,589 | | | 519 | | | 22,123 | | | (4,032 | ) | | 1992 | | Sep-07 | | 3 - 39 yrs. | | 230 | |
New Orleans | | LA | | Homewood Suites | | | 14,872 | | | 4,579 | | | 39,507 | | | 1,598 | | | 45,684 | | | (7,548 | ) | | 2002 | | Dec-06 | | 3 - 39 yrs. | | 166 | |
Hattiesburg | | MS | | Courtyard | | | 5,871 | | | 873 | | | 8,918 | | | 127 | | | 9,918 | | | (1,932 | ) | | 2006 | | Oct-06 | | 3 - 39 yrs. | | 84 | |
Tupelo | | MS | | Hampton Inn | | | 3,316 | | | 332 | | | 4,932 | | | 1,298 | | | 6,562 | | | (1,615 | ) | | 1994 | | Jan-07 | | 3 - 39 yrs. | | 96 | |
Omaha | | NE | | Courtyard | | | 10,922 | | | 2,731 | | | 19,498 | | | 3,902 | | | 26,131 | | | (5,080 | ) | | 1999 | | Nov-06 | | 3 - 39 yrs. | | 181 | |
Cranford | | NJ | | Homewood Suites | | | 0 | | | 2,607 | | | 11,375 | | | 2,093 | | | 16,075 | | | (3,108 | ) | | 2000 | | Mar-07 | | 3 - 39 yrs. | | 108 | |
Mahwah | | NJ | | Homewood Suites | | | 0 | | | 3,665 | | | 16,481 | | | 2,231 | | | 22,377 | | | (3,940 | ) | | 2001 | | Mar-07 | | 3 - 39 yrs. | | 110 | |
Ronkonkoma | | NY | | Hilton Garden Inn | | | 0 | | | 3,153 | | | 24,428 | | | 2,344 | | | 29,925 | | | (4,943 | ) | | 2003 | | Dec-06 | | 3 - 39 yrs. | | 164 | |
Cincinnati | | OH | | Homewood Suites | | | 0 | | | 551 | | | 6,822 | | | 293 | | | 7,666 | | | (1,608 | ) | | 2005 | | Dec-06 | | 3 - 39 yrs. | | 76 | |
Memphis | | TN | | Homewood Suites | | | 0 | | | 1,712 | | | 9,757 | | | 2,349 | | | 13,818 | | | (2,968 | ) | | 1989 | | May-07 | | 3 - 39 yrs. | | 140 | |
Houston | | TX | | Residence Inn | | | 10,170 | | | 1,093 | | | 13,054 | | | 296 | | | 14,443 | | | (3,161 | ) | | 2006 | | Apr-06 | | 3 - 39 yrs. | | 129 | |
Brownsville | | TX | | Courtyard | | | 0 | | | 1,131 | | | 7,743 | | | 112 | | | 8,986 | | | (1,711 | ) | | 2006 | | Jun-06 | | 3 - 39 yrs. | | 90 | |
Stafford | | TX | | Homewood Suites | | | 0 | | | 498 | | | 7,578 | | | 216 | | | 8,292 | | | (1,791 | ) | | 2006 | | Aug-06 | | 3 - 39 yrs. | | 78 | |
San Antonio | | TX | | TownePlace Suites | | | 0 | | | 700 | | | 11,525 | | | 32 | | | 12,257 | | | (2,159 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | 106 | |
Addison | | TX | | SpringHill Suites | | | 0 | | | 1,545 | | | 11,312 | | | 1,654 | | | 14,511 | | | (2,509 | ) | | 2003 | | Aug-07 | | 3 - 39 yrs. | | 159 | |
San Antonio | | TX | | TownePlace Suites | | | 0 | | | 1,126 | | | 13,093 | | | 10 | | | 14,229 | | | (2,384 | ) | | 2007 | | Sep-07 | | 3 - 39 yrs. | | 123 | |
| | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | |
| | | | | | | | Initial Cost | | Capitalized | | | | | | | | | | | | | | |
| | | | | | | | | | Bldg./ | | Bldg | | Total | | Acc | | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Brand | | Encumbrances | | Land | | FF&E /Other | | Imp. & FF&E | | Gross Cost (1) | | Deprec | | | Construction | | Acquired | | Life | | Rooms | |
El Paso | | TX | | Homewood Suites | | | 0 | | | 1,169 | | | 14,656 | | | 67 | | | 15,892 | | | (2,541 | ) | | 2008 | | Apr-08 | | 3 - 39 yrs. | | 114 | |
Provo | | UT | | Residence Inn | | | 4,775 | | | 1,352 | | | 10,394 | | | 2,967 | | | 14,713 | | | (3,250 | ) | | 1996 | | Jun-07 | | 3 - 39 yrs. | | 114 | |
Alexandria | | VA | | Courtyard | | | 0 | | | 4,010 | | | 32,832 | | | 4,427 | | | 41,269 | | | (6,860 | ) | | 1987 | | Jul-07 | | 3 - 39 yrs. | | 178 | |
Richmond | | VA | | Marriott | | | 22,376 | | | 0 | | | 59,614 | | | 15,917 | | | 75,531 | | | (18,093 | ) | | 1984 | | Jan-08 | | 3 - 39 yrs. | | 410 | |
Seattle | | WA | | Residence Inn | | | 28,956 | | | 0 | | | 60,489 | | | 6,883 | | | 67,372 | | | (14,869 | ) | | 1991 | | Sep-06 | | 3 - 39 yrs. | | 234 | |
Vancouver | | WA | | SpringHill Suites | | | 0 | | | 1,310 | | | 15,126 | | | 46 | | | 16,482 | | | (3,064 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | 119 | |
Kirkland | | WA | | Courtyard | | | 12,439 | | | 3,507 | | | 28,507 | | | 235 | | | 32,249 | | | (4,646 | ) | | 2006 | | Oct-07 | | 3 - 39 yrs. | | 150 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | $ | 161,825 | | $ | 88,961 | | $ | 824,817 | | $ | 68,039 | | $ | 981,817 | | $ | (179,491 | ) | | | | | | | | 6,205 | |
| | 2012 | | | 2011 | | | 2010 | |
Real estate owned: | | | | | | | | | |
Balance as of January 1 | | $ | 994,634 | | | $ | 986,266 | | | $ | 983,216 | |
Improvements | | | 7,446 | | | | 8,368 | | | | 3,050 | |
Discontinued Operations(2) | | | (20,263 | ) | | | - | | | | - | |
Balance at December 31 | | $ | 981,817 | | | $ | 994,634 | | | $ | 986,266 | |
| | | | | | | | | | | | |
| | 2012 | | | 2011 | | | 2010 | |
Accumulated depreciation: | | | | | | | | | | | | |
Balance as of January 1 | | $ | (148,257 | ) | | $ | (114,097 | ) | | $ | (80,923 | ) |
Depreciation expense | | | (34,557 | ) | | | (34,160 | ) | | | (33,174 | ) |
Disposals | | | 0 | | | | 0 | | | | 0 | |
Discontinued Operations(2) | | | 3,323 | | | | 0 | | | | 0 | |
Balance at December 31 | | $ | (179,491 | ) | | $ | (148,257 | ) | | $ | (114,097 | ) |
(1) The cost basis for Federal Income Tax purposes approximates the basis used in this schedule. |
(2) The Company has three hotels (Dothan, AL, Tallahassee, FL and Columbus, GA Fairfield Inns) that are held for sale that are not included in this schedule as of December 31, 2012. |
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2012
or
¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File Number 000-52585
APPLE REIT SEVEN, INC.
(Exact name of registrant as specified in its charter)
VIRGINIA | 20-2879175 |
(State of Organization) | (I.R.S. Employer Identification Number) |
| |
814 EAST MAIN STREET RICHMOND, VIRGINIA | 23219 |
(Address of principal executive offices) | (Zip Code) |
(804) 344-8121
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Units (Each Unit is equal to one common share, no par value, and one Series A preferred share)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405, of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer ý | Smaller reporting company ¨ |
| | (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
There is currently no established public trading market on which the Company’s common shares are traded. Based upon the price that the Company’s common equity last sold through its Dividend Reinvestment Plan, which was $11, on June 30, 2012, the aggregate market value of the voting common equity held by non-affiliates of the Company on such date was $1,000,173,000. The Company does not have any non-voting common equity.
The number of common shares outstanding on March 1, 2013 was 90,777,202.
Documents Incorporated by Reference.
The information required by Part III of this report, to the extent not set forth herein, is incorporated by reference from the Company’s definitive proxy statement for the annual meeting of shareholders to be held on May 16, 2013.
FORM 10-K
Index
| | | | |
| | | Page | |
Part I | | | |
| Item 1. | | 3 | |
| Item 1A. | | 8 | |
| Item 1B. | | 12 | |
| Item 2. | | 12 | |
| Item 3. | | 14 | |
| Item 4. | | 15 | |
| | | | |
Part II | | | |
| Item 5. | | 16 | |
| Item 6. | | 19 | |
| Item 7. | | 22 | |
| Item 7A. | | 36 | |
| Item 8. | | 37 | |
| Item 9. | | 59 | |
| Item 9A. | | 59 | |
| Item 9B. | | 59 | |
| | | | |
Part III | | | |
| Item 10. | | 60 | |
| Item 11. | | 60 | |
| Item 12. | | 60 | |
| Item 13. | | 60 | |
| Item 14. | | 60 | |
| | | | |
Part IV | | | |
| Item 15. | | 61 | |
| | | | |
| | | | |
This Form 10-K includes references to certain trademarks or service marks. The SpringHill Suites® by Marriott, TownePlace Suites® by Marriott, Fairfield Inn® by Marriott, Courtyard® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Homewood Suites® by Hilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites® trademarks are the property of Hilton Worldwide or one or more of its affiliates. For convenience, the applicable trademark or servicemark symbol has been omitted but will be deemed to be included wherever the above-referenced terms are used.
PART I
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of Apple REIT Seven, Inc. (“the Company”) to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries, changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Annual Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission (“SEC”) and Item 1A in this report. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
The Company is a Virginia corporation that was formed in May 2005 to invest in income-producing real estate in the United States. Initial capitalization occurred on May 26, 2005, with its first investor closing under its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) on March 15, 2006. The Company acquired its first property on April 27, 2006. The Company completed its best-efforts offering of Units in July 2007. As of December 31, 2012, the Company owned 51 hotels operating in 18 states.
The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company has wholly-owned taxable REIT subsidiaries which lease all of the Company’s hotels from wholly-owned qualified REIT subsidiaries. The hotels are operated and managed by affiliates of Marriott International, Inc. (“Marriott”), Hilton Worldwide (“Hilton”), Western International (“Western”), Larry Blumberg & Associates (“LBA”), White Lodging Services Corporation (“White”), Dimension Development Company (“Dimension”), or Inn Ventures, Inc. (“Inn Ventures”) under separate hotel management agreements.
The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. Refer to Part II, Item 8 of this report, for the consolidated financial statements.
Website Access
The address of the Company’s Internet website is www.applereitseven.com. The Company makes available free of charge through its Internet website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. Information contained on the Company’s website is not incorporated by reference in this report.
Business Objectives
The Company’s primary objective is to enhance shareholder value by increasing funds from operations and cash available for distributions through internal growth and selective hotel renovation. The Company’s acquisition strategy, substantially complete as of September 2008, included purchasing underdeveloped hotels and hotels in underdeveloped markets with strong brand recognition, high levels of customer satisfaction and the potential for cash flow growth. The internal growth strategy includes utilizing the Company’s asset management expertise to improve the performance of the Company’s hotels by aggressively managing room rates, partnering with industry leaders in hotel management, thereby improving hotel revenue and operating performance, and franchising the hotels with leading brands, thereby improving the performance of each hotel in its local market. When cost effective, the Company renovates its properties to increase its
ability to compete in particular markets. Although there are many factors that influence profitability, including national and local economic conditions, the Company believes its planned renovations and strong asset management of its portfolio will continue to improve financial results over the long-term, although there can be no assurance of these results.
Financing
The Company has twelve mortgage notes payable as of December 31, 2012: seven that were assumed with the acquisition of hotels, one that was originated in February 2011, and four that were originated in August 2012. These notes had a total outstanding balance of $161.8 million at December 31, 2012, maturity dates ranging from April 2013 to September 2022, and interest rates ranging from 4.96% to 6.95%. One of the mortgage notes payable is jointly secured by two hotel properties.
The Company also has a $40 million unsecured credit facility with a commercial bank, which originated in August 2012, that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. Interest payments are due monthly and the interest rate is equal to the LIBOR (London Interbank Offered Rate for a one-month term) plus 3.25%. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part, at any time. The Company is also required to pay a quarterly fee at an annual rate of 0.35% on the average unused balance of the credit facility. The credit facility, which matures in August 2014, had an outstanding balance at December 31, 2012 of $35.6 million, at an annual interest rate of approximately 3.46%.
The Company’s principal sources of liquidity are operating cash flow generated from the Company’s properties and its $40 million credit facility. The Company anticipates that cash flow from operations, its current revolving credit facility and other available credit will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions. The Company intends to maintain a relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles. If cash flow from operations and the credit facility are not adequate to meet liquidity requirements, 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 required levels. If the Company were unable to extend its maturing debt in future periods or if it were default on its debt, it may be unable to make distributions or redemptions.
Hotel Industry and Competition
The hotel industry is highly competitive. Each of the Company’s hotels is located in a developed area that includes other hotels and competes for guests primarily with other hotels in the immediate vicinity, and secondarily with other hotels in the Company’s geographic market. An increase in the number of competitive hotels in a particular area could have a material adverse effect on the occupancy, average daily rate (“ADR”) and revenue per available room (“RevPAR”) of the Company’s hotels in that area. The Company believes that brand recognition, location, price and quality (of both the hotel and the services provided) are the principal competitive factors affecting the Company’s hotels. Additionally, general economic conditions in a particular market, and nationally, impact the performance of the hotel industry.
Hotel Operating Performance
At December 31, 2012, the Company owned seven Hilton Garden Inn hotels, seven Residence Inn hotels, ten Courtyard hotels, twelve Homewood Suites hotels, three Fairfield Inns, four SpringHill Suites, four TownePlace Suites, three Hampton Inn hotels, and one full-service Marriott hotel. They are located in 18 states and, in aggregate, consist of 6,426 rooms. The Company’s portfolio of hotels is unchanged from December 31, 2011.
Room revenue for these hotels for the year ended December 31, 2012 totaled $195.3 million, and the hotels achieved average occupancy of 73%, ADR of $114 and RevPAR of $83. Room revenue for the year ended December 31, 2011 totaled $188.7 million, and the Company’s hotels achieved average occupancy of 73%, ADR of $110 and RevPAR of $80. Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy had a considerable negative impact on both consumer and business travel. However, economic conditions have shown evidence of improvement in 2011 and continued in 2012. Since the beginning of 2010, the Company has experienced an increase in demand over prior recessionary periods of 2008 and 2009. While occupancy levels have stabilized, the Company has been able to modestly increase average room rates, which has led to an increase in ADR during 2012 as compared to the prior year. Although the Company realized modest revenue growth, its growth rate trailed the overall industry growth rate, which is in the mid-single digits as compared to 2011. The below average growth rate is due primarily to factors specific to the individual markets where the Company’s hotels are located. Many of the Company’s markets have been impacted by declining demand from the government sector and increased supply. With steady demand and room rate improvement, the Company is forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012. Although
impacted by increased supply in certain markets, the Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for 2012 and 2011 was 124 and 126, respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market; with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.® an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue. See the Company’s complete financial statements in Part II, Item 8 of this report.
Management and Franchise Agreements
Each of the Company’s 51 hotels are operated and managed under separate management agreements, by affiliates of one of the following companies: Dimension, Hilton, Inn Ventures, LBA, Marriott, Western, or White. The agreements generally provide for initial terms ranging from one to twenty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.2 million, $6.9 million and $6.6 million, respectively, in management fees.
Dimension, LBA, Inn Ventures, Western, and White are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage (as well as the two hotels managed by Promus Hotels, Inc., which is an affiliate of Hilton) were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements provide for initial terms ranging between 10 to 20 years. Fees associated with the Hilton agreements generally include the payment of royalty fees and program fees based on room revenues. The Marriott franchise agreements provide for an initial term of between six and 20 years. Fees associated with the Marriott agreements include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $9.0 million, $8.6 million and $8.2 million, respectively, in franchise fees.
The franchise and/or management agreements provide a variety of benefits for the Company, which include national advertising, publicity, and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards, centralized reservation systems and best practices within the industry.
Hotel Maintenance and Renovation
The Company’s hotels have an ongoing need for renovation and refurbishment. Under various hotel management agreements, the Company has agreed to fund expenditures for periodic repairs, replacement or refurbishment of furniture, fixtures and equipment for the hotels in an amount equal to a certain percentage of gross revenues. In addition, other capital improvement projects may be directly funded by the Company. During 2012 and 2011, the Company’s capital expenditures were approximately $7.4 million and $8.4 million, respectively.
Employees
The Company does not have any employees. During 2012, all employees involved in the day-to-day operation of the Company’s hotels were employed by third party management companies engaged pursuant to the hotel management agreements. The Company utilizes, through an advisory agreement for corporate and strategic support, personnel from Apple Seven Advisors, Inc., which in turn utilizes personnel from Apple Fund Management, LLC, a subsidiary of Apple REIT Six, Inc.
Environmental Matters
In connection with each of the Company’s hotel acquisitions, the Company obtained a Phase I Environmental Report and additional environmental reports and surveys, as were necessitated by the preliminary report. Based on the reports, the Company is not aware of any environmental situations requiring remediation at the Company’s properties, which have not been, or are not currently being, remediated. No material remediation costs have occurred or are expected to occur. Under various laws, owners as well as tenants and operators of real estate may be required to investigate and clean up or remove hazardous substances present at or migrating from properties they own, lease or operate and may be held liable for property damage or personal injuries that result from hazardous substances. These laws also expose the Company to the possibility that it may become liable to reimburse governments for damages and costs they incur in connection with hazardous substances.
Seasonality
The hotel industry historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or available credit to make distributions.
Related Parties
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions in 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price with addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of this contract totaled approximately $18.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees were incurred during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“A7A”) pursuant to which A7A provides management services to the Company. A7A provides these management services through an affiliate called Apple Fund Management, LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.5 million, $1.0 million and $1.0 million for the years ended December 31, 2012, 2011 and 2010. At December 31, 2012, $0.5 million of the 2012 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. The increase in 2012 is due to the Company reaching the middle tier of the fee range under the advisory agreement, due to improved operating results.
In addition to the fees payable to A7A, the Company reimbursed A7A or paid directly to AFM on behalf of A7A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A7A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each Company’s level of business activity and the extent to which each Company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this
arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, Apple Nine Advisors, Inc. entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, Apple Nine Advisors, Inc. and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to Apple Nine Advisors, Inc., if it occurs, will have no impact on the Company’s advisory agreement with A7A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, and in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
A7A and ASRG are 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. 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.
Included in other assets, net on the Company’s consolidated balance sheet, is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.9 million as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, the services received by the Company are shared as applicable across the Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. See Item 7 Management’s Discussion and Analysis of Expenses for the years ended 2012 and 2011 for more information on legal fees incurred.
The following describes several risk factors which are applicable to the Company. There are many factors that may affect the Company’s business and results of operations, which would affect the Company’s operating cash flow and value. You should carefully consider, in addition to the other information contained in this report, the risks described below.
Hotel Operations
The Company’s hotels are subject to all of the risks common to the hotel industry. These risks could adversely affect hotel occupancy and the rates that can be charged for hotel rooms as well as hotel operating expenses, and generally include:
| • | increases in supply of hotel rooms that exceed increases in demand; |
| • | increases in energy costs and other travel expenses that reduce business and leisure travel; |
| • | reduced business and leisure travel due to continued geo-political uncertainty, including terrorism; |
| • | adverse effects of declines in general and local economic activity; and |
| • | adverse effects of a downturn in the hotel industry. |
General Local and National Economic Conditions
Changes in general local or national economic or market conditions, increased costs of energy, increased costs of insurance, increased costs of products, increased costs and shortages of labor, competitive factors, fuel shortages, quality of management, the ability of a hotel chain to fulfill any obligations to operators of its hotel business, limited alternative uses for the building, changing consumer habits, condemnation or uninsured losses, changing demographics, changing traffic patterns, inability to remodel outmoded buildings as required by the franchise or lease agreement and other factors beyond the Company’s control may reduce the operating results and the value of properties that the Company owns. Additionally, these items, among others, may reduce the availability of capital to the Company. As a result, cash available to make distributions to shareholders may be affected.
Current General Economic Environment in the Lodging Industry
The United States continues to be in a low-growth economic environment and continues to experience historically high levels of unemployment. Uncertainty over the depth and duration of this economic environment continues to have a negative impact on the lodging industry. Although operating results have improved, high levels of unemployment and sluggish business and consumer travel trends have been evident during the past three years. Accordingly, the Company’s financial results have been impacted by the economic environment, and future financial results and growth could be further depressed until a more expansive national economic environment is prevalent. A weaker than anticipated economic recovery, or a return to a recessionary national economic environment, could result in low or decreased levels of business and consumer travel, negatively impacting the lodging industry, and, in turn, negatively impacting the Company’s future growth prospects and results of operations.
Hospitality Industry
The success of the Company’s properties will depend largely on the property operators’ ability to adapt to dominant trends in the hotel industry as well as greater competitive pressures, increased consolidation, industry overbuilding, dependence on consumer spending patterns and changing demographics, the introduction of new concepts and products, availability of labor, price levels and general economic conditions. The success of a particular hotel brand, the ability of a hotel brand to fulfill any obligations to operators of its business, and trends in the hotel industry may affect the Company’s income and the funds it has available to distribute to shareholders.
The hospitality industry could also experience a significant decline in occupancy and average daily rates due to a reduction in both business and leisure travel. General economic conditions, increased fuel costs, natural disasters and terrorist attacks are a few factors that could affect an individual’s willingness to travel. The Company’s property insurance will typically cover losses for property damage due to terrorist attacks or natural disasters (subject to policy deductibles). However, the Company is not insured against the potential negative effect a terrorist attack or natural disaster would have on the hospitality industry as a whole.
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 and the Company may need to enter into short-term borrowing arrangements in certain periods in order to offset these fluctuations in revenues and to make distributions to shareholders.
Franchise Agreements
The Company’s wholly-owned taxable REIT subsidiaries (or subsidiaries thereof) operate all of the properties pursuant to franchise or license agreements with nationally recognized hotel brands. These franchise agreements contain specific standards for, and restrictions and limitations on, the operation and maintenance of the Company’s properties in order to maintain uniformity within the franchisor system. These standards could potentially conflict with the Company’s ability to create specific business plans tailored to each property and to each market.
Competition
The hotel industry is highly competitive. Each of the Company’s hotels is located in a developed area that includes other hotels and competes for guests primarily with other hotels in the Company’s immediate vicinity and secondarily with other hotels in the Company’s geographic market. An increase in the number of competitive hotels in a particular area could have a material adverse effect on the occupancy, average daily rate (“ADR”) and revenue per available room (“RevPAR”) of the Company’s hotels in that area.
Illiquidity of Shares
There is and will be no public trading market for the common shares and the Series A preferred shares for an indefinite period of time, if ever. Therefore, the Units are and will be highly illiquid and very difficult to trade. There is no definite time frame to provide liquidity. There also is no definite value for the Units when a liquidity event occurs. In addition, there are restrictions on the transfer of the common shares. In order to qualify as a REIT, the shares must be beneficially owned by 100 or more persons and no more than 50% of the value of the Company’s issued and outstanding shares may be owned directly or indirectly by five or fewer individuals. Therefore, the Company’s bylaws provide that no person may own more than 9.8% of the issued and outstanding Units. Any purported transfer of the Company’s shares that would result in a violation of either of these limits will be declared null and void.
Qualification as a REIT
The rules governing a REIT are highly technical and complex. They require ongoing compliance with and interpretation of a variety of tests and regulations that depend on, among other things, future operations. While the Company expects to satisfy these tests, it cannot ensure it will qualify as a REIT for any particular year. There is also the risk that the applicable laws governing a REIT could be changed, which could adversely affect the Company and its shareholders.
Distributions to Shareholders
If the Company’s properties do not generate sufficient revenue to meet operating expenses, cash flow and the Company’s ability to make distributions to shareholders may be adversely affected. The Company is subject to all operating risks common to hotels. These risks might adversely affect occupancy or room rates. Increases in operating costs due to inflation and other factors may not necessarily be offset by increased room occupancy or rates. The local, regional and national hotel markets may limit the extent to which room rates may be increased to meet increased operating expenses without decreasing occupancy rates. While the Company intends to make distributions to shareholders, there can be no assurance that the Company will be able to make distributions at any particular time or rate, or at all. Further, there is no assurance that a distribution rate achieved for a particular period will be maintained in the future. Also, while management may establish goals as to particular rates of distribution or have an intention to make distributions at a particular rate, there can be no assurance that such goals or intentions will be realized.
The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions and capital improvements, ramp up of new properties and varying economic cycles. The Company anticipates that it may need to utilize debt, offering proceeds and cash from operations to meet this objective. The Company evaluates the distribution rate on an ongoing basis and may make changes at any time if the Company feels the rate is not appropriate based on available cash resources.
While the Company generally seeks to make distributions from operating cash flows, distributions may be made (although there is no obligation to do so) in certain circumstances in part from financing proceeds or other sources, such as proceeds from the offering of Units. While distributions from such sources would result in the shareholder receiving cash, the consequences to the shareholder would differ from a distribution from operating cash flows. For example, if financing is the source of a distribution, that financing would have to be repaid, and if proceeds from the offering of Units are distributed, those proceeds would not then be available for other uses (such as property acquisitions or improvements).
Financing Risks
Although the Company anticipates maintaining relatively low levels of debt, it may periodically use short-term financing to perform renovations to its properties, make shareholder distributions or planned Unit redemptions in periods of fluctuating income from its properties. The debt markets have been volatile and subject to increased regulation; and as a result, the Company may not be able to use debt to meet its cash requirements, including refinancing any scheduled debt maturities.
Compliance with Financial Covenants
The Company’s $40 million unsecured credit facility entered into in August 2012 contains financial covenants that could require the loans to be prepaid prior to maturity or restrict the amount and timing of distributions to shareholders. The covenants include, among others, a minimum tangible net worth, debt service coverage and fixed charge coverage ratio.
Securities Class Action Lawsuits and Governmental Regulatory Oversight
As a result of regulatory inquiries or other regulatory actions, or as a result of being publicly held, the Company may become subject to lawsuits. The Company is currently subject to one securities class action lawsuit and other suits may
be filed against the Company in the future. Due to the uncertainties related to litigation, the Company is unable at this time to evaluate the likelihood of either a favorable or unfavorable outcome or to estimate the range of potential exposure. If the outcome is unfavorable, the Company may be required to pay damages and/or change its business practices, any of which could have a material adverse effect on the Company’s financial condition, results of operations and cash flows. The ability of the Company to access capital markets, including commercial debt markets, could be negatively impacted by unfavorable, or the possibility of unfavorable, outcomes to lawsuits or adverse regulatory actions.
The Company has been and may continue to be subject to regulatory inquiries, which have resulted in and which could continue to result in costs and personnel time commitment to respond. It may also be subject to action by governing regulatory agencies, as a result of its activities, which could result in costs to respond and fines or changes in the Company’s business practices, any of which could have a material adverse effect on the financial condition, results of operations, liquidity and capital resources, and cash flows of the Company.
Technology is used in operations, and any material failure, inadequacy, interruption or security failure of that technology could harm the business
The Company and its hotel managers and franchisors rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information, and to manage or support a variety of business processes, including financial transactions and records, personal identifying information, reservations, billing and operating data. Some of the information technology is purchased from vendors, on whom the systems depend. The Company and its hotel mangers and franchisors rely on commercially available and internally developed systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential operator and other customer information, such as individually identifiable information, including information relating to financial accounts. Although the Company and its hotel managers and franchisors have taken steps necessary to protect the security of their information systems and the data maintained in those systems, it is possible that the safety and security measures taken will not be able to prevent the systems’ improper functioning or damage, or the improper access or disclosure of personally identifiable information such as in the event of cyber attacks. Security breaches, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure of confidential information. Any failure to maintain proper function, security and availability of information systems could interrupt operations, damage reputation, subject the Company to liability claims or regulatory penalties and could have a material adverse effect on the business, financial condition and results of operations of the Company.
Potential losses not covered by Insurance
The Company maintains comprehensive insurance coverage for general liability, property, business interruption and other risks with respect to all of its hotels. These policies offer coverage features and insured limits that the Company believes are customary for similar types of properties. There are no assurances that coverage will be available at reasonable rates. Also, various types of catastrophic losses, like earthquakes, hurricanes, or certain types of terrorism, may not be insurable or may not be economically insurable. Even when insurable, these policies may have high deductibles and/or high premiums. There also can be risks such as certain environmental hazards that may be deemed to fall outside the coverage. In the event of a substantial loss, the Company’s insurance coverage may not be sufficient to cover the full current market value or replacement cost of its lost investment. Should an uninsured loss or a loss in excess of insured limits occur, the Company could lose all or a portion of the capital it has invested in a hotel, as well as the anticipated future revenue from the hotel. In that event, the Company might nevertheless remain obligated for any mortgage debt or other financial obligations related to the hotel. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep the Company from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. The Company also may encounter challenges with an insurance provider regarding whether it will pay a particular claim that the Company believes to be covered under its policy. Under those circumstances, the insurance proceeds the Company receives might be inadequate to restore its economic position on the damaged or destroyed hotel, which could have a material adverse effect on the Company.
| Unresolved Staff Comments |
Not applicable.
As of December 31, 2012, the Company owned 51 hotels located in 18 states with an aggregate of 6,426 rooms, consisting of the following:
Brand | | Total by Brand | | | Number of Rooms | |
Homewood Suites | | | 12 | | | | 1,374 | |
Courtyard | | | 10 | | | | 1,257 | |
Residence Inn | | | 7 | | | | 923 | |
Hilton Garden Inn | | | 7 | | | | 892 | |
SpringHill Suites | | | 4 | | | | 593 | |
TownePlace Suites | | | 4 | | | | 401 | |
Hampton Inn | | | 3 | | | | 355 | |
Fairfield Inn | | | 3 | | | | 221 | |
Marriott | | | 1 | | | | 410 | |
Total | | | 51 | | | | 6,426 | |
The following table includes the location of each hotel, the date of construction, the date acquired, encumbrances, initial acquisition cost, gross carrying value and the number of rooms of each hotel.
Real Estate and Accumulated DepreciationAs of December 31, 2012(dollars in thousands)
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | | Capitalized | | Total | | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | | Bldg | | Gross | | | Acc | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Brand | | Encumbrances | | | Land | | | FF&E /Other | | | Imp. & FF&E | | Cost (1) | | | Deprec | | Construction | | Acquired | | Life | | Rooms | |
Montgomery | | AL | | Homewood Suites | | $ | 0 | | | $ | 972 | | | $ | 10,038 | | | $ | 446 | | | | $ | 11,456 | | | $ | (2,300 | ) | | 2004 | | Aug-06 | | 3 - 39 yrs. | | | 91 | |
Montgomery | | AL | | Hilton Garden Inn | | | 0 | | | | 761 | | | | 9,964 | | | | 1,618 | | | | | 12,343 | | | | (2,337 | ) | | 2003 | | Aug-06 | | 3 - 39 yrs. | | | 97 | |
Troy | | AL | | Hampton Inn | | | 0 | | | | 497 | | | | 5,872 | | | | 335 | | | | | 6,704 | | | | (1,399 | ) | | 2003 | | Aug-06 | | 3 - 39 yrs. | | | 82 | |
Auburn | | AL | | Hilton Garden Inn | | | 0 | | | | 639 | | | | 9,883 | | | | 1,521 | | | | | 12,043 | | | | (2,848 | ) | | 2001 | | Aug-06 | | 3 - 39 yrs. | | | 101 | |
Huntsville | | AL | | Hilton Garden Inn | | | 0 | | | | 736 | | | | 9,891 | | | | 240 | | | | | 10,867 | | | | (2,251 | ) | | 2005 | | Aug-06 | | 3 - 39 yrs. | | | 101 | |
Huntsville | | AL | | Homewood Suites | | | 0 | | | | 1,086 | | | | 10,895 | | | | 228 | | | | | 12,209 | | | | (2,457 | ) | | 2006 | | Oct-06 | | 3 - 39 yrs. | | | 107 | |
Prattville | | AL | | Courtyard | | | 0 | | | | 1,163 | | | | 8,414 | | | | 92 | | | | | 9,669 | | | | (1,730 | ) | | 2007 | | Apr-07 | | 3 - 39 yrs. | | | 84 | |
Dothan | | AL | | Fairfield Inn | | | 0 | | | | 564 | | | | 4,249 | | | | (1,504 | ) | (2) | | | 3,309 | | | | (808 | ) | | 1993 | | May-07 | | 3 - 39 yrs. | | | 63 | |
Trussville | | AL | | Courtyard | | | 0 | | | | 1,082 | | | | 8,750 | | | | 81 | | | | | 9,913 | | | | (1,615 | ) | | 2007 | | Oct-07 | | 3 - 39 yrs. | | | 84 | |
Huntsville | | AL | | TownePlace Suites | | | 0 | | | | 800 | | | | 8,388 | | | | 31 | | | | | 9,219 | | | | (1,499 | ) | | 2007 | | Dec-07 | | 3 - 39 yrs. | | | 86 | |
Dothan | | AL | | Residence Inn | | | 0 | | | | 816 | | | | 9,102 | | | | 22 | | | | | 9,940 | | | | (1,680 | ) | | 2008 | | Apr-08 | | 3 - 39 yrs. | | | 84 | |
Tucson | | AZ | | Residence Inn | | | 0 | | | | 995 | | | | 15,963 | | | | 76 | | | | | 17,034 | | | | (2,759 | ) | | 2008 | | Jan-08 | | 3 - 39 yrs. | | | 124 | |
San Diego | | CA | | Hilton Garden Inn | | | 0 | | | | 5,009 | | | | 30,357 | | | | 2,407 | | | | | 37,773 | | | | (6,982 | ) | | 2004 | | May-06 | | 3 - 39 yrs. | | | 200 | |
Rancho Bernardo | | CA | | Courtyard | | | 15,424 | | | | 4,658 | | | | 32,282 | | | | 804 | | | | | 37,744 | | | | (6,199 | ) | | 1987 | | Dec-06 | | 3 - 39 yrs. | | | 210 | |
Agoura Hills | | CA | | Homewood Suites | | | 0 | | | | 4,501 | | | | 21,444 | | | | 123 | | | | | 26,068 | | | | (3,836 | ) | | 2007 | | May-07 | | 3 - 39 yrs. | | | 125 | |
San Diego | | CA | | Residence Inn | | | 13,589 | | | | 7,334 | | | | 26,235 | | | | 2,461 | | | | | 36,030 | | | | (4,767 | ) | | 1999 | | Jun-07 | | 3 - 39 yrs. | | | 121 | |
San Diego | | CA | | Hampton Inn | | | 0 | | | | 5,683 | | | | 37,949 | | | | 2,810 | | | | | 46,442 | | | | (7,047 | ) | | 2001 | | Jul-07 | | 3 - 39 yrs. | | | 177 | |
Highlands Ranch | | CO | | Residence Inn | | | 10,710 | | | | 2,339 | | | | 17,339 | | | | 865 | | | | | 20,543 | | | | (3,166 | ) | | 1996 | | Feb-07 | | 3 - 39 yrs. | | | 117 | |
Highlands Ranch | | CO | | Hilton Garden Inn | | | 0 | | | | 2,510 | | | | 18,553 | | | | 207 | | | | | 21,270 | | | | (3,570 | ) | | 2007 | | Mar-07 | | 3 - 39 yrs. | | | 128 | |
Sarasota | | FL | | Homewood Suites | | | 0 | | | | 1,778 | | | | 12,284 | | | | 772 | | | | | 14,834 | | | | (2,925 | ) | | 2005 | | Sep-06 | | 3 - 39 yrs. | | | 100 | |
Miami | | FL | | Homewood Suites | | | 8,405 | | | | 3,206 | | | | 22,161 | | | | 2,205 | | | | | 27,572 | | | | (4,987 | ) | | 2000 | | Feb-07 | | 3 - 39 yrs. | | | 159 | |
Tallahassee | | FL | | Fairfield Inn | | | 0 | | | | 904 | | | | 6,208 | | | | (1,764 | ) | (2) | | | 5,348 | | | | (1,148 | ) | | 2000 | | Apr-07 | | 3 - 39 yrs. | | | 79 | |
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | | Capitalized | | Total | | | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | | Bldg | | Gross | | | Acc | | Date of | | Date | | Depreciable | | | # of | |
City | | State | | Brand | | Encumbrances | | | Land | | | FF&E /Other | | | Imp. & FF&E | | Cost (1) | | | Deprec | | Construction | | Acquired | | Life | | | Rooms | |
Lakeland | | FL | | Courtyard | | | 0 | | | | 1,549 | | | | 8,844 | | | | 743 | | | | | 11,136 | | | | (1,667 | ) | | 2000 | | Apr-07 | | 3 - 39 yrs. | | | 78 | |
Miami | | FL | | Courtyard | | | 0 | | | | 0 | | | | 15,463 | | | | 185 | | | | | 15,648 | | | | (2,487 | ) | | 2008 | | Sep-08 | | 3 - 39 yrs. | | | 118 | |
Columbus | | GA | | Fairfield Inn | | | 0 | | | | 0 | | | | 7,620 | | | | (2,652 | ) | (2) | | | 4,968 | | | | (1,367 | ) | | 2003 | | Apr-07 | | 3 - 39 yrs. | | | 79 | |
Macon | | GA | | Hilton Garden Inn | | | 0 | | | | 0 | | | | 10,115 | | | | 98 | | | | | 10,213 | | | | (2,032 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | | 101 | |
Columbus | | GA | | SpringHill Suites | | | 0 | | | | 1,188 | | | | 8,758 | | | | 25 | | | | | 9,971 | | | | (1,553 | ) | | 2008 | | Mar-08 | | 3 - 39 yrs. | | | 85 | |
Columbus | | GA | | TownePlace Suites | | | 0 | | | | 0 | | | | 8,643 | | | | 28 | | | | | 8,671 | | | | (1,586 | ) | | 2008 | | May-08 | | 3 - 39 yrs. | | | 86 | |
Boise | | ID | | SpringHill Suites | | | 0 | | | | 2,015 | | | | 19,589 | | | | 519 | | | | | 22,123 | | | | (4,032 | ) | | 1992 | | Sep-07 | | 3 - 39 yrs. | | | 230 | |
New Orleans | | LA | | Homewood Suites | | | 14,872 | | | | 4,579 | | | | 39,507 | | | | 1,598 | | | | | 45,684 | | | | (7,548 | ) | | 2002 | | Dec-06 | | 3 - 39 yrs. | | | 166 | |
Hattiesburg | | MS | | Courtyard | | | 5,871 | | | | 873 | | | | 8,918 | | | | 127 | | | | | 9,918 | | | | (1,932 | ) | | 2006 | | Oct-06 | | 3 - 39 yrs. | | | 84 | |
Tupelo | | MS | | Hampton Inn | | | 3,316 | | | | 332 | | | | 4,932 | | | | 1,298 | | | | | 6,562 | | | | (1,615 | ) | | 1994 | | Jan-07 | | 3 - 39 yrs. | | | 96 | |
Omaha | | NE | | Courtyard | | | 10,922 | | | | 2,731 | | | | 19,498 | | | | 3,902 | | | | | 26,131 | | | | (5,080 | ) | | 1999 | | Nov-06 | | 3 - 39 yrs. | | | 181 | |
Cranford | | NJ | | Homewood Suites | | | 0 | | | | 2,607 | | | | 11,375 | | | | 2,093 | | | | | 16,075 | | | | (3,108 | ) | | 2000 | | Mar-07 | | 3 - 39 yrs. | | | 108 | |
Mahwah | | NJ | | Homewood Suites | | | 0 | | | | 3,665 | | | | 16,481 | | | | 2,231 | | | | | 22,377 | | | | (3,940 | ) | | 2001 | | Mar-07 | | 3 - 39 yrs. | | | 110 | |
Ronkonkoma | | NY | | Hilton Garden Inn | | | 0 | | | | 3,153 | | | | 24,428 | | | | 2,344 | | | | | 29,925 | | | | (4,943 | ) | | 2003 | | Dec-06 | | 3 - 39 yrs. | | | 164 | |
Cincinnati | | OH | | Homewood Suites | | | 0 | | | | 551 | | | | 6,822 | | | | 293 | | | | | 7,666 | | | | (1,608 | ) | | 2005 | | Dec-06 | | 3 - 39 yrs. | | | 76 | |
Memphis | | TN | | Homewood Suites | | | 0 | | | | 1,712 | | | | 9,757 | | | | 2,349 | | | | | 13,818 | | | | (2,968 | ) | | 1989 | | May-07 | | 3 - 39 yrs. | | | 140 | |
Houston | | TX | | Residence Inn | | | 10,170 | | | | 1,093 | | | | 13,054 | | | | 296 | | | | | 14,443 | | | | (3,161 | ) | | 2006 | | Apr-06 | | 3 - 39 yrs. | | | 129 | |
Brownsville | | TX | | Courtyard | | | 0 | | | | 1,131 | | | | 7,743 | | | | 112 | | | | | 8,986 | | | | (1,711 | ) | | 2006 | | Jun-06 | | 3 - 39 yrs. | | | 90 | |
Stafford | | TX | | Homewood Suites | | | 0 | | | | 498 | | | | 7,578 | | | | 216 | | | | | 8,292 | | | | (1,791 | ) | | 2006 | | Aug-06 | | 3 - 39 yrs. | | | 78 | |
San Antonio | | TX | | TownePlace Suites | | | 0 | | | | 700 | | | | 11,525 | | | | 32 | | | | | 12,257 | | | | (2,159 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | | 106 | |
Addison | | TX | | SpringHill Suites | | | 0 | | | | 1,545 | | | | 11,312 | | | | 1,654 | | | | | 14,511 | | | | (2,509 | ) | | 2003 | | Aug-07 | | 3 - 39 yrs. | | | 159 | |
San Antonio | | TX | | TownePlace Suites | | | 0 | | | | 1,126 | | | | 13,093 | | | | 10 | | | | | 14,229 | | | | (2,384 | ) | | 2007 | | Sep-07 | | 3 - 39 yrs. | | | 123 | |
El Paso | | TX | | Homewood Suites | | | 0 | | | | 1,169 | | | | 14,656 | | | | 67 | | | | | 15,892 | | | | (2,541 | ) | | 2008 | | Apr-08 | | 3 - 39 yrs. | | | 114 | |
Provo | | UT | | Residence Inn | | | 4,775 | | | | 1,352 | | | | 10,394 | | | | 2,967 | | | | | 14,713 | | | | (3,250 | ) | | 1996 | | Jun-07 | | 3 - 39 yrs. | | | 114 | |
Alexandria | | VA | | Courtyard | | | 0 | | | | 4,010 | | | | 32,832 | | | | 4,427 | | | | | 41,269 | | | | (6,860 | ) | | 1987 | | Jul-07 | | 3 - 39 yrs. | | | 178 | |
Richmond | | VA | | Marriott | | | 22,376 | | | | 0 | | | | 59,614 | | | | 15,915 | | | | | 75,529 | | | | (18,093 | ) | | 1984 | | Jan-08 | | 3 - 39 yrs. | | | 410 | |
Seattle | | WA | | Residence Inn | | | 28,956 | | | | 0 | | | | 60,489 | | | | 6,883 | | | | | 67,372 | | | | (14,869 | ) | | 1991 | | Sep-06 | | 3 - 39 yrs. | | | 234 | |
Vancouver | | WA | | SpringHill Suites | | | 0 | | | | 1,310 | | | | 15,126 | | | | 46 | | | | | 16,482 | | | | (3,064 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | | 119 | |
Kirkland | | WA | | Courtyard | | | 12,439 | | | | 3,507 | | | | 28,507 | | | | 235 | | | | | 32,249 | | | | (4,646 | ) | | 2006 | | Oct-07 | | 3 - 39 yrs. | | | 150 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | $ | 161,825 | | | $ | 90,429 | | | $ | 842,894 | | | $ | 62,117 | | | | $ | 995,440 | | | $ | (182,814 | ) | | | | | | | | | 6,426 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(1) The cost basis for Federal Income Tax purposes approximates the basis used in this schedule, except for an impairment loss of approximately $6.6 million included in this schedule. | |
(2) Amount includes a reduction in cost due to impairment loss. | |
Investment in real estate at December 31, 2012 consisted of the following (in thousands):
Land | | $ | 90,429 | |
Building and Improvements | | | 829,144 | |
Furniture, Fixtures and Equipment | | | 73,045 | |
Franchise Fees | | | 2,822 | |
| | | 995,440 | |
Less Accumulated Depreciation | | | (182,814 | ) |
Investments in Real Estate, net | | $ | 812,626 | |
For additional information about the Company’s properties, refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. putative class action lawsuit which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
| Market For Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities |
Common Shares
There is currently no established public trading market in which the Company’s common shares are traded. As of December 31, 2012, there were 90.9 million Units outstanding. Each Unit consists of one common share, no par value, and one Series A preferred share of the Company. As of February 28, 2013, the Units were held by approximately 19,800 beneficial shareholders.
The Company is currently selling shares to its existing shareholders at a price of $11.00 per share through its Dividend Reinvestment Plan. This price is based on the most recent price at which an unrelated person purchased the Company’s Units from the Company. The Company also uses the original price paid for the Units ($11.00 per Unit in most cases) for redemptions under its Unit Redemption Program with the intention of providing limited liquidity based on those interested in purchasing additional Units through the Company’s Dividend Reinvestment Plan. As discussed further below, since inception of the Company’s Dividend Reinvestment Plan and Unit Redemption Program, 11.3 million Units have been issued and 11.5 million Units redeemed. The price of $11.00 is not based on an appraisal or valuation of the Company or its assets. In each of the years ended December 31, 2012 and 2011, there were tender offers made for the Units of the Company by a group of related bidders. In July 2011, bidders announced that they acquired 23,602 Units for $3 per Unit. In December 2011, bidders announced that they acquired 25,989 Units for $4 per Unit. In May 2012, bidders announced that they acquired 25,669 Units for $5 per Unit. In December 2012, bidders announced that they acquired 82,438 Units for $5 per Unit. The total Units acquired by the four tender offers (as announced by bidders during 2012 and 2011) were 157,698 Units, representing approximately 0.17% of the Company’s outstanding Units at December 31, 2012. The weighted average price paid for Units through applicable tender offers and the Company’s Unit Redemption Program was approximately $10.60 in 2012 and $10.85 in 2011.
Distribution Policy
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions totaled $70.0 million in 2012, $70.4 million in 2011, and $71.3 million in 2010. Distributions from May 2009 through December 2012 were paid monthly at a rate of $0.064167 per common share. Although the Company intends to continue paying distributions on a monthly basis, the amount and timing of distributions to shareholders are within the discretion of the Company’s Board of Directors. The amount and frequency of future distributions will depend on the Company’s results of operations, cash flow from operations, economic conditions, working capital requirements, cash requirements to fund investing and financing activities, capital expenditure requirements, including improvements to and expansions of properties, as well as the distribution requirements under federal income tax provisions for qualification as a REIT. The Company’s line of credit loan agreement can potentially limit distributions to $84 million annually, subject to operational results, unless the Company is required to distribute more to meet REIT requirements. In 2013 the Company’s Board of Directors approved a reduction of the monthly distribution rate to $0.055 per common share ($0.66 on an annual basis) effective for the distribution the Company plans to pay in April 2013.
Dividend Reinvestment Plan
In July 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of 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. The Company has registered 15 million Units for potential issuance under the plan. During the years ended December 31, 2012 and 2011, approximately 1.5 million Units, representing $16.0 million in proceeds to the Company, and 2.0 million Units, representing $22.0 million in proceeds to the Company, were issued under the plan. Since inception of the plan through December 31, 2012, approximately 11.3 million Units, representing $124.5 million in proceeds to the Company, were issued under the plan. As of December 31, 2012 and 2011 the Company had approximately 19.4 million and 22.8 million Units participating in the Dividend Reinvestment Plan. Since there continues to be demand for the Units at $11 per Unit, the Company’s Board of Directors does not believe the current offering price under the Dividend Reinvestment Plan should be changed at this time. However, the Board of Directors could change the price as it determines appropriate.
Unit Redemption Program
In April 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 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 more than three years. The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. As noted below, since January 2011, total redemption requests have exceeded the authorized amount of redemptions and, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.
Since inception of the program through December 31, 2012, the Company has redeemed approximately 11.5 million Units representing $124.2 million. During the year ended December 31, 2012, the Company redeemed approximately 1.6 million Units in the amount of $17.8 million. As contemplated in the program, beginning with the January 2011 redemption, the Company redeemed Units on a pro-rata basis with approximately 64%, 56%, 13%, 6%, 4%, 4%, 3% and 3% of the amounts requested redeemed in the first, second, third and fourth quarters of 2011 and the first, second, third, and fourth quarters of 2012, respectively, leaving approximately 12.6 million Units requested but not redeemed as of the last scheduled redemption date in the fourth quarter of 2012 (October 2012). Prior to 2011, the Company had redeemed 100% of the redemption requests. The Company has a number of cash sources including cash from operations, dividend reinvestment plan proceeds, proceeds from borrowings and asset sales from which it can make redemptions. See the Company’s complete consolidated statements of cash flows for the years ended December 31, 2012, 2011 and 2010 included in the Company’s audited financial statements in Item 8 of this Form 10-K for a further description of the sources and uses of the Company’s cash flows. The following is a summary of Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 1,137,969 | | | | 728,135 | | | | 409,834 | |
April 2011 | | | 1,303,574 | | | | 728,883 | | | | 574,691 | |
July 2011 | | | 5,644,778 | | | | 732,160 | | | | 4,912,618 | |
October 2011 | | | 11,332,625 | | | | 727,980 | | | | 10,604,645 | |
January 2012 | | | 12,885,635 | | | | 455,093 | | | | 12,430,542 | |
April 2012 | | | 12,560,001 | | | | 441,458 | | | | 12,118,543 | |
July 2012 | | | 12,709,508 | | | | 364,299 | | | | 12,345,209 | |
October 2012 | | | 13,003,443 | | | | 363,755 | | | | 12,639,688 | |
The following is a summary of redemptions during the fourth quarter of 2012 (no redemptions occurred in November and December of 2012):
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 | |
October 2012 | | | 363,755 | | | $ | 10.99 | | | | 363,755 | | | | (1) | |
(1) | The maximum number of Units that may be redeemed in any 12 month period is limited to up to five percent (5.0%) of the weighted average number of Units outstanding from the beginning of the 12 month period, subject to the Company’s right to change the number of Units to be redeemed. |
Series A Preferred Shares
The Series A preferred shares have no voting rights and no conversion rights. In addition, the Series A preferred shares are not separately tradable from the common shares to which they relate. The Series A preferred shares do not have any distribution rights except a priority distribution upon the sale of the Company’s assets. The priority distribution (“Priority Distribution”) is equal to $11.00 per Series A preferred share, and will be paid before any distribution will be made to the holders of any other shares. Upon the Priority Distribution, the Series A preferred shares will have no other distribution rights.
Series B Convertible Preferred Shares
In May 2005 the Company issued 240,000 Series B convertible preferred shares to Glade M. Knight, the Company’s Chairman and Chief Executive Officer. There are no dividends payable on the Series B convertible preferred shares.
Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the Articles of Incorporation that would adversely affect the Series B convertible preferred shares. Upon liquidation, each holder of the Series B convertible preferred shares is entitled to a priority liquidation payment. However the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares into which each Series B convertible preferred share would convert. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis. The Series B convertible preferred shares are convertible into common shares of the Company upon and for 180 days following the occurrence of any of the following events: (1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company’s business; or (2) the termination or expiration without renewal of the advisory agreement with A7A, or if the company ceases to use ASRG to provide property acquisition and disposition services; or (3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Preferred Shares
The Company’s articles of incorporation authorize issuance of up to 15 million additional preferred shares. No preferred shares other than the Series A preferred shares and the Series B convertible preferred shares (discussed above) have been issued. The Company believes that the authorization to issue additional preferred shares benefits the Company and its shareholders by permitting flexibility in financing additional growth, giving the Company additional financing options in corporate planning and in responding to developments in business, including financing of additional acquisitions and other general corporate purposes. Having authorized preferred shares available for issuance in the future gives the Company the ability to respond to future developments and allows preferred shares to be issued without the expense and delay of a special shareholders’ meeting. At present, the Company has no specific financing or acquisition plans involving the issuance of additional preferred shares and the Company does not propose to fix the characteristics of any series of preferred shares in anticipation of issuing preferred shares other than the Series A preferred shares and Series B convertible preferred shares discussed above. The Company cannot now predict whether or to what extent, if any, additional preferred shares will be used or if so used what the characteristics of a particular series may be. The voting rights and rights to distributions of the holders of common shares will be subject to the prior rights of the holders of any subsequently-issued preferred shares. Unless otherwise required by applicable law or regulation, the preferred shares would be issuable without further authorization by holders of the common shares and on such terms and for such consideration as may be determined by the Board of Directors. The preferred shares could be issued in one or more series having varying voting rights, redemption and conversion features, distribution (including liquidating distribution) rights and preferences, and other rights, including rights of approval of specified transactions. A series of preferred shares could be given rights that are superior to rights of holders of common shares and a series having preferential distribution rights could limit common share distributions and reduce the amount holders of common shares would otherwise receive on dissolution.
Non-Employee Directors Stock Option Plan and Incentive Plan
The Company’s Board of Directors has adopted and the Company’s shareholders have approved a non-employee directors’ stock option plan and an Incentive Plan. The options issued under each plan convert upon exercise to Units. Each Unit consists of one common share and one Series A preferred share of the Company. As of December 31, 2012, options to purchase 440,370 Units were outstanding with a weighted average exercise price of $11 per Unit under the Directors Plan. No options have been issued under the Incentive Plan. The following is a summary of securities issued under the plans as of December 31, 2012:
Plan Category | | Number of securities to be issued upon exercise of outstanding options, warrants and rights | | | Weighted-average exercise price of outstanding options, warrants and rights | | | Number of securities remaining available for future issuance under equity compensation plans | |
Equity Compensation plans approved by security holders | | | | | | | | | |
Non-Employee Directors Stock Option Plan | | | 440,370 | | | $ | 11.00 | | | | 1,159,175 | |
Incentive Plan | | | — | | | $ | — | | | | 4,029,318 | |
The following table sets forth selected financial data for the five years ended December 31, 2012, 2011, 2010, 2009 and 2008. Certain information in the table has been derived from the Company’s audited financial statements and notes
thereto. This data should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, the Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Annual Report on Form 10-K.
(in thousands except per share and statistical data) | | | | | | | | | | | | | | | |
Revenues: | | | | | | | | | | | | | | | |
Room revenue | | $ | 195,316 | | | $ | 188,652 | | | $ | 181,161 | | | $ | 174,042 | | | $ | 195,414 | |
Other revenue | | | 20,629 | | | | 20,227 | | | | 19,370 | | | | 17,673 | | | | 18,877 | |
Total revenue | | | 215,945 | | | | 208,879 | | | | 200,531 | | | | 191,715 | | | | 214,291 | |
| | | | | | | | | | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | | | | | | | | | |
Hotel operating expenses | | | 125,517 | | | | 122,148 | | | | 116,895 | | | | 113,968 | | | | 124,588 | |
Taxes, insurance and other | | | 13,138 | | | | 12,552 | | | | 12,229 | | | | 13,717 | | | | 13,559 | |
General and administrative | | | 7,196 | | | | 5,031 | | | | 5,177 | | | | 4,600 | | | | 5,881 | |
Depreciation | | | 34,557 | | | | 34,160 | | | | 33,174 | | | | 32,425 | | | | 28,434 | |
Gain from settlement of contingency | | | - | | | | - | | | | (3,099 | ) | | | - | | | | - | |
Loss from impairment of depreciable real estate assets | | | 6,640 | | | | - | | | | - | | | | - | | | | - | |
Interest expense, net | | | 10,711 | | | | 9,975 | | | | 7,837 | | | | 6,292 | | | | 3,766 | |
Total expenses | | | 197,759 | | | | 183,866 | | | | 172,213 | | | | 171,002 | | | | 176,228 | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | | | $ | 20,713 | | | $ | 38,063 | |
| | | | | | | | | | | | | | | | | | | | |
Per Share: | | | | | | | | | | | | | | | | | | | | |
Net income per common share | | $ | 0.20 | | | $ | 0.27 | | | $ | 0.31 | | | $ | 0.22 | | | $ | 0.41 | |
Distributions paid per common share | | $ | 0.77 | | | $ | 0.77 | | | $ | 0.77 | | | $ | 0.81 | | | $ | 0.88 | |
Weighted-average common shares outstanding - basic and diluted | | | 90,891 | | | | 91,435 | | | | 92,627 | | | | 93,472 | | | | 92,637 | |
| | | | | | | | | | | | | | | | | | | | |
Balance Sheet Data (at end of period): | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 20,609 | |
Investment in real estate, net | | $ | 812,626 | | | $ | 846,377 | | | $ | 872,169 | | | $ | 902,293 | | | $ | 920,688 | |
Total assets | | $ | 835,503 | | | $ | 865,141 | | | $ | 891,967 | | | $ | 923,887 | | | $ | 967,844 | |
Notes payable | | $ | 198,123 | | | $ | 174,847 | | | $ | 148,017 | | | $ | 117,787 | | | $ | 109,275 | |
Shareholders' equity | | $ | 624,463 | | | $ | 677,980 | | | $ | 733,300 | | | $ | 792,257 | | | $ | 845,753 | |
Net book value per share | | $ | 6.87 | | | $ | 7.44 | | | $ | 7.97 | | | $ | 8.47 | | | $ | 9.04 | |
| | | | | | | | | | | | | | | | | | | | |
Other Data: | | | | | | | | | | | | | | | | | | | | |
Cash Flow From (Used In): | | | | | | | | | | | | | | | | | | | | |
Operating activities | | $ | 60,806 | | | $ | 60,035 | | | $ | 59,915 | | | $ | 55,460 | | | $ | 69,025 | |
Investing activities | | $ | (12,134 | ) | | $ | (6,882 | ) | | $ | (2,310 | ) | | $ | (10,926 | ) | | $ | (127,519 | ) |
Financing activities | | $ | (48,672 | ) | | $ | (53,153 | ) | | $ | (57,605 | ) | | $ | (65,143 | ) | | $ | (63,334 | ) |
Number of hotels owned at end of period | | | 51 | | | | 51 | | | | 51 | | | | 51 | | | | 51 | |
Average Daily Rate (ADR) (a) | | $ | 114 | | | $ | 110 | | | $ | 108 | | | $ | 111 | | | $ | 120 | |
Occupancy | | | 73 | % | | | 73 | % | | | 71 | % | | | 67 | % | | | 71 | % |
Revenue Per Available Room (RevPAR) (b) | | $ | 83 | | | $ | 80 | | | $ | 77 | | | $ | 74 | | | $ | 86 | |
Total Rooms Sold (c) | | | 1,712,349 | | | | 1,707,819 | | | | 1,671,174 | | | | 1,568,916 | | | | 1,623,062 | |
Total Rooms Available (d) | | | 2,352,344 | | | | 2,346,432 | | | | 2,346,432 | | | | 2,345,356 | | | | 2,272,353 | |
| | | | | | | | | | | | | | | | | | | | |
Modified Funds From Operations Calculation (e): | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | | | $ | 20,713 | | | $ | 38,063 | |
Loss from impairment of depreciable real estate assets | | | 6,640 | | | | - | | | | - | | | | - | | | | - | |
Depreciation of real estate owned | | | 34,557 | | | | 34,160 | | | | 33,174 | | | | 32,425 | | | | 28,434 | |
Funds from operations | | | 59,383 | | | | 59,173 | | | | 61,492 | | | | 53,138 | | | | 66,497 | |
(in thousands except per share and statistical data) | | | | | | | | | | | | | | | |
Gain from settlement of contingency | | | - | | | | - | | | | (3,099 | ) | | | - | | | | - | |
Modified funds from operations | | $ | 59,383 | | | $ | 59,173 | | | $ | 58,393 | | | $ | 53,138 | | | $ | 66,497 | |
(a) Total room revenue divided by number of rooms sold. |
(b) ADR multiplied by occupancy percentage. |
(c) Represents actual number of room nights sold during period. |
(d) Represents number of rooms owned by the Company multiplied by the number of nights in the period. |
(e) Funds from operations (FFO) is defined as net income (computed in accordance with generally accepted accounting principles - GAAP) excluding gains and losses from sales of depreciable property, or loss from impairment of depreciable real estate assets, plus depreciation and amortization. Modified funds from operations (MFFO) excludes any gain or loss from the settlement of a contingency. The Company considers FFO and MFFO in evaluating property acquisitions and its operating performance and believes that FFO and MFFO should be considered along with, but not as an alternative to, net income and cash flows as a measure of the Company's activities in accordance with GAAP. The Company considers FFO and MFFO as supplemental measures of operating performance in the real estate industry, and along with the other financial measures included in this Form 10-K, including net income, cash flow from operating activities, financing activities and investing activities, they provide investors with an indication of the performance of the Company. The Company's definition of FFO and MFFO are not necessarily the same as such terms that are used by other companies. FFO and MFFO are not necessarily indicative of cash available to fund cash needs. |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets, or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Annual Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission and Item 1A in this report. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
Overview
Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”), was formed to invest in income-producing real estate in the United States. The Company was initially capitalized on May 26, 2005, with its first investor closing on March 15, 2006. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007. The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. As of December 31, 2012, the Company owned 51 hotels within different markets in the United States. The Company’s first hotel was acquired on April 27, 2006 and the last hotel was purchased in September 2008. Accordingly, the results of operations include only the results of operations of the hotels for the period owned. Exclusive of interest income, the Company had no operating revenues before the first hotel acquisition in April 2006.
Hotel Operations
Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned. With the significant decline in economic conditions throughout the United States over the 2008 through 2010 time period, overall performance of the Company’s hotels has not met expectations since acquisition. Beginning in 2011 and continuing throughout 2012, the hotel industry and Company’s revenues have shown improvement from the significant decline in the industry during 2008 through 2010. Although there is no way to predict future general economic conditions, and there are several key factors that continue to negatively affect economic recovery in the United States and add to general market uncertainty, including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the uncertainty surrounding the fiscal policy of the United States, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012.
In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”), and market yield which compares an individual hotel’s results to other hotels in its local market, and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.
The Company continually monitors the profitability of its properties and attempts to maximize shareholder value by timely disposal of properties. In January 2013, the Company committed to sell three underperforming assets, the Fairfield Inn’s in Dothan, Alabama, Columbus, Georgia and Tallahassee, Florida. Due to the change in anticipated hold period of these assets, the estimated undiscounted cash flow for these properties was estimated to be less than their carrying value; therefore the Company recognized a loss of $6.6 million in the fourth quarter of 2012 to adjust the basis of the properties to their estimated fair market value.
The following is a summary of the Company’s results for the years ended December 31, 2012 and 2011:
| | Years Ended December 31, | |
(in thousands, except statistical data) | | 2012 | | | Percent of Revenue | | | 2011 | | | Percent of Revenue | | | Percent Change | |
| | | | | | | | | | | | | | | |
Total revenue | | $ | 215,945 | | | | 100 | % | | $ | 208,879 | | | | 100 | % | | | 3 | % |
Hotel operating expenses | | | 125,517 | | | | 58 | % | | | 122,148 | | | | 58 | % | | | 3 | % |
Taxes, insurance and other expense | | | 13,138 | | | | 6 | % | | | 12,552 | | | | 6 | % | | | 5 | % |
General and administrative expense | | | 7,196 | | | | 3 | % | | | 5,031 | | | | 2 | % | | | 43 | % |
| | | | | | | | | | | | | | | | | | | | |
Loss on impairment of depreciable real estate assets | | | 6,640 | | | | | | | | 0 | | | | | | | | N/A | |
Depreciation | | | 34,557 | | | | | | | | 34,160 | | | | | | | | 1 | % |
Interest expense, net | | | 10,711 | | | | | | | | 9,975 | | | | | | | | 7 | % |
| | | | | | | | | | | | | | | | | | | | |
Number of hotels | | | 51 | | | | | | | | 51 | | | | | | | | 0 | % |
Average Market Yield (1) | | | 124 | | | | | | | | 126 | | | | | | | | -2 | % |
ADR | | $ | 114 | | | | | | | $ | 110 | | | | | | | | 4 | % |
Occupancy | | | 73 | % | | | | | | | 73 | % | | | | | | | 0 | % |
RevPAR | | $ | 83 | | | | | | | $ | 80 | | | | | | | | 4 | % |
| | | | | | | | | | | | | | | | | | | | |
(1) Calculated from data provided by Smith Travel Research, Inc.® Excludes hotels under renovation. | | | | | | | | | |
Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Hotels Owned
The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 51 hotels the Company owned at December 31, 2012. All dollar amounts are in thousands.
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price | |
Houston | | TX | | Residence Inn | | Western | | 4/27/06 | | | 129 | | | $ | 13,600 | |
San Diego | | CA | | Hilton Garden Inn | | Inn Ventures | | 5/9/06 | | | 200 | | | | 34,500 | |
Brownsville | | TX | | Courtyard | | Western | | 6/19/06 | | | 90 | | | | 8,550 | |
Stafford | | TX | | Homewood Suites | | Western | | 8/15/06 | | | 78 | | | | 7,800 | |
Auburn | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 101 | | | | 10,185 | |
Huntsville | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 101 | | | | 10,285 | |
Montgomery | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 97 | | | | 10,385 | |
Montgomery | | AL | | Homewood Suites | | LBA | | 8/17/06 | | | 91 | | | | 10,660 | |
Troy | | AL | | Hampton Inn | | LBA | | 8/17/06 | | | 82 | | | | 6,130 | |
Seattle | | WA | | Residence Inn | | Inn Ventures | | 9/1/06 | | | 234 | | | | 56,173 | |
Sarasota | | FL | | Homewood Suites | | Hilton | | 9/15/06 | | | 100 | | | | 13,800 | |
Hattiesburg | | MS | | Courtyard | | LBA | | 10/5/06 | | | 84 | | | | 9,455 | |
Huntsville | | AL | | Homewood Suites | | LBA | | 10/27/06 | | | 107 | | | | 11,606 | |
Omaha | | NE | | Courtyard | | Marriott | | 11/4/06 | | | 181 | | | | 23,100 | |
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price | |
Cincinnati | | OH | | Homewood Suites | | White | | 12/1/06 | | | 76 | | | $ | 7,100 | |
Rancho Bernardo | | CA | | Courtyard | | Dimension | | 12/12/06 | | | 210 | | | | 36,000 | |
New Orleans | | LA | | Homewood Suites | | Dimension | | 12/15/06 | | | 166 | | | | 43,000 | |
Ronkonkoma | | NY | | Hilton Garden Inn | | White | | 12/15/06 | | | 164 | | | | 27,000 | |
Tupelo | | MS | | Hampton Inn | | LBA | | 1/23/07 | | | 96 | | | | 5,245 | |
Miami | | FL | | Homewood Suites | | Dimension | | 2/21/07 | | | 159 | | | | 24,300 | |
Highlands Ranch | | CO | | Residence Inn | | Dimension | | 2/22/07 | | | 117 | | | | 19,000 | |
Cranford | | NJ | | Homewood Suites | | Dimension | | 3/7/07 | | | 108 | | | | 13,500 | |
Mahwah | | NJ | | Homewood Suites | | Dimension | | 3/7/07 | | | 110 | | | | 19,500 | |
Highlands Ranch | | CO | | Hilton Garden Inn | | Dimension | | 3/9/07 | | | 128 | | | | 20,500 | |
Prattville | | AL | | Courtyard | | LBA | | 4/24/07 | | | 84 | | | | 9,304 | |
Lakeland | | FL | | Courtyard | | LBA | | 4/24/07 | | | 78 | | | | 9,805 | |
Tallahassee | | FL | | Fairfield Inn | | LBA | | 4/24/07 | | | 79 | | | | 6,647 | |
Columbus | | GA | | Fairfield Inn | | LBA | | 4/24/07 | | | 79 | | | | 7,333 | |
Agoura Hills | | CA | | Homewood Suites | | Dimension | | 5/8/07 | | | 125 | | | | 25,250 | |
Memphis | | TN | | Homewood Suites | | Hilton | | 5/15/07 | | | 140 | | | | 11,100 | |
Dothan | | AL | | Fairfield Inn | | LBA | | 5/16/07 | | | 63 | | | | 4,584 | |
Vancouver | | WA | | SpringHill Suites | | Inn Ventures | | 6/1/07 | | | 119 | | | | 15,988 | |
San Diego | | CA | | Residence Inn | | Dimension | | 6/13/07 | | | 121 | | | | 32,500 | |
Provo | | UT | | Residence Inn | | Dimension | | 6/13/07 | | | 114 | | | | 11,250 | |
Macon | | GA | | Hilton Garden Inn | | LBA | | 6/28/07 | | | 101 | | | | 10,660 | |
San Antonio | | TX | | TownePlace Suites | | Western | | 6/29/07 | | | 106 | | | | 11,925 | |
Alexandria | | VA | | Courtyard | | Marriott | | 7/13/07 | | | 178 | | | | 36,997 | |
San Diego | | CA | | Hampton Inn | | Dimension | | 7/19/07 | | | 177 | | | | 42,000 | |
Addison | | TX | | SpringHill Suites | | Marriott | | 8/10/07 | | | 159 | | | | 12,500 | |
Boise | | ID | | SpringHill Suites | | Inn Ventures | | 9/14/07 | | | 230 | | | | 21,000 | |
San Antonio | | TX | | TownePlace Suites | | Western | | 9/27/07 | | | 123 | | | | 13,838 | |
Trussville | | AL | | Courtyard | | LBA | | 10/4/07 | | | 84 | | | | 9,510 | |
Kirkland | | WA | | Courtyard | | Inn Ventures | | 10/23/07 | | | 150 | | | | 31,000 | |
Huntsville | | AL | | TownePlace Suites | | LBA | | 12/10/07 | | | 86 | | | | 8,927 | |
Tucson | | AZ | | Residence Inn | | Western | | 1/17/08 | | | 124 | | | | 16,640 | |
Richmond | | VA | | Marriott | | White | | 1/25/08 | | | 410 | | | | 53,300 | |
Columbus | | GA | | SpringHill Suites | | LBA | | 3/6/08 | | | 85 | | | | 9,675 | |
Dothan | | AL | | Residence Inn | | LBA | | 4/16/08 | | | 84 | | | | 9,669 | |
El Paso | | TX | | Homewood Suites | | Western | | 4/23/08 | | | 114 | | | | 15,390 | |
Columbus | | GA | | TownePlace Suites | | LBA | | 5/22/08 | | | 86 | | | | 8,428 | |
Miami | | FL | | Courtyard | | Dimension | | 9/5/08 | | | 118 | | | | 15,000 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | 6,426 | | | $ | 901,594 | |
Management and Franchise Agreements
Each of the Company’s 51 hotels are operated and managed, under separate management agreements, by affiliates of one of the following companies: Dimension Development Company (“Dimension”), Hilton Worldwide (“Hilton”), Inn Ventures, Inc. (“Inn Ventures”), Larry Blumberg & Associates (“LBA”), Marriott International, Inc. (“Marriott”), Western International (“Western”), or White Lodging Services Corporation (“White”). The agreements generally provide for initial terms ranging from one to twenty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.2 million, $6.9 million and $6.6 million, respectively, in management fees.
Dimension, Inn Ventures, LBA, Western, and White are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage (as well as the two hotels managed by Promus Hotels, Inc., which is an affiliate of Hilton) were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements provide for initial terms ranging between 10 to 20 years. Fees associated with the Hilton agreements generally include the payment of royalty fees and program fees based on room revenues. The Marriott franchise agreements provide for an initial term of between six and 20 years. Fees associated with the Marriott agreements include the payment of royalty fees, marketing
fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $9.0 million, $8.6 million and $8.2 million, respectively, in franchise fees.
Results of Operations for Years 2012 and 2011
As of December 31, 2012 the Company owned 51 hotels with 6,426 rooms. The Company’s portfolio of hotels owned is unchanged since December 31, 2008. Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy had a considerable negative impact on both consumer and business travel. However, economic conditions have shown evidence of improvement during the past two years. As a result, the Company expects improvement in revenue and operating income in 2013 as compared to 2012. The Company’s hotels in general have shown results consistent with its local markets and brand averages for the period of ownership.
Revenues
The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue. For the years ended December 31, 2012 and 2011, the Company had total hotel revenue of $215.9 million and $208.9 million, respectively. For the year ended December 31, 2012, the hotels achieved combined average occupancy of approximately 73%, ADR of $114 and RevPAR of $83. For the year ended December 31, 2011, the hotels achieved combined average occupancy of approximately 73%, ADR of $110 and RevPAR of $80. 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 over prior recessionary periods of 2008 and 2009. While occupancy for 2012 is stable with the prior year, the Company has been able to modestly increase average room rates. Signifying a stabilizing economy, the Company experienced an increase in ADR of 4% during 2012 as compared to the prior year. Although the Company realized modest revenue growth, its RevPAR growth rate of approximately 4% was behind the overall industry growth rate, which was approximately 7%, as compared to 2011. The below average growth is due primarily to factors specific to the individual markets where the Company’s hotels are located. Several of the Company’s markets are heavily dependent upon the government sector which has had a declining demand in certain markets. Overall, with steady demand and room rate improvement, the Company is forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012. Although impacted by increased supply in certain markets, the Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for 2012 and 2011 was 124 and 126. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue.
Expenses
Hotel operating expenses consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the years ended December 31, 2012 and 2011, hotel operating expenses totaled $125.5 million and $122.1 million, representing 58% of total hotel revenue for each period. Hotel operational expenses for 2012 reflect the impact of modest increases in revenues at most of the Company’s hotels and the Company’s efforts to control costs. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utilities by continually monitoring and sharing utilization data across its hotels and management companies. Although operating expenses will increase as occupancy and revenue increases, the Company has and will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
Taxes, insurance, and other expenses for the years ended December 31, 2012 and 2011 were $13.1 million and $12.6 million, representing 6% of total hotel revenue for each period. Taxes have increased due to reassessment of property values by localities resulting from the improved economy. Insurance rates increased in 2012 due to property and casualty carriers’ losses world-wide in the past year. With the improved economy, the Company anticipates continued increases in property tax assessments in 2013 and a moderate increase in insurance rates.
General and administrative expense for the years ended December 31, 2012 and 2011 was $7.2 million and $5.0 million, representing 3% and 2% of total hotel revenue. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expenses. Total advisory fees incurred by the Company increased by approximately $0.5 million in 2012 as compared to the prior year due to the Company reaching the middle tier of the fee
range under the advisory agreement. During the years ended December 31, 2012 and 2011, the Company incurred approximately $1.6 million and $0.9 million, respectively, in legal costs related to the legal matters discussed herein and continued costs responding to requests from the staff of the Securities and Exchange Commission (“SEC”). The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company’s Consolidated Balance Sheets, Consolidated Statements of Operations or Consolidated Statements of Cash Flows. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution. As discussed below under Related Parties, the Company shares legal counsel with the other Apple REIT Companies. Total costs for these legal matters across all of the Apple REIT Companies was $7.3 million in 2012. The Company anticipates it will continue to incur significant legal costs at least during the first half of 2013 related to these matters. Also during the fourth quarter of 2011 the Company began to incur costs associated with its evaluation of a potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Total costs incurred during 2012 and 2011 were approximately $0.7 million and $0.1 million. In May 2012, it was determined by the Board of Directors of the Company and the Board of Directors of each of the other Apple REITs not to move forward with the potential consolidation transaction at that time.
Depreciation expense for the years ended December 31, 2012 and 2011 was $34.6 million and $34.2 million. Depreciation expense represents the expense of the Company’s hotel buildings and related improvements, and associated personal property (furniture, fixtures and equipment) for their respective periods owned.
Interest expense, net, for the years ended December 31, 2012 and 2011 was $10.7 million and $10.0 million. Interest expense primarily arose from mortgage debt outstanding on certain properties, in addition to interest on borrowings under the Company’s unsecured credit facilities. Interest expense for the years ended December 31, 2012 and 2011 was reduced by capitalized interest of approximately $0.3 million and $0.2 million in conjunction with hotel renovations. As of December 31, 2012, the Company had debt outstanding of $198.1 million compared to $174.8 million at December 31, 2011. For the years ended December 31, 2012 and 2011, interest expense increased from 2011 primarily due to an increase in the average outstanding balance of the Company’s debt. The increase in overall debt outstanding during 2012 is to fund working capital needs, while maintaining a relatively stable distribution rate to Unit holders during a low-growth economic period.
Results of Operations for Years 2011 and 2010
Revenues
For the years ended December 31, 2011 and 2010, the Company had total hotel revenue of $208.9 million and $200.5 million. For the year ended December 31, 2011, the hotels achieved average occupancy of 73%, ADR of $110 and RevPAR of $80. For the year ended December 31, 2010, the hotels achieved average occupancy of 71%, ADR of $108 and RevPAR of $77. Since the beginning of 2010, the Company experienced an increase in demand, as shown by the improvement in average occupancy of 3% in 2011 as compared to 2010. In addition, also signifying a stabilizing economy, the Company experienced an increase in ADR of 2% in 2011 as compared to 2010. The Company’s average Market Yield for 2011 and 2010 was 127 and 126, and excluded hotels under renovation.
Expenses
For the years ended December 31, 2011 and 2010, hotel operating expenses totaled $122.1 million and $116.9 million, representing 58% of total hotel revenue for each period. Hotel operational expenses for 2011 reflect the impact of modest increases in revenues and occupancy at most of the Company’s hotels, and the Company’s efforts to control costs in a challenging and relatively flat to low-growth economic environment during 2011.
Taxes, insurance, and other expenses for the years ended December 31, 2011 and 2010 were $12.6 million and $12.2 million, representing 6% of total hotel revenue for each period. Increases in these expenses for 2011 versus the prior year reflect higher real estate property tax assessments due to the improved economy.
General and administrative expense for the years ended December 31, 2011 and 2010 was $5.0 million and $5.2 million, representing 2% and 3% of total hotel revenue. During 2011 and 2010, the Company incurred approximately $900,000 and $500,000, respectively in legal costs related to the legal matters discussed herein and costs related to responding to requests from the staff of the SEC as discussed above. Also, during the fourth quarter of 2011, the Company incurred costs totaling $90,000 associated with its evaluation of a potential consolidation transaction with the other Apple REITs as discussed above.
Depreciation expense for the years ended December 31, 2011 and 2010 was $34.2 million and $33.2 million, respectively. Depreciation expense represents the expense of the Company’s hotel buildings and related improvements, and associated personal property (furniture, fixtures and equipment) for their respective periods owned.
Interest expense, net, for the years ended December 31, 2011 and 2010 was $10.0 million and $7.8 million, respectively. Interest expense primarily arose from mortgage debt outstanding on certain properties, in addition to interest on borrowings under the Company’s credit facility. As of December 31, 2011, the Company had debt outstanding of $174.8 million compared to $148.0 million at December 31, 2010. The increase in interest expense from 2010 was due to an increase in the average outstanding balance of the Company’s debt. The increase in overall debt outstanding during 2011 was to fund working capital needs, while maintaining a relatively stable distribution rate to Unit holders during a low-growth economic period.
Gain from settlement of contingency
The Company recorded other income of $3.1 million in November 2010 arising from the de-recognition of a liability for taxes, previously assumed at purchase in January 2008 of the full service Marriott hotel in Richmond, VA. The de-recognition was a non-cash transaction and had no impact on the Company’s net cash provided by operating activities for the year ended December 31, 2010. The taxing authority to whom the tax liability was due, refinanced the debt related to the tax and therefore extinguished the Company’s liability.
Related Parties
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions in 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price with addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of this contract totaled approximately $18.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees were incurred during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“A7A”) pursuant to which A7A provides management services to the Company. A7A provides these management services through an affiliate called Apple Fund Management, LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.5 million, $1.0 million and $1.0 million for the years ended December 31, 2012, 2011 and 2010. At December 31, 2012, $0.5 million of the 2012 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. The increase in 2012 is due to the Company reaching the middle tier of the fee range under the advisory agreement, due to improved operating results.
In addition to the fees payable to A7A, the Company reimbursed A7A or paid directly to AFM on behalf of A7A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A7A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements.
Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each Company’s level of business activity and the extent to which each Company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, Apple Nine Advisors, Inc. entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, Apple Nine Advisors, Inc. and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to Apple Nine Advisors, Inc., if it occurs, will have no impact on the Company’s advisory agreement with A7A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
A7A and ASRG are 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. 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.
Included in other assets, net on the Company’s consolidated balance sheet, is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.9 million as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, the services received by the Company are shared as applicable across the Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services.
Series B Convertible Preferred Stock
In May 2005 the Company issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with A7A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $50 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to issuance of 240,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B convertible preferred shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred at December 31, 2012, expense would have ranged from $0 to $63.8 million (assumes $11 per common share fair market value) which represents approximately 5.8 million shares of common stock.
Liquidity and Capital Resources
Contractual Commitments
The following is a summary of the Company’s significant contractual obligations as of December 31, 2012:
| | | | | | Amount of Commitments Expiring per Period | |
(000’s) | | | Total | | | Less than 1 Year | | | 2-3 Years | | | 4-5 Years | | | Over 5 Years | |
Debt (including interest of $39.9 million) | | | $ | 237,354 | | | $ | 39,810 | | | $ | 97,797 | | | $ | 31,729 | | | $ | 68,018 | |
Ground Leases | | | | 97,111 | | | | 1,052 | | | | 2,300 | | | | 2,325 | | | | 91,434 | |
| | | $ | 334,465 | | | $ | 40,862 | | | $ | 100,097 | | | $ | 34,054 | | | $ | 159,452 | |
Capital Resources
In August 2012, the Company entered into a new $40 million unsecured credit facility with a commercial bank that is utilized for working capital, hotel renovations and other general corporate funding purposes, including the payment of redemptions and distributions. The outstanding principal is required to be paid by the maturity date of August 30, 2014.
Interest payments are due monthly and the interest rate is equal to the LIBOR (London Interbank Offered Rate for a one-month term) plus 3.25%. The Company is also required to pay a quarterly fee at an annual rate of 0.35% on the average unused balance of the credit facility. With the availability of the Company’s credit facility, the Company generally maintains little cash on hand, accessing the facility as necessary. As a result, cash on hand was $0 at December 31, 2012 and 2011. The outstanding balance on the credit facility as of December 31, 2012 was $35.6 million and its annual interest rate was 3.46%.
At closing, the Company borrowed approximately $24.5 million under the credit facility to repay the outstanding balance and extinguish its prior $85 million credit facility and to pay transaction costs. Loan origination costs totaled approximately $0.3 million and are being amortized as interest expense through the August 2014 maturity date. The credit facility contains the following quarterly financial covenants (capitalized terms are defined in the loan agreements):
· | Tangible Net Worth must exceed $325 million; |
· | Total Debt to Asset Value must not exceed 50%; |
· | Cumulative 12 month Distributions and Redemptions, net of proceeds from the Company’s Dividend Reinvestment Program, must not exceed $84 million, and quarterly Distributions will not exceed $0.193 per share, unless such cumulative Net Distributions are less than total Funds From Operations for the period; |
· | Loan balance must not exceed 45% of the Unencumbered Asset Value; |
· | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
· | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at December 31, 2012.
In August 2012, the Company entered into four mortgage loan agreements with a commercial bank, secured by four hotel properties for a total of $63.0 million. At closing, the Company used proceeds from each loan to reduce the outstanding balance on the Company’s prior credit facility and pay transaction costs. Combined total loan origination costs of approximately $0.3 million are being amortized as interest expense through the September 2022 maturity date for each loan. The following table summarizes the hotel property securing each loan, the interest rate, loan origination date, maturity date and principal amount originated under each loan agreement. All dollar amounts are in thousands.
Hotel Location | | Brand | | Interest Rate | | Loan Origination Date | | Maturity Date | | Principal Originated | |
Hattiesburg, MS | | Courtyard | | | 5.00 | % | | 8/24/2012 | | 9/1/2022 | | $ | 5,900 | |
Rancho Bernardo, CA | | Courtyard | | | 5.00 | % | | 8/24/2012 | | 9/1/2022 | | | 15,500 | |
Kirkland, WA | | Courtyard | | | 5.00 | % | | 8/24/2012 | | 9/1/2022 | | | 12,500 | |
Seattle, WA | | Residence Inn | | | 4.96 | % | | 8/30/2012 | | 9/1/2022 | | | 29,100 | |
Total | | | | | | | | | | | | $ | 63,000 | |
The Company has three secured mortgage notes payable that mature in 2013. The Company extinguished one of the loans in February 2013 through a short-term increase in its line of credit and intends to refinance the extinguished loan and the other maturing loans with long term loans.
Capital Uses
In October 2012, the Company extinguished through payment of the outstanding principal, two mortgage notes payable. The mortgage loans for the Tallahassee, Florida Fairfield Inn and the Lakeland, Florida Courtyard, originally assumed at acquisition of the hotels, had principal balances at pay-off of approximately $3.0 million and $3.6 million, respectively.
The Company’s principal sources of liquidity are the operating cash flow generated from the Company’s properties and its $40 million revolving credit facility. The Company anticipates that cash flow from operations, its current revolving credit facility and other available credit will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions. The Company intends to maintain a
relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles. The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions, capital improvements, ramp-up of new properties and varying economic cycles. With the depressed financial results of the Company and lodging industry as compared to pre-recession levels, the Company has and will, if necessary, 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 distributions to required levels. If the Company were to default or be unable to refinance debt maturing in the future, it may be unable to make distributions.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions in 2012 totaled $70.0 million and were paid monthly at a rate of $0.064167 per common share. Total 2012 dividends paid equaled $0.77 per common share. For the same period the Company’s cash generated from operations was approximately $60.8 million. This shortfall includes a return of capital and was funded primarily by borrowings on the credit facility. Since a portion of distributions has been funded with borrowed funds, the Company’s ability to maintain its current intended rate of distribution will be primarily based on the ability of the Company’s properties to generate cash from operations at this level, the Company’s ability to utilize currently available financing, or the Company’s ability to obtain additional financing. Since there can be no assurance of the Company’s ability to obtain additional financing or that the properties owned by the Company will provide income at this level, there can be no assurance as to the classification or duration of distributions at the current rate. The Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make additional adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company.
In April 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 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 more than three years. 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. Since inception of the program through December 31, 2012, the Company has redeemed approximately 11.5 million Units representing $124.2 million, including 1.6 million Units in the amount of $17.8 million, 2.9 million Units in the amount of $32.0 million, and 3.7 million Units in the amount of $40.7 million redeemed during 2012, 2011, and 2010. As contemplated in the program, beginning with the January 2011 redemption, the scheduled redemption date for the first quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 1,137,969 | | | | 728,135 | | | | 409,834 | |
April 2011 | | | 1,303,574 | | | | 728,883 | | | | 574,691 | |
July 2011 | | | 5,644,778 | | | | 732,160 | | | | 4,912,618 | |
October 2011 | | | 11,332,625 | | | | 727,980 | | | | 10,604,645 | |
January 2012 | | | 12,885,635 | | | | 455,093 | | | | 12,430,542 | |
April 2012 | | | 12,560,001 | | | | 441,458 | | | | 12,118,543 | |
July 2012 | | | 12,709,508 | | | | 364,299 | | | | 12,345,209 | |
October 2012 | | | 13,003,443 | | | | 363,755 | | | | 12,639,688 | |
As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent. Currently, the Company plans to redeem under its Redemption Program approximately 1-2% of weighted average Units during 2013.
In July 2007 the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of 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. The Company has registered 15 million Units for potential issuance under the plan. During the years ended December 31, 2012, 2011 and 2010, approximately 1.5 million Units, representing $16.0 million in proceeds to the Company, 2.0 million Units representing $22.0 million in proceeds to the Company, and 2.2 million Units representing $24.6 million in proceeds to the Company, were issued under the plan. Since inception of the plan through December 31, 2012, approximately 11.3 million Units, representing $124.5 million in proceeds to the Company, were issued under the plan.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and under certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. 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 December 31, 2012, the Company held $9.3 million in reserve for capital expenditures. In 2012 and 2011, the Company invested approximately $7.4 million and $8.4 million in capital expenditures and anticipates investing approximately $20 million during 2013. Due to the recent recessionary low-growth economic environment, the Company invested a slightly lower than normal amount in capital expenditures in 2012 and 2011. The Company currently does not have any existing or planned projects for new developments.
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 historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.
Critical Accounting Policies
The following contains a discussion of what the Company believes to be critical accounting policies. These items should be read to gain a further understanding of the principles used to prepare the Company’s financial statements. These principles include application of judgment; therefore, changes in judgments may have a significant impact on the Company’s reported results of operations and financial condition.
Capitalization Policy
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; and (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
Impairment Losses Policy
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that recently opened, were recently renovated or experienced other short-term business disruption. Since the Company’s planned initial hold period for each property is 39 years the Company’s ongoing analysis and annual recoverability analysis
have not identified any impairment losses and no impairment losses have been recorded to date other than the impairment on three properties discussed below. If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value. During December 2012, the Company identified three properties that it would consider selling in the next year due to anticipated returns for needed capital investment being below returns for other investment opportunities. In January 2013 management committed to a marketing effort to sell these properties. Since the Company’s anticipated hold period for these properties was reduced, the estimated undiscounted cash flows for these properties was estimated to be less than their carrying value; therefore the Company adjusted the carrying value of the properties to their estimated fair market value, which resulted in an impairment loss of $6.6 million.
Subsequent Events
In January 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 111,782 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 386,558 Units in the amount of $4.2 million. As contemplated in the Program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 3% of the total 13.4 million requested Units to be redeemed, with approximately 13.0 million requested Units not redeemed.
In January 2013, the Company entered into two mortgage loan agreements with a commercial real estate lender. The loans are separately secured by the Company’s Huntsville, Alabama Homewood Suites and Prattville, Alabama Courtyard hotels, and will amortize based on a 25 year term with a balloon payment due at maturity in February 2023. Interest is payable monthly on the outstanding balance of each loan at an annual rate of 4.12%. The total proceeds of $15.3 million under the two loan agreements were used to reduce the outstanding balance on the Company’s $40.0 million credit facility, and to pay loan origination and other transaction costs of approximately $0.2 million.
In February 2013, the Company extinguished through pay-off a mortgage note payable jointly secured by the San Diego, California Residence Inn and the Provo, Utah Residence Inn. The note payable had a scheduled maturity in April 2013, and was originally assumed upon acquisition of the two hotels in 2007. The mortgage note payable had a principal balance at pay-off of approximately $18.3 million, an interest rate of 6.55%, and was extinguished without premium or discount to the balance outstanding. Funds for the debt extinguishment were provided by borrowings under the Company’s amended unsecured credit facility. The Company entered into an amendment to its unsecured credit facility, also in February 2013, which increased the maximum aggregate commitment by the lender from $40.0 million to $55.0 million. Under the amendment the increase is effective until the earlier of completing its planned financing of the San Diego, California Residence Inn or April 2013. All other terms of the credit facility remain the same, including the payment of a quarterly fee on the average unused balance of the credit facility at an annual rate of 0.35%.
The Company’s Board of Directors approved a reduction in the Company’s projected distribution rate from an annual rate of $0.77 per common share to $0.66 per common share. The change is effective with the distribution planned for April 2013. The distribution will continue to be paid monthly.
In February 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 110,000 Units were reinvested under the Company’s Dividend Reinvestment Plan.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of December 31, 2012, the Company’s financial instruments were not exposed to significant market risk due to 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 on its credit facility. Based on the balance of the Company’s credit facility at December 31, 2012 of $35.6 million, every 100 basis points change in interest rates could impact the Company’s annual net income by $356,000, all other factors remaining the same. The Company’s cash balance at December 31, 2012 was $0.
In addition to its $35.6 million outstanding balance under its credit facility at December 31, 2012 (the credit facility’s interest rate at December 31, 2012 was approximately 3.46%), which matures in August 2014 and is included in the table below, the Company has fixed interest rate notes payable to lenders under permanent financing arrangements. The following table summarizes the annual maturities and average interest rates of the Company’s variable rate and fixed rate notes payable outstanding at December 31, 2012.
(000's) | | 2013 | | | 2014 | | | 2015 | | | 2016 | | | 2017 | | | Thereafter | | | Total | | | Fair Market Value | |
Maturities | | $ | 30,153 | | | $ | 84,148 | | | $ | 2,036 | | | $ | 23,898 | | | $ | 1,559 | | | $ | 55,631 | | | $ | 197,425 | | | $ | 204,121 | |
Average interest rates | | | 5.3 | % | | | 5.1 | % | | | 5.2 | % | | | 5.1 | % | | | 5.0 | % | | | 5.0 | % | | | | | | | | |
| Financial Statements and Supplementary Data |
Report of Management
on Internal Control Over Financial Reporting
March 6, 2013
To the Shareholders
Apple REIT Seven, Inc.
Management of Apple REIT Seven, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
The Company’s internal control over financial reporting is supported by written policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the Company’s transactions and dispositions of the Company’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with generally accepted accounting principles, and the receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In connection with the preparation of the Company’s annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of those controls.
Based on this assessment, management has concluded that as of December 31, 2012, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Ernst & Young LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this report, has issued an attestation report on the Company’s internal control over financial reporting, a copy of which appears on the next page of this annual report.
/s/ GLADE M. KNIGHT | | /s/ BRYAN PEERY |
Glade M. Knight | | Bryan Peery |
Chairman and Chief Executive Officer | | Chief Financial Officer (Principal Accounting Officer) |
Report of Independent Registered Public Accounting Firm
on Internal Control Over Financial Reporting
The Board of Directors and Shareholders of
Apple REIT Seven, Inc.
We have audited Apple REIT Seven, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Apple REIT Seven, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Apple REIT Seven, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2012 consolidated financial statements of Apple REIT Seven, Inc. and our report dated March 6, 2013 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Richmond, Virginia
March 6, 2013
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Apple REIT Seven, Inc.
We have audited the accompanying consolidated balance sheets of Apple REIT Seven, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Apple REIT Seven, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Apple REIT Seven, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 6, 2013 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Richmond, Virginia
March 6, 2013
APPLE REIT SEVEN, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)
| | As of December 31, | |
| | 2012 | | | 2011 | |
| | | | | | |
Assets | | | | | | |
Investment in real estate, net of accumulated depreciation of $182,814 and $148,257, respectively | | $ | 812,626 | | | $ | 846,377 | |
Restricted cash-furniture, fixtures and other escrows | | | 11,354 | | | | 7,141 | |
Due from third party managers, net | | | 6,798 | | | | 6,426 | |
Other assets, net | | | 4,725 | | | | 5,197 | |
Total Assets | | $ | 835,503 | | | $ | 865,141 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Credit facilities | | $ | 35,600 | | | $ | 64,700 | |
Mortgage debt | | | 162,523 | | | | 110,147 | |
Accounts payable and accrued expenses | | | 12,917 | | | | 12,314 | |
Total Liabilities | | | 211,040 | | | | 187,161 | |
| | | | | | | | |
Shareholders' Equity | | | | | | | | |
Preferred stock, authorized 15,000,000 shares; none issued and outstanding | | | 0 | | | | 0 | |
Series A preferred stock, no par value, authorized 200,000,000 shares; issued and outstanding 90,941,959 and 91,109,651 shares, respectively | | | 0 | | | | 0 | |
Series B convertible preferred stock, no par value, authorized 240,000 shares; issued and outstanding 240,000 shares | | | 24 | | | | 24 | |
Common stock, no par value, authorized 200,000,000 shares; issued and outstanding 90,941,959 and 91,109,651 shares, respectively | | | 898,821 | | | | 900,555 | |
Distributions greater than net income | | | (274,382 | ) | | | (222,599 | ) |
Total Shareholders' Equity | | | 624,463 | | | | 677,980 | |
| | | | | | | | |
Total Liabilities and Shareholders' Equity | | $ | 835,503 | | | $ | 865,141 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
| | | | | | | | | |
Revenues: | | | | | | | | | |
Room revenue | | $ | 195,316 | | | $ | 188,652 | | | $ | 181,161 | |
Other revenue | | | 20,629 | | | | 20,227 | | | | 19,370 | |
Total revenue | | | 215,945 | | | | 208,879 | | | | 200,531 | |
| | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | |
Operating expense | | | 57,821 | | | | 56,309 | | | | 53,552 | |
Hotel administrative expense | | | 16,002 | | | | 15,943 | | | | 15,084 | |
Sales and marketing | | | 16,887 | | | | 16,074 | | | | 15,385 | |
Utilities | | | 8,800 | | | | 8,994 | | | | 8,796 | |
Repair and maintenance | | | 9,799 | | | | 9,269 | | | | 9,241 | |
Franchise fees | | | 8,997 | | | | 8,637 | | | | 8,203 | |
Management fees | | | 7,211 | | | | 6,922 | | | | 6,634 | |
Taxes, insurance and other | | | 13,138 | | | | 12,552 | | | | 12,229 | |
General and administrative | | | 7,196 | | | | 5,031 | | | | 5,177 | |
Loss on impairment of depreciable real estate assets | | | 6,640 | | | | 0 | | | | 0 | |
Depreciation expense | | | 34,557 | | | | 34,160 | | | | 33,174 | |
Gain from settlement of contingency | | | 0 | | | | 0 | | | | (3,099 | ) |
Total expenses | | | 187,048 | | | | 173,891 | | | | 164,376 | |
| | | | | | | | | | | | |
Operating income | | | 28,897 | | | | 34,988 | | | | 36,155 | |
| | | | | | | | | | | | |
Interest expense, net | | | (10,711 | ) | | | (9,975 | ) | | | (7,837 | ) |
| | | | | | | | | | | | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | |
| | | | | | | | | | | | |
Basic and diluted net income per common share | | $ | 0.20 | | | $ | 0.27 | | | $ | 0.31 | |
| | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 90,891 | | | | 91,435 | | | | 92,627 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC.CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY(in thousands except per share data)
| | | | | | | | Series B Convertible | | | | | | | |
| | Common Stock | | | Preferred Stock | | | Distributions | | | | |
| | Number of Shares | | | Amount | | | Number of Shares | | | Amount | | | | | | Total | |
| | | | | | | | | | | | | | | | | | |
Balance at December 31, 2009 | | | 93,522 | | | $ | 926,419 | | | | 240 | | | $ | 24 | | | $ | (134,186 | ) | | $ | 792,257 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 2,239 | | | | 24,745 | | | | 0 | | | | 0 | | | | 0 | | | | 24,745 | |
Common shares redeemed | | | (3,733 | ) | | | (40,680 | ) | | | 0 | | | | 0 | | | | 0 | | | | (40,680 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 28,318 | | | | 28,318 | |
Cash distributions declared and paid to shareholders ($.77 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (71,340 | ) | | | (71,340 | ) |
Balance at December 31, 2010 | | | 92,028 | | | | 910,484 | | | | 240 | | | | 24 | | | | (177,208 | ) | | | 733,300 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 1,999 | | | | 22,098 | | | | 0 | | | | 0 | | | | 0 | | | | 22,098 | |
Common shares redeemed | | | (2,917 | ) | | | (32,027 | ) | | | 0 | | | | 0 | | | | 0 | | | | (32,027 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 25,013 | | | | 25,013 | |
Cash distributions declared and paid to shareholders ($.77 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (70,404 | ) | | | (70,404 | ) |
Balance at December 31, 2011 | | | 91,110 | | | | 900,555 | | | | 240 | | | | 24 | | | | (222,599 | ) | | | 677,980 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 1,457 | | | | 16,098 | | | | 0 | | | | 0 | | | | 0 | | | | 16,098 | |
Common shares redeemed | | | (1,625 | ) | | | (17,832 | ) | | | 0 | | | | 0 | | | | 0 | | | | (17,832 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 18,186 | | | | 18,186 | |
Cash distributions declared and paid to shareholders ($.77 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (69,969 | ) | | | (69,969 | ) |
Balance at December 31, 2012 | | | 90,942 | | | $ | 898,821 | | | | 240 | | | $ | 24 | | | $ | (274,382 | ) | | $ | 624,463 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
| | | | | | | | | |
Cash flows from operating activities: | | | | | | | | | |
Net income | | $ | 18,186 | | | $ | 25,013 | | | $ | 28,318 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | | | | | |
Depreciation | | | 34,557 | | | | 34,160 | | | | 33,174 | |
Loss on impairment of depreciable real estate assets | | | 6,640 | | | | 0 | | | | 0 | |
Gain from settlement of contingency | | | 0 | | | | 0 | | | | (3,099 | ) |
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net | | | 256 | | | | 491 | | | | 665 | |
Changes in operating assets and liabilities: | | | | | | | | | | | | |
Increase in due from third party managers, net | | | (372 | ) | | | (597 | ) | | | (190 | ) |
Decrease (increase) in other assets | | | 145 | | | | 1 | | | | (33 | ) |
Increase in accounts payable and accrued expenses | | | 1,394 | | | | 967 | | | | 1,080 | |
Net cash provided by operating activities | | | 60,806 | | | | 60,035 | | | | 59,915 | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Capital improvements | | | (8,237 | ) | | | (7,671 | ) | | | (4,234 | ) |
Additions to ownership interest in non-hotel properties | | | 0 | | | | (101 | ) | | | (125 | ) |
Net decrease (increase) in capital improvement reserves | | | (3,897 | ) | | | 890 | | | | 2,049 | |
Net cash used in investing activities | | | (12,134 | ) | | | (6,882 | ) | | | (2,310 | ) |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net proceeds related to issuance of Units | | | 16,004 | | | | 21,987 | | | | 24,745 | |
Redemptions of Units | | | (17,832 | ) | | | (32,027 | ) | | | (40,680 | ) |
Distributions paid to common shareholders | | | (69,969 | ) | | | (70,404 | ) | | | (71,340 | ) |
Net proceeds from (payments on) extinguished credit facility | | | (64,700 | ) | | | 19,800 | | | | 33,390 | |
Net proceeds from existing credit facility | | | 35,600 | | | | 0 | | | | 0 | |
Proceeds from mortgage debt | | | 63,000 | | | | 10,500 | | | | 0 | |
Payments on mortgage debt | | | (10,021 | ) | | | (2,874 | ) | | | (2,563 | ) |
Deferred financing costs | | | (754 | ) | | | (135 | ) | | | (1,157 | ) |
Net cash used in financing activities | | | (48,672 | ) | | | (53,153 | ) | | | (57,605 | ) |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | 0 | | | | 0 | | | | 0 | |
| | | | | | | | | | | | |
Cash and cash equivalents, beginning of period | | | 0 | | | | 0 | | | | 0 | |
| | | | | | | | | | | | |
Cash and cash equivalents, end of period | | $ | 0 | | | $ | 0 | | | $ | 0 | |
| | | | | | | | | | | | |
Supplemental information: | | | | | | | | | | | | |
Interest paid | | $ | 10,881 | | | $ | 9,959 | | | $ | 7,980 | |
See notes to consolidated financial statements.
Notes to Consolidated Financial Statements
Note 1
Organization and Summary of Significant Accounting Policies
Organization
Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”) is a Virginia corporation formed to invest in income-producing real estate in the United States. Initial capitalization occurred on May 26, 2005 and operations began on April 27, 2006 when the Company acquired its first hotel. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007. The Company’s fiscal year end is December 31. The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. As of December 31, 2012, the Company owned 51 hotels located in 18 states with an aggregate of 6,426 rooms.
The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The REIT Modernization Act, effective January 1, 2001, permits real estate investment trusts to establish taxable businesses to conduct certain previously disallowed business activities. The Company has formed wholly-owned taxable REIT subsidiaries (collectively, the “Lessee”), which lease all of the Company’s hotels.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments with original maturities of three months or less. The fair market value of cash and cash equivalents approximates their carrying value. Balances held may at times exceed federal depository insurance limits.
Restricted Cash
Restricted cash includes reserves for debt service, real estate taxes, and insurance, and reserves for furniture, fixtures, and equipment replacements of up to 5% of property revenue for certain hotels, as required by certain management or mortgage debt agreement restrictions and provisions.
Investment in Real Estate and Related Depreciation
Real estate is stated at cost, net of depreciation. Repair and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements are capitalized. Depreciation is computed using the straight-line method over average estimated useful lives of the assets, which are 39 years for buildings, 18 years for franchise fees, ten years for major improvements and three to seven years for furniture, fixtures and equipment.
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; and (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that recently opened, were recently renovated or experienced other short-term business disruption. The Company’s planned initial hold period for each property is 39 years. The Company’s ongoing analysis and annual recoverability analysis have not identified any impairment losses and no impairment losses have been recorded to date, other than the loss on
impairment of three properties discussed below. If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.
During December 2012, the Company identified three properties that it would consider selling in the next year due to anticipated returns for needed capital investment being below returns for other investment opportunities. In January 2013, the Company began the process of marketing these three underperforming assets, the Fairfield Inn’s in Dothan, Alabama, Columbus, Georgia and Tallahassee, Florida. Due to the change in anticipated hold period of the assets, the estimated undiscounted cash flow for these properties was estimated to be less than their carrying value; therefore the Company recognized a loss of $6.6 million in the fourth quarter of 2012 to adjust the basis of the properties to their estimated fair market value. The estimated fair value of the three properties is based on third party pricing estimates, including specific market analysis and management estimates of market capitalization rates. These estimates incorporate significant unobservable inputs and therefore are considered Level 3 inputs under the fair value hierarchy.
Revenue Recognition
Hotel revenue is recognized as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel’s services.
Comprehensive Income
The Company recorded no comprehensive income other than net income during the periods reported.
Earnings Per Common Share
Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the year. Diluted earnings per common share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the year. There were no potential common shares with a dilutive effect for the years ended December 31, 2012, 2011 or 2010. As a result, basic and dilutive outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares.
Federal Income Taxes
The Company is operated as, and has elected to be taxed as, a REIT under Sections 856 to 860 of the Internal Revenue Code. Earnings and profits, which will determine the taxability of distributions to shareholders, will differ from income reported for financial reporting purposes primarily due to the differences for federal income tax purposes in the estimated useful lives used to compute depreciation. Distributions in 2012 of $0.77 per share for tax purposes was 43% ordinary income and 57% return of capital. The characterization of 2011 distributions of $0.77 per share for tax purposes was 52% ordinary income and 48% return of capital. The characterization of 2010 distributions of $0.77 per share for tax purposes was 51% ordinary income and 49% return of capital.
The Lessee, as a taxable REIT subsidiary of the Company, is subject to federal and state income taxes. The taxable REIT subsidiary had taxable income for the year ended December 31, 2012 and incurred a loss for the years ended December 31, 2011 and 2010. Due to the availability of net operating losses from prior years the Company did not have any federal tax expense in 2012. No operating loss benefit has been recorded in the consolidated balance sheet since realization is uncertain due to the history of operating losses. The total net operating loss carry forward for federal income tax purposes was approximately $25.9 million as of December, 31, 2012. The net operating losses begin to expire in 2026. There are no material differences between the book and tax cost basis of the Company’s assets except for the $6.6 million impairment loss recorded for book purposes. As of December 31, 2012, the tax years that remain subject to examination by major tax jurisdictions generally include 2009 to 2012.
Sales and Marketing Costs
Sales and marketing costs are expensed when incurred. These costs represent the expense for franchise advertising and reservation systems under the terms of the hotel management and franchise agreements and general and administrative expenses that are directly attributable to advertising and promotion.
Use of Estimates
The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from those estimates.
Note 2
Investment in Real Estate
The Company’s investment in real estate consisted of the following (in thousands):
| | December 31, 2012 | | | December 31, 2011 | |
Land | | $ | 90,429 | | | $ | 90,429 | |
Building and Improvements | | | 829,144 | | | | 832,798 | |
Furniture, Fixtures and Equipment | | | 73,045 | | | | 68,585 | |
Franchise Fees | | | 2,822 | | | | 2,822 | |
| | | 995,440 | | | | 994,634 | |
Less Accumulated Depreciation | | | (182,814 | ) | | | (148,257 | ) |
Investment in Real Estate, net | | $ | 812,626 | | | $ | 846,377 | |
Hotels Owned
As of December 31, 2012, the Company owned 51 hotels, located in 18 states, consisting of the following:
Brand | | Total by Brand | | | Number of Rooms | |
Homewood Suites | | | 12 | | | | 1,374 | |
Courtyard | | | 10 | | | | 1,257 | |
Residence Inn | | | 7 | | | | 923 | |
Hilton Garden Inn | | | 7 | | | | 892 | |
SpringHill Suites | | | 4 | | | | 593 | |
TownePlace Suites | | | 4 | | | | 401 | |
Hampton Inn | | | 3 | | | | 355 | |
Fairfield Inn | | | 3 | | | | 221 | |
Marriott | | | 1 | | | | 410 | |
Total | | | 51 | | | | 6,426 | |
Note 3
Credit Facility and Mortgage Debt
In August 2012, the Company entered into a new $40 million unsecured credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. Interest payments are due monthly and the interest rate is equal to the LIBOR (London Interbank Offered Rate for a one-month term) plus 3.25%. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part, at any time. The Company is also required to pay a quarterly fee at an annual rate of 0.35% on the average unused balance of the credit facility. The Company’s prior $85 million unsecured credit facility, originated in October 2010, had an interest rate equal to one-month LIBOR plus 3.5%, subject to a minimum LIBOR interest rate floor of 1.5%, and was subject to a fee on the average unused balance of the facility an annualized rate of 0.50%. The credit facility matures in August 2014. At closing, the Company borrowed approximately $24.5 million under the credit facility to repay the outstanding balance and extinguish the prior $85 million credit facility and pay transaction costs. The balance outstanding under the credit facility on December 31, 2012 was $35.6 million, at an annual interest rate of approximately 3.46%. Loan origination costs totaled approximately $0.3 million and are being amortized as interest expense through the August 2014 maturity date. The credit facility contains the following quarterly financial covenants (capitalized terms are defined in the loan agreements):
· | Tangible Net Worth must exceed $325 million; |
· | Total Debt to Asset Value must not exceed 50%; |
· | Cumulative 12 month Distributions and Redemptions, net of proceeds from the Company’s Dividend Reinvestment Program, cannot exceed $84 million and quarterly Distributions cannot exceed $0.193 per share, unless such cumulative Net Distributions are less than total Funds From Operations for the period; |
· | Loan balance must not exceed 45% of the Unencumbered Asset Value; |
· | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
· | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at December 31, 2012.
In conjunction with the acquisition of several hotel properties, the Company assumed mortgage notes payable outstanding, secured by the applicable hotel property. In August 2012, the Company entered into four mortgage loan agreements with a commercial bank, secured by four hotel properties, for a total of $63.0 million. Scheduled payments of interest and principal are due monthly. At closing, the Company used proceeds from each loan to reduce the outstanding balance on the Company’s prior credit facility and pay transaction costs. Combined total loan origination costs of approximately $0.3 million are being amortized as interest expense through the September 2022 maturity date for each loan. In addition, on February 28, 2011, the Company entered into a mortgage loan agreement, secured by the Company’s Houston, Texas Residence Inn property, for $10.5 million. Scheduled payments of interest and principal are due monthly. At closing, the Company used proceeds from the loan for general corporate purposes, including the reduction in the outstanding balance of the Company’s former revolving credit facility. The following table summarizes the hotel property securing each loan, the interest rate, maturity date, the principal amount assumed or originated, and the outstanding balance as of December 31, 2012 and 2011. All dollar amounts are in thousands.
Location | | Brand | | Interest Rate (1) | | Acquisition or Loan Origination Date | | Maturity Date | | Principal Assumed or Originated | | | Outstanding balance as of December 31, 2012 | | | Outstanding balance as of December 31, 2011 | |
Omaha, NE | | Courtyard | | | 6.79 | % | | 11/4/2006 | | 1/1/2014 | | $ | 12,658 | | | $ | 10,922 | | | $ | 11,258 | |
New Orleans, LA | | Homewood Suites | | | 5.85 | % | | 12/15/2006 | | 10/1/2014 | | | 17,144 | | | | 14,872 | | | | 15,307 | |
Tupelo, MS | | Hampton Inn | | | 5.90 | % | | 1/23/2007 | | 3/1/2016 | | | 4,110 | | | | 3,316 | | | | 3,470 | |
Miami, FL | | Homewood Suites | | | 6.50 | % | | 2/21/2007 | | 7/1/2013 | | | 9,820 | | | | 8,405 | | | | 8,687 | |
Highlands Ranch, CO | | Residence Inn | | | 5.94 | % | | 2/21/2007 | | 6/1/2016 | | | 11,550 | | | | 10,710 | | | | 10,883 | |
Tallahassee, FL | | Fairfield Inn | | | 6.80 | % | | 4/24/2007 | | 1/11/2013 | | | 3,494 | | | | 0 | | | | 3,099 | |
Lakeland, FL | | Courtyard | | | 6.80 | % | | 4/24/2007 | | 1/11/2013 | | | 4,210 | | | | 0 | | | | 3,734 | |
San Diego, CA | | Residence Inn | | | 6.55 | % | | 6/12/2007 | | 4/1/2013 | | | 15,804 | | | | 13,589 | | | | 14,053 | |
Provo, UT | | Residence Inn | | | 6.55 | % | | 6/12/2007 | | 4/1/2013 | | | 5,553 | | | | 4,775 | | | | 4,938 | |
Richmond, VA | | Marriott | | | 6.95 | % | | 1/25/2008 | | 9/1/2014 | | | 25,298 | | | | 22,376 | | | | 23,054 | |
Houston, TX | | Residence Inn | | | 5.71 | % | | 2/28/2011 | | 3/1/2016 | | | 10,500 | | | | 10,170 | | | | 10,363 | |
Hattiesburg, MS | | Courtyard | | | 5.00 | % | | 8/24/2012 | | 9/1/2022 | | | 5,900 | | | | 5,871 | | | | 0 | |
Rancho Bernardo, CA | | Courtyard | | | 5.00 | % | | 8/24/2012 | | 9/1/2022 | | | 15,500 | | | | 15,424 | | | | 0 | |
Kirkland, WA | | Courtyard | | | 5.00 | % | | 8/24/2012 | | 9/1/2022 | | | 12,500 | | | | 12,439 | | | | 0 | |
Seattle, WA | | Residence Inn | | | 4.96 | % | | 8/30/2012 | | 9/1/2022 | | | 29,100 | | | | 28,956 | | | | 0 | |
Total | | | | | | | | | | | | $ | 183,141 | | | $ | 161,825 | | | $ | 108,846 | |
| | | | | | | | | | | | | | | | | | | | | | | |
(1) These rates are the rates per the loan agreement. At acquisition, the Company adjusted the interest rates on the loans assumed to market rates and is amortizing the adjustments to interest expense over the life of the loan. |
In October 2012, the Company extinguished through payment of the outstanding principal two mortgage notes payable. The mortgage loans for the Tallahassee, Florida Fairfield Inn and the Lakeland, Florida Courtyard, originally assumed at acquisition of the hotels, had principal balances at pay-off of approximately $3.0 million and $3.6 million, respectively. Each mortgage loan had an interest rate of 6.80%, a stated maturity date in January 2013, and was extinguished without premium or discount to the balance outstanding.
The aggregate amounts of principal payable under the Company’s debt obligations, for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
2013 | | $ | 30,153 | |
2014 | | | 84,148 | |
2015 | | | 2,036 | |
2016 | | | 23,898 | |
2017 | | | 1,559 | |
Thereafter | | | 55,631 | |
| | | 197,425 | |
Fair Value Adjustment of Assumed Debt | | | 698 | |
Total | | $ | 198,123 | |
A fair value adjustment was recorded upon the assumption of above market rate mortgage loans in connection with several of the Company’s hotel acquisitions. These fair value adjustments will be amortized into interest expense over the remaining term of the related indebtedness using a method approximating the effective interest rate method. The effective interest rates on the applicable debt obligations assumed ranged from 5.40% to 6.24% at the date of assumption. The total adjustment resulted in a reduction to interest expense of $603,000, $597,000, and $597,000 in each of the years 2012, 2011 and 2010. The unamortized balance of the fair value adjustment was $0.7 million at December 31, 2012 and $1.3 million at December 31, 2011.
The Company incurred loan origination costs related to the assumption of the mortgage obligations on purchased hotels, upon the origination of its current corporate unsecured credit facility and on the former corporate line of credit facilities extinguished in 2012 and 2010, and upon the origination of four mortgage loans in 2012 and one mortgage loan in 2011. Such costs are amortized over the period to maturity of the applicable mortgage loan or credit facility, or to termination of the applicable credit agreement, as an addition to interest expense. Amortization of such costs totaled $764,000 in 2012, $799,000 in 2011 and $351,000 in 2010, and is included in interest expense.
The mortgage loan assumed on the Richmond, Virginia Marriott hotel has a stated maturity date of September 1, 2014. As a condition of the mortgage loan, the maturity date of the note payable may be accelerated by the lender should the Company be required to expand the hotel, under terms of the ground lease on the hotel property. The Company is under no such requirement as of December 31, 2012.
Note 4
Fair Value of Financial Instruments
The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit terms and credit characteristics which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. As of December 31, 2012, the carrying value and estimated fair value of the Company’s debt was approximately $198.1 million and $204.1 million. As of December 31, 2011, the carrying value and estimated fair value of the Company’s debt was $174.8 million and $175.6 million. The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.
Note 5
Related Parties
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions in 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price with addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of
this contract totaled approximately $18.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees were incurred during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“A7A”) pursuant to which A7A provides management services to the Company. A7A provides these management services through an affiliate called Apple Fund Management, LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.5 million $1.0 million and $1.0 million for the years ended December 31, 2012, 2011 and 2010. At December 31, 2012, $0.5 million of the 2012 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. The increase in 2012 is due to the Company reaching the middle tier of the fee range under the advisory agreement, due to improved operating results.
In addition to the fees payable to A7A, the Company reimbursed A7A or paid directly to AFM on behalf of A7A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A7A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each Company’s level of business activity and the extent to which each Company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, Apple Nine Advisors, Inc. entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, Apple Nine Advisors, Inc. and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to Apple Nine Advisors, Inc., if it occurs, will have no impact on the Company’s advisory agreement with A7A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
A7A and ASRG are 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. 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.
Included in other assets, net on the Company’s consolidated balance sheet, is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.9 million as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, the services received by the Company are shared as applicable across the Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the legal matters discussed herein for all of the Apple REIT Companies was approximately $7.3 million in 2012, of which $1.6 million was allocated to the Company.
Note 6
Shareholders’ Equity
Best-efforts Offering
The Company concluded its best-efforts offering of Units on July 17, 2007. The Company registered its Units on Registration Statement Form S-11 (File No. 333-125546). The Company began its best-efforts offering (the “Offering”) of Units on March 15, 2006, the same day the Registration Statement was declared effective by the Securities and Exchange Commission. Each Unit consists of one common share and one Series A preferred share.
Series A Preferred Shares
The Series A preferred shares have no voting rights and no conversion rights. In addition, the Series A preferred shares are not separately tradable from the common shares to which they relate. The Series A preferred shares do not have any distribution rights except a priority distribution upon the sale of the Company’s assets. The priority distribution (“Priority Distribution”) is equal to $11.00 per Series A preferred share, and will be paid before any distribution will be made to the holders of any other shares. Upon the Priority Distribution, the Series A preferred shares will have no other distribution rights.
Series B Convertible Preferred Stock
The Company has issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with A7A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $50 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to issuance of 240,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B convertible preferred shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred at December 31, 2012, expense would have ranged from $0 to $63.8 million (assumes $11 per common share fair market value) which represents approximately 5.8 million shares of common stock.
Preferred Shares
The Company’s articles of incorporation authorize issuance of up to 15 million additional preferred shares. No preferred shares other than the Series A preferred shares and the Series B convertible preferred shares (discussed above) have been issued. The Company believes that the authorization to issue additional preferred shares benefits the Company and its shareholders by permitting flexibility in financing additional growth, giving the Company additional financing options in corporate planning and in responding to developments in business, including financing of additional acquisitions and other general corporate purposes. Having authorized preferred shares available for issuance in the future gives the Company the ability to respond to future developments and allows preferred shares to be issued without the expense and delay of a special shareholders’ meeting. At present, the Company has no specific financing or acquisition plans involving the issuance of additional preferred shares and the Company does not propose to fix the characteristics of any series of preferred shares in anticipation of issuing preferred shares other than the Series A preferred shares and Series B convertible preferred shares discussed above. The Company cannot now predict whether or to what extent, if any, additional preferred shares will be used or if so used what the characteristics of a particular series may be. The voting rights and rights to distributions of the holders of common shares will be subject to the prior rights of the holders of any subsequently-issued preferred shares. Unless otherwise required by applicable law or regulation, the preferred shares would be issuable without further authorization by holders of the common shares and on such terms and for such consideration as may be determined by the Board of Directors. The preferred shares could be issued in one or more series having varying voting rights, redemption and conversion features, distribution (including liquidating distribution) rights and preferences, and other rights, including rights of approval of specified transactions. A series of preferred shares could be given rights that are superior to rights of holders of common shares and a series having preferential distribution rights could limit common share distributions and reduce the amount holders of common shares would otherwise receive on dissolution.
Unit Redemption Program
In April 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 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 more than three years. 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. Since inception of the program through December 31, 2012, the Company has redeemed approximately 11.5 million Units representing $124.2 million, including 1.6 million Units in the amount of $17.8 million in
2012, 2.9 million Units in the amount of $32.0 million in 2011 and 3.7 million Units in the amount of $40.7 million in 2010. As contemplated in the program, beginning with the January 2011 redemption, the scheduled redemption date for the first quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 1,137,969 | | | | 728,135 | | | | 409,834 | |
April 2011 | | | 1,303,574 | | | | 728,883 | | | | 574,691 | |
July 2011 | | | 5,644,778 | | | | 732,160 | | | | 4,912,618 | |
October 2011 | | | 11,332,625 | | | | 727,980 | | | | 10,604,645 | |
January 2012 | | | 12,885,635 | | | | 455,093 | | | | 12,430,542 | |
April 2012 | | | 12,560,001 | | | | 441,458 | | | | 12,118,543 | |
July 2012 | | | 12,709,508 | | | | 364,299 | | | | 12,345,209 | |
October 2012 | | | 13,003,443 | | | | 363,755 | | | | 12,639,688 | |
As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.
Dividend Reinvestment Plan
In July 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of 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. The Company has registered 15 million Units for potential issuance under the plan. During the years ended December 31, 2012, 2011 and 2010, approximately 1.5 million Units, representing $16.0 million in proceeds to the Company, 2.0 million Units representing $22.0 million in proceeds to the Company, and 2.2 million Units representing $24.6 million in proceeds to the Company, were issued under the plan. Since inception of the plan through December 31, 2012, approximately 11.3 million Units, representing $124.5 million in proceeds to the Company, were issued under the plan.
Distributions
The Company’s annual distribution rate as of December 31, 2012 was $0.77 per common share, payable monthly. For the years ended December 31, 2012, 2011 and 2010, the Company made distributions of $0.77 per common share each year, for a total of $70.0 million, $70.4 million and $71.3 million, respectively.
Note 7
Stock Option Plans
In 2006 the Board of Directors approved a Non-Employee Directors Stock Option Plan (the “Directors Plan”) whereby directors, who are not employees of the Company or affiliates, automatically receive the option to purchase Units. Under the Directors Plan, the number of Units authorized for issuance is equal to 45,000 plus 1.8% of the number of Units sold in excess of the minimum offering of 4,761,905 Units. This plan currently relates to the initial public offering of 91,125,541 Units. The maximum number of Units authorized under the Directors Plan as of December 31, 2012 is 1,599,545.
Also in 2006, the Board of Directors approved an Incentive Stock Option Plan (the “Incentive Plan”) whereby incentive awards may be granted to certain personnel of the Company or affiliates. Under the Incentive Plan, the number of Units authorized for issuance is equal to 35,000 plus 4.625% of the number of Units sold in the initial offering in excess of 4,761,905. This plan also currently relates to the initial public offering of 91,125,541 Units. The maximum number of Units that can be issued under the Incentive Plan as of December 31, 2012 is 4,029,318.
Both plans generally provide, among other things, that options be granted at exercise prices not lower than the market value of the Units on the date of grant. The options expire 10 years from the date of the grant. During 2012, 2011 and 2010, the Company granted options to purchase 72,672, 73,204 and 74,224 Units, respectively, under the Directors Plan. All of the options issued vested at the date of issuance, and have an exercise price of $11 per Unit. The Company has
granted no options under the Incentive Plan as of December 31, 2012. Activity in the Company’s stock option plans during 2012, 2011 and 2010 is summarized in the following table:
| | Year ended | | | Year ended | | | Year ended | |
| | December 31, 2012 | | | December 31, 2011 | | | December 31, 2010 | |
Outstanding, beginning of year: | | | 367,698 | | | | 294,494 | | | | 220,270 | |
Granted | | | 72,672 | | | | 73,204 | | | | 74,224 | |
Exercised | | | 0 | | | | 0 | | | | 0 | |
Expired or canceled | | | 0 | | | | 0 | | | | 0 | |
Outstanding, end of year: | | | 440,370 | | | | 367,698 | | | | 294,494 | |
Exercisable, end of year: | | | 440,370 | | | | 367,698 | | | | 294,494 | |
The weighted-average exercise price of outstanding options: | | $ | 11.00 | | | $ | 11.00 | | | $ | 11.00 | |
Compensation expense associated with the issuance of stock options was approximately $95,000 in 2012, $111,000 in 2011 and $117,000 in 2010.
Note 8
Management and Franchise Agreements
Each of the Company’s 51 hotels owned at December 31, 2012 are operated and managed, under separate management agreements, by affiliates of one of the following companies (indicates the number of hotels managed): Marriott International, Inc. (“Marriott”) (3), Dimension Development Company (“Dimension”) (12), Hilton Worldwide (“Hilton”) (2), Western International (“Western”) (7), Larry Blumberg & Associates (“LBA”) (19), White Lodging Services Corporation (“White”) (3), or Inn Ventures, Inc. (“Inn Ventures”) (5). The agreements generally provide for initial terms ranging from one to twenty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.2 million, $6.9 million and $6.6 million in management fees.
Dimension, Western, LBA, White, and Inn Ventures are not affiliated with either Marriott or Hilton, and as a result, these hotels (as well as the two hotels managed by Promus Hotels, Inc., which is an affiliate of Hilton) were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for initial terms ranging between 10 to 20 years. Fees associated with the Hilton agreements generally include the payment of royalty fees and program fees based on room revenues. The Marriott franchise agreements provide for an initial term of between six and 20 years. Fees associated with the Marriott agreements include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010 the Company incurred approximately $9.0 million, $8.6 million and $8.2 million in franchise fees.
Note 9
Gain from Settlement of Contingency
The Company recorded other income of $3.1 million in November 2010 arising from the de-recognition of a liability for taxes, previously assessed by the Broad Street Community Development Authority of Richmond, VA (“CDA”). Upon the Company’s purchase in January 2008 of the full service Marriott hotel in Richmond, VA (“MRV”), the Company assumed all remaining obligations of the MRV under a multi-year minimum tax assessment on hotels operating within the CDA’s jurisdiction. The MRV was obligated for minimum annual tax payments to the CDA of $257,000, which related to the 2003 issuance by the CDA of tax-exempt revenue bonds with maturities extending through 2033. Annual tax payments to the CDA were effective through the earlier of a) a period extending through 2033, or b) payment or defeasance in full of all applicable CDA revenue bonds. In November 2010, the CDA provided for the full defeasance or redemption of the applicable CDA revenue bonds. Accordingly, the CDA announced that assessments and collections of the prior tax have ceased as of November 2010. The Company’s net present value of the previously required minimum annual tax assessments, originally projected to extend through 2033, was $3.1 million at the date of the CDA’s bond defeasance and redemption in November 2010.
Note 10
Commitments
The Company leases the underlying land for six hotel properties and one hotel parking lot as of December 31, 2012. These land leases have remaining terms available to the Company ranging from 15 to 93 years, excluding any potential option periods to extend the initial lease term.
The initial term for the land lease for the Residence Inn in Seattle, WA extends through February 2049, with an additional three consecutive 10-year extensions available to the Company (the lessee under the assumed lease). The lease is subject to various payment adjustments during the lease term, including potential periodic increases in lease payments based on the appraised market value of the underlying land at time of adjustment. Based on an assessment of the fair value of the assumed land lease at the date of the hotel acquisition, the Company recorded an initial land lease liability. This liability is being amortized over the life of the lease, and is included in accrued expenses on the Company’s consolidated balance sheet; the amount of the liability at December 31, 2012 and 2011 was approximately $2.0 million and $2.1 million.
The initial term for the land lease for the full-service Marriott hotel in Richmond, VA extends through December 2102. The lease is subject to payment adjustments, based on the Consumer Price Index, at stated intervals during its term. A fair value adjustment was recorded by the Company upon the assumption of the below market rate ground lease. This favorable lease asset will be amortized over the remaining term of the ground lease. The unamortized balance of the land lease’s fair value adjustment was approximately $0.9 million at December 31, 2012 and 2011, and is included in other assets, net on the Company’s consolidated balance sheet. Upon assumption of the MRV land lease, the Company also assumed certain contingent responsibilities of the hotel’s predecessor owner, with respect to the third-party lessor of the land. Dependent on conditions which include the hotel exceeding stated revenue per available room (“RevPAR”) thresholds for a trailing twelve month period (with thresholds adjusting upward by 3% annually), the Company may be obligated to construct an addition to the MRV hotel containing a minimum of 209 rooms. As of December 31, 2012, there is no requirement to commence an expansion of the MRV hotel.
The Company also assumed land leases pertaining to the Columbus, GA Fairfield Inn; Macon, GA Hilton Garden Inn; Columbus, GA TownePlace Suites; Huntsville, AL Homewood Suites; and the Miami, FL Courtyard hotel properties. Based on an assessment of each of these leases, no material land lease liability, or favorable lease asset, was assumed at date of acquisition.
The aggregate amounts of the estimated minimum lease payments pertaining to the Company’s land leases, for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
| | Total | |
2013 | | $ | 1,052 | |
2014 | | | 1,141 | |
2015 | | | 1,159 | |
2016 | | | 1,159 | |
2017 | | | 1,166 | |
Thereafter | | | 91,434 | |
Total | | $ | 97,111 | |
Note 11
Industry Segments
The Company owns hotel properties throughout the United States that generate rental and other property related income. The Company separately evaluates the performance of each of its hotel properties. However, because each of the hotels has similar economic characteristics, facilities, and services, and each hotel is not individually significant, the properties have been aggregated into a single operating segment. All segment disclosures are included in, or can be derived from the Company’s consolidated financial statements.
Note 12
Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc. et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company’s consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Note 13
Quarterly Financial Data (Unaudited)
The following is a summary of quarterly results of operations for the years ended December 31, 2012 and 2011.
2012 (in thousands except per share data) | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | |
Revenues | | $ | 52,499 | | | $ | 56,197 | | | $ | 56,747 | | | $ | 50,502 | |
Net income (loss) | | $ | 5,530 | | | $ | 8,139 | | | $ | 7,299 | | | $ | (2,782 | ) |
Basic and diluted income (loss) per common share | | $ | 0.06 | | | $ | 0.09 | | | $ | 0.08 | | | $ | (.03 | ) |
Distributions declared and paid per common share | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | |
2011 (in thousands except per share data) | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | |
Revenues | | $ | 49,443 | | | $ | 54,912 | | | $ | 55,827 | | | $ | 48,697 | |
Net income | | $ | 5,189 | | | $ | 7,745 | | | $ | 8,437 | | | $ | 3,642 | |
Basic and diluted income per common share | | $ | 0.06 | | | $ | 0.08 | | | $ | 0.09 | | | $ | 0.04 | |
Distributions declared and paid per common share | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.193 | |
Net income for the fourth quarter of 2012 includes a loss on impairment of depreciable assets of $6.6 million, representing a net loss of $(0.07) per basic and diluted income per common share.
Note 14
Subsequent Events
In January 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 111,782 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 386,558 Units in the amount of $4.2 million. As contemplated in the Program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 3% of the total 13.4 million requested Units to be redeemed, with approximately 13.0 million requested Units not redeemed.
In January 2013, the Company entered into two mortgage loan agreements with a commercial real estate lender. The loans are separately secured by the Company’s Huntsville, Alabama Homewood Suites and Prattville, Alabama Courtyard hotels, and will amortize based on a 25 year term with a balloon payment due at maturity in February 2023. Interest is payable monthly on the outstanding balance of each loan at an annual rate of 4.12%. The total proceeds of $15.3 million under the two loan agreements were used to reduce the outstanding balance on the Company’s $40.0 million credit facility, and to pay loan origination and other transaction costs of approximately $0.2 million.
In February 2013, the Company extinguished through pay-off a mortgage note payable jointly secured by the San Diego, California Residence Inn and the Provo, Utah Residence Inn. The note payable had a scheduled maturity in April 2013, and was originally assumed upon acquisition of the two hotels in 2007. The mortgage note payable had a principal balance at pay-off of approximately $18.3 million, an interest rate of 6.55%, and was extinguished without premium or discount to the balance outstanding. Funds for the debt extinguishment were provided by borrowings under the Company’s amended unsecured credit facility. The Company entered into an amendment to its unsecured credit facility, also in February 2013, which increased the maximum aggregate commitment by the lender from $40.0 million to $55.0 million. Under the amendment the increase is effective until the earlier of completing its planned financing of the San Diego, California Residence Inn or April 2013. All other terms of the credit facility remain the same, including the payment of a quarterly fee on the average unused balance of the credit facility at an annual rate of 0.35%.
The Company’s Board of Directors approved a reduction in the Company’s projected distribution rate from an annual rate of $0.77 per common share to $0.66 per common share. The change is effective with the distribution planned for April 2013. The distribution will continue to be paid monthly.
In February 2013, the Company declared and paid approximately $5.8 million or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.2 million or 110,000 Units were reinvested under the Company’s Dividend Reinvestment Plan.
| Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. |
None.
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 were effective as of December 31, 2012. 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.
See Item 8 for the Report of Management on Internal Control over Financial Reporting and the Company’s Independent Registered Public Accounting Firm’s attestation report regarding internal control over financial reporting which are incorporated by reference herein.
None.
PART III
| Directors, Executive Officers and Corporate Governance |
The information required by Items 401, 405, 406 and 407(c)(3), (d)(4) and (d)(5) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 10, the 2013 Proxy Statement is incorporated herein by this reference.
The information required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 11, the 2013 Proxy Statement is incorporated herein by this reference.
| Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters |
The information required by Items 201(d) and 403 of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 12, the 2013 Proxy Statement is incorporated herein by this reference.
| Certain Relationships and Related Transactions, and Director Independence |
The information required by Items 404 and 407(a) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 13, the 2013 Proxy Statement is incorporated herein by this reference.
| Principal Accounting Fees and Services |
The information required by Item 9(e) of Schedule 14A will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 14, the 2013 Proxy Statement is incorporated herein by this reference.
PART IV
| Exhibits, Financial Statement Schedules |
1. Financial Statements of Apple REIT Seven, Inc.
Report of Management on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm on Internal Control over Financial
Reporting – Ernst & Young LLP
Report of Independent Registered Public Accounting Firm – Ernst & Young LLP
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010
Consolidated Statement of Shareholders’ Equity for the years ended December 31, 2012, 2011 and 2010
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010
Notes to Consolidated Financial Statements
These financial statements are set forth in Item 8 of this report and are hereby incorporated by reference.
2. Financial Statement Schedules
Schedule III—Real Estate and Accumulated Depreciation (Included at the end of this Part IV of this report.)
Financial statement schedules not listed are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
3. Exhibits
Incorporated herein by reference are the exhibits listed under “Exhibits Index” to this Report available at www.sec.gov.
SCHEDULE III
Real Estate and Accumulated DepreciationAs of December 31, 2012(dollars in thousands)
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | | Capitalized | | Total | | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | | Bldg | | Gross | | | Acc | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Brand | | Encumbrances | | | Land | | | FF&E /Other | | | Imp. & FF&E | | Cost (1) | | | Deprec | | Construction | | Acquired | | Life | | Rooms | |
Montgomery | | AL | | Homewood Suites | | $ | 0 | | | $ | 972 | | | $ | 10,038 | | | $ | 446 | | | | $ | 11,456 | | | $ | (2,300 | ) | | 2004 | | Aug-06 | | 3 - 39 yrs. | | | 91 | |
Montgomery | | AL | | Hilton Garden Inn | | | 0 | | | | 761 | | | | 9,964 | | | | 1,618 | | | | | 12,343 | | | | (2,337 | ) | | 2003 | | Aug-06 | | 3 - 39 yrs. | | | 97 | |
Troy | | AL | | Hampton Inn | | | 0 | | | | 497 | | | | 5,872 | | | | 335 | | | | | 6,704 | | | | (1,399 | ) | | 2003 | | Aug-06 | | 3 - 39 yrs. | | | 82 | |
Auburn | | AL | | Hilton Garden Inn | | | 0 | | | | 639 | | | | 9,883 | | | | 1,521 | | | | | 12,043 | | | | (2,848 | ) | | 2001 | | Aug-06 | | 3 - 39 yrs. | | | 101 | |
Huntsville | | AL | | Hilton Garden Inn | | | 0 | | | | 736 | | | | 9,891 | | | | 240 | | | | | 10,867 | | | | (2,251 | ) | | 2005 | | Aug-06 | | 3 - 39 yrs. | | | 101 | |
Huntsville | | AL | | Homewood Suites | | | 0 | | | | 1,086 | | | | 10,895 | | | | 228 | | | | | 12,209 | | | | (2,457 | ) | | 2006 | | Oct-06 | | 3 - 39 yrs. | | | 107 | |
Prattville | | AL | | Courtyard | | | 0 | | | | 1,163 | | | | 8,414 | | | | 92 | | | | | 9,669 | | | | (1,730 | ) | | 2007 | | Apr-07 | | 3 - 39 yrs. | | | 84 | |
Dothan | | AL | | Fairfield Inn | | | 0 | | | | 564 | | | | 4,249 | | | | (1,504 | ) | (2) | | | 3,309 | | | | (808 | ) | | 1993 | | May-07 | | 3 - 39 yrs. | | | 63 | |
Trussville | | AL | | Courtyard | | | 0 | | | | 1,082 | | | | 8,750 | | | | 81 | | | | | 9,913 | | | | (1,615 | ) | | 2007 | | Oct-07 | | 3 - 39 yrs. | | | 84 | |
Huntsville | | AL | | TownePlace Suites | | | 0 | | | | 800 | | | | 8,388 | | | | 31 | | | | | 9,219 | | | | (1,499 | ) | | 2007 | | Dec-07 | | 3 - 39 yrs. | | | 86 | |
Dothan | | AL | | Residence Inn | | | 0 | | | | 816 | | | | 9,102 | | | | 22 | | | | | 9,940 | | | | (1,680 | ) | | 2008 | | Apr-08 | | 3 - 39 yrs. | | | 84 | |
Tucson | | AZ | | Residence Inn | | | 0 | | | | 995 | | | | 15,963 | | | | 76 | | | | | 17,034 | | | | (2,759 | ) | | 2008 | | Jan-08 | | 3 - 39 yrs. | | | 124 | |
San Diego | | CA | | Hilton Garden Inn | | | 0 | | | | 5,009 | | | | 30,357 | | | | 2,407 | | | | | 37,773 | | | | (6,982 | ) | | 2004 | | May-06 | | 3 - 39 yrs. | | | 200 | |
Rancho Bernardo | | CA | | Courtyard | | | 15,424 | | | | 4,658 | | | | 32,282 | | | | 804 | | | | | 37,744 | | | | (6,199 | ) | | 1987 | | Dec-06 | | 3 - 39 yrs. | | | 210 | |
Agoura Hills | | CA | | Homewood Suites | | | 0 | | | | 4,501 | | | | 21,444 | | | | 123 | | | | | 26,068 | | | | (3,836 | ) | | 2007 | | May-07 | | 3 - 39 yrs. | | | 125 | |
San Diego | | CA | | Residence Inn | | | 13,589 | | | | 7,334 | | | | 26,235 | | | | 2,461 | | | | | 36,030 | | | | (4,767 | ) | | 1999 | | Jun-07 | | 3 - 39 yrs. | | | 121 | |
San Diego | | CA | | Hampton Inn | | | 0 | | | | 5,683 | | | | 37,949 | | | | 2,810 | | | | | 46,442 | | | | (7,047 | ) | | 2001 | | Jul-07 | | 3 - 39 yrs. | | | 177 | |
Highlands Ranch | | CO | | Residence Inn | | | 10,710 | | | | 2,339 | | | | 17,339 | | | | 865 | | | | | 20,543 | | | | (3,166 | ) | | 1996 | | Feb-07 | | 3 - 39 yrs. | | | 117 | |
Highlands Ranch | | CO | | Hilton Garden Inn | | | 0 | | | | 2,510 | | | | 18,553 | | | | 207 | | | | | 21,270 | | | | (3,570 | ) | | 2007 | | Mar-07 | | 3 - 39 yrs. | | | 128 | |
Sarasota | | FL | | Homewood Suites | | | 0 | | | | 1,778 | | | | 12,284 | | | | 772 | | | | | 14,834 | | | | (2,925 | ) | | 2005 | | Sep-06 | | 3 - 39 yrs. | | | 100 | |
Miami | | FL | | Homewood Suites | | | 8,405 | | | | 3,206 | | | | 22,161 | | | | 2,205 | | | | | 27,572 | | | | (4,987 | ) | | 2000 | | Feb-07 | | 3 - 39 yrs. | | | 159 | |
Tallahassee | | FL | | Fairfield Inn | | | 0 | | | | 904 | | | | 6,208 | | | | (1,764 | ) | (2) | | | 5,348 | | | | (1,148 | ) | | 2000 | | Apr-07 | | 3 - 39 yrs. | | | 79 | |
Lakeland | | FL | | Courtyard | | | 0 | | | | 1,549 | | | | 8,844 | | | | 743 | | | | | 11,136 | | | | (1,667 | ) | | 2000 | | Apr-07 | | 3 - 39 yrs. | | | 78 | |
Miami | | FL | | Courtyard | | | 0 | | | | 0 | | | | 15,463 | | | | 185 | | | | | 15,648 | | | | (2,487 | ) | | 2008 | | Sep-08 | | 3 - 39 yrs. | | | 118 | |
Columbus | | GA | | Fairfield Inn | | | 0 | | | | 0 | | | | 7,620 | | | | (2,652 | ) | (2) | | | 4,968 | | | | (1,367 | ) | | 2003 | | Apr-07 | | 3 - 39 yrs. | | | 79 | |
Macon | | GA | | Hilton Garden Inn | | | 0 | | | | 0 | | | | 10,115 | | | | 98 | | | | | 10,213 | | | | (2,032 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | | 101 | |
Columbus | | GA | | SpringHill Suites | | | 0 | | | | 1,188 | | | | 8,758 | | | | 25 | | | | | 9,971 | | | | (1,553 | ) | | 2008 | | Mar-08 | | 3 - 39 yrs. | | | 85 | |
Columbus | | GA | | TownePlace Suites | | | 0 | | | | 0 | | | | 8,643 | | | | 28 | | | | | 8,671 | | | | (1,586 | ) | | 2008 | | May-08 | | 3 - 39 yrs. | | | 86 | |
Boise | | ID | | SpringHill Suites | | | 0 | | | | 2,015 | | | | 19,589 | | | | 519 | | | | | 22,123 | | | | (4,032 | ) | | 1992 | | Sep-07 | | 3 - 39 yrs. | | | 230 | |
New Orleans | | LA | | Homewood Suites | | | 14,872 | | | | 4,579 | | | | 39,507 | | | | 1,598 | | | | | 45,684 | | | | (7,548 | ) | | 2002 | | Dec-06 | | 3 - 39 yrs. | | | 166 | |
Hattiesburg | | MS | | Courtyard | | | 5,871 | | | | 873 | | | | 8,918 | | | | 127 | | | | | 9,918 | | | | (1,932 | ) | | 2006 | | Oct-06 | | 3 - 39 yrs. | | | 84 | |
Tupelo | | MS | | Hampton Inn | | | 3,316 | | | | 332 | | | | 4,932 | | | | 1,298 | | | | | 6,562 | | | | (1,615 | ) | | 1994 | | Jan-07 | | 3 - 39 yrs. | | | 96 | |
Omaha | | NE | | Courtyard | | | 10,922 | | | | 2,731 | | | | 19,498 | | | | 3,902 | | | | | 26,131 | | | | (5,080 | ) | | 1999 | | Nov-06 | | 3 - 39 yrs. | | | 181 | |
Cranford | | NJ | | Homewood Suites | | | 0 | | | | 2,607 | | | | 11,375 | | | | 2,093 | | | | | 16,075 | | | | (3,108 | ) | | 2000 | | Mar-07 | | 3 - 39 yrs. | | | 108 | |
Mahwah | | NJ | | Homewood Suites | | | 0 | | | | 3,665 | | | | 16,481 | | | | 2,231 | | | | | 22,377 | | | | (3,940 | ) | | 2001 | | Mar-07 | | 3 - 39 yrs. | | | 110 | |
Ronkonkoma | | NY | | Hilton Garden Inn | | | 0 | | | | 3,153 | | | | 24,428 | | | | 2,344 | | | | | 29,925 | | | | (4,943 | ) | | 2003 | | Dec-06 | | 3 - 39 yrs. | | | 164 | |
Cincinnati | | OH | | Homewood Suites | | | 0 | | | | 551 | | | | 6,822 | | | | 293 | | | | | 7,666 | | | | (1,608 | ) | | 2005 | | Dec-06 | | 3 - 39 yrs. | | | 76 | |
Memphis | | TN | | Homewood Suites | | | 0 | | | | 1,712 | | | | 9,757 | | | | 2,349 | | | | | 13,818 | | | | (2,968 | ) | | 1989 | | May-07 | | 3 - 39 yrs. | | | 140 | |
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | | Capitalized | | Total | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | | Bldg | | Gross | | | Acc | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Brand | | Encumbrances | | | Land | | | FF&E /Other | | | Imp. & FF&E | | Cost (1) | | | Deprec | | Construction | | Acquired | | Life | | Rooms | |
Houston | | TX | | Residence Inn | | | 10,170 | | | | 1,093 | | | | 13,054 | | | | 296 | | | | | 14,443 | | | | (3,161 | ) | | 2006 | | Apr-06 | | 3 - 39 yrs. | | | 129 | |
Brownsville | | TX | | Courtyard | | | 0 | | | | 1,131 | | | | 7,743 | | | | 112 | | | | | 8,986 | | | | (1,711 | ) | | 2006 | | Jun-06 | | 3 - 39 yrs. | | | 90 | |
Stafford | | TX | | Homewood Suites | | | 0 | | | | 498 | | | | 7,578 | | | | 216 | | | | | 8,292 | | | | (1,791 | ) | | 2006 | | Aug-06 | | 3 - 39 yrs. | | | 78 | |
San Antonio | | TX | | TownePlace Suites | | | 0 | | | | 700 | | | | 11,525 | | | | 32 | | | | | 12,257 | | | | (2,159 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | | 106 | |
Addison | | TX | | SpringHill Suites | | | 0 | | | | 1,545 | | | | 11,312 | | | | 1,654 | | | | | 14,511 | | | | (2,509 | ) | | 2003 | | Aug-07 | | 3 - 39 yrs. | | | 159 | |
San Antonio | | TX | | TownePlace Suites | | | 0 | | | | 1,126 | | | | 13,093 | | | | 10 | | | | | 14,229 | | | | (2,384 | ) | | 2007 | | Sep-07 | | 3 - 39 yrs. | | | 123 | |
El Paso | | TX | | Homewood Suites | | | 0 | | | | 1,169 | | | | 14,656 | | | | 67 | | | | | 15,892 | | | | (2,541 | ) | | 2008 | | Apr-08 | | 3 - 39 yrs. | | | 114 | |
Provo | | UT | | Residence Inn | | | 4,775 | | | | 1,352 | | | | 10,394 | | | | 2,967 | | | | | 14,713 | | | | (3,250 | ) | | 1996 | | Jun-07 | | 3 - 39 yrs. | | | 114 | |
Alexandria | | VA | | Courtyard | | | 0 | | | | 4,010 | | | | 32,832 | | | | 4,427 | | | | | 41,269 | | | | (6,860 | ) | | 1987 | | Jul-07 | | 3 - 39 yrs. | | | 178 | |
Richmond | | VA | | Marriott | | | 22,376 | | | | 0 | | | | 59,614 | | | | 15,915 | | | | | 75,529 | | | | (18,093 | ) | | 1984 | | Jan-08 | | 3 - 39 yrs. | | | 410 | |
Seattle | | WA | | Residence Inn | | | 28,956 | | | | 0 | | | | 60,489 | | | | 6,883 | | | | | 67,372 | | | | (14,869 | ) | | 1991 | | Sep-06 | | 3 - 39 yrs. | | | 234 | |
Vancouver | | WA | | SpringHill Suites | | | 0 | | | | 1,310 | | | | 15,126 | | | | 46 | | | | | 16,482 | | | | (3,064 | ) | | 2007 | | Jun-07 | | 3 - 39 yrs. | | | 119 | |
Kirkland | | WA | | Courtyard | | | 12,439 | | | | 3,507 | | | | 28,507 | | | | 235 | | | | | 32,249 | | | | (4,646 | ) | | 2006 | | Oct-07 | | 3 - 39 yrs. | | | 150 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | $ | 161,825 | | | $ | 90,429 | | | $ | 842,894 | | | $ | 62,117 | | | | $ | 995,440 | | | $ | (182,814 | ) | | | | | | | | | 6,426 | |
(1) The cost basis for Federal Income Tax purposes approximates the basis used in this schedule, except for an impairment loss of approximately $6.6 million included in this schedule. |
(2) Amount includes a reduction in cost due to impairment loss. |
SCHEDULE III
Real Estate and Accumulated Depreciation (continued)
As of December 31, 2012
(dollars in thousands)
| | 2012 | | | 2011 | | | 2010 | |
Real estate owned: | | | | | | | | | |
Balance as of January 1 | | $ | 994,634 | | | $ | 986,266 | | | $ | 983,216 | |
Improvements | | | 7,446 | | | | 8,368 | | | | 3,050 | |
Impairment of depreciable assets | | | (6,640 | ) | | | 0 | | | | 0 | |
Balance at December 31 | | $ | 995,440 | | | $ | 994,634 | | | $ | 986,266 | |
| | 2012 | | | 2011 | | | 2010 | |
Accumulated depreciation: | | | | | | | |
Balance as of January 1 | | $ | (148,257 | ) | | $ | (114,097 | ) | | $ | (80,923 | ) |
Depreciation expense | | | (34,557 | ) | | | (34,160 | ) | | | (33,174 | ) |
Disposals | | | 0 | | | | 0 | | | | 0 | |
Balance at December 31 | | $ | (182,814 | ) | | $ | (148,257 | ) | | $ | (114,097 | ) |
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: | | | Date: March 6, 2013 |
| Glade M. Knight, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | | |
| | | |
By: | | | Date: March 6, 2013 |
| Bryan Peery, | | |
| Chief Financial Officer (Principal Financial and Principal Accounting Officer) | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.
By: | /s/ GLADE M. KNIGHT | | Date: March 6, 2013 |
| Glade M. Knight, Director | | |
| | | |
| | | |
By: | /s/ GLENN W. BUNTING | | Date: March 6, 2013 |
| Glenn W. Bunting, Director | | |
| | | |
| | | |
By: | /s/ KENT W. COLTON | | Date: March 6, 2013 |
| Kent W. Colton, Director | | |
| | | |
| | | |
By: | /s/ BRUCE H. MATSON | | Date: March 6, 2013 |
| Bruce H. Matson, Director | | |
EXHIBIT INDEX
Exhibit Number | | Description of Documents |
| | |
3.1 | | Amended and Restated Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.3 to the 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) |
| | |
10.1 | | Advisory Agreement between the Registrant and Apple Seven Advisors, Inc. (Incorporated by reference to Exhibit 10.1 to the registrant’s quarterly report on Form 10-Q (SEC File No. 333-125546) filed April 28, 2006) |
| | |
10.2 | | Property Acquisition/Disposition Agreement between the Registrant and Apple Suites Realty Group, Inc. (Incorporated by reference to Exhibit 10.2 to the registrant’s quarterly report on Form 10-Q (SEC File No. 333-125546) filed April 28, 2006) |
| | |
10.3 | | Apple REIT Seven, Inc. 2005 Incentive Plan. (Incorporated by reference to Exhibit 10.3 to the registrant’s quarterly report on Form 10-Q (SEC File No. 333-125546) filed April 28, 2006) * |
| | |
10.4 | | Apple REIT Seven, Inc. 2005 Non-Employee Directors Stock Option Plan. (Incorporated by reference to Exhibit 10.4 to the registrant’s quarterly report on Form 10-Q (SEC File No. 333-125546) filed April 28, 2006) * |
| | |
10.8 | | Management Agreement dated as of April 26, 2006 between Texas Western Management Partners, L.P. and Apple Seven Services, L.P. (Incorporated by reference to Exhibit 10.8 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.9 | | Residence Inn by Marriott Relicensing Agreement dated as of April 26, 2006 between Marriott International, Inc. and Apple Seven Services, L.P. (Incorporated by reference to Exhibit 10.9 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.10 | | Hotel Lease Agreement effective as of April 26, 2006 between Apple Seven Hospitality Texas, L.P. and Apple Seven Services, L.P. (Incorporated by reference to Exhibit 10.10 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.16 | | Management Agreement dated as of May 9, 2006 between Inn Ventures, Inc. and Apple Seven Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.16 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.17 | | Franchise License Agreement dated as of May 9, 2006 between Hilton Hotels Corporation and Apple Seven Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.17 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.18 | | Schedule of information for an additional and substantially identical Hotel Lease Agreement dated as of May 9, 2006 (substantially identical to Exhibit 10.10 listed above) (Incorporated by reference to Exhibit 10.18 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.21 | | Management Agreement dated as of June 6, 2006 between Texas Western Management Partners, L.P. and Apple Seven Services, L.P. (Incorporated by reference to Exhibit 10.21 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.22 | | Schedule of information for an additional and substantially identical Hotel Lease Agreement effective as of June 6, 2006 (substantially identical to Exhibit 10.10 listed above) (Incorporated by reference to Exhibit 10.22 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
| | |
10.23 | | Courtyard by Marriott Relicensing Agreement dated as of June 19, 2006 between Marriott International, Inc. and Apple Seven Services, L.P. (Incorporated by reference to Exhibit 10.23 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-125546) filed July 26, 2006) |
Exhibit Number | | Description of Documents |
| | |
21.1 | | Subsidiaries of the Registrant (FILED HEREWITH). |
| | |
23.1 | | Consent of Ernst & Young LLP (FILED HEREWITH). |
| | |
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). |
| | |
101 | | The following materials from Apple REIT Seven, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) related notes to these financial statements, tagged as blocks of text and in detail (FURNISHED HEREWITH) |
* | Denotes Compensation Plan. |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the quarterly period ended September 30, 2013 |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ |
Commission File Number 000-52585
Apple REIT Seven, Inc.
(Exact name of registrant as specified in its charter)
Virginia | 20-2879175 |
(State or other jurisdiction | (IRS Employer |
of incorporation or organization) | Identification No.) |
| |
814 East Main Street | |
Richmond, Virginia | 23219 |
(Address of principal executive offices) | (Zip Code) |
(804) 344-8121
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | | Accelerated filer ¨ | | Non-accelerated filer x | | Smaller reporting company ¨ |
| | | | (Do not check if a smaller reporting company) | | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of registrant’s common shares outstanding as of November 1, 2013: 90,613,633
APPLE REIT SEVEN, INC.
FORM 10-Q
| Page Number |
PART I. FINANCIAL INFORMATION | |
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| Item 1. | | |
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| | | 6 |
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| Item 2. | | 14 |
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| Item 3. | | 25 |
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| Item 4. | | 25 |
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PART II. OTHER INFORMATION | |
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| Item 1. | | 26 |
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| Item 1A. | | 26 |
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| Item 6. | | 28 |
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| 29 |
This Form 10-Q includes references to certain trademarks or service marks. The SpringHill Suites® by Marriott, TownePlace Suites® by Marriott, Fairfield Inn® by Marriott, Courtyard® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Homewood Suites® by Hilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites® trademarks are the property of Hilton Worldwide or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLE REIT SEVEN, INC. CONSOLIDATED BALANCE SHEETS(in thousands, except share data)
| | September 30, | | | December 31, | |
| | 2013 | | | 2012 | |
| | (unaudited) | | | | |
Assets | | | | | | |
Investment in real estate, net of accumulated depreciation of $205,180 and $179,491, respectively | | $ | 784,535 | | | $ | 802,326 | |
Hotels held for sale | | | 9,600 | | | | 10,300 | |
Restricted cash-furniture, fixtures and other escrows | | | 12,020 | | | | 11,354 | |
Due from third party managers, net | | | 9,324 | | | | 6,798 | |
Other assets, net | | | 5,155 | | | | 4,725 | |
Total Assets | | $ | 820,634 | | | $ | 835,503 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Credit facility | | $ | 24,500 | | | $ | 35,600 | |
Mortgage debt | | | 183,560 | | | | 162,523 | |
Accounts payable and accrued expenses | | | 15,032 | | | | 12,917 | |
Total Liabilities | | | 223,092 | | | | 211,040 | |
| | | | | | | | |
Shareholders' Equity | | | | | | | | |
Preferred stock, authorized 15,000,000 shares; none issued and outstanding | | | 0 | | | | 0 | |
Series A preferred stock, no par value, authorized 200,000,000 shares; issued and outstanding 90,613,633 and 90,941,959 shares, respectively | | | 0 | | | | 0 | |
Series B convertible preferred stock, no par value, authorized 240,000 shares; issued and outstanding 240,000 shares | | | 24 | | | | 24 | |
Common stock, no par value, authorized 200,000,000 shares; issued and outstanding 90,613,633 and 90,941,959 shares, respectively | | | 895,318 | | | | 898,821 | |
Distributions greater than net income | | | (297,800 | ) | | | (274,382 | ) |
Total Shareholders' Equity | | | 597,542 | | | | 624,463 | |
| | | | | | | | |
Total Liabilities and Shareholders' Equity | | $ | 820,634 | | | $ | 835,503 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC. CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)(in thousands, except per share data)
| | Three Months Ended | | | Nine Months Ended | |
| | September 30, | | | September 30, | |
| | 2013 | | | 2012 | | | 2013 | | | 2012 | |
| | | | | | | | | | | | |
Revenues: | | | | | | | | | | | | |
Room revenue | | $ | 53,715 | | | $ | 51,166 | | | $ | 153,725 | | | $ | 147,516 | |
Other revenue | | | 5,458 | | | | 4,658 | | | | 16,117 | | | | 14,880 | |
Total revenue | | | 59,173 | | | | 55,824 | | | | 169,842 | | | | 162,396 | |
| | | | | | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | | | | | |
Operating expense | | | 15,250 | | | | 14,834 | | | | 44,745 | | | | 42,878 | |
Hotel administrative expense | | | 4,138 | | | | 4,028 | | | | 12,096 | | | | 11,797 | |
Sales and marketing | | | 4,460 | | | | 4,274 | | | | 13,004 | | | | 12,604 | |
Utilities | | | 2,588 | | | | 2,521 | | | | 6,797 | | | | 6,576 | |
Repair and maintenance | | | 2,569 | | | | 2,493 | | | | 7,423 | | | | 7,098 | |
Franchise fees | | | 2,517 | | | | 2,345 | | | | 7,130 | | | | 6,761 | |
Management fees | | | 1,949 | | | | 1,856 | | | | 5,743 | | | | 5,512 | |
Property taxes, insurance and other | | | 3,178 | | | | 3,179 | | | | 9,303 | | | | 9,317 | |
General and administrative | | | 1,366 | | | | 1,684 | | | | 4,245 | | | | 4,815 | |
Merger transaction costs | | | 1,527 | | | | 0 | | | | 1,714 | | | | 722 | |
Depreciation expense | | | 8,512 | | | | 8,496 | | | | 25,689 | | | | 25,374 | |
Total expenses | | | 48,054 | | | | 45,710 | | | | 137,889 | | | | 133,454 | |
| | | | | | | | | | | | | | | | |
Operating income | | | 11,119 | | | | 10,114 | | | | 31,953 | | | | 28,942 | |
| | | | | | | | | | | | | | | | |
Interest expense, net | | | (2,680 | ) | | | (2,713 | ) | | | (7,892 | ) | | | (7,923 | ) |
| | | | | | | | | | | | | | | | |
Income before income taxes | | | 8,439 | | | | 7,401 | | | | 24,061 | | | | 21,019 | |
| | | | | | | | | | | | | | | | |
Income tax expense | | | (80 | ) | | | (75 | ) | | | (260 | ) | | | (263 | ) |
| | | | | | | | | | | | | | | | |
Income from continuing operations | | | 8,359 | | | | 7,326 | | | | 23,801 | | | | 20,756 | |
| | | | | | | | | | | | | | | | |
Income (loss) from discontinued operations | | | (442 | ) | | | (27 | ) | | | 162 | | | | 212 | |
| | | | | | | | | | | | | | | | |
Net income | | $ | 7,917 | | | $ | 7,299 | | | $ | 23,963 | | | $ | 20,968 | |
| | | | | | | | | | | | | | | | |
Basic and diluted net income per common share | | | | | | | | | | | | | | | | |
From continuing operations | | $ | 0.09 | | | $ | 0.08 | | | $ | 0.26 | | | $ | 0.23 | |
From discontinued operations | | | 0.00 | | | | 0.00 | | | | 0.00 | | | | 0.00 | |
Total basic and diluted net income per common share | | $ | 0.09 | | | $ | 0.08 | | | $ | 0.26 | | | $ | 0.23 | |
| | | | | | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 90,614 | | | | 90,866 | | | | 90,676 | | | | 90,903 | |
See notes to consolidated financial statements.
APPLE REIT SEVEN, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)(in thousands)
| | Nine Months Ended | |
| | September 30, | |
| | 2013 | | | 2012 | |
Cash flows from operating activities: | | | | | | |
Net income | | $ | 23,963 | | | $ | 20,968 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | |
Depreciation, including discontinued operations | | | 25,689 | | | | 25,848 | |
Loss on hotels held for sale | | | 700 | | | | 0 | |
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net | | | 107 | | | | 297 | |
Changes in operating assets and liabilities: | | | | | | | | |
Increase in due from third party managers, net | | | (2,526 | ) | | | (2,698 | ) |
Increase in other assets | | | (665 | ) | | | (650 | ) |
Increase in accounts payable and accrued expenses | | | 1,748 | | | | 1,927 | |
Net cash provided by operating activities | | | 49,016 | | | | 45,692 | |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Capital improvements | | | (7,532 | ) | | | (6,255 | ) |
Increase in capital improvement reserves | | | (262 | ) | | | (3,270 | ) |
Net cash used in investing activities | | | (7,794 | ) | | | (9,525 | ) |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Net proceeds related to issuance of Units | | | 6,559 | | | | 12,180 | |
Redemptions of Units | | | (10,162 | ) | | | (13,835 | ) |
Distributions paid to common shareholders | | | (47,382 | ) | | | (52,484 | ) |
Payments on extinguished credit facility | | | 0 | | | | (64,700 | ) |
Proceeds from (payments on) existing credit facility | | | (11,100 | ) | | | 22,600 | |
Proceeds from mortgage debt | | | 51,250 | | | | 63,000 | |
Payments on mortgage debt | | | (29,863 | ) | | | (2,300 | ) |
Deferred financing costs | | | (524 | ) | | | (628 | ) |
Net cash used in financing activities | | | (41,222 | ) | | | (36,167 | ) |
| | | | | | | | |
Net change in cash and cash equivalents | | | 0 | | | | 0 | |
| | | | | | | | |
Cash and cash equivalents, beginning of period | | | 0 | | | | 0 | |
| | | | | | | | |
Cash and cash equivalents, end of period | | $ | 0 | | | $ | 0 | |
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Summary of Significant Accounting Policies
Organization
Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”), is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company was formed to invest in income-producing real estate in the United States. Initial capitalization occurred on May 26, 2005 and operations began on April 27, 2006 when the Company acquired its first hotel. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007. The Company’s fiscal year end is December 31. The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. As of September 30, 2013, the Company owned 51 hotels located in 18 states with an aggregate of 6,426 rooms.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not include all of the information required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its 2012 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2013.
Use of Estimates
The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain amounts in the 2012 consolidated financial statements have been reclassified to conform with the 2013 presentation with no effect on previously reported net income or shareholders’ equity.
Earnings per Common Share
Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the period. Diluted earnings per common share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period. There were no potential common shares with a dilutive effect for the three and nine months ended September 30, 2013 or 2012. As a result, basic and diluted outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares.
2. Merger Agreement
On August 7, 2013, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”), Apple Seven Acquisition Sub, Inc. (“Seven Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, and Apple Eight Acquisition Sub, Inc. (“Eight Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, entered into an Agreement and Plan of Merger, as amended (the “Merger Agreement”). The Merger Agreement provides for the merger of Apple Seven and Apple Eight with and into Seven Acquisition Sub and Eight Acquisition Sub, respectively, which were formed solely for engaging in the mergers and have not conducted any prior activities. Upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight will cease and Seven Acquisition Sub and Eight Acquisition Sub will be the surviving corporations. Pursuant to the terms of the Merger Agreement, upon completion of the mergers the current Apple Nine common shares totaling 182,784,131 will remain outstanding, and:
· | Each issued and outstanding unit of Apple Seven (consisting of one Apple Seven common share together with one Apple Seven Series A preferred share) will be converted into one (the “Apple Seven exchange ratio”) common share of Apple Nine, or a total of approximately 90,613,633 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Seven will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Seven exchange ratio, or a total of 5,801,050 common shares; and |
· | Each issued and outstanding unit of Apple Eight (consisting of one Apple Eight common share together with one Apple Eight Series A preferred share) will be converted into 0.85 (the “Apple Eight exchange ratio”) common share of Apple Nine, or a total of approximately 78,319,004 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Eight will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Eight exchange ratio, or a total of 4,930,892 common shares. |
If the mergers are approved by the shareholders of each of Apple Seven, Apple Eight and Apple Nine and all of the other conditions to the mergers are completed, Apple Seven will record an expense related to the conversion of Apple Seven’s Series B convertible preferred shares into common shares of Apple Nine. Although the final estimate of fair value may vary significantly from these estimates, Apple Nine’s preliminary estimate of the fair value of $9.00 to $11.00 per Apple Nine common share would result in an expense to Apple Seven ranging from approximately $52 million to $64 million.
The Merger Agreement contains various closing conditions, including shareholder approval by Apple Seven, Apple Eight and Apple Nine. As a result, there is no assurance that the mergers will occur. Under the Merger Agreement, Apple Seven, Apple Eight and Apple Nine may terminate the Merger Agreement under certain circumstances; however, each of the companies may be required to pay a fee of $1.7 million, plus reasonable third party expenses, to each of the other companies upon such termination. All costs related to the proposed mergers are being expensed in the period they are incurred and are included in the merger transaction costs in the Company’s consolidated statements of operations. In connection with these activities, the Company incurred approximately $1.7 million in expenses for the nine months ended September 30, 2013.
3. Credit Facility and Mortgage Debt
Credit Facility
In August 2012, the Company entered into a new $40 million unsecured credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. The outstanding principal is required to be paid by the maturity date of August 30, 2014. Interest payments are due monthly and the interest rate is equal to the applicable LIBOR (London Interbank Offered Rate for a one-month term) plus 3.25%. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part at any time. The Company is also required to pay a quarterly fee at an annual rate of 0.35% on the average unused balance of the credit facility. In January 2013, the Company entered into an amendment to its credit facility to temporarily increase the maximum aggregate commitment from $40 million to $55 million, which, on April 1, 2013, was reduced back to $40 million. As noted below, the additional borrowings were used to pay off and extinguish a mortgage note in February 2013 and were subsequently repaid with proceeds from the secured mortgage loan entered into in March 2013. The balance outstanding under the credit facility on September 30, 2013 and December 31, 2012 was $24.5 million and $35.6 million, at an annual interest rate of approximately 3.43% and 3.46%, respectively. The credit facility contains customary affirmative covenants and negative covenants and events of defaults. It also contains quarterly financial covenants, which include, among others, a minimum tangible net worth, maximum debt limits, maximum distributions and redemptions and minimum debt service and fixed charge coverage ratios. The Company was in compliance with each of these covenants at September 30, 2013.
Mortgage Debt
During the nine months ended September 30, 2013, the Company entered into four mortgage loan agreements with commercial lenders, secured by four hotel properties for a total of $51.3 million. Combined scheduled payments of interest and principal totaling approximately $271,000 are due monthly and each loan will amortize on a 25 year term with a balloon payment due at maturity. At closing, the Company used proceeds from each loan to reduce the outstanding balance on its credit facility, extinguish through pay-off a mortgage note payable, as described below, and to pay transaction costs. Loan origination costs totaling approximately $0.5 million are being amortized as interest expense through the maturity date for each loan. The following table summarizes the hotel property securing each loan, the interest rate, loan origination date, maturity date and principal amount originated under each loan agreement. All dollar amounts are in thousands:
Hotel Location | | Brand | | Interest Rate | | Loan Origination Date | | Maturity Date | | Principal Originated | |
Huntsville, AL | | Homewood Suites | | | 4.12 | % | 1/15/2013 | | 2/6/2023 | | $ | 8,500 | |
Prattville, AL | | Courtyard | | | 4.12 | % | 1/15/2013 | | 2/6/2023 | | | 6,750 | |
San Diego, CA | | Residence Inn | | | 3.97 | % | 3/4/2013 | | 3/6/2023 | | | 19,000 | |
Miami, FL | | Homewood Suites | | | 4.02 | % | 4/1/2013 | | 4/1/2023 | | | 17,000 | |
Total | | | | | | | | | | | $ | 51,250 | |
In February 2013, the Company extinguished through pay-off a mortgage loan jointly secured by the San Diego, California Residence Inn and the Provo, Utah Residence Inn. The mortgage loan had a scheduled maturity in April 2013 and was originally assumed upon acquisition of the two hotels in 2007. The mortgage loan had a principal balance at pay-off of approximately $18.3 million, an interest rate of 6.55%, and was extinguished without premium or discount to the balance outstanding. Funds for the debt extinguishment were provided by borrowings under the Company’s amended unsecured credit facility.
In April, 2013, the Company extinguished through pay-off the prior mortgage loan secured by the Miami, Florida Homewood Suites. Funds for the debt extinguishment were provided by the origination of the new mortgage loan secured by the Miami, Florida Homewood Suites. The mortgage loan had a scheduled maturity in July 2013, and was originally assumed upon acquisition of the hotel in 2007. The mortgage loan had a principal balance at pay-off of approximately $8.3 million, an interest rate of 6.5%, and was extinguished without premium or discount to the balance outstanding.
4. Fair Value of Financial Instruments
The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit terms and credit characteristics which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. As of September 30, 2013, the carrying value and estimated fair value of the Company’s debt was approximately $208.1 million and $208.7 million. As of December 31, 2012, the carrying value and estimated fair value of the Company’s debt was approximately $198.1 million and $204.1 million. The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.
5. Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the nine months ended September 30, 2013 (other than the transactions related to the completion of Apple REIT Six, Inc.’s merger with a third party and the Merger Agreement and related transactions discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The term the “Apple REIT Entities” means Apple REIT Six, Inc. (“Apple Six”), Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc.(“Apple Nine”) and Apple REIT Ten, Inc. (“Apple Ten”). The term the “Advisors” means Apple Six Advisors, Inc., Apple Seven Advisors, Inc. (“A7A”), Apple Eight Advisors, Inc., Apple Nine Advisors, Inc. (“A9A”), Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. (“ASRG”) and Apple Six Realty Group, Inc. The Advisors are wholly owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple Eight, Apple Nine and Apple Ten. Members of the Company’s Board of Directors are also on the Board of Directors of Apple Eight, Apple Nine and Apple Ten.
On May 14, 2013, Apple Six merged with and into an entity that is not affiliated with the Apple REIT Entities or the Advisors. Pursuant to the terms and conditions of the merger agreement, dated as of November 29, 2012, upon completion of the merger, the separate corporate existence of Apple Six ceased (the “A6 Merger”). Prior to the A6 Merger, Glade M. Knight was Chairman and Chief Executive Office of Apple Six and members of the Company’s Board of Directors were also on the Board of Directors of Apple Six.
ASRG Agreement
The Company has a contract with ASRG to acquire and dispose of real estate assets for the Company. A fee of 2% of
the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. No fees or expenses were incurred by the Company during the nine months ended September 30, 2013 and 2012 under this contract.
A7A Agreement
The Company is party to an advisory agreement with A7A, pursuant to which A7A provides management services to the Company. A7A provides these management services through Apple Fund Management, LLC (“AFM”), which immediately after the A6 Merger became a wholly-owned subsidiary of A9A. This transaction between A9A and Apple Six was made with no cash consideration exchanged between the entities. Prior to May 14, 2013, AFM was a wholly-owned subsidiary of Apple Six. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses as described below, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.1 million for both the nine months ended September 30, 2013 and 2012.
Apple REIT Entities and Advisors Cost Sharing Structure
In addition to the fees payable to A7A, the Company reimbursed to A7A, or paid directly to AFM on behalf of A7A, approximately $1.3 million for both the nine months ended September 30, 2013 and 2012. The costs are included in general and administrative expenses and are for the Company’s allocated share of the staffing and related costs provided by AFM at the direction of A7A.
AFM is an affiliate of each of the Advisors. Each of the Advisors provides management services through the use of AFM to, respectively, Apple Six (prior to the A6Merger), Apple Seven, Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, effective May 14, 2013, the entire membership interest of Apple Six in AFM was transferred and assigned to A9A, which then became the sole member of AFM. As part of the assignment, A9A and the other Advisors agreed to indemnify the buyer of Apple Six for liabilities related to AFM. The assignment of AFM’s interest to A9A had no impact on the Company’s advisory agreement with A7A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors as described below, except Apple Six and its advisors, Apple Six Advisors, Inc. and Apple Six Realty Group, Inc. (collectively “A6 Advisors”), no longer participate in the cost sharing arrangement, thereby increasing the remaining companies’ share of the allocated costs.
Also, in connection with the A6 Merger, on May 13, 2013, Apple Nine acquired from Apple Six the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and assumed the Fort Worth, Texas office lease agreement. As described below, any costs associated with the Headquarters and office lease, including office rent, utilities, office supplies, etc. (“Office Related Costs”) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors.
Prior to the A6 Merger, amounts reimbursed to AFM included both compensation for personnel and Office Related Costs used by the companies. As discussed above, as a result of the A6 Merger, beginning on May 14, 2013, Office Related Costs are now allocated from Apple Nine to the other Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors. Each of these companies has agreed to reimburse Apple Nine for its share of these costs. From the period May 14, 2013 through September 30, 2013, the Company reimbursed Apple Nine approximately $111,000 for its share of Office Related Costs, which are included in general and administrative costs in the Company’s consolidated statements of operations.
All of the Office Related Costs and costs of AFM are allocated among the Apple REIT Entities and the Advisors, excluding Apple Six and A6 Advisors after the A6 Merger. The allocation of costs is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described above allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
As part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) are reimbursed or collected and are not significant in amount.
The Company has incurred legal fees associated with the Legal Proceedings and Related Matters discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities (excluding Apple Six after the A6 Merger). The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the Legal Proceedings and Related Matters discussed herein for all of the Apple REIT Entities was approximately $2.2 million for the nine months ended September 30, 2013, of which approximately $0.5 million was allocated to the Company. Total costs for the nine months ended September 30, 2012 for all of the Apple REIT Entities was approximately $5.7 million, of which approximately $1.2 million was allocated to the Company.
Apple Air Holding, LLC (“Apple Air”) Membership Interest
Included in other assets, net on the Company’s consolidated balance sheet is a 26% equity investment in Apple Air. The other current members of Apple Air are Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, on May 13, 2013, Apple Ten acquired its membership interest in Apple Air from Apple Six. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.5 million and $1.7 million as of September 30, 2013 and December 31, 2012. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the nine months ended September 30, 2013 and 2012, the Company recorded a loss of approximately $196,000 and $158,000, respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.
Merger Agreement and Related Transactions
Concurrently with the execution of the Merger Agreement (as discussed in note 2), on August 7, 2013, Apple Seven, Apple Eight and Apple Nine entered into a termination agreement, as amended (the “Termination Agreement”) with A7A, Apple Eight Advisors, Inc., A9A and ASRG, effective immediately before the completion of the mergers. Pursuant to the Termination Agreement, the existing advisory agreements and property acquisition/disposition agreements with respect to Apple Seven, Apple Eight and Apple Nine will be terminated. The Termination Agreement does not provide for any separate payments to be made in connection with the termination of the existing advisory agreements and property acquisition/disposition agreements. As a result, if the merger is completed, Apple Seven, Apple Eight and Apple Nine will no longer pay the various fees currently paid to its respective advisors.
6. Shareholders’ Equity
Unit Redemption Program
In April 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 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 more than three years. The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. On June 27, 2013, the Company announced the suspension of its Unit Redemption Program, as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the program until the Merger Agreement is terminated or the mergers are completed.
Since inception of the program through September 30, 2013, the Company has redeemed approximately 12.4 million Units representing $134.4 million, including 0.9 million Units in the amount of $10.2 million and 1.3 million Units in the amount of $13.8 million redeemed during the nine months ended September 30, 2013 and 2012, respectively. Since the first quarter of 2011, the total redemption requests have exceeded the authorized amount of redemptions and, as a result, the Board of Directors has limited the amount of redemptions as deemed prudent. Therefore, as contemplated in the program, beginning with the first quarter 2011 redemption, the Company redeemed Units on a pro-rata basis. Prior to 2011, the
Company redeemed 100% of redemption requests. The following is a summary of Unit redemptions during 2012 and the first nine months of 2013:
Redemption Date | | Total Requested Unit Redemptions at Redemption Date | | | Units Redeemed | | | Total Redemption Requests Not Redeemed at Redemption Date | |
| | | | | | | | | |
First Quarter 2012 | | | 12,885,635 | | | | 455,093 | | | | 12,430,542 | |
Second Quarter 2012 | | | 12,560,001 | | | | 441,458 | | | | 12,118,543 | |
Third Quarter 2012 | | | 12,709,508 | | | | 364,299 | | | | 12,345,209 | |
Fourth Quarter 2012 | | | 13,003,443 | | | | 363,755 | | | | 12,639,688 | |
First Quarter 2013 | | | 13,394,933 | | | | 386,558 | | | | 13,008,375 | |
Second Quarter 2013 | | | 13,975,946 | | | | 538,067 | | | | 13,437,879 | |
Dividend Reinvestment Plan
In July 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. The Company has registered 15 million Units for potential issuance under the plan. Since inception of the plan through September 30, 2013, approximately 11.9 million Units, representing $131.1 million in proceeds to the Company, were issued under the plan. During the nine months ended September 30, 2013 and 2012, approximately 0.6 million Units, representing $6.6 million in proceeds to the Company, and 1.1 million Units, representing $12.2 million in proceeds to the Company, were issued under the plan. On June 27, 2013, the Company announced the suspension of its Dividend Reinvestment Plan, as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the plan until the Merger Agreement is terminated or the mergers are completed.
Distributions
For the three months ended September 30, 2013 and 2012, the Company made distributions of $0.165 and $0.193 per common share for a total of $15.0 million and $17.5 million. For the nine months ended September 30, 2013 and 2012, the Company made distributions of $0.523 and $0.578 per common share for a total of $47.4 million and $52.5 million. In 2013, the Company’s Board of Directors approved a reduction of the annual distribution rate from $0.77 per common share to $0.66 per common share, effective with the distribution paid in April 2013. The Company’s distributions will continue to be paid monthly.
7. Legal Proceedings and Related Matters
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments”. The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other
things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The Securities and Exchange Commission (“SEC”) staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Entities. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company’s consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution.
8. Discontinued Operations
During December 2012, the Company identified three properties, the Fairfield Inn’s in Dothan, Alabama, Columbus, Georgia and Tallahassee, Florida, that it would consider selling in 2013 due to anticipated returns for needed capital investment being below returns for other investment opportunities. Due to the change in anticipated hold period of the assets, the estimated undiscounted cash flow for these properties was estimated to be less than their carrying value; therefore the Company recognized a loss of $6.6 million in the fourth quarter of 2012 to adjust the basis of the properties to their estimated fair market value. In January 2013, the Company committed to sell these properties and began the process of marketing efforts. These hotels have been classified on the consolidated balance sheets as “Hotels held for sale” as of September 30, 2013, and are recorded at the estimated sales proceeds less cost to sell. During the third quarter of 2013, the Company reduced its estimate of sale proceeds, less cost to sell by approximately $700,000 based on current market estimates. The results of operations for these properties for the three and nine months ended September 30, 2013 and 2012 are classified on the consolidated statements of operations in the line item “Income from discontinued operations”.
The following table sets forth the components of income from discontinued operations for the three and nine months ended September 30, 2013 and 2012 (in thousands):
| | Three months ended | | | Nine months ended | |
| | September 30, | | | September 30, | |
| | 2013 | | | 2012 | | | 2013 | | | 2012 | |
| | | | | | | | | | | | |
Total revenue | | $ | 950 | | | $ | 923 | | | $ | 3,223 | | | $ | 3,047 | |
Hotel operating expenses | | | 690 | | | | 689 | | | | 2,150 | | | | 2,082 | |
Property taxes, insurance and other | | | 2 | | | | 56 | | | | 211 | | | | 139 | |
Depreciation expense | | | 0 | | | | 159 | | | | 0 | | | | 474 | |
Loss on hotels held for sale | | | 700 | | | | 0 | | | | 700 | | | | 0 | |
Interest expense, net | | | 0 | | | | 46 | | | | 0 | | | | 140 | |
Income from discontinued operations | | $ | (442 | ) | | $ | (27 | ) | | $ | 162 | | | $ | 212 | |
9. Subsequent Events
In October 2013, the Company declared and paid approximately $5.0 million, or $0.055 per outstanding common share, in distributions to its common shareholders.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company, Apple REIT Eight, Inc. or Apple REIT Nine, Inc. to obtain required shareholder or other third-party approvals required to consummate the proposed mergers, under which Apple REIT Seven, Inc. and Apple REIT Eight, Inc. would be merged with and into wholly owned subsidiaries of Apple REIT Nine, Inc.; the satisfaction or waiver of other conditions in the merger agreement; a material adverse effect on the Company, Apple REIT Eight, Inc. or Apple REIT Nine, Inc.; the outcome of any legal proceedings that may be instituted against the Company, Apple REIT Eight, Inc. or Apple REIT Nine, Inc. and others related to the merger agreement, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets, or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission (“SEC”). Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
Overview
Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”), was formed to invest in income-producing real estate in the United States. The Company was initially capitalized on May 26, 2005, with its first investor closing on March 15, 2006. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007. The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company’s first hotel was acquired on April 27, 2006. As of September 30, 2013, the Company owned 51 hotels within different markets in the United States.
Hotel Operations
Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned. The hotel industry and the Company continue to see improvement in both revenues and operating income as compared to the prior year. Although there is no way to predict future general economic conditions, and there are several key factors that may continue to negatively affect the economic recovery in the United States and add to general market uncertainty, including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the ongoing uncertainty surrounding the fiscal policy of the United States (including the “sequester”, tax increases and potential government spending cuts), the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 with the trend expected to continue into 2014.
In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”) and market yield which compares an individual hotel’s results to others in its local market, and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.
The Company continually monitors the profitability of its properties and attempts to maximize shareholder value by timely disposal of properties. In January 2013, the Company committed to sell three underperforming assets, the Fairfield Inn’s in Dothan, Alabama, Columbus, Georgia, and Tallahassee, Florida. Due to the change in anticipated hold period of these assets, the Company recognized an impairment loss of $6.6 million in the fourth quarter of 2012 and further reduced its estimate of sales proceeds less cost to sell based on current market conditions by $700,000 in the third quarter of 2013. The results of these properties have been included in discontinued operations in the Company’s consolidated statements of operations and are not included in the summary below.
The following is a summary of the Company’s results from continuing operations for the three and nine months ended September 30, 2013 and 2012:
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
(in thousands except statistical data) | | 2013 | | | Percent of Revenue | | | 2012 | | | Percent of Revenue | | | Percent Change | | | 2013 | | | Percent of Revenue | | | 2012 | | | Percent of Revenue | | | Percent Change | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total revenue | | $ | 59,173 | | | | 100 | % | | $ | 55,824 | | | | 100 | % | | | 6 | % | | $ | 169,842 | | | | 100 | % | | $ | 162,396 | | | | 100 | % | | | 5 | % |
Hotel operating expenses | | | 33,471 | | | | 57 | % | | | 32,351 | | | | 58 | % | | | 3 | % | | | 96,938 | | | | 57 | % | | | 93,226 | | | | 57 | % | | | 4 | % |
Property taxes, insurance and other expense | | | 3,178 | | | | 5 | % | | | 3,179 | | | | 6 | % | | | 0 | % | | | 9,303 | | | | 5 | % | | | 9,317 | | | | 6 | % | | | 0 | % |
General and administrative expense | | | 1,366 | | | | 2 | % | | | 1,684 | | | | 3 | % | | | -19 | % | | | 4,245 | | | | 2 | % | | | 4,815 | | | | 3 | % | | | -12 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Merger transaction costs | | | 1,527 | | | | | | | | 0 | | | | | | | | N/A | | | 1,714 | | | | | | | | 722 | | | | | | | | 137 | % |
Depreciation | | | 8,512 | | | | | | | | 8,496 | | | | | | | | 0 | % | | | 25,689 | | | | | | | | 25,374 | | | | | | | | 1 | % |
Interest expense, net | | | 2,680 | | | | | | | | 2,713 | | | | | | | | -1 | % | | | 7,892 | | | | | | | | 7,923 | | | | | | | | 0 | % |
Income tax expense | | | 80 | | | | | | | | 75 | | | | | | | | 7 | % | | | 260 | | | | | | | | 263 | | | | | | | | -1 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Number of hotels | | | 48 | | | | | | | | 48 | | | | | | | | 0 | % | | | 48 | | | | | | | | 48 | | | | | | | | 0 | % |
Average Market Yield (1) | | | 126 | | | | | | | | 123 | | | | | | | | 2 | % | | | 124 | | | | | | | | 124 | | | | | | | | 0 | % |
ADR | | $ | 119 | | | | | | | $ | 117 | | | | | | | | 2 | % | | $ | 118 | | | | | | | $ | 115 | | | | | | | | 3 | % |
Occupancy | | | 79 | % | | | | | | | 77 | % | | | | | | | 3 | % | | | 77 | % | | | | | | | 75 | % | | | | | | | 3 | % |
RevPAR | | $ | 94 | | | | | | | $ | 90 | | | | | | | | 4 | % | | $ | 91 | | | | | | | $ | 87 | | | | | | | | 5 | % |
Total rooms sold (2) | | | 452,558 | | | | | | | | 434,777 | | | | | | | | 4 | % | | | 1,308,333 | | | | | | | | 1,267,851 | | | | | | | | 3 | % |
Total rooms available (3) | | | 571,228 | | | | | | | | 567,084 | | | | | | | | 1 | % | | | 1,696,611 | | | | | | | | 1,689,870 | | | | | | | | 0 | % |
(1) Calculated from data provided by Smith Travel Research, Inc.® Excludes hotels under renovation.
(2) Represents the number of room nights sold during the period.
(3) Represents the number of rooms owned by the Company multiplied by the number of nights in the period.
Merger Agreement
On August 7, 2013, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”), Apple Seven Acquisition Sub, Inc. (“Seven Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, and Apple Eight Acquisition Sub, Inc. (“Eight Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, entered into an Agreement and Plan of Merger, as amended (the “Merger Agreement”). The Merger Agreement provides for the merger of Apple Seven and Apple Eight with and into Seven Acquisition Sub and Eight Acquisition Sub, respectively, which were formed solely for engaging in the mergers and have not conducted any prior activities. Upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight will cease and Seven Acquisition Sub and Eight Acquisition Sub will be the surviving corporations. Pursuant to the terms of the Merger Agreement, upon completion of the mergers the current Apple Nine common shares totaling 182,784,131 will remain outstanding, and:
· | Each issued and outstanding unit of Apple Seven (consisting of one Apple Seven common share together with one Apple Seven Series A preferred share) will be converted into one (the “Apple Seven exchange ratio”) common share of Apple Nine, or a total of approximately 90,613,633 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Seven will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Seven exchange ratio, or a total of 5,801,050 common shares; and |
· | Each issued and outstanding unit of Apple Eight (consisting of one Apple Eight common share together with one Apple Eight Series A preferred share) will be converted into 0.85 (the “Apple Eight exchange ratio”) common share of Apple Nine, or a total of approximately 78,319,004 common shares (assuming |
| no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Eight will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Eight exchange ratio, or a total of 4,930,892 common shares. |
If the mergers are approved by the shareholders of each of Apple Seven, Apple Eight and Apple Nine and all of the other conditions to the mergers are completed, Apple Seven will record an expense related to the conversion of Apple Seven’s Series B convertible preferred shares into common shares of Apple Nine. Although the final estimate of fair value may vary significantly from these estimates, Apple Nine’s preliminary estimate of the fair value of $9.00 to $11.00 per Apple Nine common share would result in an expense to Apple Seven ranging from approximately $52 million to $64 million.
The Merger Agreement contains various closing conditions, including shareholder approval by Apple Seven, Apple Eight and Apple Nine. As a result, there is no assurance that the mergers will occur. Under the Merger Agreement, Apple Seven, Apple Eight and Apple Nine may terminate the Merger Agreement under certain circumstances; however, each of the companies may be required to pay a fee of $1.7 million, plus reasonable third party expenses, to each of the other companies upon such termination. All costs related to the proposed mergers are being expensed in the period they are incurred and are included in the merger transaction costs in the Company’s consolidated statements of operations. In connection with these activities, the Company incurred approximately $1.7 million in expenses for the nine months ended September 30, 2013.
Legal Proceedings
The term the “Apple REIT Entities” means Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013.
Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
Hotels Owned
The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 51 hotels the Company owned at September 30, 2013. All dollar amounts are in thousands.
Location | | State | | Brand | | Manager | | Date of Purchase | | Rooms | | | Gross Purchase Price | |
Auburn | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 101 | | | $ | 10,185 | |
Dothan* | | AL | | Fairfield Inn | | LBA | | 5/16/07 | | | 63 | | | | 4,584 | |
Dothan | | AL | | Residence Inn | | LBA | | 4/16/08 | | | 84 | | | | 9,669 | |
Huntsville | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 101 | | | | 10,285 | |
Huntsville | | AL | | Homewood Suites | | LBA | | 10/27/06 | | | 107 | | | | 11,606 | |
Huntsville | | AL | | TownePlace Suites | | LBA | | 12/10/07 | | | 86 | | | | 8,927 | |
Montgomery | | AL | | Hilton Garden Inn | | LBA | | 8/17/06 | | | 97 | | | | 10,385 | |
Montgomery | | AL | | Homewood Suites | | LBA | | 8/17/06 | | | 91 | | | | 10,660 | |
Prattville | | AL | | Courtyard | | LBA | | 4/24/07 | | | 84 | | | | 9,304 | |
Troy | | AL | | Hampton Inn | | LBA | | 8/17/06 | | | 82 | | | | 6,130 | |
Trussville | | AL | | Courtyard | | LBA | | 10/4/07 | | | 84 | | | | 9,510 | |
Tucson | | AZ | | Residence Inn | | Western | | 1/17/08 | | | 124 | | | | 16,640 | |
Agoura Hills | | CA | | Homewood Suites | | Dimension | | 5/8/07 | | | 125 | | | | 25,250 | |
Rancho Bernardo | | CA | | Courtyard | | Inn Ventures | | 12/12/06 | | | 210 | | | | 36,000 | |
San Diego | | CA | | Hampton Inn | | Dimension | | 7/19/07 | | | 177 | | | | 42,000 | |
San Diego | | CA | | Hilton Garden Inn | | Inn Ventures | | 5/9/06 | | | 200 | | | | 34,500 | |
San Diego | | CA | | Residence Inn | | Dimension | | 6/13/07 | | | 121 | | | | 32,500 | |
Highlands Ranch | | CO | | Hilton Garden Inn | | Dimension | | 3/9/07 | | | 128 | | | | 20,500 | |
Highlands Ranch | | CO | | Residence Inn | | Dimension | | 2/22/07 | | | 117 | | | | 19,000 | |
Lakeland | | FL | | Courtyard | | LBA | | 4/24/07 | | | 78 | | | | 9,805 | |
Miami | | FL | | Courtyard | | Dimension | | 9/5/08 | | | 118 | | | | 15,000 | |
Miami | | FL | | Homewood Suites | | Dimension | | 2/21/07 | | | 159 | | | | 24,300 | |
Sarasota | | FL | | Homewood Suites | | Hilton | | 9/15/06 | | | 100 | | | | 13,800 | |
Tallahassee* | | FL | | Fairfield Inn | | LBA | | 4/24/07 | | | 79 | | | | 6,647 | |
Columbus* | | GA | | Fairfield Inn | | LBA | | 4/24/07 | | | 79 | | | | 7,333 | |
Columbus | | GA | | SpringHill Suites | | LBA | | 3/6/08 | | | 85 | | | | 9,675 | |
Columbus | | GA | | TownePlace Suites | | LBA | | 5/22/08 | | | 86 | | | | 8,428 | |
Macon | | GA | | Hilton Garden Inn | | LBA | | 6/28/07 | | | 101 | | | | 10,660 | |
Boise | | ID | | SpringHill Suites | | Inn Ventures | | 9/14/07 | | | 230 | | | | 21,000 | |
New Orleans | | LA | | Homewood Suites | | Dimension | | 12/15/06 | | | 166 | | | | 43,000 | |
Hattiesburg | | MS | | Courtyard | | LBA | | 10/5/06 | | | 84 | | | | 9,455 | |
Tupelo | | MS | | Hampton Inn | | LBA | | 1/23/07 | | | 96 | | | | 5,245 | |
Omaha | | NE | | Courtyard | | Marriott | | 11/4/06 | | | 181 | | | | 23,100 | |
Cranford | | NJ | | Homewood Suites | | Dimension | | 3/7/07 | | | 108 | | | | 13,500 | |
Mahwah | | NJ | | Homewood Suites | | Dimension | | 3/7/07 | | | 110 | | | | 19,500 | |
Ronkonkoma | | NY | | Hilton Garden Inn | | White | | 12/15/06 | | | 164 | | | | 27,000 | |
Cincinnati | | OH | | Homewood Suites | | White | | 12/1/06 | | | 76 | | | | 7,100 | |
Memphis | | TN | | Homewood Suites | | Hilton | | 5/15/07 | | | 140 | | | | 11,100 | |
Addison | | TX | | SpringHill Suites | | Marriott | | 8/10/07 | | | 159 | | | | 12,500 | |
Brownsville | | TX | | Courtyard | | Western | | 6/19/06 | | | 90 | | | | 8,550 | |
El Paso | | TX | | Homewood Suites | | Western | | 4/23/08 | | | 114 | | | | 15,390 | |
Houston | | TX | | Residence Inn | | Western | | 4/27/06 | | | 129 | | | | 13,600 | |
San Antonio | | TX | | TownePlace Suites | | Western | | 6/29/07 | | | 106 | | | | 11,925 | |
San Antonio | | TX | | TownePlace Suites | | Western | | 9/27/07 | | | 123 | | | | 13,838 | |
Stafford | | TX | | Homewood Suites | | Western | | 8/15/06 | | | 78 | | | | 7,800 | |
Provo | | UT | | Residence Inn | | Dimension | | 6/13/07 | | | 114 | | | | 11,250 | |
Alexandria | | VA | | Courtyard | | Marriott | | 7/13/07 | | | 178 | | | | 36,997 | |
Richmond | | VA | | Marriott | | White | | 1/25/08 | | | 410 | | | | 53,300 | |
Location | | State | | Brand | | Manager | | Date of Purchase | | Rooms | | | Gross Purchase Price | |
Kirkland | | WA | | Courtyard | | Inn Ventures | | 10/23/07 | | | 150 | | | | 31,000 | |
Seattle | | WA | | Residence Inn | | Inn Ventures | | 9/1/06 | | | 234 | | | | 56,173 | |
Vancouver | | WA | | SpringHill Suites | | Inn Ventures | | 6/1/07 | | | 119 | | | | 15,988 | |
Total | | | | | | | | | | | 6,426 | | | $ | 901,594 | |
* Hotels are reported as held for sale
Results of Operations
As of September 30, 2013, the Company owned 51 hotels with 6,426 rooms, including the three hotels held for sale. The Company’s portfolio of hotels owned is unchanged since 2008. Hotel performance is impacted by many factors, including the economic conditions in the United States as well as each locality. Although hampered by government spending uncertainty, economic indicators in the United States have shown evidence of a sustainable recovery, which continues to overall positively impact the lodging industry. As a result, the Company’s revenue and operating income from continuing operations improved during the first nine months of 2013 as compared to the same period of 2012 and the Company expects continued improvement in revenue and operating income in 2013 as compared to 2012 and into 2014. The Company’s hotels in general have shown results consistent with their local markets and brand averages for the period of ownership.
Revenues
The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue. For the three months ended September 30, 2013 and 2012, the Company had hotel revenue from continuing operations of $59.2 million and $55.8 million, respectively. For the nine months ended September 30, 2013 and 2012, the Company had hotel revenue from continuing operations of $169.8 million and $162.4 million, respectively. For the three months ended September 30, 2013 and 2012, the continuing hotels achieved combined average occupancy of approximately 79% and 77%, ADR of $119 and $117, and RevPAR of $94 and $90. For the nine months ended September 30, 2013 and 2012, the continuing hotels achieved combined average occupancy of approximately 77% and 75%, ADR of $118 and $115, and RevPAR of $91 and $87. ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.
During the third quarter and first nine months of 2013, the Company experienced an increase in demand as demonstrated by the improvement in average occupancy of 3% during these periods in 2013 as compared to the same periods of 2012. In addition, also signifying a progressing economy, the Company experienced an increase in ADR of 2% during the third quarter and 3% during the first nine months of 2013 as compared to the same periods of 2012. Although certain markets have been negatively impacted by reduced government spending, with overall continued demand and room rate improvement, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012, with the trend expected to continue in 2014. Although impacted by increased supply in certain markets, the Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for the first nine months of 2013 and 2012 was 124 for each period. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue.
Expenses
Hotel operating expenses consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the three months ended September 30, 2013 and 2012, hotel operating expenses from continuing operations totaled $33.5 million and $32.4 million, representing 57% and 58% of total hotel revenue. For the nine months ended September 30, 2013 and 2012, hotel operating expenses from continuing operations totaled $96.9 million and $93.2 million, representing 57% of total hotel revenue for each period. Overall hotel operational expenses for the first nine months of 2013 reflect the impact of increases in revenues and occupancy at most of the Company’s hotels and the Company’s efforts to control costs. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utility costs by continually monitoring and sharing utilization data across its hotels and management companies. The Company has experienced an increase in labor benefit costs compared to the prior year, which are likely to continue to grow at increased rates due to new government regulations surrounding healthcare. Although operating expenses will increase as revenue increases, the Company will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
Property taxes, insurance and other expenses from continuing operations for the three months ended September 30, 2013 and 2012 totaled $3.2 million for each period, representing 5% and 6% of total hotel revenue. For the nine months ended September 30, 2013 and 2012, property taxes, insurance, and other expenses from continuing operations totaled $9.3 million for each period, representing 5% and 6% of total hotel revenue. Property taxes have decreased slightly as a percentage of revenue due to successful appeals of tax assessments at certain locations, which is partially offset by higher taxes for certain properties due to the reassessment of property values by localities resulting from the improved economy. Insurance rates increased modestly in 2013.
General and administrative expense from continuing operations for the three months ended September 30, 2013 and 2012 was $1.4 million and $1.7 million, representing 2% and 3% of total hotel revenue. For the nine months ended September 30, 2013 and 2012, general and administrative expense from continuing operations was $4.2 million and $4.8 million, representing 2% and 3% of total hotel revenue. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expenses. During the nine months ended September 30, 2013 and 2012, the Company incurred approximately $0.5 million and $1.2 million, respectively in legal costs related to the legal matters discussed herein and continued costs related to responding to requests from the staff of the SEC. The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Entities. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company's consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution. As discussed below under Related Parties, the Company shares legal counsel with the other Apple REIT Entities. Total costs for these legal matters for all of the Apple REIT Entities were approximately $2.2 million and $5.7 million during the nine months ended September 30, 2013 and 2012. The Company anticipates it will continue to incur costs associated with these matters.
Merger transaction costs for the three months ended September 30, 2013 and 2012 totaled $1.5 million and $0, and for the nine months ended September 30, 2013 and 2012, were $1.7 million and $0.7 million. Costs incurred during the three and nine months ended September 30, 2013 were in connection with the Merger Agreement discussed herein. The Company will continue to incur these costs until the mergers are completed or the Merger Agreement is terminated. Costs incurred during the nine months ended September 30, 2012 were associated with the Company’s evaluation of a prior potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. (the “other Apple REIT’s”). In May 2012, it was determined by the Board of Directors of the Company and the Board of Directors of each of the other Apple REITs not to move forward with the prior potential consolidation transaction at that time.
Depreciation expense from continuing operations for the three months ended September 30, 2013 and 2012 was $8.5 million for each period, and for the nine months ended September 30, 2013 and 2012 was $25.7 million and $25.4 million. Depreciation expense represents the expense of the Company’s hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment), for the respective periods owned.
Interest expense, net from continuing operations for the three months ended September 30, 2013 and 2012 was $2.7 million for each period, and for the nine months ended September 30, 2013 and 2012 was $7.9 million for each period. Interest expense primarily arose from mortgage debt outstanding on certain properties, in addition to interest on borrowings under the Company’s credit facility. Interest expense for the nine months ended September 30, 2013 and 2012 was reduced by capitalized interest of approximately $0.1 million and $0.2 million in conjunction with hotel renovations. As of September 30, 2013, the Company had debt outstanding of $208.1 million compared to $193.0 million at September 30, 2012. The increase in debt outstanding was offset by lower interest rates on the Company’s mortgage debt and credit facility during the first nine months of 2013 as compared to the prior year. The increase in overall debt outstanding during the first nine months of 2013 was necessary to fund working capital needs and capital improvements, while maintaining a relatively stable distribution rate to Unit holders during a low-growth economic period.
Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the nine months ended September 30, 2013 (other than the transactions related to the completion of
Apple REIT Six, Inc.’s merger with a third party and the Merger Agreement and related transactions discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The term the “Apple REIT Entities” means Apple REIT Six, Inc. (“Apple Six”), Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc.(“Apple Nine”) and Apple REIT Ten, Inc. (“Apple Ten”). The term the “Advisors” means Apple Six Advisors, Inc., Apple Seven Advisors, Inc. (“A7A”), Apple Eight Advisors, Inc., Apple Nine Advisors, Inc. (“A9A”), Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. (“ASRG”) and Apple Six Realty Group, Inc. The Advisors are wholly owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple Eight, Apple Nine and Apple Ten. Members of the Company’s Board of Directors are also on the Board of Directors of Apple Eight, Apple Nine and Apple Ten.
On May 14, 2013, Apple Six merged with and into an entity that is not affiliated with the Apple REIT Entities or the Advisors. Pursuant to the terms and conditions of the merger agreement, dated as of November 29, 2012, upon completion of the merger, the separate corporate existence of Apple Six ceased (the “A6 Merger”). Prior to the A6 Merger, Glade M. Knight was Chairman and Chief Executive Office of Apple Six and members of the Company’s Board of Directors were also on the Board of Directors of Apple Six.
ASRG Agreement
The Company has a contract with ASRG to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. No fees or expenses were incurred by the Company during the nine months ended September 30, 2013 and 2012 under this contract.
A7A Agreement
The Company is party to an advisory agreement with A7A, pursuant to which A7A provides management services to the Company. A7A provides these management services through Apple Fund Management, LLC (“AFM”), which immediately after the A6 Merger became a wholly-owned subsidiary of A9A. This transaction between A9A and Apple Six was made with no cash consideration exchanged between the entities. Prior to May 14, 2013, AFM was a wholly-owned subsidiary of Apple Six. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses as described below, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.1 million for both the nine months ended September 30, 2013 and 2012.
Apple REIT Entities and Advisors Cost Sharing Structure
In addition to the fees payable to A7A, the Company reimbursed to A7A, or paid directly to AFM on behalf of A7A, approximately $1.3 million for both the nine months ended September 30, 2013 and 2012. The costs are included in general and administrative expenses and are for the Company’s allocated share of the staffing and related costs provided by AFM at the direction of A7A.
AFM is an affiliate of each of the Advisors. Each of the Advisors provides management services through the use of AFM to, respectively, Apple Six (prior to the A6Merger), Apple Seven, Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, effective May 14, 2013, the entire membership interest of Apple Six in AFM was transferred and assigned to A9A, which then became the sole member of AFM. As part of the assignment, A9A and the other Advisors agreed to indemnify the buyer of Apple Six for liabilities related to AFM. The assignment of AFM’s interest to A9A had no impact on the Company’s advisory agreement with A7A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors as described below, except Apple Six and its advisors, Apple Six Advisors, Inc. and Apple Six Realty Group, Inc. (collectively “A6 Advisors”), no longer participate in the cost sharing arrangement, thereby increasing the remaining companies’ share of the allocated costs.
Also, in connection with the A6 Merger, on May 13, 2013, Apple Nine acquired from Apple Six the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and assumed the Fort Worth, Texas office lease agreement. As described below, any costs associated with the Headquarters and office lease, including office rent, utilities, office supplies, etc. (“Office Related Costs”) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors.
Prior to the A6 Merger, amounts reimbursed to AFM included both compensation for personnel and Office Related Costs used by the companies. As discussed above, as a result of the A6 Merger, beginning on May 14, 2013, Office Related Costs are now allocated from Apple Nine to the other Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors. Each of these companies has agreed to reimburse Apple Nine for its share of these costs. From the period May 14, 2013 through September 30, 2013, the Company reimbursed Apple Nine approximately $111,000 for its share of Office Related Costs, which are included in general and administrative costs in the Company’s consolidated statements of operations.
All of the Office Related Costs and costs of AFM are allocated among the Apple REIT Entities and the Advisors, excluding Apple Six and A6 Advisors after the A6 Merger. The allocation of costs is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described above allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
As part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) are reimbursed or collected and are not significant in amount.
The Company has incurred legal fees associated with the Legal Proceedings and Related Matters discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities (excluding Apple Six after the A6 Merger). The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the Legal Proceedings and Related Matters discussed herein for all of the Apple REIT Entities was approximately $2.2 million for the nine months ended September 30, 2013, of which approximately $0.5 million was allocated to the Company. Total costs for the nine months ended September 30, 2012 for all of the Apple REIT Entities was approximately $5.7 million, of which approximately $1.2 million was allocated to the Company.
Apple Air Holding, LLC (“Apple Air”) Membership Interest
Included in other assets, net on the Company’s consolidated balance sheet is a 26% equity investment in Apple Air. The other current members of Apple Air are Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, on May 13, 2013, Apple Ten acquired its membership interest in Apple Air from Apple Six. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.5 million and $1.7 million as of September 30, 2013 and December 31, 2012. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the nine months ended September 30, 2013 and 2012, the Company recorded a loss of approximately $196,000 and $158,000, respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.
Merger Agreement and Related Transactions
Concurrently with the execution of the Merger Agreement (as discussed in note 2), on August 7, 2013, Apple Seven, Apple Eight and Apple Nine entered into a termination agreement, as amended (the “Termination Agreement”) with A7A, Apple Eight Advisors, Inc., A9A and ASRG, effective immediately before the completion of the mergers. Pursuant to the Termination Agreement, the existing advisory agreements and property acquisition/disposition agreements with respect to Apple Seven, Apple Eight and Apple Nine will be terminated. The Termination Agreement does not provide for any separate payments to be made in connection with the termination of the existing advisory agreements and property acquisition/disposition agreements. As a result, if the merger is completed, Apple Seven, Apple Eight and Apple Nine will no longer pay the various fees currently paid to its respective advisors.
Liquidity and Capital Resources
Capital Resources
Credit Facility
In August 2012, the Company entered into a new $40 million unsecured credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. The outstanding principal is required to be paid by the maturity date of August 30, 2014. Interest payments are due monthly and the interest rate is equal to the applicable LIBOR (London Interbank Offered Rate for a one-month term) plus 3.25%. The Company is also required to pay a quarterly fee at an annual rate of 0.35% on the average unused balance of the credit facility. With the availability of this credit facility, the Company generally maintains little cash on hand, accessing the facility as necessary. As a result, cash on hand was $0 at September 30, 2013. The outstanding balance on the credit facility as of September 30, 2013 was $24.5 million compared to $35.6 million at December 31, 2012, and its annual interest rate was approximately 3.43% at September 30, 2013. The credit facility contains the following quarterly financial covenants (capitalized terms are defined in the loan agreements):
· | Tangible Net Worth must exceed $325 million; |
· | Total Debt to Asset Value must not exceed 50%; |
· | Cumulative 12 month Distributions and Redemptions, net of proceeds from the Company’s Dividend Reinvestment Program, cannot exceed $84 million and quarterly Distributions cannot exceed $0.193 per share, unless such cumulative Net Distributions are less than total Funds From Operations for the period; |
· | Loan balance must not exceed 45% of the Unencumbered Asset Value; |
· | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
· | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at September 30, 2013.
In January 2013, the Company entered into an amendment to its credit facility to temporarily increase the maximum aggregate commitment from $40 million to $55 million, which on April 1, 2013, was reduced back to $40 million. As noted below, the additional borrowings were used to pay off and extinguish a mortgage note in February 2013, which were subsequently repaid with proceeds from the refinancing of debt.
Mortgage Debt
During the nine months ended September 30, 2013, the Company entered into four mortgage loan agreements with commercial lenders, secured by four hotel properties for a total of $51.3 million. Combined scheduled payments of interest and principal totaling approximately $271,000 are due monthly and each loan will amortize on a 25 year term with a balloon payment due at maturity. At closing, the Company used proceeds from each loan to reduce the outstanding balance on its credit facility, extinguish through pay-off a mortgage note payable, as described below, and to pay transaction costs. Loan origination costs totaling approximately $0.5 million are being amortized as interest expense through the maturity date for each loan. The following table summarizes the hotel property securing each loan, the interest rate, loan origination date, maturity date and principal amount originated under each loan agreement. All dollar amounts are in thousands:
Hotel Location | | Brand | | Interest Rate | | Loan Origination Date | | Maturity Date | | Principal Originated | |
Huntsville, AL | | Homewood Suites | | | 4.12 | % | 1/15/2013 | | 2/6/2023 | | $ | 8,500 | |
Prattville, AL | | Courtyard | | | 4.12 | % | 1/15/2013 | | 2/6/2023 | | | 6,750 | |
San Diego, CA | | Residence Inn | | | 3.97 | % | 3/4/2013 | | 3/6/2023 | | | 19,000 | |
Miami, FL | | Homewood Suites | | | 4.02 | % | 4/1/2013 | | 4/1/2023 | | | 17,000 | |
Total | | | | | | | | | | | $ | 51,250 | |
Capital Uses
In February 2013, the Company extinguished through pay-off a mortgage loan jointly secured by the San Diego, California Residence Inn and the Provo, Utah Residence Inn. The mortgage loan had a scheduled maturity in April 2013, and was originally assumed upon acquisition of the two hotels in 2007. The mortgage loan had a principal balance at pay-off of approximately $18.3 million, an interest rate of 6.55%, and was extinguished without premium or discount to the balance outstanding. Funds for the debt extinguishment were provided by borrowings under the Company’s amended unsecured credit facility.
In April, 2013, the Company extinguished through pay-off the prior mortgage loan secured by the Miami, Florida Homewood Suites. Funds for the debt extinguishment were provided by the origination of the new mortgage loan secured by the Miami, Florida Homewood Suites. The mortgage loan had a scheduled maturity in July 2013, and was originally assumed upon acquisition of the hotel in 2007. The mortgage loan had a principal balance at pay-off of approximately $8.3 million, an interest rate of 6.5%, and was extinguished without premium or discount to the balance outstanding.
The Company’s principal sources of liquidity are the operating cash flow generated from the Company’s properties and its $40 million revolving credit facility. The Company anticipates that cash flow from operations, its current revolving credit facility and other available credit will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions (if the mergers are not completed). Although reduced effective with the April 2013 distribution, the Company’s goal is to maintain a relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles. The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions, capital improvements, ramp-up of new properties and varying economic cycles. With the decline in financial results of the Company and lodging industry as compared to pre-recession levels, the Company has and will, if necessary, 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 required levels. If the Company were to default or be unable to refinance debt maturing in the future it may be unable to make distributions.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions during the first nine months of 2013 totaled approximately $47.4 million and were paid at a monthly rate of $0.064167 per common share for the first quarter of 2013 and $0.055 per common share for the second and third quarters of 2013. For the same period, the Company’s net cash generated from operations was approximately $49.0 million. 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. The Company’s Board of Directors approved in 2013, a reduction of the annual distribution rate from $0.77 per common share to $0.66 per common share, effective with the April 2013 distribution. The Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make additional adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company.
In April 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 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 more than three years. The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. On June 27, 2013, the Company announced the suspension of its Unit Redemption Program as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the program until the Merger Agreement is terminated or the mergers are completed.
Since inception of the program through September 30, 2013, the Company has redeemed approximately 12.4 million Units representing $134.4 million, including 0.9 million Units in the amount of $10.2 million and 1.3 million Units in the amount of $13.8 million redeemed during the nine months ended September 30, 2013 and 2012. Since the first quarter of 2011, the total redemption requests have exceeded the authorized amount of redemptions and, as a result, the Board of Directors has limited the amount of redemptions as deemed prudent. Therefore, as contemplated in the program, beginning with the first quarter 2011 redemption, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2012 and the first nine months of 2013:
Redemption Date | | Total Requested Unit Redemptions at Redemption Date | | | Units Redeemed | | | Total Redemption Requests Not Redeemed at Redemption Date | |
| | | | | | | | | |
First Quarter 2012 | | | 12,885,635 | | | | 455,093 | | | | 12,430,542 | |
Second Quarter 2012 | | | 12,560,001 | | | | 441,458 | | | | 12,118,543 | |
Third Quarter 2012 | | | 12,709,508 | | | | 364,299 | | | | 12,345,209 | |
Fourth Quarter 2012 | | | 13,003,443 | | | | 363,755 | | | | 12,639,688 | |
First Quarter 2013 | | | 13,394,933 | | | | 386,558 | | | | 13,008,375 | |
Second Quarter 2013 | | | 13,975,946 | | | | 538,067 | | | | 13,437,879 | |
In July 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. The Company has registered 15 million Units for potential issuance under the plan. Since inception of the plan through September 30, 2013, approximately 11.9 million Units, representing $131.1 million in proceeds to the Company, were issued under the plan. During the nine months ended September 30, 2013 and 2012, approximately 0.6 million Units, representing $6.6 million in proceeds to the Company, and 1.1 million Units, representing $12.2 million in proceeds to the Company, were issued under the plan. On June 27, 2013, the Company announced the suspension of its Dividend Reinvestment Plan as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the plan until the Merger Agreement is terminated or the mergers are completed.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and under certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. 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, 2013, the Company held $9.6 million in reserve for capital expenditures. During the first nine months of 2013, the Company spent approximately $7.5 million on capital expenditures and anticipates spending an additional $15 to $20 million through 2014. The Company currently does not have any existing or planned projects for new development.
As discussed above in Related Parties, as part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies.
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 historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.
Subsequent Events
In October 2013, the Company declared and paid approximately $5.0 million, or $0.055 per outstanding common share, in distributions to its common shareholders.
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, 2013, the Company’s financial instruments were not exposed to significant market risk due to 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 on its credit facility. Based on the balance of the Company’s credit facility at September 30, 2013 of $24.5 million, every 100 basis points change in interest rates could impact the Company’s annual net income by $0.2 million, all other factors remaining the same. The Company’s cash balance at September 30, 2013 was $0.
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 were effective as of September 30, 2013. 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.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The term the “Apple REIT Entities” means Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc. The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws. On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The Company faces many risks, a number of which are described under “Risk Factors” in Part I of its 2012 Annual Report and described below. The risks so described may not be the only risks the Company faces. Additional risks of which the Company is not yet aware, or that currently are not significant, may also impair its operations or financial results. If any of the events or circumstances described in the risk factors contained in the Company’s 2012 Annual Report or described below occurs, the business, financial condition or results of operations of the Company could be negatively impacted. The following updates the disclosures from Item 1A. “Risk Factors” previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, filed with the Securities and Exchange Commission, and should be read in conjunction with those risk factors.
The proposed mergers of Apple REIT Seven, Inc. and Apple REIT Eight, Inc. with and into Apple REIT Nine, Inc. present certain risks to the Company’s business and operations.
In August 2013, the Company entered into an agreement and plan of merger with Apple REIT Eight, Inc. and Apple REIT Nine, Inc. under which Apple REIT Seven, Inc. and Apple REIT Eight, Inc. would merge into wholly owned subsidiaries of Apple REIT Nine, Inc. The mergers are expected to be completed in the fourth quarter of 2013 or the first quarter of 2014, although there can be no assurance of completion by any particular date, if at all. Because the mergers are subject to a number of conditions, including required shareholder and other third party approvals and the receipt of certain consents and waivers from third parties, the exact timing of when the mergers will be completed, if at all, cannot be determined at this time.
Prior to closing, the mergers may present certain risks to the Company’s business and operations, including, among other things, that:
· | management’s attention to day-to-day business may be diverted; |
· | the Company expects to incur significant transaction costs related to the mergers; |
· | if the merger agreement is terminated under certain circumstances, the Company may be required to pay termination fees and reimburse certain expenses; and |
· | the merger agreement prohibits the Company from soliciting competing transactions, and places conditions on its ability to negotiate and accept a superior competing transaction. |
Exhibit Number | Description of Documents |
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2.1 | Agreement and Plan of Merger, dated as of August 7, 2013, as amended, among Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc., Apple Seven Acquisition Sub, Inc. and Apple Eight Acquisition Sub, Inc. (Incorporated by reference to Annex A to the joint proxy statement/prospectus included in Apple REIT Nine, Inc.’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
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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) |
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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) |
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10.24 | Voting agreement, dated as of August 7, 2013, as amended, by and among Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Glade M. Knight (Incorporated by reference to Exhibit 10.7 to Apple REIT Nine, Inc.’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
10.25 | Termination Agreement dated as of August 7, 2013, as amended, by and among Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Suites Realty Group, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. (Incorporated by reference to Annex G to the joint proxy statement/prospectus included in Apple REIT Nine, Inc.’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
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31.1 | Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH) |
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31.2 | Certification of the Company's Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH) |
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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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101 | The following materials from Apple REIT Seven, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text and in detail (FILED HEREWITH) |
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.
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APPLE REIT SEVEN, INC. | | |
| | | | |
By: | /s/ GLADE M. KNIGHT | | | Date: November 6, 2013 |
| Glade M. Knight, | | | |
| Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | | | |
| | | | |
By: | /s/ BRYAN PEERY | | | Date: November 6, 2013 |
| Bryan Peery, | | | |
| Chief Financial Officer (Principal Financial and Principal Accounting Officer) | | | |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 |
for the fiscal year ended December 31, 2012
¨ | Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File Number 000-53175
APPLE REIT EIGHT, INC.
(Exact name of registrant as specified in its charter)VIRGINIA | 20-8268625 |
(State of Organization) | (I.R.S. Employer Identification Number) |
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814 EAST MAIN STREET RICHMOND, VIRGINIA | 23219 |
(Address of principal executive offices) | (Zip Code) |
(804) 344-8121
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Units (Each Unit is equal to one common share, no par value, and one Series A preferred share)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:
Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer ý | Smaller reporting company ¨ |
| | (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
There is currently no established public trading market on which the Company’s common shares are traded. Based upon the price that the Company’s common equity last sold through its dividend reinvestment plan, which was $11, on June 30, 2012, the aggregate market value of the voting common equity held by non-affiliates of the Company on such date was $1,024,226,000. The Company does not have any non-voting common equity.
The number of common shares outstanding on March 1, 2013 was 92,554,507.
Documents Incorporated by Reference.
The information required by Part III of this report, to the extent not set forth herein, is incorporated by reference from the Company’s definitive proxy statement for the annual meeting of shareholders to be held on May 16, 2013.
APPLE REIT EIGHT, INC.
FORM 10-K
| | | Page | |
Part I | | | |
| Item 1. | | 3 | |
| Item 1A. | | 8 | |
| Item 1B. | | 12 | |
| Item 2. | | 12 | |
| Item 3. | | 14 | |
| Item 4. | | 14 | |
| | | | |
Part II | | | |
| Item 5. | | 15 | |
| Item 6. | | 18 | |
| Item 7. | | 21 | |
| Item 7A. | | 35 | |
| Item 8. | | 36 | |
| Item 9. | | 60 | |
| Item 9A. | | 60 | |
| Item 9B. | | 60 | |
| | | | |
Part III | | | |
| Item 10. | | 61 | |
| Item 11. | | 61 | |
| Item 12. | | 61 | |
| Item 13. | | 61 | |
| Item 14. | | 61 | |
| | | | |
Part IV | | | |
| Item 15. | | 62 | |
| | | | |
| | | |
This Form 10-K includes references to certain trademarks or service marks. The SpringHill Suites® by Marriott, TownePlace Suites® by Marriott, Fairfield Inn® by Marriott, Courtyard® by Marriott, Residence Inn® by Marriott, Marriott® and Renaissance® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Homewood Suites® by Hilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites® trademarks are the property of Hilton Worldwide or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above-referenced terms are used.
PART I
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of Apple REIT Eight, Inc. (“the Company”) to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings, or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Annual Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission (“SEC”) and Item 1A in this report. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
The Company is a Virginia corporation that was formed to invest in hotels and other income-producing real estate in the United States. Initial capitalization occurred on January 22, 2007, when 10 Units, each Unit consisting of one common share and one Series A preferred shares were purchased by Apple Eight Advisors, Inc. (“A8A”) and 240,000 Series B convertible shares were purchased by Glade M. Knight, the Company’s Chairman and Chief Executive Officer. The Company’s first investor closing occurred on July 27, 2007 and the Company acquired its first property on November 9, 2007. As of December 31, 2012, the Company owned 51 hotel properties operating in 19 states. 45 hotels were purchased in 2008 and six were purchased in 2007. The Company completed its best efforts-offering of Units in April 2008.
The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company has wholly-owned taxable REIT subsidiaries which lease all of the Company’s hotels from wholly-owned qualified REIT subsidiaries. The hotels are operated and managed by affiliates of Newport Hospitality Group, Inc. (“Newport”), Larry Blumberg & Associates (“LBA”), Western International (“Western”), Marriott International, Inc. (“Marriott”), White Lodging Services Corporation (“White”), Dimension Development Company (“Dimension”), Inn Ventures, Inc. (“Inn Ventures”), True North Hotel Group, Inc. (“True North”), Intermountain Management, LLC (“Intermountain”), MHH Management, LLC (“McKibbon”) and Crestline Hotels & Resorts, Inc. (“Crestline”) under separate hotel management agreements.
The Company separately evaluates the performance of each of its hotel properties. Due to the significance of the New York, New York hotel, the Company has two reportable segments. The Company has no foreign operations. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. Refer to Part II, Item 8 of this report, for the consolidated financial statements.
Website Access
The address of the Company’s Internet website is www.applereiteight.com. The Company makes available free of charge through its Internet website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. Information contained on the Company’s website is not incorporated by reference into this report.
Business Objectives
The Company’s primary objective is to enhance shareholder value by increasing funds from operations and cash
available for distributions through internal growth and selective hotel renovation. The Company’s acquisition strategy, substantially complete as of December 2008, included purchasing underdeveloped hotels and hotels in underdeveloped markets with strong brand recognition, high levels of customer satisfaction and the potential for cash flow growth. The internal growth strategy includes utilizing the Company’s asset management expertise to improve the performance of the Company’s hotels by aggressively managing room rates, partnering with industry leaders in hotel management and franchising the hotels with leading brands, thereby improving revenue and operating performance of each hotel in its individual market. When cost effective, the Company renovates its properties to increase its ability to compete in particular markets. Although there are many factors that influence profitability, including national and local economic conditions, the Company believes its completed acquisitions, planned renovations and strong asset management will improve financial results over the long-term, although there can be no assurance of these results.
Financing
At December 31, 2012 the Company had 20 mortgage notes payable, secured by 21 hotel properties, with a total outstanding balance of $219.2 million. Maturity dates for the mortgage notes range from January 2015 to October 2022, and interest rates range from 4.73% to 6.29%. The Company assumed 15 mortgage loans upon the acquisition of hotels in 2008. During 2012, three mortgage loans totaling $58.7 million, secured by four existing hotel properties, were originated by the Company. During 2011, two mortgage loans were extinguished, and the Company originated four mortgage loans on existing hotel properties totaling $60.0 million.
The Company also has an unsecured $60 million revolving line of credit, which it originated in March 2012 with a commercial bank. Interest is payable monthly on the outstanding balance based on an annual interest rate of either the one-month London InterBank Offered Rate (“LIBOR”) plus 3.0%, or the prime interest rate plus 2.0%, at the Company’s option. The Company is also required to pay a fee of 0.35% on the average unused balance of the credit facility. The credit facility matures in March 2013; however, the Company has the right and intends, upon satisfaction of certain conditions including covenant compliance and payment of an extension fee, to extend the maturity date to March 2014. The outstanding balance on this credit facility as of December 31, 2012 was $45.3 million and its interest rate was approximately 3.21%.
The Company’s principal sources of liquidity are the operating cash flow generated from the Company’s properties and its $60 million revolving credit facility. The Company anticipates that cash flow from operations and credit availability, including potentially new mortgage loans and new or restructured unsecured lending arrangements, will be adequate to meet substantially all of its anticipated liquidity requirements, including debt service, capital improvements, required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions. The Company intends to maintain a relatively stable dividend rate instead of raising and lowering the distribution rate with varying economic cycles. If cash flow from operations and the credit facility are not adequate to meet liquidity requirements, 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 distributions to required levels. If the Company was unsuccessful in extending maturing debt in future periods or if it were to default under any of its debt agreements, it may be unable to make distributions or redemptions.
Hotel Industry and Competition
The hotel industry is highly competitive. Each of the Company’s hotels is located in a developed area that includes other hotels and competes for guests primarily with other hotels in the immediate vicinity and secondarily with other hotels in the same geographic market. An increase in the number of competitive hotels in a particular area could have a material adverse effect on the occupancy, average daily rate (“ADR”) and revenue per available room (“RevPAR”) of the Company’s hotels in that area. The Company believes that brand recognition, location, price and quality (of both the hotel and the services provided) are the principal competitive factors affecting the Company’s hotels. Additionally, general economic conditions in a particular market and nationally impact the performance of the hotel industry.
Hotel Operating Performance
At December 31, 2012, the Company owned eleven Courtyard hotels, ten Residence Inn hotels, six Hilton Garden Inn hotels, five Hampton Inn hotels, five Homewood Suites hotels, three Fairfield Inn & Suites hotels, three Hampton Inn & Suites hotels, three SpringHill Suites hotels, three TownePlace Suites hotels, one full-service Marriott hotel and one Renaissance hotel. They are located in 19 states and, in aggregate, consist of 5,912 rooms.
Room revenue for these hotels totaled $183.9 million for the year ended December 31, 2012, and the hotels achieved average occupancy of 73%, ADR of $116 and RevPAR of $85. Room revenue for the year ended December 31, 2011 totaled
$177.0 million, and the hotels achieved average occupancy of 72%, ADR of $113 and RevPAR of $82. Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. With the significant decline in economic conditions throughout the United States over the 2008 through 2010 time period, overall performance of the Company’s hotels has not met expectations since acquisition. Beginning in 2011 and continuing through 2012, the hotel industry and the Company’s revenues have shown improvement from the significant decline in the industry during 2008 through 2010. The Company’s revenue growth has been behind the industry due to certain of the Company’s local markets trailing the industry and due to rooms out of service for renovations completed by the Company. The Company’s operating income generally has also trailed the industry due to the revenue shortfall and increased operating costs at its New York hotel. Although there is no way to predict future general economic conditions, and there are several key factors that continue to negatively affect the economic recovery in the United States and add to general market uncertainty, including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the uncertainty surrounding the fiscal policy of the United States, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 for comparable hotels.
The Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for 2012 and 2011 was 128 and 130, respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation or open less than two years) and is provided by Smith Travel Research, Inc.® an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue. See the Company’s complete financial statements in Part II Item 8 of this report.
Management and Franchise Agreements
Each of the Company’s 51 hotels are operated and managed under separate management agreements, by affiliates of one of the following companies: Newport, LBA, Western, Marriott, White, Dimension, Inn Ventures, True North, Intermountain, McKibbon and Crestline. The agreements generally provide for initial terms ranging from one to thirty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.0 million, $6.8 million and $6.3 million in management fees.
Newport, LBA, Western, White, Dimension, Inn Ventures, True North, Intermountain, McKibbon and Crestline are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for initial terms of 10 to 20 years. Fees associated with the agreements generally include the payment of royalty fees and program fees. The Marriott franchise agreements provide for initial terms of 10 to 30 years. Fees associated with the agreements include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.7 million, $7.4 million and $7.1 million in franchise fees.
The franchise and/or management agreements provide a variety of benefits for the Company, which include national advertising, publicity, and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards, centralized reservations systems and best practices within the industry.
Hotel Maintenance and Renovation
The Company’s hotels have an ongoing need for renovation and refurbishment. Under various hotel management agreements, the Company has agreed to fund expenditures for periodic repairs, replacement or refurbishment of furniture, fixtures and equipment for the hotels in an amount equal to a certain percentage of gross revenues. In addition, other capital improvement projects may be directly funded by the Company. During 2012 and 2011, the Company’s capital expenditures were approximately $11.6 million and $5.3 million.
Employees
The Company does not have any employees. During 2012, all employees involved in the day-to-day operation of the Company’s hotels were employed by third party management companies engaged pursuant to the hotel management agreements. The Company utilizes, through an advisory agreement for corporate and strategic support, personnel from A8A,
which in turn utilizes personnel from Apple Fund Management, LLC, a subsidiary of Apple REIT Six, Inc.
Environmental Matters
In connection with each of the Company’s hotel acquisitions, the Company obtained a Phase I Environmental Report and additional environmental reports and surveys, as were necessitated by the preliminary report. Based on the reports, the Company is not aware of any environmental situations requiring remediation at the Company’s properties, which have not been, or are not currently being remediated as necessary. No material remediation costs have occurred or are expected to occur. Under various laws, owners as well as tenants and operators of real estate may be required to investigate and clean up or remove hazardous substances present at or migrating from properties they own, lease or operate and may be held liable for property damage or personal injuries that result from hazardous substances. These laws also expose the Company to the possibility that it may become liable to reimburse governments for damages and costs they incur in connection with hazardous substances.
Seasonality
The hotel industry historically has been 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. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or available credit to make distributions.
Related Parties
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section, and no new significant related party transactions during 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of this contract have totaled approximately $19.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees or expenses were incurred by the Company during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with A8A, pursuant to which A8A provides management services to the Company. A8A provides these management services through an affiliate called Apple Fund Management LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A8A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.0 million for each of the years ended December 31, 2012, 2011 and 2010.
In addition to the fees payable to A8A, the Company reimbursed A8A or paid directly to AFM on behalf of A8A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A8A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., A8A, Apple Nine Advisors, Inc.(“A9A”), Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc., Apple REIT Ten, Inc. and the Company (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform
services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, A9A entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, A9A and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to A9A, if it occurs, will have no impact on the Company’s advisory agreement with A8A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
ASRG and A8A are 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 Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the boards of Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was $1.9 million and $2.1 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.8 million respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
In 2010, Apple REIT Nine, Inc. purchased from the Company’s third party lender a note payable secured by the Columbia, South Carolina Hilton Garden Inn. The purchase of the note by Apple REIT Nine, Inc. had no financial effect on the Company. In December 2011, in accordance with the terms of the note, the note was extinguished by the Company through payment of all principal and interest due.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. See Item 7 Management’s Discussion and Analysis of Expenses for the years 2012 and 2011 for more information on legal fees incurred.
In April 2011, the Company entered into a Loan Agreement (the “Loan Agreement”) with a commercial bank, which provided for a $20 million revolving credit facility with a maturity of April 2012. During the first quarter of 2012, the credit
facility was extinguished and the outstanding principal balance totaling $20 million, plus accrued interest, was paid in full. The Loan Agreement was guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and was secured by assets of Mr. Knight. Mr. Knight did not receive any consideration in exchange for providing this guaranty and security. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement.
The following describes several risk factors which are applicable to the Company. There are many factors that may affect the Company’s business and results of operations, which would affect the Company’s operating cash flow and value. You should carefully consider, in addition to the other information contained in this report, the risks described below.
Hotel Operations
The Company’s hotels are subject to all of the risks common to the hotel industry. These risks could adversely affect hotel occupancy and the rates that can be charged for hotel rooms as well as hotel operating expenses, and generally include:
| • | increases in supply of hotel rooms that exceed increases in demand; |
| • | increases in energy costs and other travel expenses that reduce business and leisure travel; |
| • | reduced business and leisure travel due to continued geo-political uncertainty, including terrorism; |
| • | adverse effects of declines in general and local economic activity; and |
| • | adverse effects of a downturn in the hotel industry. |
General Local and National Economic Conditions
Changes in general local or national economic or market conditions, increased costs of energy, increased costs of insurance, increased costs of products, increased costs and shortages of labor, competitive factors, fuel shortages, quality of management, the ability of a hotel chain to fulfill any obligations to operators of its hotel business, limited alternative uses for the building, changing consumer habits, condemnation or uninsured losses, changing demographics, changing traffic patterns, inability to remodel outmoded buildings as required by the franchise or lease agreement and other factors beyond the Company’s control may reduce the operating results and the value of properties that the Company owns. Additionally these items, among others, may reduce the availability of capital to the Company. As a result, cash available to make distributions to shareholders may be affected.
Current General Economic Environment in the Lodging Industry
The United States continues to be in a low-growth economic environment and continues to experience historically high levels of unemployment. Uncertainty over the depth and duration of this economic environment continues to have a negative impact on the lodging industry. Although operating results have improved, high levels of unemployment and sluggish business and consumer travel trends have been evident during the past three years. Accordingly, the Company’s financial results have been impacted by the economic environment, and future financial results and growth could be further depressed until a more expansive national economic environment is prevalent. A weaker than anticipated economic recovery, or a return to a recessionary national economic environment, could result in low or decreased levels of business and consumer travel, negatively impacting the lodging industry, and, in turn, negatively impacting the Company’s future growth prospects and results of operations.
Hospitality Industry
The success of the Company’s properties will depend largely on the property operators’ ability to adapt to dominant trends in the hotel industry as well as greater competitive pressures, increased consolidation, industry overbuilding, dependence on consumer spending patterns and changing demographics, the introduction of new concepts and products, availability of labor, price levels and general economic conditions. The success of a particular hotel brand, the ability of a hotel brand to fulfill any obligations to operators of its business, and trends in the hotel industry may affect the Company’s income and the funds it has available to distribute to shareholders.
The hospitality industry could also experience a significant decline in occupancy and average daily rates due to a reduction in both business and leisure travel. General economic conditions, increased fuel costs, natural disasters and terrorist attacks are a few factors that could affect an individual’s willingness to travel. The Company’s property insurance will typically cover losses for property damage due to terrorist attacks or natural disasters (subject to policy deductibles). However, the Company is not insured against the potential negative effect a terrorist attack or natural disaster would have on the hospitality industry as a whole.
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, and the Company may need to enter into short-term borrowing arrangements in certain periods in order to offset these fluctuations in revenues and to make distributions to shareholders.
Franchise Agreements
The Company’s wholly-owned taxable REIT subsidiaries (or subsidiaries thereof) operate all of the properties pursuant to franchise or license agreements with nationally recognized hotel brands. These franchise agreements contain specific standards for, and restrictions and limitations on, the operation and maintenance of the Company’s properties in order to maintain uniformity within the franchisor system. These standards could potentially conflict with the Company’s ability to create specific business plans tailored to each property and to each market.
Competition
The hotel industry is highly competitive. Each of the Company’s hotels is located in a developed area that includes other hotels and competes for guests primarily with other hotels in the Company’s immediate vicinity and secondarily with other hotels in the Company’s geographic market. An increase in the number of competitive hotels in a particular area could have a material adverse effect on the occupancy, average daily rate and revenue per available room of the Company’s hotels in that area.
Illiquidity of Shares
There is and will be no public trading market for the common shares and the Series A preferred shares for an indefinite period of time, if ever. Therefore, the Units are and will be highly illiquid and very difficult to trade. There is no definite time frame to provide liquidity. There also is no definite value for the Units when a liquidity event occurs. In addition, there are restrictions on the transfer of the common shares. In order to qualify as a REIT, the shares must be beneficially owned by 100 or more persons and no more than 50% of the value of the issued and outstanding shares may be owned directly or indirectly by five or fewer individuals. Therefore, the Company’s bylaws provide that no person may own more than 9.8% of the issued and outstanding Units. Any purported transfer of the Company’s shares that would result in a violation of either of these limits will be declared null and void.
Qualification as a REIT
The rules governing a REIT are highly technical and complex. They require ongoing compliance with and interpretation of a variety of tests and regulations that depend on, among other things, future operations. While the Company expects to satisfy these tests, it cannot ensure it will qualify as a REIT for any particular year. There is also the risk that the applicable laws governing a REIT could be changed, which could adversely affect the Company and its shareholders.
Distributions to Shareholders
If the Company’s properties do not generate sufficient revenue to meet operating expenses, the Company’s cash flow and the Company’s ability to make distributions to shareholders may be adversely affected. The Company is subject to all operating risks common to hotels. These risks might adversely affect occupancy or room rates. Increases in operating costs due to inflation and other factors may not necessarily be offset by increased room rates. The local, regional and national hotel markets may limit the extent to which room rates may be increased to meet increased operating expenses without decreasing occupancy rates. While the Company intends to make monthly distributions to shareholders, there can be no assurance that the Company will be able to make distributions at any particular time or rate, or at all. Further, there is no assurance that a distribution rate achieved for a particular period will be maintained in the future. Also, while management may establish goals
as to particular rates of distribution or have an intention to make distributions at a particular rate, there can be no assurance that such goals or intentions will be realized.
The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions and capital improvements, ramp up of new properties and varying economic cycles. The Company anticipates that it may need to utilize debt, offering proceeds and cash from operations to meet this objective. The Company evaluates the distribution rate on an ongoing basis and may make changes at any time if the Company feels the rate is not appropriate based on available cash resources.
While the Company generally seeks to make distributions from its operating cash flows, distributions may be made (although there is no obligation to do so) in certain circumstances in part from financing proceeds or other sources, such as proceeds from the offering of Units. While distributions from such sources would result in the shareholder receiving cash, the consequences to the shareholders would differ from a distribution from the Company’s operating cash flows. For example, if financing is the source of a distribution, that financing would have to be repaid, and if proceeds from the offering of Units are distributed, those proceeds would not then be available for other uses (such as property acquisitions or improvements).
Financing Risks
Although the Company anticipates maintaining relatively low levels of debt, it may periodically use short-term financing to perform renovations to its properties, make shareholder distributions or planned Unit redemptions in periods of fluctuating income from its properties. The debt markets have been volatile and subject to increased regulation, and as a result, the Company may not be able to use debt to meet any of its cash requirements, including refinancing any scheduled debt maturities.
Compliance with Financial Covenants
The Company’s $60.0 million unsecured line of credit debt facility, entered into in March 2012, contains financial covenants that could require the outstanding balance to be prepaid prior to the scheduled maturity of March 2013, prevent the Company from extending the maturity to March 2014, or restrict the amount and timing of distributions to shareholders. The Company was in compliance with all covenants at December 31, 2012. The covenants include, among others, a minimum tangible net worth, debt service coverage and income to debt service and distributions. The Company’s secured debt increases the Company’s risk of property losses as defaults on the debt may result in foreclosure by the lenders.
Securities Class Action Lawsuits and Governmental Regulatory Oversight Risks
As a result of regulatory inquiries or other regulatory actions, or as a result of being publicly held, the Company may become subject to lawsuits. The Company is currently subject to a securities class action lawsuit and other suits may be filed against the Company in the future. Due to the uncertainties related to litigation, the Company is unable at this time to evaluate the likelihood of either a favorable or unfavorable outcome or to estimate the range of potential exposure. If the outcome is unfavorable, the Company may be required to pay damages and/or change its business practices, any of which could have a material adverse effect on the Company’s financial condition, results of operations and cash flows. The ability of the Company to access capital markets, including commercial debt markets, could be negatively impacted by unfavorable, or the possibility of unfavorable, outcomes to lawsuits or adverse regulatory actions.
The Company has been and may continue to be subject to regulatory inquiries, which have resulted in and which could continue to result in costs and personnel time commitment to respond. It may also be subject to action by governing regulatory agencies, as a result of its activities, which could result in costs to respond and fines or changes in the Company’s business practices, any of which could have a material adverse effect on the financial condition, results of operations, liquidity and capital resources, and cash flows of the Company.
Technology is used in operations, and any material failure, inadequacy, interruption or security failure of that technology could harm the business.
The Company and its hotel managers and franchisors rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information, and to manage or support a variety of business processes, including financial transactions and records, personal identifying information, reservations, billing and operating data. Some of the information technology is purchased from vendors, on whom the systems depend. The Company and its hotel managers and franchisors rely on commercially available and internally developed systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential operator and other customer information, such as individually identifiable information, including information relating to financial accounts. Although the Company and its hotel managers
and franchisors have taken steps necessary to protect the security of their information systems and the data maintained in those systems, it is possible that the safety and security measures taken will not be able to prevent the systems’ improper functioning or damage, or the improper access or disclosure of personally identifiable information such as in the event of cyber attacks. Security breaches, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure of confidential information. Any failure to maintain proper function, security and availability of information systems could interrupt operations, damage reputation, subject the Company to liability claims or regulatory penalties and could have a material adverse effect on the business, financial condition and results of operations of the Company.
Potential losses not covered by Insurance
The Company maintains comprehensive insurance coverage for general liability, property, business interruption and other risks with respect to all of its hotels. These policies offer coverage features and insured limits that the Company believes are customary for similar types of properties. There are no assurances that coverage will be available at reasonable rates. Also, various types of catastrophic losses, like earthquakes, hurricanes, or certain types of terrorism, may not be insurable or may not be economically insurable. Even when insurable, these policies may have high deductibles and/or high premiums. There also can be risks such as certain environmental hazards that may be deemed to fall outside the coverage. In the event of a substantial loss, the Company’s insurance coverage may not be sufficient to cover the full current market value or replacement cost of its lost investment. Should an uninsured loss or a loss in excess of insured limits occur, the Company could lose all or a portion of the capital it has invested in a hotel, as well as the anticipated future revenue from the hotel. In that event, the Company might nevertheless remain obligated for any mortgage debt or other financial obligations related to the hotel. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep the Company from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. The Company also may encounter challenges with an insurance provider regarding whether it will pay a particular claim that the Company believes to be covered under its policy.Under those circumstances, the insurance proceeds the Company receives might be inadequate to restore its economic position on the damaged or destroyed hotel, which could have a material adverse effect on the Company.
Item 1B. Unresolved Staff Comments
Not applicable.
As of December 31, 2012, the Company owned 51 hotels with an aggregate of 5,912 rooms, consisting of the following:
Brand | | Total by Brand | | | Number of Rooms | |
Courtyard | | | 11 | | | | 1,445 | |
Residence Inn | | | 10 | | | | 1,067 | |
Hilton Garden Inn | | | 6 | | | | 717 | |
Hampton Inn | | | 5 | | | | 549 | |
Homewood Suites | | | 5 | | | | 536 | |
Fairfield Inn & Suites | | | 3 | | | | 331 | |
Hampton Inn & Suites | | | 3 | | | | 298 | |
SpringHill Suites | | | 3 | | | | 289 | |
TownePlace Suites | | | 3 | | | | 252 | |
Marriott | | | 1 | | | | 226 | |
Renaissance | | | 1 | | | | 202 | |
Total | | | 51 | | | | 5,912 | |
The following table includes the location of each hotel, the date of construction, the date acquired, encumbrances (if any), initial acquisition cost, gross carrying value and the number of rooms of each hotel.
REAL ESTATE AND ACCUMULATED DEPRECIATIONAs of December 31, 2012(dollars in thousands)
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | Capitalized | | Total | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | Bldg. | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Brand | | Encumbrances | | Land (1) | | FF&E /Other | | Imp. & FF&E | | Cost | | Deprec. | | Construction | | Acquired | | Life | | Guestrooms |
Birmingham | | AL | | Homewood Suites | | $ | 11,118 | | | $ | 1,176 | | | $ | 15,917 | | | $ | 391 | | | $ | 17,484 | | | $ | (2,502 | ) | | 2005 | | May-08 | | 3 - 39 yrs. | | | 95 | |
Rogers | | AR | | Fairfield Inn | | | 0 | | | | 881 | | | | 7,394 | | | | 1,198 | | | | 9,473 | | | | (1,632 | ) | | 2002 | | February-08 | | 3 - 39 yrs. | | | 99 | |
Rogers | | AR | | Residence Inn | | | 0 | | | | 920 | | | | 11,187 | | | | 1,271 | | | | 13,378 | | | | (1,950 | ) | | 2003 | | February-08 | | 3 - 39 yrs. | | | 88 | |
Springdale | | AR | | Residence Inn | | | 0 | | | | 447 | | | | 5,383 | | | | 1,476 | | | | 7,306 | | | | (1,533 | ) | | 2001 | | March-08 | | 3 - 39 yrs. | | | 72 | |
Burbank | | CA | | Residence Inn | | | 24,000 | | | | 4,229 | | | | 47,200 | | | | 78 | | | | 51,507 | | | | (6,656 | ) | | 2007 | | May-08 | | 3 - 39 yrs. | | | 166 | |
Cypress | | CA | | Courtyard | | | 0 | | | | 3,234 | | | | 28,688 | | | | 1,454 | | | | 33,376 | | | | (4,653 | ) | | 1988 | | April-08 | | 3 - 39 yrs. | | | 180 | |
Oceanside | | CA | | Residence Inn | | | 16,000 | | | | 3,312 | | | | 25,964 | | | | 93 | | | | 29,369 | | | | (3,884 | ) | | 2007 | | May-08 | | 3 - 39 yrs. | | | 125 | |
Sacramento | | CA | | Hilton Garden Inn | | | 0 | | | | 2,544 | | | | 25,764 | | | | 2,059 | | | | 30,367 | | | | (4,749 | ) | | 1999 | | March-08 | | 3 - 39 yrs. | | | 154 | |
San Jose | | CA | | Homewood Suites | | | 0 | | | | 6,523 | | | | 15,901 | | | | 2,146 | | | | 24,570 | | | | (3,060 | ) | | 1991 | | July-08 | | 3 - 39 yrs. | | | 140 | |
Tulare | | CA | | Hampton Inn & Suites | | | 0 | | | | 1,100 | | | | 9,495 | | | | 35 | | | | 10,630 | | | | (1,659 | ) | | 2008 | | June-08 | | 3 - 39 yrs. | | | 86 | |
Jacksonville | | FL | | Homewood Suites | | | 16,161 | | | | 1,546 | | | | 22,370 | | | | 698 | | | | 24,614 | | | | (3,421 | ) | | 2005 | | June-08 | | 3 - 39 yrs. | | | 119 | |
Sanford | | FL | | SpringHill Suites | | | 0 | | | | 933 | | | | 10,609 | | | | 440 | | | | 11,982 | | | | (1,737 | ) | | 2000 | | March-08 | | 3 - 39 yrs. | | | 105 | |
Tallahassee | | FL | | Hilton Garden Inn | | | 0 | | | | 0 | | | | 13,580 | | | | 178 | | | | 13,758 | | | | (2,291 | ) | | 2006 | | January-08 | | 3 - 39 yrs. | | | 85 | |
Tampa | | FL | | TownePlace Suites | | | 0 | | | | 1,307 | | | | 10,344 | | | | 366 | | | | 12,017 | | | | (1,656 | ) | | 1999 | | June-08 | | 3 - 39 yrs. | | | 95 | |
Port Wentworth | | GA | | Hampton Inn | | | 0 | | | | 837 | | | | 10,288 | | | | 281 | | | | 11,406 | | | | (1,598 | ) | | 1997 | | January-08 | | 3 - 39 yrs. | | | 106 | |
Savannah | | GA | | Hilton Garden Inn | | | 5,143 | | | | 0 | | | | 15,119 | | | | 786 | | | | 15,905 | | | | (2,491 | ) | | 2004 | | July-08 | | 3 - 39 yrs. | | | 105 | |
Overland Park | | KS | | Fairfield Inn & Suites | | | 0 | | | | 1,571 | | | | 10,875 | | | | 27 | | | | 12,473 | | | | (1,700 | ) | | 2008 | | August-08 | | 3 - 39 yrs. | | | 110 | |
Overland Park | | KS | | Residence Inn | | | 6,259 | | | | 1,522 | | | | 14,631 | | | | 422 | | | | 16,575 | | | | (2,387 | ) | | 2000 | | April-08 | | 3 - 39 yrs. | | | 120 | |
Overland Park | | KS | | SpringHill Suites | | | 0 | | | | 939 | | | | 8,214 | | | | 836 | | | | 9,989 | | | | (1,471 | ) | | 1999 | | March-08 | | 3 - 39 yrs. | | | 102 | |
Wichita | | KS | | Courtyard | | | 0 | | | | 1,177 | | | | 8,013 | | | | 852 | | | | 10,042 | | | | (1,635 | ) | | 2000 | | June-08 | | 3 - 39 yrs. | | | 90 | |
Bowling Green | | KY | | Hampton Inn | | | 0 | | | | 1,481 | | | | 17,890 | | | | 255 | | | | 19,626 | | | | (2,877 | ) | | 1989 | | December-07 | | 3 - 39 yrs. | | | 130 | |
Marlborough | | MA | | Residence Inn | | | 0 | | | | 2,112 | | | | 18,591 | | | | 213 | | | | 20,916 | | | | (3,132 | ) | | 2006 | | January-08 | | 3 - 39 yrs. | | | 112 | |
Westford | | MA | | Hampton Inn & Suites | | | 0 | | | | 1,570 | | | | 14,122 | | | | 95 | | | | 15,787 | | | | (2,356 | ) | | 2007 | | March-08 | | 3 - 39 yrs. | | | 110 | |
Westford | | MA | | Residence Inn | | | 6,704 | | | | 906 | | | | 14,173 | | | | 1,152 | | | | 16,231 | | | | (2,684 | ) | | 2000 | | April-08 | | 3 - 39 yrs. | | | 108 | |
Annapolis | | MD | | Hilton Garden Inn | | | 0 | | | | 2,440 | | | | 23,342 | | | | 83 | | | | 25,865 | | | | (3,739 | ) | | 2007 | | January-08 | | 3 - 39 yrs. | | | 126 | |
Kansas City | | MO | | Residence Inn | | | 10,839 | | | | 1,178 | | | | 16,152 | | | | 2,052 | | | | 19,382 | | | | (3,413 | ) | | 1968 | | April-08 | | 3 - 39 yrs. | | | 106 | |
Carolina Beach | | NC | | Courtyard | | | 12,272 | | | | 3,244 | | | | 21,617 | | | | 1,960 | | | | 26,821 | | | | (3,772 | ) | | 2003 | | June-08 | | 3 - 39 yrs. | | | 144 | |
Concord | | NC | | Hampton Inn | | | 4,814 | | | | 1,241 | | | | 8,366 | | | | 290 | | | | 9,897 | | | | (1,570 | ) | | 1996 | | March-08 | | 3 - 39 yrs. | | | 101 | |
Dunn | | NC | | Hampton Inn | | | 0 | | | | 545 | | | | 12,542 | | | | 405 | | | | 13,492 | | | | (2,279 | ) | | 2006 | | January-08 | | 3 - 39 yrs. | | | 120 | |
Fayetteville | | NC | | Residence Inn | | | 6,721 | | | | 668 | | | | 12,570 | | | | 182 | | | | 13,420 | | | | (2,088 | ) | | 2006 | | May-08 | | 3 - 39 yrs. | | | 92 | |
Greensboro | | NC | | SpringHill Suites | | | 0 | | | | 663 | | | | 7,634 | | | | 120 | | | | 8,417 | | | | (1,278 | ) | | 2004 | | November-07 | | 3 - 39 yrs. | | | 82 | |
Matthews | | NC | | Hampton Inn | | | 0 | | | | 636 | | | | 10,436 | | | | 627 | | | | 11,699 | | | | (2,074 | ) | | 1995 | | January-08 | | 3 - 39 yrs. | | | 92 | |
| | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | Capitalized | | Total | | | | | | | | | | | |
| | | | | | | | | | | Bldg./ | | Bldg. | | Gross | | Acc | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Brand | | Encumbrances | | | Land (1) | | FF&E /Other | | Imp. & FF&E | | Cost | | Deprec. | | Construction | | Acquired | | Life | | Guestrooms | |
Wilmington | | NC | | Fairfield Inn & Suites | | | 0 | | | | 1,841 | | | | 13,475 | | | | 21 | | | | 15,337 | | | | (1,929 | ) | | 2008 | | December-08 | | 3 - 39 yrs. | | | 122 | |
Winston-Salem | | NC | | Courtyard | | | 7,595 | | | | 1,439 | | | | 12,457 | | | | 1,758 | | | | 15,654 | | | | (2,126 | ) | | 1998 | | May-08 | | 3 - 39 yrs. | | | 122 | |
Somerset | | NJ | | Courtyard | | | 8,970 | | | | 0 | | | | 16,504 | | | | 193 | | | | 16,697 | | | | (2,754 | ) | | 2001 | | November-07 | | 3 - 39 yrs. | | | 162 | |
New York | | NY | | Renaissance | | | 0 | | | | 0 | | | | 111,870 | | | | 21,778 | | | | 133,648 | | | | (29,669 | ) | | 1916 | | January-08 | | 3 - 39 yrs. | | | 202 | |
Tulsa | | OK | | Hampton Inn & Suites | | | 0 | | | | 899 | | | | 9,940 | | | | 80 | | | | 10,919 | | | | (1,896 | ) | | 2007 | | December-07 | | 3 - 39 yrs. | | | 102 | |
Columbia | | SC | | Hilton Garden Inn | | | 0 | | | | 1,385 | | | | 20,499 | | | | 97 | | | | 21,981 | | | | (3,005 | ) | | 2006 | | September-08 | | 3 - 39 yrs. | | | 143 | |
Greenville | | SC | | Residence Inn | | | 6,128 | | | | 692 | | | | 8,372 | | | | 223 | | | | 9,287 | | | | (1,365 | ) | | 1998 | | May-08 | | 3 - 39 yrs. | | | 78 | |
Hilton Head | | SC | | Hilton Garden Inn | | | 5,746 | | | | 1,094 | | | | 13,114 | | | | 1,557 | | | | 15,765 | | | | (2,697 | ) | | 2001 | | May-08 | | 3 - 39 yrs. | | | 104 | |
Chattanooga | | TN | | Homewood Suites | | | 0 | | | | 688 | | | | 8,211 | | | | 2,314 | | | | 11,213 | | | | (2,380 | ) | | 1997 | | December-07 | | 3 - 39 yrs. | | | 76 | |
Texarkana | | TX | | Courtyard | | | 0 | | | | 678 | | | | 12,656 | | | | 1,345 | | | | 14,679 | | | | (1,981 | ) | | 2003 | | March-08 | | 3 - 39 yrs. | | | 90 | |
Texarkana | | TX | | TownePlace Suites | | | 0 | | | | 615 | | | | 8,742 | | | | 320 | | | | 9,677 | | | | (1,676 | ) | | 2006 | | March-08 | | 3 - 39 yrs. | | | 85 | |
Charlottesville | | VA | | Courtyard | | | 15,217 | | | | 2,312 | | | | 26,436 | | | | 975 | | | | 29,723 | | | | (3,689 | ) | | 2000 | | June-08 | | 3 - 39 yrs. | | | 139 | |
Chesapeake | | VA | | Marriott Full Service | | | 0 | | | | 3,256 | | | | 36,384 | | | | 57 | | | | 39,697 | | | | (6,122 | ) | | 2008 | | October-08 | | 3 - 39 yrs. | | | 226 | |
Harrisonburg | | VA | | Courtyard | | | 0 | | | | 1,684 | | | | 22,137 | | | | 1,813 | | | | 25,634 | | | | (3,564 | ) | | 1999 | | November-07 | | 3 - 39 yrs. | | | 125 | |
Suffolk | | VA | | Courtyard | | | 8,195 | | | | 968 | | | | 11,684 | | | | 36 | | | | 12,688 | | | | (1,948 | ) | | 2007 | | July-08 | | 3 - 39 yrs. | | | 92 | |
Suffolk | | VA | | TownePlace Suites | | | 6,286 | | | | 750 | | | | 9,390 | | | | 12 | | | | 10,152 | | | | (1,527 | ) | | 2007 | | July-08 | | 3 - 39 yrs. | | | 72 | |
VA Beach | | VA | | Courtyard | | | 14,235 | | | | 7,203 | | | | 20,708 | | | | 2,216 | | | | 30,127 | | | | (3,151 | ) | | 1999 | | June-08 | | 3 - 39 yrs. | | | 141 | |
VA Beach | | VA | | Courtyard | | | 17,180 | | | | 9,871 | | | | 30,988 | | | | 2,080 | | | | 42,939 | | | | (5,060 | ) | | 2002 | | June-08 | | 3 - 39 yrs. | | | 160 | |
Tukwila | | WA | | Homewood Suites | | | 9,667 | | | | 1,388 | | | | 14,756 | | | | 2,614 | | | | 18,758 | | | | (2,743 | ) | | 1991 | | July-08 | | 3 - 39 yrs. | | | 106 | |
Construction in Progress | | | | | 0 | | | | 0 | | | | 0 | | | | 82 | | | | 82 | | | | 0 | | | | | | | | | | | |
| | | | | | $ | 219,250 | | | $ | 87,645 | | | $ | 902,694 | | | $ | 62,092 | | | $ | 1,052,431 | | | $ | (163,209 | ) | | | | | | | | | 5,912 | |
(1) Land is owned fee simple unless cost is $0 which means the property is subject to a ground lease. |
Investment in hotels at December 31, 2012, consisted of the following (in thousands):
Land | | $ | 87,645 | |
Building and Improvements | | | 883,855 | |
Furniture, Fixtures and Equipment | | | 78,308 | |
Franchise Fees | | | 2,623 | |
| | | 1,052,431 | |
Less Accumulated Depreciation | | | (163,209 | ) |
Investment in real estate, net | | $ | 889,222 | |
For additional information about the Company’s properties, refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al, putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries
Item 4. Mine Safety Disclosures
Not applicable.
PART II
| Market For Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities |
Common Shares
There is currently no established public trading market in which the Company’s common shares are traded. As of December 31, 2012 there were 92.8 million Units outstanding. Each Unit consists of one common share, no par value, and one series A preferred share of the Company. As of February 28, 2013 the Units were held by approximately 19,700 beneficial shareholders.
The Company is currently selling Units to its existing shareholders at a price of $11.00 per share through its Dividend Reinvestment Plan. This price is based on the most recent price at which an unrelated person purchased the Company’s Units from the Company. The Company also uses the original price paid for Units ($11.00 per Unit in most cases) for redemptions under its Unit Redemption Program with the intention of providing limited liquidity based on those interested in purchasing additional Units through the Company’s Dividend Reinvestment Plan. As discussed further below, since inception of the Company’s Dividend Reinvestment Plan and Unit Redemption Program, 9.1 million Units have been issued and 7.4 million Units redeemed. The price of $11.00 is not based on an appraisal or valuation of the Company or its assets. In 2011 there were two tender offers made for the Units of the Company by the same bidders. The weighted average price paid for the 17,403 (0.02% of the outstanding Units) acquired through the offers was $3.13 per Unit. In February 2013, the same bidders announced a tender offer to purchase Units of the Company for $3.50 per Unit; unless extended, the offer expires in March 2013.
Distribution Policy
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions during 2012 totaled $51.2 million and were paid at a monthly rate of $0.045833 per common share. Distributions in 2011 totaled $62.1 million and were paid at a monthly rate of $0.064167 per common share during the first six months of 2011, and at a monthly rate of $0.045833 per common share during the last six months of 2011. Distributions in 2010 totaled $72.5 million and were paid monthly at a rate of $0.064167 per common share. Although the Company intends to continue paying distributions on a monthly basis, the amount and timing of distributions to shareholders are within the discretion of the Company’s Board of Directors. The amount and frequency of future distributions will depend on the Company’s results of operations, cash flow from operations, economic conditions, working capital requirements, cash requirements to fund investing and financing activities, capital expenditure requirements, including improvements to and expansions of properties, as well as the distribution requirements under federal income tax provisions for qualification as a REIT. The Company’s unsecured credit facility has loan covenants which can and may impose restrictions on the amount of distributions declared by the Company. As of December 31, 2012, distributions plus Unit redemptions, net of proceeds from the Company’s Dividend Reinvestment Plan, cannot exceed $68.0 million in any cumulative 12 month period, and quarterly distributions cannot exceed $0.1375 per share, unless such distributions are less than total funds from operations (as defined within the credit facility) for the quarter and 12 month period, or the Company is required to distribute more to meet REIT requirements. In 2013 the Company’s Board of Directors approved a reduction of the monthly distribution rate to $0.038958 ($0.4675 on an annual basis) effective for the distribution the Company plans to pay in April 2013.
Dividend Reinvestment Plan
In the second quarter of 2008 the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. The Company has registered 10 million Units for potential issuance under the plan. Since inception through December 31, 2012, approximately 9.1 million Units were issued under the plan representing approximately $99.9 million, including 1.0 million Units for $11.0 million in 2012 and 1.8 million Units for $20.0 million in 2011. As of December 31, 2012 and 2011, the Company had approximately 18.1 million and 22.7 million Units participating in the Dividend Reinvestment Plan. Since there continues to be demand for the Units at $11 per Unit, the Company’s Board of Directors does not believe the offering price under the Dividend Reinvestment Plan should be changed at this time. However, the Board of Directors could change the price as it determines appropriate.
Unit Redemption Program
In October 2008, 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 92% of the price paid per Unit if the Units have been owned less than three years or 100% of the price per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any 12-month period is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price for redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. As noted below, during 2011 and 2012 the total redemption requests exceeded the authorized amount of redemptions and the Board of Directors has limited, and will continue to limit, the amount of redemptions as it deems prudent.
Since inception of the program through December 31, 2012, the Company has redeemed approximately 7.4 million Units in the amount of $79.3 million, including 1.7 million Units in the amount of $18.3 million in 2012 and 2.9 million Units in the amount of $32.1 million in 2011. As contemplated by the program, beginning with the January 2011 redemption, the Company redeemed Units on a pro-rata basis with approximately 63%, 48%, 9% and 4% of the amounts requested redeemed in the first, second, third and fourth quarters of 2011, respectively. Approximately 2% of the number of shares requested for redemption was redeemed in each quarter of 2012, leaving approximately 18.7 million Units requested but not redeemed as of the last scheduled redemption date in 2012 (October 2012). Prior to 2011, the Company had redeemed 100% of redemption requests. The Company has a number of cash sources including cash from operations, dividend reinvestment plan proceeds, proceeds from borrowings and asset sales from which it can make redemptions. See the Company’s complete consolidated statements of cash flows for the years ended December 31, 2012, 2011 and 2010 included in the Company’s audited financial statements in Item 8 of this Form 10-K for a further description of the sources and uses of the Company’s cash flows. The following is a summary of Unit redemptions during 2011 and 2012:
| | Requested Unit Redemptions | | | | | | Redemption Requests not Redeemed | |
January 2011 | | | 1,168,279 | | | | 732,647 | | | | 435,632 | |
April 2011 | | | 1,529,096 | | | | 729,016 | | | | 800,080 | |
July 2011 | | | 8,255,381 | | | | 736,960 | | | | 7,518,421 | |
October 2011 | | | 17,938,386 | | | | 727,604 | | | | 17,210,782 | |
January 2012 | | | 18,910,430 | | | | 454,405 | | | | 18,456,025 | |
April 2012 | | | 18,397,381 | | | | 454,638 | | | | 17,942,743 | |
July 2012 | | | 18,607,044 | | | | 362,553 | | | | 18,244,491 | |
October 2012 | | | 19,112,925 | | | | 391,142 | | | | 18,721,783 | |
The following is a summary of redemptions during the fourth quarter of 2012 (no redemptions occurred in November and December 2012):
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 | |
October 2012 | | | 391,142 | | | $ | 10.98 | | | | 391,142 | | | | (1) | |
(1) | The maximum number of Units that may be redeemed in any 12 month period is limited to up to five percent (5.0%) of the weighted average number of Units outstanding from the beginning of the 12 month period, subject to the Company’s right to change the number of Units to be redeemed. |
Series A Preferred Shares
The Series A preferred shares have no voting rights and no conversion rights. In addition, the Series A preferred shares are not separately tradable from the common shares to which they relate. The Series A preferred shares do not have any
distribution rights except a priority distribution upon the sale of the Company’s assets. The priority distribution (“Priority Distribution”) is equal to $11.00 per Series A preferred share, and will be paid before any distribution will be made to the holders of any other shares. Upon the Priority Distribution the Series A preferred shares will have no other distribution rights.
Series B Convertible Preferred Shares
In January 2007 the Company issued 240,000 Series B convertible preferred shares to Glade M. Knight, the Company’s Chairman and Chief Executive Officer. There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the Articles of Incorporation that would adversely affect the Series B convertible preferred shares. Upon liquidation, each holder of the Series B convertible preferred shares is entitled to a priority liquidation payment. However the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares into which each Series B convertible preferred share would convert. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis. The Series B convertible preferred shares are convertible into common shares upon and for 180 days following the occurrence of any of the following events: (1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company’s business; or (2) the termination or expiration without renewal of the advisory agreement with A8A, or if the company ceases to use ASRG to provide property acquisition and disposition services; or (3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Preferred Shares
The Company’s articles of incorporation authorize issuance of up to 15 million additional preferred shares. No preferred shares other than the Series A preferred shares and the Series B convertible preferred shares (discussed above) have been issued. The Company believes that the authorization to issue additional preferred shares benefits the Company and its shareholders by permitting flexibility in financing additional growth, giving the Company additional financing options in corporate planning and in responding to developments in business, including financing of additional acquisitions and other general corporate purposes. Having authorized preferred shares available for issuance in the future gives the Company the ability to respond to future developments and allows preferred shares to be issued without the expense and delay of a special shareholders’ meeting. At present, the Company has no specific financing or acquisition plans involving the issuance of additional preferred shares and the Company does not propose to fix the characteristics of any series of preferred shares in anticipation of issuing preferred shares other than the Series A preferred shares and Series B convertible preferred shares discussed above. The Company cannot now predict whether or to what extent, if any, additional preferred shares will be used or if so used what the characteristics of a particular series may be. The voting rights and rights to distributions of the holders of common shares will be subject to the prior rights of the holders of any subsequently-issued preferred shares. Unless otherwise required by applicable law or regulation, the preferred shares would be issuable without further authorization by holders of the common shares and on such terms and for such consideration as may be determined by the Board of Directors. The preferred shares could be issued in one or more series having varying voting rights, redemption and conversion features, distribution (including liquidating distribution) rights and preferences, and other rights, including rights of approval of specified transactions. A series of preferred shares could be given rights that are superior to rights of holders of common shares and a series having preferential distribution rights could limit common share distributions and reduce the amount holders of common shares would otherwise receive on dissolution.
Non-Employee Directors Stock Option Plan and Incentive Plan
The Company’s Board of Directors has adopted and the Company’s shareholders have approved a Non-Employee Directors Stock Option Plan and an Incentive Plan. The options issued under each plan convert upon exercise of the options to Units. Each Unit consists of one common share and one Series A preferred share of the Company. As of December 31, 2012, options to purchase 394,208 Units were outstanding with a weighted average exercise price of $11 per Unit under the Directors Plan. No options have been issued under the Incentive Plan. The following is a summary of securities issued under the plans as of December 31, 2012:
Plan Category | | Number of securities to be issued upon exercise of outstanding options, warrants and rights | | | Weighted-average exercise price of outstanding options, warrants and rights | | | Number of securities remaining available for future issuance under equity compensation plans | |
Equity Compensation plans approved by security holders | | | | | | | | | |
Non-Employee Directors Stock Option Plan | | | 394,208 | | | $ | 11.00 | | | | 1,205,337 | |
Incentive Plan | | | — | | | $ | — | | | | 4,029,318 | |
Item 6. Selected Financial Data
The following table sets forth selected financial data for each of the five years ended December 31, 2012. Certain information in the table has been derived from the Company’s audited financial statements and notes thereto. This data should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, the Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Annual Report on Form 10-K.
(in thousands except per share and statistical data) | | | | | | | | | | | | | | | |
Revenues: | | | | | | | | | | | | | | | |
Room revenue | | $ | 183,913 | | | $ | 177,009 | | | $ | 169,944 | | | $ | 158,316 | | | $ | 124,208 | |
Other revenue | | | 14,015 | | | | 13,695 | | | | 12,678 | | | | 12,569 | | | | 9,076 | |
Total revenue | | | 197,928 | | | | 190,704 | | | | 182,622 | | | | 170,885 | | | | 133,284 | |
| | | | | | | | | | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | | | | | | | | | |
Hotel operating expenses | | | 117,815 | | | | 113,203 | | | | 108,987 | | | | 105,091 | | | | 77,612 | |
Taxes, insurance and other | | | 10,014 | | | | 9,369 | | | | 10,089 | | | | 10,188 | | | | 6,818 | |
Land lease expense | | | 6,400 | | | | 6,391 | | | | 6,386 | | | | 6,376 | | | | 6,258 | |
General and administrative | | | 6,576 | | | | 5,302 | | | | 5,216 | | | | 4,523 | | | | 4,359 | |
Depreciation | | | 36,961 | | | | 35,987 | | | | 34,979 | | | | 32,907 | | | | 22,044 | |
Net gain from mortgage debt restructuring and extinguishment | | | - | | | | (1,093 | ) | | | - | | | | - | | | | - | |
Investment income, net | | | (19 | ) | | | (23 | ) | | | (3,076 | ) | | | (1,071 | ) | | | (2,225 | ) |
Interest expense | | | 14,666 | | | | 12,104 | | | | 9,166 | | | | 7,366 | | | | 4,153 | |
Total expenses | | | 192,413 | | | | 181,240 | | | | 171,747 | | | | 165,380 | | | | 119,019 | |
Net income | | $ | 5,515 | | | $ | 9,464 | | | $ | 10,875 | | | $ | 5,505 | | | $ | 14,265 | |
| | | | | | | | | | | | | | | | | | | | |
Per Share | | | | | | | | | | | | | | | | | | | | |
Net income per common share | | $ | 0.06 | | | $ | 0.10 | | | $ | 0.12 | | | $ | 0.06 | | | $ | 0.16 | |
Distributions paid to common shareholders per share | | $ | 0.55 | | | $ | 0.66 | | | $ | 0.77 | | | $ | 0.81 | | | $ | 0.88 | |
Weighted-average common shares outstanding - basic and diluted | | | 93,046 | | | | 93,998 | | | | 94,170 | | | | 92,963 | | | | 87,271 | |
| | | | | | | | | | | | | | | | | | | | |
Balance Sheet Data (at end of period) | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 68 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
Investment in real estate, net | | $ | 889,222 | | | $ | 914,594 | | | $ | 945,312 | | | $ | 974,773 | | | $ | 982,886 | |
Total assets | | $ | 912,864 | | | $ | 935,709 | | | $ | 962,486 | | | $ | 998,851 | | | $ | 1,003,048 | |
Notes payable | | $ | 264,019 | | | $ | 236,257 | | | $ | 200,439 | | | $ | 184,175 | | | $ | 138,704 | |
Shareholders' equity | | $ | 619,175 | | | $ | 671,988 | | | $ | 736,569 | | | $ | 789,099 | | | $ | 842,304 | |
Net book value per share | | $ | 6.67 | | | $ | 7.19 | | | $ | 7.78 | | | $ | 8.43 | | | $ | 9.11 | |
| | | | | | | | | | | | | | | | | | | | |
Other Data | | | | | | | | | | | | | | | | | | | | |
Cash Flow From (Used In): | | | | | | | | | | | | | | | | | | | | |
Operating activities | | $ | 46,138 | | | $ | 45,396 | | | $ | 44,249 | | | $ | 45,739 | | | $ | 39,714 | |
Investing activities | | $ | (14,495 | ) | | $ | (7,898 | ) | | $ | 711 | | | $ | (30,379 | ) | | $ | (766,854 | ) |
Financing activities | | $ | (31,575 | ) | | $ | (37,498 | ) | | $ | (44,960 | ) | | $ | (15,360 | ) | | $ | 165,131 | |
(in thousands except per share and statistical data) | | | | | | | | | | | | | | | |
Number of hotels owned at end of period | | | 51 | | | | 51 | | | | 51 | | | | 51 | | | | 51 | |
Average Daily Rate (ADR) (b) | | $ | 116 | | | $ | 113 | | | $ | 112 | | | $ | 112 | | | $ | 121 | |
Occupancy | | | 73 | % | | | 72 | % | | | 70 | % | | | 66 | % | | | 69 | % |
Revenue Per Available Room (RevPAR) (c) | | $ | 85 | | | $ | 82 | | | $ | 79 | | | $ | 73 | | | $ | 83 | |
Total Rooms Sold (d) | | | 1,584,570 | | | | 1,560,155 | | | | 1,515,805 | | | | 1,414,748 | | | | 1,027,472 | |
Total Rooms Available (e) | | | 2,162,138 | | | | 2,156,180 | | | | 2,155,648 | | | | 2,155,621 | | | | 1,490,606 | |
| | | | | | | | | | | | | | | | | | | | |
Funds From Operations Calculation (a) | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 5,515 | | | $ | 9,464 | | | $ | 10,875 | | | $ | 5,505 | | | $ | 14,265 | |
Depreciation of real estate owned | | | 36,961 | | | | 35,987 | | | | 34,979 | | | | 32,907 | | | | 22,044 | |
Funds from operations | | $ | 42,476 | | | $ | 45,451 | | | $ | 45,854 | | | $ | 38,412 | | | $ | 36,309 | |
(a) Funds from operations (FFO) is defined as net income (computed in accordance with generally accepted accounting principles—GAAP) excluding gains and losses from sales of depreciable property, plus depreciation and amortization. The Company considers FFO in evaluating property acquisitions and its operating performance and believes that FFO should be considered along with, but not as an alternative to, net income and cash flows as a measure of the Company's activities in accordance with GAAP. The Company considers FFO as a supplemental measure of operating performance in the real estate industry, and along with the other financial measures included in this Form 10-K, including net income, cash flow from operating activities, financing activities and investing activities, it provides investors with an indication of the performance of the Company. The Company's definition of FFO is not necessarily the same as such terms that are used by other companies. FFO is not necessarily indicative of cash available to fund cash needs. |
(b) Total room revenue divided by number of rooms sold. |
(c) ADR multiplied by occupancy percentage. |
(d) Represents the number of room nights sold during the period. |
(e) Represents the number of rooms owned by the Company multiplied by the number of nights in the period. |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classifications as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Annual Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission and Item 1A in this report. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statement or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
Overview
Apple REIT Eight, Inc., together with its wholly owned subsidiaries (the “Company”), was formed to invest in hotels and other income-producing real estate in the United States. The Company was initially capitalized on January 22, 2007, with its first investor closing on July 27, 2007. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in April 2008. The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. As of December 31, 2012, the Company owned 51 hotels (the Company’s first six hotels were acquired in November and December 2007, and 45 additional hotels were acquired during 2008). Accordingly, the results of operations include only the results of operations of the hotels for the periods owned. Exclusive of interest income, the Company had no operating revenues before the first hotel acquisition in November 2007.
Hotel Operations
Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective markets, in general, has met the Company’s expectations for the periods owned. With the significant decline in economic conditions throughout the United States over the 2008 through 2010 time period, overall performance of the Company’s hotels has not met expectations since acquisition. Beginning in 2011 and continuing through 2012, the hotel industry and the Company’s revenues have shown improvement from the significant decline in the industry during 2008 through 2010. The Company’s revenue growth has been behind the industry due to certain of the Company’s local markets trailing the industry and due to rooms out of service for renovations completed by the Company. The Company’s operating income generally has also trailed the industry due to the revenue shortfall and increased operating costs at its New York hotel. Although there is no way to predict future general economic conditions, and there are several key factors that continue to negatively affect the economic recovery in the United States and add to general market uncertainty, including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the uncertainty surrounding the fiscal policy of the United States, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 for comparable hotels.
In evaluating financial condition and operating performance, the most important matters on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”), and market yield which compares an individual hotel’s results to other hotels in its local market, and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.
The following is a summary of results of the 51 hotels owned by the Company for the years ended December 31, 2012 and 2011:
(in thousands, except statistical data) | | Year ended December 31, 2012 | | | | | | Year ended December 31, 2011 | | | | | | | |
| | | | | | | | | | | | | | | |
Total revenues | | $ | 197,928 | | | | 100 | % | | $ | 190,704 | | | | 100 | % | | | 4 | % |
Hotel operating expenses | | | 117,815 | | | | 60 | % | | | 113,203 | | | | 59 | % | | | 4 | % |
Taxes, insurance and other expense | | | 10,014 | | | | 5 | % | | | 9,369 | | | | 5 | % | | | 7 | % |
Land lease expense | | | 6,400 | | | | 3 | % | | | 6,391 | | | | 3 | % | | | 0 | % |
General and administrative expense | | | 6,576 | | | | 3 | % | | | 5,302 | | | | 3 | % | | | 24 | % |
| | | | | | | | | | | | | | | | | | | | |
Depreciation | | | 36,961 | | | | | | | | 35,987 | | | | | | | | 3 | % |
Net gain from mortgage debt restructuring and extinguishment | | | - | | | | | | | | 1,093 | | | | | | | | N/A | |
Interest expense, net | | | 14,647 | | | | | | | | 12,081 | | | | | | | | 21 | % |
| | | | | | | | | | | | | | | | | | | | |
Number of hotels | | | 51 | | | | | | | | 51 | | | | | | | | 0 | % |
Average Market Yield(1) | | | 128 | | | | | | | | 130 | | | | | | | | -2 | % |
ADR | | $ | 116 | | | | | | | $ | 113 | | | | | | | | 3 | % |
Occupancy | | | 73 | % | | | | | | | 72 | % | | | | | | | 1 | % |
RevPAR | | $ | 85 | | | | | | | $ | 82 | | | | | | | | 4 | % |
| | | | | | | | | | | | | | | | | | | | |
(1)Statistics calculated from data provided by Smith Travel Research, Inc.®. Excludes hotels under renovation during the applicable periods. | | | | | |
Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al, putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Hotels Owned
As of December 31, 2012, the Company owned 51 hotels, with a total of 5,912 rooms. The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each hotel. All dollar amounts are in thousands.
City | | State | | Brand | | Manager | | | | Rooms | | | | |
Greensboro | | NC | | SpringHill Suites | | Newport | | 11/9/2007 | | | 82 | | | $ | 8,000 | |
Somerset | | NJ | | Courtyard | | Newport | | 11/9/2007 | | | 162 | | | | 16,000 | |
Harrisonburg | | VA | | Courtyard | | Newport | | 11/16/2007 | | | 125 | | | | 23,219 | |
Bowling Green | | KY | | Hampton Inn | | Newport | | 12/6/2007 | | | 130 | | | | 18,832 | |
Chattanooga | | TN | | Homewood Suites | | LBA | | 12/14/2007 | | | 76 | | | | 8,600 | |
Tulsa | | OK | | Hampton Inn & Suites | | Western | | 12/28/2007 | | | 102 | | | | 10,200 | |
Port Wentworth | | GA | | Hampton Inn | | Newport | | 1/2/2008 | | | 106 | | | | 10,780 | |
New York | | NY | | Renaissance | | Marriott | | 1/4/2008 | | | 202 | | | | 99,000 | |
Marlborough | | MA | | Residence Inn | | True North | | 1/15/2008 | | | 112 | | | | 20,200 | |
City | | State | | Brand | | Manager | | | | | Rooms | | | | | |
Annapolis | | MD | | Hilton Garden Inn | | White | | 1/15/2008 | | | 126 | | | $ | 25,000 | |
Matthews | | NC | | Hampton Inn | | Newport | | 1/15/2008 | | | 92 | | | | 11,300 | |
Dunn | | NC | | Hampton Inn | | McKibbon | | 1/24/2008 | | | 120 | | | | 12,500 | |
Tallahassee | | FL | | Hilton Garden Inn | | LBA | | 1/25/2008 | | | 85 | | | | 13,200 | |
Rogers | | AR | | Fairfield Inn & Suites | | Intermountain | | 2/29/2008 | | | 99 | | | | 8,000 | |
Rogers | | AR | | Residence Inn | | Intermountain | | 2/29/2008 | | | 88 | | | | 11,744 | |
Westford | | MA | | Hampton Inn & Suites | | True North | | 3/6/2008 | | | 110 | | | | 15,250 | |
Sacramento | | CA | | Hilton Garden Inn | | Dimension | | 3/7/2008 | | | 154 | | | | 27,630 | |
Concord | | NC | | Hampton Inn | | Newport | | 3/7/2008 | | | 101 | | | | 9,200 | |
Texarkana | | TX | | Courtyard | | Intermountain | | 3/7/2008 | | | 90 | | | | 12,924 | |
Texarkana | | TX | | TownePlace Suites | | Intermountain | | 3/7/2008 | | | 85 | | | | 9,057 | |
Springdale | | AR | | Residence Inn | | Intermountain | | 3/14/2008 | | | 72 | | | | 5,606 | |
Sanford | | FL | | SpringHill Suites | | LBA | | 3/14/2008 | | | 105 | | | | 11,150 | |
Overland Park | | KS | | SpringHill Suites | | True North | | 3/17/2008 | | | 102 | | | | 8,850 | |
Cypress | | CA | | Courtyard | | Dimension | | 4/30/2008 | | | 180 | | | | 31,164 | |
Overland Park | | KS | | Residence Inn | | True North | | 4/30/2008 | | | 120 | | | | 15,850 | |
Westford | | MA | | Residence Inn | | True North | | 4/30/2008 | | | 108 | | | | 14,850 | |
Kansas City | | MO | | Residence Inn | | True North | | 4/30/2008 | | | 106 | | | | 17,350 | |
Fayetteville | | NC | | Residence Inn | | Intermountain | | 5/9/2008 | | | 92 | | | | 12,201 | |
Burbank | | CA | | Residence Inn | | Marriott | | 5/13/2008 | | | 166 | | | | 50,500 | |
Oceanside | | CA | | Residence Inn | | Marriott | | 5/13/2008 | | | 125 | | | | 28,750 | |
Winston-Salem | | NC | | Courtyard | | McKibbon | | 5/19/2008 | | | 122 | | | | 13,500 | |
Greenville | | SC | | Residence Inn | | McKibbon | | 5/19/2008 | | | 78 | | | | 8,700 | |
Birmingham | | AL | | Homewood Suites | | McKibbon | | 5/23/2008 | | | 95 | | | | 16,500 | |
Hilton Head | | SC | | Hilton Garden Inn | | McKibbon | | 5/29/2008 | | | 104 | | | | 13,500 | |
Carolina Beach | | NC | | Courtyard | | Crestline | | 6/5/2008 | | | 144 | | | | 24,214 | |
Charlottesville | | VA | | Courtyard | | Crestline | | 6/5/2008 | | | 139 | | | | 27,900 | |
Virginia Beach | | VA | | Courtyard | | Crestline | | 6/5/2008 | | | 141 | | | | 27,100 | |
Virginia Beach | | VA | | Courtyard | | Crestline | | 6/5/2008 | | | 160 | | | | 39,700 | |
Wichita | | KS | | Courtyard | | Intermountain | | 6/13/2008 | | | 90 | | | | 8,874 | |
Jacksonville | | FL | | Homewood Suites | | McKibbon | | 6/17/2008 | | | 119 | | | | 23,250 | |
Tampa | | FL | | TownePlace Suites | | McKibbon | | 6/17/2008 | | | 95 | | | | 11,250 | |
Tulare | | CA | | Hampton Inn & Suites | | Inn Ventures | | 6/26/2008 | | | 86 | | | | 10,331 | |
San Jose | | CA | | Homewood Suites | | Dimension | | 7/2/2008 | | | 140 | | | | 21,862 | |
Suffolk | | VA | | Courtyard | | Crestline | | 7/2/2008 | | | 92 | | | | 12,500 | |
Suffolk | | VA | | TownePlace Suites | | Crestline | | 7/2/2008 | | | 72 | | | | 10,000 | |
Tukwila | | WA | | Homewood Suites | | Dimension | | 7/2/2008 | | | 106 | | | | 15,707 | |
Savannah | | GA | | Hilton Garden Inn | | Newport | | 7/31/2008 | | | 105 | | | | 12,500 | |
Overland Park | | KS | | Fairfield Inn & Suites | | True North | | 8/20/2008 | | | 110 | | | | 12,050 | |
Columbia | | SC | | Hilton Garden Inn | | Newport | | 9/22/2008 | | | 143 | | | | 21,200 | |
Chesapeake | | VA | | Marriott | | Crestline | | 10/21/2008 | | | 226 | | | | 38,400 | |
Wilmington | | NC | | Fairfield Inn & Suites | | Crestline | | 12/11/2008 | | | 122 | | | | 14,800 | |
| | | | | | | | | | | 5,912 | | | $ | 950,745 | |
Management and Franchise Agreements
Each of the Company’s 51 hotels are operated and managed, under separate management agreements, by affiliates of one of the following companies: Newport Hospitality Group, Inc. (“Newport”), Larry Blumberg & Associates (“LBA”), Western International (“Western”), Marriott International, Inc. (“Marriott”), White Lodging Services Corporation (“White”), Dimension Development Company (“Dimension”), Inn Ventures, Inc. (“Inn Ventures”), True North Hotel Group, Inc. (“True North”), Intermountain Management, LLC (“Intermountain”), MHH Management, LLC (“McKibbon”) or Crestline Hotels & Resorts, Inc. (“Crestline”). The agreements generally provide for initial terms ranging from one to thirty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.0 million, $6.8 million and $6.3 million in management fees.
Newport, LBA, Western, White, Dimension, Inn Ventures, True North, Intermountain, McKibbon and Crestline are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for initial terms of 10 to 20 years. Fees associated with the agreements generally include the payment of royalty fees and program fees. The Marriott franchise agreements provide for initial terms of 10 to 30 years. Fees associated with the agreements include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010 the Company incurred approximately $7.7 million, $7.4 million and $7.1 million in franchise fees.
Results of Operations for Years 2012 and 2011
As of December 31, 2012, the Company owned 51 hotels with 5,912 rooms. The Company’s portfolio of hotels owned is unchanged since December 31, 2011. Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy had a considerable negative impact on both consumer and business travel. However, economic conditions have shown evidence of improvement during the past two years. As a result, the Company expects improvement in revenue and operating income in 2013 as compared to 2012. The Company’s hotels in general have shown results consistent with its local markets and brand averages for the period of ownership.
The Company separately evaluates the performance of each of its hotel properties. Due to the significance of the New York, New York hotel’s revenues, the Company has two reportable segments.
Revenues
The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue. For the year ended December 31, 2012, the Company had total revenue of $197.9 million. Revenue for the New York hotel was $22.7 million or 11% of total revenue for the year. For the year, the hotels achieved combined average occupancy of approximately 73%, ADR of $116 and RevPAR of $85. The New York hotel had average occupancy of 88%, ADR of $288 and RevPAR of $253. All other hotels combined had occupancy of 73%, ADR of $109 and RevPAR of $79. RevPAR is calculated as ADR multiplied by the occupancy percentage. ADR is calculated as room revenue divided by the number of rooms sold.
For the year ended December 31, 2011, the Company had total revenue of $190.7 million. Revenue for the New York hotel was $21.6 million or 11% of total revenue for the year. For the year, the hotels achieved combined average occupancy of approximately 72%, ADR of $113 and RevPAR of $82. The New York hotel had average occupancy of 86%, ADR of $288 and RevPAR of $246. All other hotels combined had occupancy of 72%, ADR of $106 and RevPAR of $76.
During 2012, the Company experienced a modest increase in demand as demonstrated by the improvement in average occupancy for its hotels, from 72% in 2011 to 73% in 2012. In addition, also signifying a stabilizing economy, the Company experienced an increase in ADR of 3% for its hotels for 2012, as compared to 2011. During 2012, the Company’s revenue growth and occupancy were impacted by approximately 13,300 rooms out of service for renovations, resulting in below industry average growth during this time period, and certain markets were impacted by additional supply or government spending reductions. With continued demand and room rate improvement, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012.
Although impacted by increased supply in certain markets, the Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for 2012 and 2011 was 128 and 130, respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue.
Expenses
Hotel operating expenses consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the year ended December 31, 2012, hotel operating expenses of the Company’s hotels totaled $117.8 million or 60% of total revenue. The New York hotel had operating expenses of $13.4 million or 59% of its total revenue for the year. For the year ended December 31, 2011, hotel operating expenses were $113.2 million or 59% of total revenue. The New York hotel had operating expenses of $12.3 million
or 57% of its total revenue for the year. Overall hotel operational expenses for 2012 reflect the impact of modest increases in revenues and occupancy at most of the Company’s hotels, and the Company’s efforts to control costs. The increase in hotel expenses at the New York hotel is primarily due to union contract increases for salaries and benefits and a scheduled hotel management contract fee increase. The Company’s operating expenses were also impacted by several hotel renovations during 2012. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utility costs by continually monitoring and sharing utilization data across its hotels and management companies. Although operating expenses will increase as occupancy and revenue increase, the Company will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
Taxes, insurance, and other expense for each of 2012 and 2011 totaled $10.0 million (5% of total revenues for 2012) and $9.4 million (5% of total revenues for 2011), of which approximately $1.3 million and $800,000 related to the New York hotel. Overall, the Company’s real estate tax expense was higher in 2012, versus 2011, reflecting upward reassessments of some property values by localities resulting from the improved economy. Insurance rates for 2012 increased over 2011 due to property and casualty carriers’ casualty losses world-wide in the past year. With the improved economy, the Company anticipates continued increases in property tax assessments in 2013 and a moderate increase in insurance rates. The Company’s New York property will also continue to experience increased costs in future periods, as real estate tax incentives in place at purchase will decline over time.
Land lease expense was $6.4 million for both 2012 and 2011. This expense represents the expense incurred by the Company to lease land for five hotel properties. Land lease expense for the years ended December 31, 2012 and 2011 for the New York hotel was $5.9 million.
General and administrative expense for 2012 and 2011 was $6.6 million and $5.3 million. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding LLC, and reporting expenses. During 2012 and 2011, the Company incurred approximately $1.6 million and $1.0 million, respectively in legal costs related to the legal matters discussed herein and continued costs related to responding to requests from the staff of the Securities and Exchange Commission (“SEC”). The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy if the Company’s consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution. As discussed below under Related Parties, the Company shares legal counsel with the other Apple REIT Companies. Total costs for these legal matters for all of the Apple REIT Companies were approximately $7.3 million in 2012. The Company anticipates it will continue to incur significant legal costs at least during the first half of 2013 related to these matters. Also during the fourth quarter of 2011, the Company began to incur costs associated with its evaluation of a potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc. (the “other Apple REITs”). Total costs incurred during 2012 and 2011 related to this evaluation were approximately $0.5 million and $0.1 million. In May 2012, it was determined by the Board of Directors of the Company and the Boards of Directors of each of the other Apple REITs to not move forward with the potential consolidation transaction at that time.
Depreciation expense was $37.0 million for 2012 and $36.0 million for 2011. This expense includes $6.6 million and $6.5 million for the New York hotel in 2012 and 2011. Depreciation expense represents depreciation expense of the Company’s hotel buildings and related improvements, and associated furniture, fixtures and equipment, for the respective periods owned. The increase reflects capital improvements made by the Company during 2012 and 2011.
In the third quarter of 2011, the Company recognized a net gain of $1.1 million from mortgage debt restructuring and extinguishment. The net gain arose from the early extinguishment, at a discount to the principal amount outstanding, of a mortgage loan secured by one of the Company’s hotel properties. Simultaneously with the debt extinguishment, two additional mortgage loans with the same loan servicer were returned to current status, with the Company agreeing to payment of applicable fees and reimbursement of the loan servicer’s expenses incurred in the transaction.
Interest expense, net for 2012 and 2011 totaled $14.7 million and $12.1 million and primarily represents interest expense incurred on mortgage loans and lines of credit outstanding during the respective periods. The increase in 2012 is due to the increase in outstanding debt during the year and an increase in the Company’s average interest rate. Interest expense, net was
reduced by capitalized interest of approximately $0.4 million in 2012 related to renovations at six hotels. Two mortgage loans and a term loan were repaid and extinguished in 2011.
Results of Operations for Years 2011 and 2010
Revenues
For the year ended December 31, 2011, the Company had total revenue of $190.7 million. Revenue for the New York hotel was $21.6 million or 11% of total revenue for the year. For the year, the hotels achieved combined average occupancy of approximately 72%, ADR of $113 and RevPAR of $82. The New York hotel had average occupancy of 86%, ADR of $288 and RevPAR of $246. All other hotels combined had occupancy of 72%, ADR of $106 and RevPAR of $76. For the year ended December 31, 2010, the Company had total revenue of $182.6 million. Revenue for the New York hotel was $19.6 million or 11% of total revenue for the year. For the year, the hotels achieved combined average occupancy of approximately 70%, ADR of $112 and RevPAR of $79. The New York hotel had average occupancy of 85%, ADR of $271 and RevPAR of $229. All other hotels combined had occupancy of 70%, ADR of $105 and RevPAR of $74.
As reflected in the Company’s occupancy increase in 2011, the industry realized an overall increase in demand as compared to 2010. The increase was a result of the U.S. economy stabilizing and exhibiting some growth over prior year levels, generating more business and leisure travelers. While ADR for 2011 still trailed pre-recession levels, it improved over 2010 operating results. As a result, the Company’s RevPAR increased 4% for 2011 as compared to 2010.
Expenses
For the year ended December 31, 2011, hotel operating expenses of the Company’s hotels totaled $113.2 million or 59% of total revenue. The New York hotel had direct expenses of $12.3 million or 57% of its total revenue for the year. For the year ended December 31, 2010, hotel direct expenses were $109.0 million or 60% of total revenue. The New York hotel had direct expenses of $11.1 million or 57% of its total revenue for the year. Hotel operational expenses for 2011 reflect the impact of modest increases in revenues and occupancy at most of the Company’s hotels, and the Company’s efforts to control costs in a challenging and relatively flat to low-growth economic environment during 2011, versus the prior year. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company was successful in reducing relative to revenue increases in certain labor costs, hotel supply costs and utility costs by monitoring and sharing utilization data across its hotels and management companies.
Taxes, insurance, and other expense for each of 2011 and 2010 totaled $9.4 million (5% of total revenues for 2011) and $10.1 million (6% of total revenues for 2010) of which approximately $800,000 and $680,000 related to the New York hotel. Tax expense in 2011 reflects successful real estate assessment appeals at certain locations. New York hotel results in part reflect the scheduled decline in tax incentives in place at the purchase date of the hotel.
Land lease expense was $6.4 million for each of 2011 and 2010. This expense represents the expense incurred by the Company to lease land for five hotel properties. Land lease expense for the years ended December 31, 2011 and 2010 for the New York hotel was $5.9 million.
General and administrative expense for 2011 and 2010 was $5.3 million and $5.2 million. The Company incurred approximately $1.1 million in legal costs in 2011, an increase over prior years due to the legal and related matters discussed herein and costs related to requests from the staff of the SEC as discussed above. Also during the fourth quarter of 2011 the Company incurred costs of approximately $91,000 associated with the evaluation of a potential consolidation transaction with the other Apple REITs discussed above.
Depreciation expense was $36.0 million for 2011 and $35.0 million for 2010. This expense includes $6.5 million and $6.4 million for the New York hotel in 2011 and 2010. Depreciation expense represents depreciation expense of the Company’s hotel buildings and related improvements, and associated furniture, fixtures and equipment, for the respective periods owned. The increase reflects capital improvements made by the Company during 2011 and 2010.
In the first quarter of 2010, the Company sold its equity securities in a publicly traded real estate investment trust, resulting in realized gains and other investment income of approximately $3.0 million.
Interest expense for 2011 and 2010 totaled $12.1 million and $9.2 million and primarily represents interest expense incurred on mortgage loans assumed on 15 hotel properties acquired during 2008, four mortgage loans originated on existing hotel properties during 2011, and expenses associated with the Company’s lines of credit and term loans outstanding during the
respective periods. The increase in 2011 is due to the increase in outstanding debt during the year and the increase in the Company’s average interest rate. Interest expense is offset by capitalized interest of $0.1 million in 2010 in conjunction with renovations. Two mortgage loans and a term loan were repaid and extinguished in 2011.
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 arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section, and no new significant related party transactions during 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of this contract have totaled approximately $19.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees or expenses were incurred by the Company during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with A8A, pursuant to which A8A provides management services to the Company. A8A provides these management services through an affiliate called Apple Fund Management LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A8A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.0 million for each of the years ended December 31, 2012, 2011 and 2010.
In addition to the fees payable to A8A, the Company reimbursed A8A or paid directly to AFM on behalf of A8A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A8A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., A8A, Apple Nine Advisors, Inc.(“A9A”), Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc., Apple REIT Ten, Inc. and the Company (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, A9A entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, A9A and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to A9A, if it occurs, will have no impact on the Company’s advisory agreement with A8A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
ASRG and A8A are 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 Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the boards of Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was $1.9 million and $2.1 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.8 million respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
In 2010, Apple REIT Nine, Inc. purchased from the Company’s third party lender a note payable secured by the Columbia, South Carolina Hilton Garden Inn. The purchase of the note by Apple REIT Nine, Inc. had no financial effect on the Company. In December 2011, in accordance with the terms of the note, the note was extinguished by the Company through payment of all principal and interest due.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services.
In April 2011, the Company entered into a Loan Agreement (the “Loan Agreement”) with a commercial bank, which provided for a $20 million revolving credit facility with a maturity of April 2012. During the first quarter of 2012, the credit facility was extinguished and the outstanding principal balance totaling $20 million, plus accrued interest, was paid in full. The Loan Agreement was guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and was secured by assets of Mr. Knight. Mr. Knight did not receive any consideration in exchange for providing this guaranty and security. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement.
Series B Convertible Preferred Stock
The Company has issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with A8A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $50 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to the issuance of 240,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred at December 31, 2012, expense would have ranged from $0 to in excess of $63 million (assumes $11 per common share fair market value) which represents approximately 5.8 million shares of common stock.
Liquidity and Capital Resources
Contractual Commitments
The following is a summary of the Company’s significant commercial commitments as of December 31, 2012:
| | | | | Amount of Commitments Expiring per Period | |
Commercial Commitments (000's) | | Total | | | Less than 1 year | | | 2-3 Years | | | 4-5 Years | | | Over 5 Years | |
Debt (including interest of $48.4 million) | | $ | 312,950 | | | $ | 62,469 | | | $ | 97,569 | | | $ | 132,898 | | | $ | 20,014 | |
Ground leases | | | 228,939 | | | | 4,146 | | | | 8,689 | | | | 9,197 | | | | 206,907 | |
| | $ | 541,889 | | | $ | 66,615 | | | $ | 106,258 | | | $ | 142,095 | | | $ | 226,921 | |
Capital Resources
The Company has a $60 million unsecured line of credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. The facility was originated in March 2012 and the scheduled maturity of the facility is March 2013; however, the Company has the right and intends, upon satisfaction of certain conditions including covenant compliance and payment of an extension fee, to extend the maturity date to March 2014. Interest is payable monthly on the outstanding balance and the interest rate is equal to LIBOR (London Interbank Offered Rate for a one-month term) plus 3.0%, or the prime interest rate plus 2.0%, at the Company’s option. The Company is also required to pay a fee of 0.35% on the average unused balance of the credit facility. With the availability of this line of credit, the Company maintains little cash on hand, accessing the line as necessary. Cash on hand was approximately $0.1 million at December 31, 2012.
At closing in March 2012, the Company borrowed approximately $48 million under the credit facility to pay all outstanding balances and extinguish its previously existing $75 million and $20 million credit facilities, and pay transaction costs. At December 31, 2012, the outstanding balance under the credit facility was $45.3 million, and had an interest rate of approximately 3.21%. Loan origination costs totaling approximately $0.4 million are being amortized as interest expense through the March 2013 maturity date. The credit facility contains the following quarterly financial covenants (capitalized terms are defined in the loan agreement):
· | Tangible Net Worth must exceed $275 million; |
· | Total Debt to Asset Value must not exceed 50%; |
· | Distributions, net of proceeds from the Company’s Dividend Reinvestment Program, cannot exceed $17 million during any calendar quarter in 2012 (and must not exceed $68 million in any cumulative 12 month period thereafter), and quarterly Distributions cannot exceed $0.1375 per share, unless such Distributions are less than total Funds From Operations for the quarter; |
· | Loan balance must not exceed 45% of the Unencumbered Asset Value; |
· | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
· | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at December 31, 2012.
In September 2012, the Company entered into two secured mortgage loan agreements with a commercial lender. A mortgage loan for $9.7 million is secured by the Company’s Tukwila, Washington Homewood Suites; a separate mortgage loan for $9.0 million is secured by the Company’s Somerset, New Jersey Courtyard. Combined scheduled payments of interest and principal of $106 thousand are due monthly for each loan, and each loan will amortize on a 25 year term with a balloon payment due at maturity in October 2022. Each mortgage loan has an applicable fixed interest rate of approximately 4.73%. At closing, the Company used proceeds from each loan to reduce the outstanding balance on its credit facility, and to pay transaction costs. Combined total loan origination costs of approximately $0.2 million are being amortized as interest expense through the October 2022 maturity date of each loan.
In January 2012, the Company entered into a secured mortgage loan agreement with a commercial bank for $40 million. The loan is jointly secured by the Company’s Burbank, California Residence Inn and Oceanside, California Residence Inn. Interest is payable monthly on the outstanding balance of the loan at a variable interest rate of one-month LIBOR plus 4.25%. The loan matures in January 2015 with an option for the Company to extend the maturity for one year. Interest only is payable for the first year of the loan, with monthly principal payments of $65,000 required beginning in February 2013. Loan origination costs totaling approximately $0.5 million are being amortized as interest expense through the January 2015 maturity date.
To effectively fix the interest rate on the $40 million variable rate mortgage loan and reduce the Company’s exposure to interest rate risk, simultaneous with the closing of the loan the Company entered into an interest rate swap agreement with the same commercial bank. Under terms of the interest rate swap agreement, the Company pays a monthly fixed interest rate of 1.0% and receives a floating rate of interest equal to the one-month LIBOR, effectively fixing the interest rate of the $40 million
loan at 5.25%. The notional amount of $40 million for the interest rate swap amortizes in tandem with the amortization of the loan and matures with the loan agreement in January 2015. At closing on the loan and swap agreements in January 2012, the Company used the proceeds to reduce the outstanding balance on its prior credit facility and to pay transaction costs.
Capital Uses
The Company’s principal sources of liquidity are the operating cash flow generated from the Company’s properties and its $60 million revolving credit facility. The Company anticipates that cash flow from operations, the Company’s existing revolving line of credit facility, and access to commercial secured and unsecured credit markets will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions. Although reduced in July 2011, the Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions, capital improvements, ramp-up of new properties and varying economic cycles. With the depressed financial results of the Company and the lodging industry as compared to pre-recession levels, the Company has and will attempt if necessary 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 distributions further to required levels. If the Company were unable to extend maturing debt or enter into new borrowing agreements, or if it were to default on its debt, it may be unable to make distributions.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions in 2012 totaled $51.2 million and were paid at a monthly rate of $0.045833 per common share. For the same period the Company’s cash generated from operations was approximately $46.1 million. This shortfall includes a return of capital and was funded primarily by additional borrowings by the Company. The Company intends to continue paying distributions on a monthly basis. 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 of $0.045833 per month. In June 2011, the Board of Directors approved a reduction in the Company’s annual distribution rate from $0.77 to $0.55 per common share; the reduction of the distribution was effective beginning with the July 2011 distribution. 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 October 2008, 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 92% of the price paid per Unit if the Units have been owned less than three years or 100% of the price per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any 12-month period is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price for redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. Since the inception of the program through December 31, 2012, the Company has redeemed approximately 7.4 million Units in the amount of $79.3 million under the program, including 1.7 million Units in the amount of $18.3 million in 2012 and 2.9 million Units in the amount of $32.1 million redeemed in 2011. As contemplated by the program, beginning with the January 2011 redemption, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of Unit redemptions during 2011 and 2012:
| | Requested Unit Redemptions | | | | | | | |
January 2011 | | | 1,168,279 | | | | 732,647 | | | | 435,632 | |
April 2011 | | | 1,529,096 | | | | 729,016 | | | | 800,080 | |
July 2011 | | | 8,255,381 | | | | 736,960 | | | | 7,518,421 | |
October 2011 | | | 17,938,386 | | | | 727,604 | | | | 17,210,782 | |
January 2012 | | | 18,910,430 | | | | 454,405 | | | | 18,456,025 | |
April 2012 | | | 18,397,381 | | | | 454,638 | | | | 17,942,743 | |
July 2012 | | | 18,607,044 | | | | 362,553 | | | | 18,244,491 | |
October 2012 | | | 19,112,925 | | | | 391,142 | | | | 18,721,783 | |
As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent. Currently, the Company plans to redeem under its Unit Redemption Program approximately 1% of weighted average Units in 2013.
In the second quarter of 2008, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. The Company has registered 10 million Units for potential issuance under the plan. Since inception through December 31, 2012, approximately 9.1 million Units were issued under the plan representing approximately $99.9 million, including 1.0 million Units for $11.0 million in 2012 and 1.8 million Units for $20.0 million in 2011.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements, and under certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. As of December 31, 2012, the Company held $12.7 million in restricted cash escrow accounts reserved for capital expenditures. Total capital expenditures in 2012 were $11.6 million, and were $5.3 million in 2011. Due to a post-recessionary low-growth economic environment during 2011 and 2010, the Company invested a lower than normal amount in capital expenditures in 2011 and 2010. The Company anticipates 2013 capital improvements to be in the range of $15 to $18 million. The Company does not currently have any existing or planned projects for development.
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 historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.
Critical Accounting Policies
The following contains a discussion of what the Company believes to be critical accounting policies. These items should be read to gain a further understanding of the principles used to prepare the Company’s financial statements. These principles include application of judgment; therefore, changes in judgments may have a significant impact on the Company’s reported results of operations and financial condition.
Capitalization Policy
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
Impairment Losses Policy
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated
remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that were recently renovated or experienced other short-term business disruption. Since the Company’s planned initial hold period for each property is 39 years, the Company’s ongoing analysis and annual recoverability analysis have not identified any impairment losses and no impairment losses have been recorded to date. If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.
Subsequent Events
In January 2013, the Company declared and paid approximately $4.3 million, or $0.045833 per outstanding common share, in distributions to its common shareholders, of which approximately $0.8 million or 75,000 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 435,000 Units in the amount of $4.8 million. As contemplated in the Program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 2% of the total 19.5 million requested Units to be redeemed, with approximately 19.1 million requested Units not redeemed.
In February 2013, the Company declared and paid approximately $4.2 million, or $0.045833 per outstanding common share, in distributions to its common shareholders, of which approximately $0.8 million or 73,000 Units were issued under the Company’s Dividend Reinvestment Plan.
The Company’s Board of Directors approved a reduction in the Company’s projected distribution rate from an annual rate of $0.55 per common share to $0.4675 per common share. The change is effective with the distribution planned for April 2013. The distribution will continue to be paid monthly.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
With the exception of two interest rate swap transactions, the Company has not engaged in transactions in derivative financial instruments or derivative commodity instruments. The Company entered into interest rate swap agreements with a notional amount at December 31, 2012 of approximately $46.7 million, and based on the London InterBank Offered Rate (“LIBOR”), to increase stability and manage interest rate fluctuations related to interest expense on two variable rate mortgage loans. Neither swap is designated as a hedge, therefore the changes in the fair market values of each swap transaction are recorded in earnings. The Company recognized a net loss of approximately $36 thousand in 2012 from the combined change in fair value of the two derivative instruments, which is recorded in Interest expense in the Company’s Consolidated Statements of Operations.
As of December 31, 2012, the Company’s financial instruments were not exposed to significant market risk due to 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 on its credit facility and due to its variable interest rate term loans. The Company had an outstanding balance of $45.3 million on its $60.0 million credit facility at December 31, 2012, and to the extent it utilizes the credit facility, the Company will be exposed to changes in short-term interest rates. Additionally, the outstanding balance of the Company’s variable rate term mortgage loans was $46.7 million at December 31, 2012. Based on these outstanding balances at December 31, 2012, every 100 basis points change in interest rates can potentially impact the Company’s annual net income by approximately $0.9 million, with all other factors remaining the same. The Company’s cash balance at December 31, 2012 was approximately $0.1 million.
In addition to its variable rate debt discussed above, the Company has assumed fixed interest rate notes payable to lenders under permanent financing arrangements. The following table summarizes the annual maturities and average interest rates of the Company’s notes payable and lines of credit outstanding at December 31, 2012. All dollar amounts are in thousands.
| | 2013 | | | 2014 | | | 2015 | | | 2016 | | | 2017 | | | Thereafter | | | Total | | | | |
Total debt: | | | | | | | | | | | | | | | | | | | | | | | | |
Maturities | | $ | 49,533 | | | $ | 4,568 | | | $ | 70,786 | | | $ | 69,660 | | | $ | 53,522 | | | $ | 16,481 | | | $ | 264,550 | | | $ | 275,363 | |
Average interest rate | | | 5.4 | % | | | 5.5 | % | | | 5.7 | % | | | 5.8 | % | | | 5.5 | % | | | 4.7 | % | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Variable rate debt: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Maturities | | $ | 46,164 | | | $ | 938 | | | $ | 44,902 | | | $ | - | | | $ | - | | | $ | - | | | $ | 92,004 | | | $ | 92,795 | |
Average interest rate | | | 4.2 | % | | | 4.4 | % | | | 4.4 | % | | | - | | | | - | | | | - | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Fixed rate debt: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Maturities | | $ | 3,369 | | | $ | 3,630 | | | $ | 25,884 | | | $ | 69,660 | | | $ | 53,522 | | | $ | 16,481 | | | $ | 172,546 | | | $ | 182,568 | |
Average interest rate | | | 5.8 | % | | | 5.8 | % | | | 5.8 | % | | | 5.8 | % | | | 5.5 | % | | | 4.7 | % | | | | | | | | |
Item 8. Financial Statements and Supplementary Data
Report of Management
on Internal Control Over Financial Reporting
March 7, 2013
To the Shareholders
Apple REIT Eight, Inc.
Management of Apple REIT Eight, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
The Company’s internal control over financial reporting is supported by written policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the Company’s transactions and dispositions of the Company’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with generally accepted accounting principles, and the receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In connection with the preparation of the Company’s annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of those controls.
Based on this assessment, management has concluded that as of December 31, 2012, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Ernst & Young LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this report, has issued an attestation report on the Company’s internal control over financial reporting, a copy of which appears on the next page of this annual report.
/s/ GLADE M. KNIGHT | | /s/ BRYAN PEERY |
Glade M. Knight | | Bryan Peery |
Chairman and Chief Executive Officer | | Chief Financial Officer (Principal Accounting Officer) |
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
The Board of Directors and Shareholders of
Apple REIT Eight, Inc.
We have audited Apple REIT Eight, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Apple REIT Eight, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Apple REIT Eight, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2012 consolidated financial statements of Apple REIT Eight, Inc. and our report dated March 7, 2013 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Richmond, Virginia
March 7, 2013
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Apple REIT Eight, Inc.
We have audited the accompanying consolidated balance sheets of Apple REIT Eight, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Apple REIT Eight, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Apple REIT Eight, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2013 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Richmond, Virginia
March 7, 2013
APPLE REIT EIGHT, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)
| | As of December 31, | |
| | 2012 | | | 2011 | |
Assets | | | | | | |
Investment in real estate, net of accumulated depreciation of $163,209 and $126,248, respectively | | $ | 889,222 | | | $ | 914,594 | |
Cash and cash equivalents | | | 68 | | | | 0 | |
Restricted cash-furniture, fixtures and other escrows | | | 14,420 | | | | 11,822 | |
Due from third party managers, net | | | 4,391 | | | | 4,449 | |
Other assets, net | | | 4,763 | | | | 4,844 | |
Total Assets | | $ | 912,864 | | | $ | 935,709 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Credit facilities | | $ | 45,300 | | | $ | 73,213 | |
Mortgage debt | | | 218,719 | | | | 163,044 | |
Accounts payable and accrued expenses | | | 20,796 | | | | 17,726 | |
Intangible liabilities, net | | | 8,874 | | | | 9,738 | |
Total Liabilities | | | 293,689 | | | | 263,721 | |
| | | | | | | | |
Shareholders' Equity | | | | | | | | |
Preferred stock, authorized 15,000,000 shares; none issued and outstanding | | | 0 | | | | 0 | |
Series A preferred stock, no par value, authorized 200,000,000 shares; issued and outstanding 92,840,914 and 93,506,042 shares, respectively | | | 0 | | | | 0 | |
Series B convertible preferred stock, no par value, authorized 240,000 shares; issued and outstanding 240,000 shares | | | 24 | | | | 24 | |
Common stock, no par value, authorized 200,000,000 shares; issued and outstanding 92,840,914 and 93,506,042 shares, respectively | | | 919,605 | | | | 926,759 | |
Distributions greater than net income | | | (300,454 | ) | | | (254,795 | ) |
Total Shareholders' Equity | | | 619,175 | | | | 671,988 | |
Total Liabilities and Shareholders' Equity | | $ | 912,864 | | | $ | 935,709 | |
See notes to consolidated financial statements.
APPLE REIT EIGHT, INC.CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
Revenues: | | | | | | | | | |
Room revenue | | $ | 183,913 | | | $ | 177,009 | | | $ | 169,944 | |
Other revenue | | | 14,015 | | | | 13,695 | | | | 12,678 | |
Total revenue | | | 197,928 | | | | 190,704 | | | | 182,622 | |
| | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | |
Operating expense | | | 53,115 | | | | 49,751 | | | | 48,064 | |
Hotel administrative expense | | | 16,314 | | | | 16,293 | | | | 15,774 | |
Sales and marketing | | | 15,449 | | | | 14,889 | | | | 14,109 | |
Utilities | | | 8,280 | | | | 8,367 | | | | 8,078 | |
Repair and maintenance | | | 9,910 | | | | 9,725 | | | | 9,591 | |
Franchise fees | | | 7,723 | | | | 7,414 | | | | 7,108 | |
Management fees | | | 7,024 | | | | 6,764 | | | | 6,263 | |
Taxes, insurance and other | | | 10,014 | | | | 9,369 | | | | 10,089 | |
Land lease expense | | | 6,400 | | | | 6,391 | | | | 6,386 | |
General and administrative | | | 6,576 | | | | 5,302 | | | | 5,216 | |
Depreciation expense | | | 36,961 | | | | 35,987 | | | | 34,979 | |
Total expenses | | | 177,766 | | | | 170,252 | | | | 165,657 | |
| | | | | | | | | | | | |
Operating income | | | 20,162 | | | | 20,452 | | | | 16,965 | |
| | | | | | | | | | | | |
Net gain from mortgage debt restructuring and extinguishment | | | 0 | | | | 1,093 | | | | 0 | |
Investment income, net | | | 19 | | | | 23 | | | | 3,076 | |
Interest expense | | | (14,666 | ) | | | (12,104 | ) | | | (9,166 | ) |
| | | | | | | | | | | | |
Net income | | $ | 5,515 | | | $ | 9,464 | | | $ | 10,875 | |
| | | | | | | | | | | | |
Basic and diluted net income per common share | | $ | 0.06 | | | $ | 0.10 | | | $ | 0.12 | |
| | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 93,046 | | | | 93,998 | | | | 94,170 | |
See notes to consolidated financial statements.
APPLE REIT EIGHT, INC.CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY(in thousands, except per share data)
| | | | | | | | Series B Convertible | | | | | | | |
| | Common Stock | | | Preferred Stock | | | Distributions | | | | |
| | Number of Shares | | | Amount | | | Number of Shares | | | Amount | | | | | | Total | |
| | | | | | | | | | | | | | | | | | |
Balance at December 31, 2009 | | | 93,643 | | | $ | 927,269 | | | | 240 | | | $ | 24 | | | $ | (138,194 | ) | | $ | 789,099 | |
Net proceeds from the sale of common shares | | | 2,372 | | | | 26,207 | | | | 0 | | | | 0 | | | | 0 | | | | 26,207 | |
Common shares redeemed | | | (1,400 | ) | | | (14,743 | ) | | | 0 | | | | 0 | | | | 0 | | | | (14,743 | ) |
Realized gain on sale of equity securities | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (2,404 | ) | | | (2,404 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 10,875 | | | | 10,875 | |
Cash distributions declared to shareholders ($0.77 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (72,465 | ) | | | (72,465 | ) |
Balance at December 31, 2010 | | | 94,615 | | | | 938,733 | | | | 240 | | | | 24 | | | | (202,188 | ) | | | 736,569 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 1,817 | | | | 20,100 | | | | 0 | | | | 0 | | | | 0 | | | | 20,100 | |
Common shares redeemed | | | (2,926 | ) | | | (32,074 | ) | | | 0 | | | | 0 | | | | 0 | | | | (32,074 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 9,464 | | | | 9,464 | |
Cash distributions declared to shareholders ($0.66 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (62,071 | ) | | | (62,071 | ) |
Balance at December 31, 2011 | | | 93,506 | | | | 926,759 | | | | 240 | | | | 24 | | | | (254,795 | ) | | | 671,988 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net proceeds from the sale of common shares | | | 998 | | | | 11,119 | | | | 0 | | | | 0 | | | | 0 | | | | 11,119 | |
Common shares redeemed | | | (1,663 | ) | | | (18,273 | ) | | | 0 | | | | 0 | | | | 0 | | | | (18,273 | ) |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 5,515 | | | | 5,515 | |
Cash distributions declared to shareholders ($0.55 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (51,174 | ) | | | (51,174 | ) |
Balance at December 31, 2012 | | | 92,841 | | | $ | 919,605 | | | | 240 | | | $ | 24 | | | $ | (300,454 | ) | | $ | 619,175 | |
See notes to consolidated financial statements.
APPLE REIT EIGHT, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
Cash flows from operating activities: | | | | | | | | | |
Net income | | $ | 5,515 | | | $ | 9,464 | | | $ | 10,875 | |
Adjustments to reconcile net income to cash provided | | | | | | | | | | | | |
Depreciation | | | 36,961 | | | | 35,987 | | | | 34,979 | |
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net | | | 510 | | | | (119 | ) | | | 505 | |
Non-cash portion of net gain on extinguishment of mortgage debt | | | 0 | | | | (1,482 | ) | | | 0 | |
Net realized gain on sale of investments | | | 0 | | | | 0 | | | | (3,011 | ) |
Changes in operating assets and liabilities: | | | | | | | | | | | | |
Decrease (increase) in due from third party managers | | | 58 | | | | (418 | ) | | | (112 | ) |
Decrease (increase) in other assets | | | 191 | | | | (749 | ) | | | (325 | ) |
Increase in accounts payable and accrued expenses | | | 2,903 | | | | 2,713 | | | | 1,338 | |
Net cash provided by operating activities | | | 46,138 | | | | 45,396 | | | | 44,249 | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Capital improvements | | | (11,939 | ) | | | (5,227 | ) | | | (6,443 | ) |
Net (increase) decrease in cash restricted for property improvements | | | (2,556 | ) | | | (2,671 | ) | | | 3,578 | |
Proceeds from sale of equity securities - available for sale | | | 0 | | | | 0 | | | | 3,804 | |
Investment in other assets | | | 0 | | | | 0 | | | | (228 | ) |
Net cash provided by (used in) investing activities | | | (14,495 | ) | | | (7,898 | ) | | | 711 | |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net proceeds related to issuance of Units | | | 10,974 | | | | 19,985 | | | | 26,088 | |
Redemptions of Units | | | (18,273 | ) | | | (32,074 | ) | | | (14,743 | ) |
Distributions paid to common shareholders | | | (51,174 | ) | | | (62,071 | ) | | | (72,465 | ) |
Net proceeds from (payments on) extinguished credit facilities | | | (73,213 | ) | | | 21,320 | | | | (6,454 | ) |
Net proceeds from existing credit facility | | | 45,300 | | | | 0 | | | | 0 | |
Proceeds from mortgage debt | | | 58,700 | | | | 60,000 | | | | 39,000 | |
Payments of mortgage debt | | | (2,717 | ) | | | (43,519 | ) | | | (15,942 | ) |
Deferred financing costs | | | (1,172 | ) | | | (1,139 | ) | | | (444 | ) |
Net cash used in financing activities | | | (31,575 | ) | | | (37,498 | ) | | | (44,960 | ) |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | 68 | | | | 0 | | | | 0 | |
Cash and cash equivalents, beginning of period | | | 0 | | | | 0 | | | | 0 | |
Cash and cash equivalents, end of period | | $ | 68 | | | $ | 0 | | | $ | 0 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Supplemental information: | | | | | | | | | | | | |
Interest paid | | $ | 13,525 | | | $ | 11,601 | | | $ | 8,985 | |
See notes to consolidated financial statements.
Notes to Consolidated Financial Statements
Note 1
Organization and Summary of Significant Accounting Policies
Organization
Apple REIT Eight, Inc., together with its wholly owned subsidiaries (the “Company”) is a Virginia corporation formed to invest in income-producing real estate in the United States. Initial capitalization occurred on January 22, 2007 and operations began on November 9, 2007 when the Company acquired its first hotels. The Company has no foreign operations or assets and as of December 31, 2012, its operations include two segments. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. As of December 31, 2012, the Company owned 51 hotels located in 19 states with an aggregate of 5,912 rooms.
The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The REIT Modernization Act, effective January 1, 2001, permits real estate investment trusts to establish taxable businesses to conduct certain previously disallowed business activities. The Company has wholly-owned taxable REIT subsidiaries (collectively, the “Lessee”), which lease all of the Company’s hotels.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments with original maturities of three months or less. The fair market value of cash and cash equivalents approximates their carrying value. The balances held may at times exceed federal depository insurance limits.
Restricted cash
Restricted cash includes reserves for debt service, real estate taxes, and insurance, as well as excess cash flow deposits and reserves for furniture, fixtures, and equipment replacements of up to 5% of property revenue for certain hotels, as required by certain management or mortgage debt agreement restrictions and provisions.
Investment in Real Estate and Related Depreciation
Real estate is stated at cost, net of depreciation. Repair and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements are capitalized. Depreciation is computed using the straight-line method over average estimated useful lives of the assets, which are 39 years for buildings, 16 years for franchise fees, ten years for major improvements, and three to seven years for furniture and equipment.
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that were recently renovated or experienced other short-term business disruption. Since the Company’s planned initial hold period for each property is 39 years, the Company’s ongoing analysis and annual recoverability analysis have not identified any impairment losses and no impairment losses have been recorded to date.
If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.
During 2010 the Company held equity securities classified as available-for-sale, in accordance with the applicable accounting standards for certain investments in debt and equity securities. The Company sold these equity securities in 2010, resulting in a realized gain of $3.0 million which is recorded in Investment income, net in the Company’s consolidated statement of operations.
Revenue Recognition
Hotel revenue is recognized as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel’s services.
Comprehensive Income
The Company recorded no comprehensive income other than net income for the periods reported.
Earnings Per Common Share
Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the year. Diluted earnings per share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the year. There were no potential common shares with a dilutive effect for the years ended December 31, 2012, 2011 and 2010. As a result, basic and dilutive outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time the Series B convertible preferred shares are eligible to be converted to common shares.
Federal Income Taxes
The Company is operated as, and has elected to be taxed as, a REIT under Sections 856 to 860 of the Internal Revenue Code. Earnings and profits, which will determine the taxability of distributions to shareholders, will differ from income reported for financial reporting purposes primarily due to the differences for federal income tax purposes in the estimated useful lives used to compute depreciation. Total distributions in 2012 of $0.55 per share for tax purposes were 28% ordinary income and 72% return of capital. The characterization of 2011 distributions of $0.66 per share for tax purposes was 50% ordinary income and 50% return of capital. The characterization of 2010 distributions of $0.77 per share for tax purposes was 42% ordinary income and 58% return of capital.
The Lessee, as a taxable REIT subsidiary of the Company, is subject to federal and state income taxes. The taxable REIT subsidiary incurred a loss for the years ended December 31, 2012, 2011 and 2010, and therefore did not have any federal tax expense. No operating loss benefit has been recorded in the consolidated balance sheet since realization is uncertain due to the history of operating losses. Total net operating loss carry forward for federal income tax purposes was approximately $50.3 million as of December 31, 2012. The net operating loss carry forward will expire beginning in 2027. There are no material differences between the book and tax cost basis of the Company’s assets. As of December 31, 2012, the tax years that remain subject to examination by major tax jurisdictions generally include 2009 to 2012.
Sales and Marketing Costs
Sales and marketing costs are expensed when incurred. These costs represent the expense for franchise advertising and reservation systems under the terms of the hotel management and franchise agreements and general and administrative expenses that are directly attributable to advertising and promotion.
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates.
Note 2
Investment in Real Estate
The Company’s investment in real estate consisted of the following (in thousands):
| | December 31, 2012 | | | December 31, 2011 | |
Land | | $ | 87,645 | | | $ | 87,645 | |
Building and Improvements | | | 883,855 | | | | 878,125 | |
Furniture, Fixtures and Equipment | | | 78,308 | | | | 72,449 | |
Franchise Fees | | | 2,623 | | | | 2,623 | |
| | | 1,052,431 | | | | 1,040,842 | |
Less Accumulated Depreciation | | | (163,209 | ) | | | (126,248 | ) |
Investment in real estate, net | | $ | 889,222 | | | $ | 914,594 | |
Hotels Owned
As of December 31, 2012, the Company owned 51 hotels, located in nineteen states, consisting of the following:
Brand | | Total by Brand | | | Number of Rooms | |
Courtyard | | | 11 | | | | 1,445 | |
Residence Inn | | | 10 | | | | 1,067 | |
Hilton Garden Inn | | | 6 | | | | 717 | |
Hampton Inn | | | 5 | | | | 549 | |
Homewood Suites | | | 5 | | | | 536 | |
Fairfield Inn & Suites | | | 3 | | | | 331 | |
Hampton Inn & Suites | | | 3 | | | | 298 | |
SpringHill Suites | | | 3 | | | | 289 | |
TownePlace Suites | | | 3 | | | | 252 | |
Marriott | | | 1 | | | | 226 | |
Renaissance | | | 1 | | | | 202 | |
Total | | | 51 | | | | 5,912 | |
At acquisition of the hotels, the purchase price of the hotels and other closing costs were allocated to the various components such as land, buildings and improvements, furniture and equipment, and intangible assets based on the fair value of each component. No goodwill was recorded in connection with any of the acquisitions. Generally, the Company has not acquired real estate assets that have in-place leases as lease terms for hotel properties are very short term in nature. However, in conjunction with two hotel acquisitions in 2008, one in New York, New York and one in Savannah, Georgia, amounts were identified and allocated to Intangible liabilities, net in the Company’s Consolidated Balance Sheets. These amounts are being amortized to rental income and land lease expense over the remaining terms of the associated contracts (remaining terms at December 31, 2012 range from 5 - 42 years). The unamortized value of these liabilities at December 31, 2012 was approximately $6.7 million for the New York hotel and $2.2 million for the Savannah, Georgia hotel. The Company has not allocated any purchase price to intangible assets such as management contracts and franchise agreements as such contracts are generally at current market rates and any other value attributable to these contracts are not considered material.
Note 3
Credit Facilities, Mortgage Debt, and Net Gain from Mortgage Debt Restructuring and Extinguishment
Credit Facilities
In March 2012, the Company entered into a new $60 million unsecured credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. Interest is payable monthly on the outstanding balance based on an annual rate of either one-month LIBOR (the London Inter-Bank Offered Rate) plus 3.0%, or the prime interest rate plus 2.0%, at the Company’s option. The Company is also required to pay a fee of 0.35% on the average unused balance of the credit facility. Under the terms and conditions of the credit facility, the Company may make voluntary prepayments in whole or in part, at any time. The credit
facility matures in March 2013; however, the Company has the right and intends, upon satisfaction of certain conditions including covenant compliance and payment of an extension fee, to extend the maturity date to March 2014.
At closing in March 2012, the Company borrowed approximately $48 million under the credit facility to pay all outstanding balances and extinguish its previously existing $75 million and $20 million credit facilities, and pay transaction costs. At December 31, 2012, the outstanding balance under the credit facility was $45.3 million, and had an interest rate of approximately 3.21%. Loan origination costs totaling approximately $0.4 million are being amortized as interest expense through the March 2013 maturity date. The credit facility contains the following quarterly financial covenants (capitalized terms are defined in the loan agreement):
· | Tangible Net Worth must exceed $275 million; |
· | Total Debt to Asset Value must not exceed 50%; |
· | Distributions, net of proceeds from the Company’s Dividend Reinvestment Program, cannot exceed $17 million during any calendar quarter in 2012 (and must not exceed $68 million in any cumulative 12 month period thereafter), and quarterly Distributions cannot exceed $0.1375 per share, unless such Distributions are less than total Funds From Operations for the quarter; |
· | Loan balance must not exceed 45% of the Unencumbered Asset Value; |
· | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
· | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at December 31, 2012.
The Company’s prior unsecured credit facility originated in October 2010 and was modified in August 2011. At time of its extinguishment in March 2012, the $75 million facility had an applicable annual interest rate equal to the one-month LIBOR plus 2.25%, subject to an interest rate floor of 3.75%. The applicable interest rate on borrowings under the facility was 3.75% at December 31, 2011. Prior to the credit facility’s modification in August 2011, the applicable interest rate floor was 3.50%.
In April 2011, the Company entered into a Loan Agreement (the “Loan Agreement”) with a commercial bank. The Loan Agreement provided for a revolving credit facility of $20 million and a maturity date of April 19, 2012. Interest was payable quarterly on the outstanding balance based on an annual rate of LIBOR plus 2.0%. The Loan Agreement was guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and was secured by assets of Mr. Knight. Mr. Knight did not receive any consideration in exchange for providing this guaranty and security. Proceeds of the loan were used by the Company for general working capital purposes, including the payment of redemptions and distributions. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement. At December 31, 2011, the Loan Agreement had an outstanding principal balance of $20.0 million, at an interest rate of approximately 2.29%. The Loan Agreement was paid off and extinguished in full in March 2012.
In October 2010 the Company entered into a $25 million term loan with a credit facility lender. The loan was secured by two properties and had a maturity date of October 2012. Payments of interest only were due monthly at LIBOR plus 2.25%, with a floor interest rate of 3.50%. The term loan was paid off and extinguished in full in October 2011.
Mortgage Debt
In conjunction with the acquisition of 15 hotel properties in 2008, the Company assumed mortgage notes payable, secured by the applicable hotel property. The Company entered into three mortgage loan agreements, secured by four additional hotel properties, during 2012 and four mortgage loan agreements, secured by four additional hotel properties, during 2011. In addition, two mortgage loans were extinguished during 2011. The following table summarizes the hotel property, interest rate, maturity date, principal amount assumed or originated, and the outstanding balance as of December 31, 2012 and 2011 for the Company’s mortgage loan obligations. All dollar amounts are in thousands.
Location | | Brand | | | | | | | | | | | | | |
Oceanside, CA(4) | | Residence Inn | | | | (1) | | 1/13/2015 | | $ | 16,000 | | | $ | 16,000 | | | $ | 0 | |
Burbank, CA(4) | | Residence Inn | | | | (1) | | 1/13/2015 | | | 24,000 | | | | 24,000 | | | | 0 | |
Overland Park, KS | | Residence Inn | | | 5.74 | % | | 4/1/2015 | | | 7,079 | | | | 6,259 | | | | 6,453 | |
Westford, MA | | Residence Inn | | | | (2) | | 10/1/2015 | | | 7,199 | | | | 6,704 | | | | 6,844 | |
Kansas City, MO | | Residence Inn | | | 5.74 | % | | 11/1/2015 | | | 11,645 | | | | 10,839 | | | | 11,029 | |
Fayetteville, NC | | Residence Inn | | | 5.14 | % | | 12/1/2015 | | | 7,204 | | | | 6,721 | | | | 6,864 | |
Hilton Head, SC | | Hilton Garden Inn | | | 6.29 | % | | 4/11/2016 | | | 6,371 | | | | 5,746 | | | | 5,898 | |
Virginia Beach, VA(3) | | Courtyard | | | 6.02 | % | | 11/11/2016 | | | 14,500 | | | | 14,235 | | | | 14,479 | |
Virginia Beach, VA(3) | | Courtyard | | | 6.02 | % | | 11/11/2016 | | | 17,500 | | | | 17,180 | | | | 17,475 | |
Charlottesville, VA(3) | | Courtyard | | | 6.02 | % | | 11/11/2016 | | | 15,500 | | | | 15,217 | | | | 15,478 | |
Carolina Beach, NC(3) | | Courtyard | | | 6.02 | % | | 11/11/2016 | | | 12,500 | | | | 12,272 | | | | 12,482 | |
Winston-Salem, NC | | Courtyard | | | 5.94 | % | | 12/8/2016 | | | 8,000 | | | | 7,595 | | | | 7,705 | |
Savannah, GA | | Hilton Garden Inn | | | 5.87 | % | | 2/1/2017 | | | 5,679 | | | | 5,143 | | | | 5,277 | |
Greenville, SC | | Residence Inn | | | 6.03 | % | | 2/8/2017 | | | 6,512 | | | | 6,128 | | | | 6,220 | |
Birmingham, AL | | Homewood Suites | | | 6.03 | % | | 2/8/2017 | | | 11,815 | | | | 11,118 | | | | 11,286 | |
Jacksonville, FL | | Homewood Suites | | | 6.03 | % | | 2/8/2017 | | | 17,159 | | | | 16,161 | | | | 16,405 | |
Concord, NC | | Hampton Inn | | | 6.10 | % | | 3/1/2017 | | | 5,143 | | | | 4,814 | | | | 4,891 | |
Suffolk, VA | | TownePlace Suites | | | 6.03 | % | | 7/1/2017 | | | 6,630 | | | | 6,286 | | | | 6,286 | |
Suffolk, VA | | Courtyard | | | 6.03 | % | | 7/1/2017 | | | 8,644 | | | | 8,195 | | | | 8,195 | |
Somerset, NJ(4) | | Courtyard | | | 4.73 | % | | 10/6/2022 | | | 9,000 | | | | 8,970 | | | | 0 | |
Tukwila, WA(4) | | Homewood Suites | | | 4.73 | % | | 10/6/2022 | | | 9,700 | | | | 9,667 | | | | 0 | |
| | | | | | | | | | $ | 227,780 | | | $ | 219,250 | | | $ | 163,267 | |
(1) The interest rate on this mortgage is a variable rate based on 1-month LIBOR. An interest rate swap agreement entered into in January 2012, when the loan was originated, results in an effective annual fixed interest rate of 5.25%. |
(2) The interest rate on this mortgage is a variable rate based on 1-month LIBOR. An interest rate swap agreement entered into in October 2010, when this loan was refinanced, results in an effective annual fixed interest rate of 5.30%. |
(3) Loan was originated in 2011. |
(4) Loan was originated in 2012. |
In September 2012, the Company entered into two secured mortgage loan agreements with a commercial lender. A mortgage loan for $9.7 million is secured by the Company’s Tukwila, Washington Homewood Suites; a separate mortgage loan for $9.0 million is secured by the Company’s Somerset, New Jersey Courtyard. Combined scheduled payments of interest and principal of $106 thousand are due monthly for each loan, and each loan will amortize on a 25 year term with a balloon payment due at maturity in October 2022. Each mortgage loan has an applicable fixed interest rate of approximately 4.73%. At closing, the Company used proceeds from each loan to reduce the outstanding balance on its credit facility, and to pay transaction costs. Combined total loan origination costs of approximately $0.2 million are being amortized as interest expense through the October 2022 maturity date of each loan.
In January 2012, the Company entered into a secured mortgage loan agreement with a commercial bank for $40 million. The loan is jointly secured by the Company’s Burbank, California Residence Inn and Oceanside, California Residence Inn. Interest is payable monthly on the outstanding balance of the loan at a variable interest rate of one-month LIBOR plus 4.25%. The loan matures in January 2015 with an option for the Company to extend the maturity for one year. Interest only is payable for the first year of the loan, with monthly principal payments of $65,000 required beginning in February 2013. Loan origination costs totaling approximately $0.5 million are being amortized as interest expense through the January 2015 maturity date.
To effectively fix the interest rate on the $40 million variable rate mortgage loan and reduce the Company’s exposure to interest rate risk, simultaneous with the closing of the loan the Company entered into an interest rate swap agreement with the same commercial bank. Under terms of the interest rate swap agreement, the Company pays a monthly fixed interest rate of 1.0% and receives a floating rate of interest equal to the one-month LIBOR, effectively fixing the interest rate of the $40 million loan at 5.25%. The notional amount of $40 million for the interest rate swap amortizes in tandem with the amortization of the loan and matures with the loan agreement in January 2015. At closing on the loan and swap agreements in January 2012, the Company used the proceeds to reduce the outstanding balance on its prior credit facility and to pay transaction costs.
In October 2011, the Company entered into four separate secured loan agreements with a commercial real estate lender. Each loan is secured by one of the following Company hotels: Carolina Beach, North Carolina Courtyard; Charlottesville, Virginia Courtyard; Virginia Beach, Virginia Courtyard North; and Virginia Beach, Virginia Courtyard South. Each loan matures in November 2016, and will amortize based on a 25 year term with a balloon payment due at maturity. Interest is payable monthly on the outstanding balance of each loan at an annual rate of 6.015%. The total proceeds of $60.0 million under the four loan agreements were used to extinguish the Company’s $25.0 million secured term loan due in October 2012, reduce the outstanding balance on the Company’s prior $75.0 million unsecured line of credit facility, and to pay loan origination and other transaction costs of approximately $1.1 million.
In May 2011, the two mortgage loans secured by the Suffolk, Virginia TownePlace Suites and Courtyard were modified and returned to current status; the Company had previously suspended payments due in March 2011 in order to renegotiate terms of the loans with the loan servicer. Under the modified agreements, the Company is required to make monthly interest payments at an annual rate of 5.031%, with no payment of principal until March 1, 2013. During this period, interest will continue to accrue at 6.031%, with the 1% difference accrued and payable at maturity. Certain lender expenses were reimbursed to the lender as part of the restructuring of the two loans and a modification fee of approximately 0.75% of the principal balance of approximately $14 million at date of modification will be due at maturity.
The aggregate amounts of principal payable under the Company’s notes payable (mortgage debt and the balance outstanding under the Company’s credit facility), for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
| | Total | |
2013 | | $ | 49,533 | |
2014 | | | 4,568 | |
2015 | | | 70,786 | |
2016 | | | 69,660 | |
2017 | | | 53,522 | |
Thereafter | | | 16,481 | |
| | | 264,550 | |
Fair Value Adjustment of Assumed Debt | | | (531 | ) |
Total | | $ | 264,019 | |
A fair value adjustment was recorded for the assumption of above and below market rate mortgage loans in connection with some of the Company’s mortgage debt assumptions and originations. These fair value adjustments will be amortized into interest expense over the remaining term of the related indebtedness using a method approximating the effective interest rate method. The effective interest rates on the applicable debt obligations assumed ranged from 5.4% to 6.9% at the date of assumption. The total amortization adjustment resulted in an addition to interest expense of $209,000 and $40,000 for the years ended December 31, 2012 and 2011, respectively, and a reduction to interest expense of $340,000 for the year ended December 31, 2010.
With the assumption of mortgage loans on purchased hotels and with its originated loans and credit facilities, the Company incurred loan origination and modification costs. In 2012 and 2011 in conjunction with its debt origination and refinancing activities, loan origination costs totaled $1.2 million and $1.1 million, respectively. All such costs are amortized over the period to maturity of the applicable mortgage loan or credit agreement, or to termination of the applicable mortgage loan or credit agreement, as an addition to interest expense. Amortization of such costs totaled $1.0 million, $0.9 million, and $0.4 million for the years ended December 31, 2012, 2011 and 2010, respectively.
The Company’s Interest expense in its Consolidated Statements of Operations is net of capitalized interest of $0.4 million and $0.1 million for the years ended December 31, 2012 and 2010. Interest capitalized during the year ended December 31, 2011 was not significant. The interest was capitalized in conjunction with hotel renovations.
Net Gain from Mortgage Debt Restructuring and Extinguishment
In August 2011, the Company recognized a net gain from mortgage debt restructuring and extinguishment of $1.1 million. Negotiations with the single mortgage servicer on three of the Company’s non-recourse mortgage loans resulted in the early extinguishment, at a discount to the principal amount outstanding, of the mortgage loan secured by the Company’s Tampa, Florida TownePlace Suites property. The mortgage loan was extinguished by the Company for a payment of $6.0 million, excluding applicable fees and legal costs; the loan’s principal balance at extinguishment was $8.0 million. Simultaneously, the Company’s mortgage loans secured by the Winston-Salem, North Carolina Courtyard and the Greenville,
South Carolina Residence Inn properties were returned to current status, with the Company agreeing to payment of applicable fees and reimbursement of the loan servicer’s expenses incurred in connection with the restructuring and extinguishment transactions. The Company had previously suspended payments due under the three mortgage loans in March 2011, in order to renegotiate terms of the agreements with the loan servicer. In addition to the loan servicer’s fees and reimbursed costs for all three loans, and the Company’s legal and advisory costs incurred with the transactions, the net gain reflects the servicer’s assumption of certain mortgage escrow balances and the Company’s write-off of the deferred financing fees and unamortized fair market adjustment for the Tampa, Florida TownePlace Suites mortgage loan at date of extinguishment.
Note 4
Fair Value of Financial Instruments and Derivative Transactions
The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit terms and credit characteristics, which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. As of December 31, 2012, the carrying value and estimated fair value of the Company’s debt was approximately $264.0 million and $275.4 million. As of December 31, 2011, the carrying value and estimated fair value of the Company’s debt was $236.3 million and $236.7 million. The carrying value of the Company’s other non-derivative financial instruments approximates fair value due to the short-term nature of these financial instruments.
In January 2012, the Company entered into an interest rate swap agreement that effectively fixes the interest rate on a variable rate mortgage, bearing interest at one month LIBOR plus 4.25%, originated with a $40.0 million term loan jointly secured by the Burbank, California Residence Inn and the Oceanside, California Residence Inn. Under terms of the interest rate swap agreement, the Company pays a fixed rate of 1.00% and receives floating rate interest equal to the one month LIBOR, effectively fixing the interest rate at 5.25%. The notional amount amortizes in tandem with the amortization of the underlying mortgage debt, and totaled $40.0 million at December 31, 2012. The interest rate swap agreement matures in January 2015.
In October 2010, the Company entered into an interest rate swap agreement that effectively fixes the interest rate on a variable rate mortgage, bearing interest at one month LIBOR plus 3.50%, originated upon the refinance of the debt associated with the Westford, Massachusetts Residence Inn. Under the terms of this interest rate swap, the Company pays a fixed rate interest of 1.80% and receives floating rate interest equal to the one month LIBOR, effectively fixing the interest at a rate of 5.30%. The notional amount of the interest rate swap agreement amortizes in tandem with the amortization of the underlying mortgage debt, and totaled $6.7 million and $6.8 million as of December 31, 2012 and 2011, respectively. The interest rate swap agreement matures in October 2015.
The two derivatives are recorded in the Company’s Consolidated Balance Sheets at fair value. At December 31, 2012 and 2011, a liability of $0.8 million and $0.2 million, respectively, was included in Accounts payable and accrued expenses. The fair value of the interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments) which is considered a Level 2 measurement within the Financial Accounting Standards Board’s (“FASB”) fair value hierarchy. The variable cash receipts (or payments) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The two derivatives are not designated as qualifying hedges of interest risk, and therefore the changes in the fair value are recognized as Interest expense in the Consolidated Statements of Operations. For the year ended December 31, 2012, the change in fair value resulted in an additional $36,000 in interest expense. For the year ended December 31, 2011, the change in fair value resulted in an additional $284,000 in interest expense. For the year ended December 31, 2010, the change in fair value resulted in a credit, or reduction in interest expense, of $40,000.
Note 5
Related Parties
The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section, and no new significant related party transactions during 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for services under the terms of this contract have totaled approximately $19.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees or expenses were incurred by the Company during 2012, 2011 and 2010 under this contract.
The Company is party to an advisory agreement with A8A, pursuant to which A8A provides management services to the Company. A8A provides these management services through an affiliate called Apple Fund Management LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A8A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1.0 million for each of the years ended December 31, 2012, 2011 and 2010.
In addition to the fees payable to A8A, the Company reimbursed A8A or paid directly to AFM on behalf of A8A approximately $1.8 million, $1.7 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A8A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., A8A, Apple Nine Advisors, Inc.(“A9A”), Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc., Apple REIT Ten, Inc. and the Company (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, A9A entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, A9A and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to A9A, if it occurs, will have no impact on the Company’s advisory agreement with A8A or the process of allocating costs from AFM to the Apple REIT Entities, excluding Apple REIT Six, Inc. as described above, which will increase the remaining Companies’ share of the allocated costs.
On November 29, 2012, in connection with the merger, Apple REIT Nine, Inc. entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement which is expected to close immediately prior to the closing of the merger. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
ASRG and A8A are 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 Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the boards of Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was $1.9 million and $2.1 million at December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.8 million respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
In 2010, Apple REIT Nine, Inc. purchased from the Company’s third party lender a note payable secured by the Columbia, South Carolina Hilton Garden Inn. The purchase of the note by Apple REIT Nine, Inc. had no financial effect on the Company. In December 2011, in accordance with the terms of the note, the note was extinguished by the Company through payment of all principal and interest due.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the legal matters discussed herein for all of the Apple REIT Companies were approximately $7.3 million in 2012 of which approximately $1.6 million was allocated to the Company.
In April 2011, the Company entered into a Loan Agreement (the “Loan Agreement”) with a commercial bank, which provided for a $20 million revolving credit facility with a maturity of April 2012. During the first quarter of 2012, the credit facility was extinguished and the outstanding principal balance totaling $20 million, plus accrued interest, was paid in full. The Loan Agreement was guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and was secured by assets of Mr. Knight. Mr. Knight did not receive any consideration in exchange for providing this guaranty and security. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement.
Note 6
Shareholders’ Equity
Best-efforts Offering
The Company concluded its best-efforts offering of Units in April 2008. The Company registered its Units on Registration Statement Form S-11 (File No. 333-140548). The Company began its best-efforts offering (the “Offering”) of Units, on July 19, 2007, the same day the Registration Statement was declared effective by the Securities and Exchange Commission.
Series A Preferred Stock
The Series A preferred shares have no voting rights and no conversion rights. In addition, the Series A preferred shares are not separately tradable from the common shares to which they relate. The Series A preferred shares do not have any distribution rights except a priority distribution upon the sale of the Company’s assets. The priority distribution (“Priority Distribution”) is equal to $11.00 per Series A preferred share, and will be paid before any distribution will be made to the holders of any other shares. Upon the Priority Distribution the Series A preferred shares will have no other distribution rights.
Series B Preferred Stock
The Company has issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief
Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with Apple Eight Advisors, Inc. (“A8A”), or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event that the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $50 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to issuance of 240,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred at December 31, 2012, expense would have ranged from $0 to in excess of $63 million (assumes $11 per common share fair market value) which represents approximately 5.8 million shares of common stock.
Preferred Shares
The Company’s articles of incorporation authorize issuance of up to 15 million additional preferred shares. No preferred shares other than the Series A preferred shares and the Series B convertible preferred shares (discussed above) have been issued. The Company believes that the authorization to issue additional preferred shares benefits the Company and its shareholders by permitting flexibility in financing additional growth, giving the Company additional financing options in corporate planning and in responding to developments in business, including financing of additional acquisitions and other general corporate purposes. Having authorized preferred shares available for issuance in the future gives the Company the ability to respond to future developments and allows preferred shares to be issued without the expense and delay of a special shareholders’ meeting. At present, the Company has no specific financing or acquisition plans involving the issuance of additional preferred shares and the Company does not propose to fix the characteristics of any series of preferred shares in
anticipation of issuing preferred shares other than the Series A preferred shares and Series B convertible preferred shares discussed above. The Company cannot now predict whether or to what extent, if any, additional preferred shares will be used or if so used what the characteristics of a particular series may be. The voting rights and rights to distributions of the holders of common shares will be subject to the prior rights of the holders of any subsequently-issued preferred shares. Unless otherwise required by applicable law or regulation, the preferred shares would be issuable without further authorization by holders of the common shares and on such terms and for such consideration as may be determined by the Board of Directors. The preferred shares could be issued in one or more series having varying voting rights, redemption and conversion features, distribution (including liquidating distribution) rights and preferences, and other rights, including rights of approval of specified transactions. A series of preferred shares could be given rights that are superior to rights of holders of common shares and a series having preferential distribution rights could limit common share distributions and reduce the amount holders of common shares would otherwise receive on dissolution.
Unit Redemption Plan
In October 2008, 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 92% of the price paid per Unit if the Units have been owned less than three years or 100% of the price per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any 12-month period is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price for redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. Since the inception of the program through December 31, 2012, the Company has redeemed approximately 7.4 million Units in the amount of $79.3 million under the program, including 1.7 million Units in the amount of $18.3 million in 2012 and 2.9 million Units in the amount of $32.1 million redeemed in 2011. As contemplated by the program, beginning with the January 2011 redemption, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of Unit redemptions during 2011 and 2012:
| | Requested Unit Redemptions | | | | | | | |
January 2011 | | | 1,168,279 | | | | 732,647 | | | | 435,632 | |
April 2011 | | | 1,529,096 | | | | 729,016 | | | | 800,080 | |
July 2011 | | | 8,255,381 | | | | 736,960 | | | | 7,518,421 | |
October 2011 | | | 17,938,386 | | | | 727,604 | | | | 17,210,782 | |
January 2012 | | | 18,910,430 | | | | 454,405 | | | | 18,456,025 | |
April 2012 | | | 18,397,381 | | | | 454,638 | | | | 17,942,743 | |
July 2012 | | | 18,607,044 | | | | 362,553 | | | | 18,244,491 | |
October 2012 | | | 19,112,925 | | | | 391,142 | | | | 18,721,783 | |
As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the board of Directors has and will continue to limit the amount of redemptions as it deems prudent.
Dividend Reinvestment Plan
In the second quarter of 2008, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. The Company has registered 10 million Units for potential issuance under the plan. Since inception through December 31, 2012, approximately 9.1 million Units were issued under the plan representing approximately $99.9 million, including 1.0 million Units for $11.0 million in 2012 and 1.8 million Units for $20.0 million in 2011.
Distributions
In 2012, the annual distribution rate for common shares was $0.55 per common share, and was composed of twelve monthly distributions of $0.045833 per share. A total of $51.2 million was distributed during the year ended December 31, 2012. In June 2011 the Company’s Board of Directors reduced the annual distribution rate to $0.55 per common share; the
previous annual distribution rate was $0.77 per common share. The reduction was effective with the July 2011 distribution. A total of $0.66 per common share was distributed during the year ended December 31, 2011, composed of six monthly distributions of $0.064167 per common share and six monthly distributions of $0.045833 per common share, for a total of $62.1 million. The Company’s annual distribution rate was $0.77 per common share for the year ended December 31, 2010, for a total $72.5 million, and was composed of twelve monthly distributions of $0.064167 per common share.
Note 7
Stock Option Plans
During 2007, the Company adopted a non-employee directors stock option plan (the “Directors’ Plan”) whereby directors, who are not employees of the Company or affiliates, automatically receive the option to purchase Units. Under the Directors Plan, the number of Units authorized for issuance is equal to 45,000 plus 1.8% of the number of Units sold in excess of the minimum offering of 4,761,905 Units. This plan currently relates to the initial public offering of 91,125,541 Units. Therefore, the maximum number of Units authorized under the Directors Plan is currently 1,599,545.
Also in 2007, the Board of Directors approved an Incentive Stock Option Plan (the “Incentive Plan”) whereby incentive awards may be granted to certain personnel of the Company or affiliates. Under the Incentive Plan, the number of Units authorized for issuance is equal to 35,000 plus 4.625% of the number of Units sold in the initial offering in excess of 4,761,905. This plan also currently relates to the initial public offering of 91,125,541 Units. The maximum number of Units that can be issued under the Incentive Plan is 4,029,318.
Both plans generally provide, among other things, that options be granted at exercise prices not lower than the market value of the Units on the date of grant. The options expire 10 years from the date of the grant. During 2012, 2011 and 2010, the Company granted options to purchase 74,432, 75,308 and 75,284 Units under the Directors Plan and granted no options under the Incentive Plan. All of the options issued vested at the date of issuance and have an exercise price of $11 per Unit. Activity in the Company’s share option plan during 2012, 2011 and 2010 is summarized in the following table:
| | Year ended December 31, 2012 | | | Year ended December 31, 2011 | | | Year ended December 31, 2010 | |
Outstanding, beginning of year: | | | 319,776 | | | | 244,468 | | | | 169,184 | |
Granted | | | 74,432 | | | | 75,308 | | | | 75,284 | |
Exercised | | | 0 | | | | 0 | | | | 0 | |
Expired or canceled | | | 0 | | | | 0 | | | | 0 | |
Outstanding, end of year: | | | 394,208 | | | | 319,776 | | | | 244,468 | |
Exercisable, end of year: | | | 394,208 | | | | 319,776 | | | | 244,468 | |
The weighted-average exercise price of outstanding options: | | $ | 11.00 | | | $ | 11.00 | | | $ | 11.00 | |
The Company records compensation expense related to the issuance of stock options based on a determination of the fair value of options issued. Compensation expense associated with the issuance of stock options was approximately $145,000 in 2012, $115,000 in 2011 and $118,000 in 2010.
Note 8
Management and Franchise Agreements
Each of the Company’s 51 hotels are operated and managed, under separate management agreements, by affiliates of one of the following companies (indicates the number of hotels managed): Newport Hospitality Group, Inc. (“Newport”) (9), Larry Blumberg & Associates (“LBA”) (3), Western International (“Western”) (1), Marriott International, Inc. (“Marriott”) (3), White Lodging Services Corporation (“White”) (1), Dimension Development Company (“Dimension”) (4), Inn Ventures, Inc. (“Inn Ventures”) (1), True North Hotel Group, Inc. (“True North”) (7), Intermountain Management, LLC (“Intermountain”) (7), MHH Management, LLC (“McKibbon”) (7) or Crestline Hotels & Resorts, Inc. (“Crestline”) (8). The agreements generally provide for initial terms ranging from one to thirty years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if
specified performance thresholds are not satisfied. During the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $7.0 million, $6.8 million and $6.3 million in management fees.
Newport, LBA, Western, White, Dimension, Inn Ventures, True North, Intermountain, McKibbon and Crestline are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for initial terms of 10 to 20 years. Fees associated with the agreements generally include the payment of royalty fees and program fees. The Marriott franchise agreements provide for initial terms of 10 to 30 years with certain agreements having options to renew. Fees associated with the agreements include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. During the years ended December 31, 2012, 2011 and 2010 the Company incurred approximately $7.7 million, $7.4 million and $7.1 million in franchise fees.
Note 9
Commitments
In connection with the acquisition of five hotels, the Company assumed five land leases. The initial terms of the leases range from approximately 15 to 80 years. One of the lease’s rent is adjusted periodically for consumer price index increases. Two of the leases have defined escalations over the life of the lease and straight-line rent is being recorded to reflect the average rent over the life of the leases. The accrued straight line lease liability balance at December 31, 2012 and 2011 was $13.2 million and $10.8 million and is recorded in Accounts payable and accrued expenses on the Company’s Consolidated Balance Sheets.
The aggregate amounts of the estimated lease payments pertaining to all land leases, for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
| | Total | |
| | | |
2013 | | $ | 4,146 | |
2014 | | | 4,283 | |
2015 | | | 4,406 | |
2016 | | | 4,533 | |
2017 | | | 4,664 | |
Thereafter | | | 206,907 | |
Total | | $ | 228,939 | |
Also, the New York, New York and Somerset, New Jersey hotels have leases for retail space. The remaining terms of these leases range from approximately six months to seven years and the remaining minimum lease payments to be received are approximately $9.0 million. The aggregate amount of the minimum rentals to be received for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
| | Total | |
| | | |
2013 | | $ | 1,812 | |
2014 | | | 1,721 | |
2015 | | | 1,696 | |
2016 | | | 1,452 | |
2017 | | | 1,350 | |
Thereafter | | | 1,017 | |
Total | | $ | 9,048 | |
Rental income from these leases is recorded in Other revenue in the Company’s Consolidated Statements of Operations.
Note 10
Industry Segments
The Company owns hotel properties throughout the United States that generate rental and other property related income.
The Company separately evaluates the performance of each of its hotel properties. Due to the significance of the New York hotel’s revenues, the Company has two reportable segments. The Company does not allocate corporate-level accounts to its operating segments, including corporate general and administrative expenses, non-operating interest income and interest expense. Dollar amounts are in thousands.
| | For the year ended December 31, 2012 | |
| | | | | | | | Corporate | | | Consolidated | |
Total revenue | | $ | 22,683 | | | $ | 175,245 | | | $ | 0 | | | $ | 197,928 | |
Hotel expenses | | | 20,537 | | | | 113,692 | | | | 0 | | | | 134,229 | |
General and administrative expense | | | 0 | | | | 0 | | | | 6,576 | | | | 6,576 | |
Depreciation expense | | | 6,567 | | | | 30,394 | | | | 0 | | | | 36,961 | |
Operating income/(loss) | | | (4,421 | ) | | | 31,159 | | | | (6,576 | ) | | | 20,162 | |
Investment income, net | | | 0 | | | | 0 | | | | 19 | | | | 19 | |
Interest expense | | | 0 | | | | (12,543 | ) | | | (2,123 | ) | | | (14,666 | ) |
Net income/(loss) | | $ | (4,421 | ) | | $ | 18,616 | | | $ | (8,680 | ) | | $ | 5,515 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | 106,971 | | | $ | 803,730 | | | $ | 2,163 | | | $ | 912,864 | |
| | For the year ended December 31, 2011 | |
| | | | | | | | Corporate | | | Consolidated | |
Total revenue | | $ | 21,631 | | | $ | 169,073 | | | $ | 0 | | | $ | 190,704 | |
Hotel expenses | | | 18,956 | | | | 110,007 | | | | 0 | | | | 128,963 | |
General and administrative expense | | | 0 | | | | 0 | | | | 5,302 | | | | 5,302 | |
Depreciation expense | | | 6,531 | | | | 29,456 | | | | 0 | | | | 35,987 | |
Operating income/(loss) | | | (3,856 | ) | | | 29,610 | | | | (5,302 | ) | | | 20,452 | |
Net gain from mortgage debt restructuring and extinguishment | | | 0 | | | | 1,093 | | | | 0 | | | | 1,093 | |
Investment income, net | | | 0 | | | | 0 | | | | 23 | | | | 23 | |
Interest expense | | | 0 | | | | (8,494 | ) | | | (3,610 | ) | | | (12,104 | ) |
Net income/(loss) | | $ | (3,856 | ) | | $ | 22,209 | | | $ | (8,889 | ) | | $ | 9,464 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | 112,526 | | | $ | 820,937 | | | $ | 2,246 | | | $ | 935,709 | |
Note 11
Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al, putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc.,
or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company’s consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Note 12
Quarterly Financial Data (unaudited)
The following is a summary of quarterly results of operations for the years ended December 31, 2012 and 2011.
2012 (in thousands, except per share data) | | | | | | | | | | | | |
Revenues | | $ | 43,217 | | | $ | 53,631 | | | $ | 55,630 | | | $ | 45,450 | |
Net income / (loss) | | $ | (2,318 | ) | | $ | 4,606 | | | $ | 5,335 | | | $ | (2,108 | ) |
Basic and diluted income / (loss) per common share | | $ | (0.02 | ) | | $ | 0.05 | | | $ | 0.06 | | | $ | (0.02 | ) |
Distributions paid per share | | $ | 0.137 | | | $ | 0.137 | | | $ | 0.137 | | | $ | 0.137 | |
2011 (in thousands, except per share data) | | | | | | | | | | | | |
Revenues | | $ | 40,317 | | | $ | 51,883 | | | $ | 53,930 | | | $ | 44,574 | |
Net income / (loss) | | $ | (2,109 | ) | | $ | 4,774 | | | $ | 7,137 | | | $ | (338 | ) |
Basic and diluted income / (loss) per common share | | $ | (0.02 | ) | | $ | 0.05 | | | $ | 0.08 | | | $ | 0.00 | |
Distributions paid per share | | $ | 0.193 | | | $ | 0.193 | | | $ | 0.137 | | | $ | 0.137 | |
Note 13
Subsequent Events
In January 2013, the Company declared and paid approximately $4.3 million, or $0.045833 per outstanding common share, in distributions to its common shareholders, of which approximately $0.8 million or 75,000 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 435,000 Units in the amount of $4.8 million. As contemplated in the Program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 2% of the total 19.5 million requested Units to be redeemed, with approximately 19.1 million requested Units not redeemed.
In February 2013, the Company declared and paid approximately $4.2 million, or $0.045833 per outstanding common share, in distributions to its common shareholders, of which approximately $0.8 million or 73,000 Units were issued under the Company’s Dividend Reinvestment Plan.
The Company’s Board of Directors approved a reduction in the Company’s projected distribution rate from an annual rate of $0.55 per common share to $0.4675 per common share. The change is effective with the distribution planned for April 2013. The distribution will continue to be paid monthly.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. 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 were effective as of December 31, 2012. 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.
See Item 8 for the Report of Management on Internal Control over Financial Reporting and the Company’s Independent Registered Public Accounting Firm’s attestation report regarding internal control over financial reporting, which are incorporated by reference herein.
Item 9B. Other Information
None.
PART III
| Directors, Executive Officers and Corporate Governance |
The information required by Items 401, 405, 406 and 407(c)(3), (d)(4) and (d)(5) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 10, the 2013 Proxy Statement is incorporated herein by this reference.
The information required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 11, the 2013 Proxy Statement is incorporated herein by this reference.
| Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters |
The information required by Items 201(d) and 403 of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 12, the 2013 Proxy Statement is incorporated herein by this reference.
| Certain Relationships and Related Transactions, and Director Independence |
The information required by Items 404 and 407(a) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 13, the 2013 Proxy Statement is incorporated herein by this reference.
| Principal Accounting Fees and Services |
This information required by Item 9(e) of Schedule 14A will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 14, the 2013 Proxy Statement is incorporated herein by this reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules
1. Financial Statements of Apple REIT Eight, Inc.
Report of Management on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting—Ernst & Young LLP
Report of Independent Registered Public Accounting Firm—Ernst & Young LLP
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2012, 2011 and 2010
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010
Notes to Consolidated Financial Statements
These financial statements are set forth in Item 8 of this report and are hereby incorporated by reference.
2. Financial Statement Schedule
Schedule III—Real Estate and Accumulated Depreciation (Included at the end of this Part IV of this report.)
Financial statement schedules not listed are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
3. Exhibits
Incorporated herein by reference are the exhibits listed under “Exhibits Index” to this Report available at www.sec.gov.
SCHEDULE IIIReal Estate and Accumulated DepreciationAs of December 31, 2012(dollars in thousands)
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | Capitalized | | Total | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | Bldg. | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Brand | | Encumbrances | | Land | | FF&E /Other | | Imp. & FF&E | | Cost (1) | | Deprec. | | Construction | | Acquired | | Life | | Guestrooms |
Birmingham | | AL | | Homewood Suites | | $ | 11,118 | | | $ | 1,176 | | | $ | 15,917 | | | $ | 391 | | | $ | 17,484 | | | $ | (2,502 | ) | | 2005 | | May-08 | | 3 - 39 yrs. | | | 95 | |
Rogers | | AR | | Fairfield Inn | | | 0 | | | | 881 | | | | 7,394 | | | | 1,198 | | | | 9,473 | | | | (1,632 | ) | | 2002 | | February-08 | | 3 - 39 yrs. | | | 99 | |
Rogers | | AR | | Residence Inn | | | 0 | | | | 920 | | | | 11,187 | | | | 1,271 | | | | 13,378 | | | | (1,950 | ) | | 2003 | | February-08 | | 3 - 39 yrs. | | | 88 | |
Springdale | | AR | | Residence Inn | | | 0 | | | | 447 | | | | 5,383 | | | | 1,476 | | | | 7,306 | | | | (1,533 | ) | | 2001 | | March-08 | | 3 - 39 yrs. | | | 72 | |
Burbank | | CA | | Residence Inn | | | 24,000 | | | | 4,229 | | | | 47,200 | | | | 78 | | | | 51,507 | | | | (6,656 | ) | | 2007 | | May-08 | | 3 - 39 yrs. | | | 166 | |
Cypress | | CA | | Courtyard | | | 0 | | | | 3,234 | | | | 28,688 | | | | 1,454 | | | | 33,376 | | | | (4,653 | ) | | 1988 | | April-08 | | 3 - 39 yrs. | | | 180 | |
Oceanside | | CA | | Residence Inn | | | 16,000 | | | | 3,312 | | | | 25,964 | | | | 93 | | | | 29,369 | | | | (3,884 | ) | | 2007 | | May-08 | | 3 - 39 yrs. | | | 125 | |
Sacramento | | CA | | Hilton Garden Inn | | | 0 | | | | 2,544 | | | | 25,764 | | | | 2,059 | | | | 30,367 | | | | (4,749 | ) | | 1999 | | March-08 | | 3 - 39 yrs. | | | 154 | |
San Jose | | CA | | Homewood Suites | | | 0 | | | | 6,523 | | | | 15,901 | | | | 2,146 | | | | 24,570 | | | | (3,060 | ) | | 1991 | | July-08 | | 3 - 39 yrs. | | | 140 | |
Tulare | | CA | | Hampton Inn & Suites | | | 0 | | | | 1,100 | | | | 9,495 | | | | 35 | | | | 10,630 | | | | (1,659 | ) | | 2008 | | June-08 | | 3 - 39 yrs. | | | 86 | |
Jacksonville | | FL | | Homewood Suites | | | 16,161 | | | | 1,546 | | | | 22,370 | | | | 698 | | | | 24,614 | | | | (3,421 | ) | | 2005 | | June-08 | | 3 - 39 yrs. | | | 119 | |
Sanford | | FL | | SpringHill Suites | | | 0 | | | | 933 | | | | 10,609 | | | | 440 | | | | 11,982 | | | | (1,737 | ) | | 2000 | | March-08 | | 3 - 39 yrs. | | | 105 | |
Tallahassee | | FL | | Hilton Garden Inn | | | 0 | | | | 0 | | | | 13,580 | | | | 178 | | | | 13,758 | | | | (2,291 | ) | | 2006 | | January-08 | | 3 - 39 yrs. | | | 85 | |
Tampa | | FL | | TownePlace Suites | | | 0 | | | | 1,307 | | | | 10,344 | | | | 366 | | | | 12,017 | | | | (1,656 | ) | | 1999 | | June-08 | | 3 - 39 yrs. | | | 95 | |
Port Wentworth | | GA | | Hampton Inn | | | 0 | | | | 837 | | | | 10,288 | | | | 281 | | | | 11,406 | | | | (1,598 | ) | | 1997 | | January-08 | | 3 - 39 yrs. | | | 106 | |
Savannah | | GA | | Hilton Garden Inn | | | 5,143 | | | | 0 | | | | 15,119 | | | | 786 | | | | 15,905 | | | | (2,491 | ) | | 2004 | | July-08 | | 3 - 39 yrs. | | | 105 | |
Overland Park | | KS | | Fairfield Inn & Suites | | | 0 | | | | 1,571 | | | | 10,875 | | | | 27 | | | | 12,473 | | | | (1,700 | ) | | 2008 | | August-08 | | 3 - 39 yrs. | | | 110 | |
Overland Park | | KS | | Residence Inn | | | 6,259 | | | | 1,522 | | | | 14,631 | | | | 422 | | | | 16,575 | | | | (2,387 | ) | | 2000 | | April-08 | | 3 - 39 yrs. | | | 120 | |
Overland Park | | KS | | SpringHill Suites | | | 0 | | | | 939 | | | | 8,214 | | | | 836 | | | | 9,989 | | | | (1,471 | ) | | 1999 | | March-08 | | 3 - 39 yrs. | | | 102 | |
Wichita | | KS | | Courtyard | | | 0 | | | | 1,177 | | | | 8,013 | | | | 852 | | | | 10,042 | | | | (1,635 | ) | | 2000 | | June-08 | | 3 - 39 yrs. | | | 90 | |
Bowling Green | | KY | | Hampton Inn | | | 0 | | | | 1,481 | | | | 17,890 | | | | 255 | | | | 19,626 | | | | (2,877 | ) | | 1989 | | December-07 | | 3 - 39 yrs. | | | 130 | |
Marlborough | | MA | | Residence Inn | | | 0 | | | | 2,112 | | | | 18,591 | | | | 213 | | | | 20,916 | | | | (3,132 | ) | | 2006 | | January-08 | | 3 - 39 yrs. | | | 112 | |
Westford | | MA | | Hampton Inn & Suites | | | 0 | | | | 1,570 | | | | 14,122 | | | | 95 | | | | 15,787 | | | | (2,356 | ) | | 2007 | | March-08 | | 3 - 39 yrs. | | | 110 | |
Westford | | MA | | Residence Inn | | | 6,704 | | | | 906 | | | | 14,173 | | | | 1,152 | | | | 16,231 | | | | (2,684 | ) | | 2000 | | April-08 | | 3 - 39 yrs. | | | 108 | |
Annapolis | | MD | | Hilton Garden Inn | | | 0 | | | | 2,440 | | | | 23,342 | | | | 83 | | | | 25,865 | | | | (3,739 | ) | | 2007 | | January-08 | | 3 - 39 yrs. | | | 126 | |
Kansas City | | MO | | Residence Inn | | | 10,839 | | | | 1,178 | | | | 16,152 | | | | 2,052 | | | | 19,382 | | | | (3,413 | ) | | 1968 | | April-08 | | 3 - 39 yrs. | | | 106 | |
Carolina Beach | | NC | | Courtyard | | | 12,272 | | | | 3,244 | | | | 21,617 | | | | 1,960 | | | | 26,821 | | | | (3,772 | ) | | 2003 | | June-08 | | 3 - 39 yrs. | | | 144 | |
Concord | | NC | | Hampton Inn | | | 4,814 | | | | 1,241 | | | | 8,366 | | | | 290 | | | | 9,897 | | | | (1,570 | ) | | 1996 | | March-08 | | 3 - 39 yrs. | | | 101 | |
Dunn | | NC | | Hampton Inn | | | 0 | | | | 545 | | | | 12,542 | | | | 405 | | | | 13,492 | | | | (2,279 | ) | | 2006 | | January-08 | | 3 - 39 yrs. | | | 120 | |
Fayetteville | | NC | | Residence Inn | | | 6,721 | | | | 668 | | | | 12,570 | | | | 182 | | | | 13,420 | | | | (2,088 | ) | | 2006 | | May-08 | | 3 - 39 yrs. | | | 92 | |
Greensboro | | NC | | SpringHill Suites | | | 0 | | | | 663 | | | | 7,634 | | | | 120 | | | | 8,417 | | | | (1,278 | ) | | 2004 | | November-07 | | 3 - 39 yrs. | | | 82 | |
Matthews | | NC | | Hampton Inn | | | 0 | | | | 636 | | | | 10,436 | | | | 627 | | | | 11,699 | | | | (2,074 | ) | | 1995 | | January-08 | | 3 - 39 yrs. | | | 92 | |
Wilmington | | NC | | Fairfield Inn & Suites | | | 0 | | | | 1,841 | | | | 13,475 | | | | 21 | | | | 15,337 | | | | (1,929 | ) | | 2008 | | December-08 | | 3 - 39 yrs. | | | 122 | |
Winston-Salem | | NC | | Courtyard | | | 7,595 | | | | 1,439 | | | | 12,457 | | | | 1,758 | | | | 15,654 | | | | (2,126 | ) | | 1998 | | May-08 | | 3 - 39 yrs. | | | 122 | |
Somerset | | NJ | | Courtyard | | | 8,970 | | | | 0 | | | | 16,504 | | | | 193 | | | | 16,697 | | | | (2,754 | ) | | 2001 | | November-07 | | 3 - 39 yrs. | | | 162 | |
New York | | NY | | Renaissance | | | 0 | | | | 0 | | | | 111,870 | | | | 21,778 | | | | 133,648 | | | | (29,669 | ) | | 1916 | | January-08 | | 3 - 39 yrs. | | | 202 | |
Tulsa | | OK | | Hampton Inn & Suites | | | 0 | | | | 899 | | | | 9,940 | | | | 80 | | | | 10,919 | | | | (1,896 | ) | | 2007 | | December-07 | | 3 - 39 yrs. | | | 102 | |
Columbia | | SC | | Hilton Garden Inn | | | 0 | | | | 1,385 | | | | 20,499 | | | | 97 | | | | 21,981 | | | | (3,005 | ) | | 2006 | | September-08 | | 3 - 39 yrs. | | | 143 | |
Greenville | | SC | | Residence Inn | | | 6,128 | | | | 692 | | | | 8,372 | | | | 223 | | | | 9,287 | | | | (1,365 | ) | | 1998 | | May-08 | | 3 - 39 yrs. | | | 78 | |
Hilton Head | | SC | | Hilton Garden Inn | | | 5,746 | | | | 1,094 | | | | 13,114 | | | | 1,557 | | | | 15,765 | | | | (2,697 | ) | | 2001 | | May-08 | | 3 - 39 yrs. | | | 104 | |
Chattanooga | | TN | | Homewood Suites | | | 0 | | | | 688 | | | | 8,211 | | | | 2,314 | | | | 11,213 | | | | (2,380 | ) | | 1997 | | December-07 | | 3 - 39 yrs. | | | 76 | |
Texarkana | | TX | | Courtyard | | | 0 | | | | 678 | | | | 12,656 | | | | 1,345 | | | | 14,679 | | | | (1,981 | ) | | 2003 | | March-08 | | 3 - 39 yrs. | | | 90 | |
Texarkana | | TX | | TownePlace Suites | | | 0 | | | | 615 | | | | 8,742 | | | | 320 | | | | 9,677 | | | | (1,676 | ) | | 2006 | | March-08 | | 3 - 39 yrs. | | | 85 | |
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION -- (Continued)
As of December 31, 2012
(dollars in thousands)
| | | | | | | | | | | | Subsequently | | | | | | | | | | | | |
| | | | | | | | Initial Cost | | Capitalized | | Total | | | | | | | | | | |
| | | | | | | | | | Bldg./ | | Bldg. | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Brand | | Encumbrances | | Land | | FF&E /Other | | Imp. & FF&E | | Cost (1) | | Deprec. | | Construction | | Acquired | | Life | | Guestrooms |
Charlottesville | | VA | | Courtyard | | | 15,217 | | | | 2,312 | | | | 26,436 | | | | 975 | | | | 29,723 | | | | (3,689 | ) | | 2000 | | June-08 | | 3 - 39 yrs. | | | 139 | |
Chesapeake | | VA | | Marriott Full Service | | | 0 | | | | 3,256 | | | | 36,384 | | | | 57 | | | | 39,697 | | | | (6,122 | ) | | 2008 | | October-08 | | 3 - 39 yrs. | | | 226 | |
Harrisonburg | | VA | | Courtyard | | | 0 | | | | 1,684 | | | | 22,137 | | | | 1,813 | | | | 25,634 | | | | (3,564 | ) | | 1999 | | November-07 | | 3 - 39 yrs. | | | 125 | |
Suffolk | | VA | | Courtyard | | | 8,195 | | | | 968 | | | | 11,684 | | | | 36 | | | | 12,688 | | | | (1,948 | ) | | 2007 | | July-08 | | 3 - 39 yrs. | | | 92 | |
Suffolk | | VA | | TownePlace Suites | | | 6,286 | | | | 750 | | | | 9,390 | | | | 12 | | | | 10,152 | | | | (1,527 | ) | | 2007 | | July-08 | | 3 - 39 yrs. | | | 72 | |
VA Beach | | VA | | Courtyard | | | 14,235 | | | | 7,203 | | | | 20,708 | | | | 2,216 | | | | 30,127 | | | | (3,151 | ) | | 1999 | | June-08 | | 3 - 39 yrs. | | | 141 | |
VA Beach | | VA | | Courtyard | | | 17,180 | | | | 9,871 | | | | 30,988 | | | | 2,080 | | | | 42,939 | | | | (5,060 | ) | | 2002 | | June-08 | | 3 - 39 yrs. | | | 160 | |
Tukwila | | WA | | Homewood Suites | | | 9,667 | | | | 1,388 | | | | 14,756 | | | | 2,614 | | | | 18,758 | | | | (2,743 | ) | | 1991 | | July-08 | | 3 - 39 yrs. | | | 106 | |
Construction in Progress | | | 0 | | | | 0 | | | | 0 | | | | 82 | | | | 82 | | | | 0 | | | | | | | | | | | |
| | | | | | $ | 219,250 | | | $ | 87,645 | | | $ | 902,694 | | | $ | 62,092 | | | $ | 1,052,431 | | | $ | (163,209 | ) | | | | | | | | | 5,912 | |
(1) The gross cost basis for Federal Income Tax purposes approximates the basis used in this schedule. |
| | 2012 | | | 2011 | | | 2010 | |
Real estate owned: | | | | | | | | | |
Balance as of January 1 | | $ | 1,040,842 | | | $ | 1,035,573 | | | $ | 1,030,055 | |
Acquisitions | | | 0 | | | | 0 | | | | 83 | |
Improvements | | | 11,589 | | | | 5,269 | | | | 5,435 | |
Balance at December 31 | | $ | 1,052,431 | | | $ | 1,040,842 | | | $ | 1,035,573 | |
| | 2012 | | | 2011 | | | 2010 | |
Accumulated depreciation: | | | | | | | | | | | | |
Balance as of January 1 | | $ | (126,248 | ) | | $ | (90,261 | ) | | $ | (55,282 | ) |
Depreciation expense | | | (36,961 | ) | | | (35,987 | ) | | | (34,979 | ) |
Balance at December 31 | | $ | (163,209 | ) | | $ | (126,248 | ) | | $ | (90,261 | ) |
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 EIGHT, INC. | | |
| | | |
By: | /s/ Glade M. Knight | | Date: March 7, 2013 |
| Glade M. Knight, | | |
| Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | | |
| | | |
By: | /s/ Bryan Peery | | Date: March 7, 2013 |
| Bryan Peery, | | |
| Chief Financial Officer (Principal Financial and Principal Accounting Officer) | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.
By: | /s/ Glade M. Knight | | Date: March 7, 2013 |
| Glade M. Knight, Director | | |
| | | |
By: | /s/ Glenn W. Bunting, Jr. | | Date: March 7, 2013 |
| Glenn W. Bunting, Jr., Director | | |
| | | |
By: | /s/ Kent W. Colton | | Date: March 7, 2013 |
| Kent W. Colton, Director | | |
| | | |
By: | /s/ Michael S. Waters | | Date: March 7, 2013 |
| Michael S. Waters, Director | | |
| | | |
By: | /s/ Robert M. Wily | | Date: March 7, 2013 |
| Robert M. Wily, Director | | |
EXHIBIT INDEX
Exhibit Number | | Description of Documents |
| | |
3.1 | | Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| | |
3.2 | | Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to amendment no. 1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| | |
10.1 | | Advisory Agreement between the Registrant and Apple Eight Advisors, Inc. (Incorporated by reference to Exhibit 10.1 to amendment no. 2 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| | |
10.2 | | Property Acquisition/Disposition Agreement between the Registrant and Apple Suites Realty Group, Inc. (Incorporated by reference to Exhibit 10.2 to amendment no. 2 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| | |
10.3 | | Apple REIT Eight, Inc. 2007 Incentive Plan. (Incorporated by reference to Exhibit 10.3 to amendment no. 1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007)* |
| | |
10.4 | | Apple REIT Eight, Inc. 2007 Non-Employee Directors Stock Option Plan. (Incorporated by reference to Exhibit 10.4 to amendment no. 1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007)* |
| | |
10.16 | | Management Agreement dated as of November 9, 2007 between Newport Somerset Management, LLC and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.16 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.17 | | Courtyard by Marriott Relicensing Franchise Agreement dated as of November 9, 2007 between Marriott International, Inc. and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.17 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.18 | | Hotel Lease Agreement effective as of November 9, 2007 between Apple Eight Hospitality Ownership, Inc. and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.18 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.19 | | Management Agreement dated as of November 9, 2007 between Newport Greensboro Management, LLC and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.19 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.20 | | SpringHill Suites by Marriott Relicensing Franchise Agreement dated as of November 9, 2007 between Marriott International, Inc. and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.20 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.23 | | Management Agreement dated as of November 16, 2007 between Newport Harrisonburg Management, LLC and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.23 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
Exhibit Number | | Description of Documents |
| | |
10.24 | | Courtyard by Marriott Relicensing Franchise Agreement dated as of November 16, 2007 between Marriott International, Inc. and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.24 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.29 | | Franchise License Agreement dated as of December 6, 2007 between Hampton Inn Franchise LLC and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.29 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.30 | | Management Agreement dated as of December 6, 2007 between Newport Bowling Green Management, LLC and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.30 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.32 | | Management Agreement dated as of December 14, 2007 between LBAM-Investor, L.L.C. and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.32 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
10.33 | | Franchise License Agreement dated as of December 14, 2007 between Homewood Suites Franchise LLC and Apple Eight Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.33 to the registrant’s Post-Effective Amendment No. 1 to Form S-11 (SEC File No. 333-140548) filed December 27, 2007) |
| | |
21.1 | | Subsidiaries of Registrant (FILED HEREWITH) |
| | |
23.1 | | Consent of Ernst & Young LLP (FILED HEREWITH) |
| | |
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 Action 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) |
| | |
101 | | The following materials from Apple REIT Eight, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) related notes to these financial statements, tagged as blocks of text and in detail (FURNISHED HEREWITH) |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2013
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ |
Commission File Number 000-53175
Apple REIT Eight, Inc.
(Exact name of registrant as specified in its charter)
Virginia | 20-8268625 |
(State or other jurisdiction | (IRS Employer |
of incorporation or organization) | Identification No.) |
| |
814 East Main Street | 23219 |
Richmond, Virginia | (Zip Code) |
(Address of principal executive offices) | |
(804) 344-8121
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | | Accelerated filer ¨ | | Non-accelerated filer x | | Smaller reporting company ¨ |
| | | | (Do not check if a smaller reporting company) | | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of registrant’s common shares outstanding as of November 1, 2013: 92,140,005
FORM 10-Q
INDEX
| | | Page Number |
PART I. FINANCIAL INFORMATION |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
PART II. OTHER INFORMATION |
| | | |
| Item 1A. | | |
| | | |
| | |
This Form 10-Q includes references to certain trademarks or service marks. The SpringHill Suites® by Marriott, TownePlace Suites® by Marriott, Fairfield Inn® by Marriott, Residence Inn® by Marriott, Courtyard® by Marriott, Marriott®, and Renaissance® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Homewood Suites® by Hilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites® trademarks are the property of Hilton Worldwide or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.
PART I. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| | September 30, | | | December 31, | |
| | 2013 | | | 2012 | |
| | (unaudited) | | | | |
Assets | | | | | | |
Investment in real estate, net of accumulated depreciation of $191,502and $163,209, respectively | | $ | 867,867 | | | $ | 889,222 | |
Cash and cash equivalents | | | 0 | | | | 68 | |
Restricted cash-furniture, fixtures and other escrows | | | 16,274 | | | | 14,420 | |
Due from third party managers, net | | | 7,829 | | | | 4,391 | |
Other assets, net | | | 5,438 | | | | 4,763 | |
Total Assets | | $ | 897,408 | | | $ | 912,864 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Credit facilities | | $ | 64,590 | | | $ | 45,300 | |
Mortgage debt | | | 215,763 | | | | 218,719 | |
Accounts payable and accrued expenses | | | 24,449 | | | | 20,796 | |
Intangible liabilities, net | | | 8,227 | | | | 8,874 | |
Total Liabilities | | | 313,029 | | | | 293,689 | |
| | | | | | | | |
Shareholders' Equity | | | | | | | | |
Preferred stock, authorized 15,000,000 shares; none issued and outstanding | | | 0 | | | | 0 | |
Series A preferred stock, no par value, authorized 200,000,000 shares; issued and outstanding 92,140,005 and 92,840,914 shares, respectively | | | 0 | | | | 0 | |
Series B convertible preferred stock, no par value, authorized 240,000 shares; issued and outstanding 240,000 shares | | | 24 | | | | 24 | |
Common stock, no par value, authorized 200,000,000 shares;issued and outstanding 92,140,005 and 92,840,914 shares, respectively | | | 912,063 | | | | 919,605 | |
Distributions greater than net income | | | (327,708 | ) | | | (300,454 | ) |
Total Shareholders' Equity | | | 584,379 | | | | 619,175 | |
Total Liabilities and Shareholders' Equity | | $ | 897,408 | | | $ | 912,864 | |
See notes to consolidated financial statements.
APPLE REIT EIGHT, INC.CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
| | Three months ended | | | Nine months ended | |
| | September 30, | | | September 30, | |
| | 2013 | | | 2012 | | | 2013 | | | 2012 | |
Revenues: | | | | | | | | | | | | |
Room revenue | | $ | 52,935 | | | $ | 51,894 | | | $ | 144,790 | | | $ | 142,118 | |
Other revenue | | | 3,960 | | | | 3,736 | | | | 11,200 | | | | 10,360 | |
Total revenue | | | 56,895 | | | | 55,630 | | | | 155,990 | | | | 152,478 | |
| | | | | | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | | | | | |
Operating expense | | | 14,576 | | | | 14,184 | | | | 41,215 | | | | 40,039 | |
Hotel administrative expense | | | 4,391 | | | | 4,120 | | | | 12,659 | | | | 12,183 | |
Sales and marketing | | | 4,183 | | | | 4,103 | | | | 11,837 | | | | 11,705 | |
Utilities | | | 2,410 | | | | 2,377 | | | | 6,368 | | | | 6,305 | |
Repair and maintenance | | | 2,695 | | | | 2,461 | | | | 7,893 | | | | 7,397 | |
Franchise fees | | | 2,318 | | | | 2,234 | | | | 6,225 | | | | 6,028 | |
Management fees | | | 2,046 | | | | 2,001 | | | | 5,575 | | | | 5,430 | |
Property taxes, insurance and other | | | 2,639 | | | | 2,484 | | | | 7,477 | | | | 7,269 | |
Land lease expense | | | 1,600 | | | | 1,599 | | | | 4,805 | | | | 4,802 | |
General and administrative | | | 1,253 | | | | 1,548 | | | | 3,990 | | | | 4,566 | |
Merger transaction costs | | | 1,253 | | | | 0 | | | | 1,305 | | | | 484 | |
Depreciation expense | | | 9,480 | | | | 9,287 | | | | 28,293 | | | | 27,613 | |
Total expenses | | | 48,844 | | | | 46,398 | | | | 137,642 | | | | 133,821 | |
| | | | | | | | | | | | | | | | |
Operating income | | | 8,051 | | | | 9,232 | | | | 18,348 | | | | 18,657 | |
| | | | | | | | | | | | | | | | |
Interest expense, net | | | (4,004 | ) | | | (3,844 | ) | | | (11,156 | ) | | | (10,884 | ) |
| | | | | | | | | | | | | | | | |
Income before income taxes | | | 4,047 | | | | 5,388 | | | | 7,192 | | | | 7,773 | |
| | | | | | | | | | | | | | | | |
Income tax expense | | | (39 | ) | | | (53 | ) | | | (141 | ) | | | (150 | ) |
| | | | | | | | | | | | | | | | |
Net income | | $ | 4,008 | | | $ | 5,335 | | | $ | 7,051 | | | $ | 7,623 | |
| | | | | | | | | | | | | | | | |
Basic and diluted net income per common share | | $ | 0.04 | | | $ | 0.06 | | | $ | 0.08 | | | $ | 0.08 | |
| | | | | | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 92,140 | | | | 92,968 | | | | 92,375 | | | | 93,123 | |
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)(in thousands)
| | Nine months ended | |
| | September 30, | |
| | 2013 | | | 2012 | |
Cash flows from operating activities: | | | | | | |
Net income | | $ | 7,051 | | | $ | 7,623 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | |
Depreciation | | | 28,293 | | | | 27,613 | |
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net | | | 379 | | | | 414 | |
Changes in operating assets and liabilities: | | | | | | | | |
Increase in due from third party managers, net | | | (3,438 | ) | | | (3,370 | ) |
Increase in other assets, net | | | (1,340 | ) | | | (1,076 | ) |
Increase in accounts payable and accrued expenses | | | 2,966 | | | | 5,268 | |
Net cash provided by operating activities | | | 33,911 | | | | 36,472 | |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Capital improvements | | | (6,251 | ) | | | (10,370 | ) |
Increase in capital improvement reserves | | | (1,097 | ) | | | (2,326 | ) |
Net cash used in investing activities | | | (7,348 | ) | | | (12,696 | ) |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Net proceeds related to issuance of Units | | | 4,288 | | | | 8,434 | |
Redemptions of Units | | | (12,003 | ) | | | (13,977 | ) |
Distributions paid to common shareholders | | | (34,305 | ) | | | (38,412 | ) |
Net proceeds from existing credit facilities | | | 19,290 | | | | 37,800 | |
Net payments on extinguished credit facilities | | | 0 | | | | (73,213 | ) |
Proceeds from mortgage debt | | | 0 | | | | 58,700 | |
Payments of mortgage debt | | | (3,118 | ) | | | (1,963 | ) |
Deferred financing costs | | | (783 | ) | | | (1,145 | ) |
Net cash used in financing activities | | | (26,631 | ) | | | (23,776 | ) |
| | | | | | | | |
Net change in cash and cash equivalents | | | (68 | ) | | | 0 | |
| | | | | | | | |
Cash and cash equivalents, beginning of period | | | 68 | | | | 0 | |
| | | | | | | | |
Cash and cash equivalents, end of period | | $ | 0 | | | $ | 0 | |
See notes to consolidated financial statements.
APPLE REIT EIGHT, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Summary of Significant Accounting Policies
Organization
Apple REIT Eight, Inc., together with its wholly owned subsidiaries (the “Company”), is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company was formed to invest in income-producing real estate in the United States. Initial capitalization occurred on January 22, 2007 and operations began on November 9, 2007 when the Company acquired its first hotels. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in April 2008. The Company’s fiscal year end is December 31. The Company has no foreign operations or assets, and its operating structure includes two reportable segments. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. As of September 30, 2013, the Company owned 51 hotels located in 19 states with an aggregate of 5,914 rooms.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not include all of the information required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its 2012 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2013.
Use of Estimates
The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain amounts in the 2012 consolidated financial statements have been reclassified to conform with the 2013 presentation with no effect on previously reported net income or shareholders’ equity.
Earnings Per Common Share
Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the period. Diluted earnings per common share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period. There were no potential common shares with a dilutive effect for the three or nine months ended September 30, 2013 or 2012. As a result, basic and diluted outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares.
2. Merger Agreement
On August 7, 2013, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”), Apple Seven Acquisition Sub, Inc. (“Seven Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, and Apple Eight Acquisition Sub, Inc. (“Eight Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, entered into an Agreement and Plan of Merger, as amended (the “Merger Agreement”). The Merger Agreement provides for the merger of Apple Seven and Apple Eight with and into Seven Acquisition Sub and Eight Acquisition Sub, respectively, which were formed solely for engaging in the mergers and have not conducted any prior activities. Upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight will cease and Seven Acquisition Sub and Eight Acquisition Sub will be the surviving corporations. Pursuant to the terms of the Merger Agreement, upon completion of the mergers, the current Apple Nine common shares totaling 182,784,131 will remain outstanding and:
· | Each issued and outstanding unit of Apple Seven (consisting of one Apple Seven common share together with one Apple Seven Series A preferred share) will be converted into one (the “Apple Seven exchange ratio”) common share of Apple Nine, or a total of approximately 90,613,633 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Seven will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Seven exchange ratio, or a total of 5,801,050 common shares; and |
· | Each issued and outstanding unit of Apple Eight (consisting of one Apple Eight common share together with one Apple Eight Series A preferred share) will be converted into 0.85 (the “Apple Eight exchange ratio”) common share of Apple Nine, or a total of approximately 78,319,004 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Eight will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Eight exchange ratio, or a total of 4,930,892 common shares. |
If the mergers are approved by the shareholders of each of Apple Seven, Apple Eight and Apple Nine and all of the other conditions to the mergers are completed, Apple Eight will record an expense related to the conversion of Apple Eight’s Series B convertible preferred shares into common shares of Apple Nine. Although the final estimate of fair value may vary significantly from these estimates, Apple Nine’s preliminary estimate of the fair value of $9.00 to $11.00 per Apple Nine common share would result in an expense to Apple Eight ranging from approximately $44 million to $54 million.
The Merger Agreement contains various closing conditions, including shareholder approval by Apple Seven, Apple Eight and Apple Nine. As a result, there is no assurance that the mergers will occur. Under the Merger Agreement, Apple Seven, Apple Eight and Apple Nine may terminate the Merger Agreement under certain circumstances; however, each of the companies may be required to pay a fee of $1.7 million, plus reasonable third party expenses, to each of the other companies upon such termination. All costs related to the proposed mergers are being expensed in the period they are incurred and are included in the merger transaction costs in the Company’s consolidated statements of operations. In connection with these activities, the Company incurred approximately $1.3 million in expenses for the nine months ended September 30, 2013.
3. Credit Facilities and Mortgage Debt
In March 2012, the Company entered into a $60 million unsecured revolving credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part at any time. The Company entered into a modification of this facility during the second quarter of 2013 in order to extend the maturity date of the facility; the Company also increased the available borrowing commitment to $70 million. The credit facility, as amended, matures in April 2015; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to April 2016. Interest payments are due monthly, and the interest rate is equal to either one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 3.00%, depending on the Company’s leverage ratio as calculated under the terms of the credit agreement, or the prime interest rate plus a margin ranging from 1.25% to 2.00%, at the Company’s option. The Company is also required to pay an unused facility fee of 0.25% to 0.35% on the average unused portion of the credit facility.
As of September 30, 2013 and December 31, 2012, the credit facility had an outstanding principal balance of $64.5 million and $45.3 million and an annual interest rate of approximately 2.93% and 3.21%, respectively. The Company incurred loan modification costs of approximately $0.4 million, which are being amortized as interest expense from the date of modification to the loan’s April 2015 maturity date. The credit facility contains customary affirmative covenants, negative covenants and events of defaults. The amended credit facility contains the following quarterly financial covenants (capitalized terms are defined in the credit agreement):
· | Tangible Net Worth must exceed $275 million; |
· | Total Debt to Asset Value must not exceed 55%; |
· | Distributions, net of proceeds from the Company’s Dividend Reinvestment Program, cannot exceed $16.5 million during the second quarter of 2013 and $12.5 million during any quarter thereafter, and quarterly dividends cannot exceed $0.1169 per share, effective with the second quarter of 2013, unless such Distributions are less than total Funds From Operations for the quarter; |
· | Loan balance must not exceed 50% of the Unencumbered Asset Value; |
· | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
· | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at September 30, 2013.
In April 2013, the Company entered into a term loan agreement with the same commercial bank providing for up to $15 million in unsecured borrowings. Proceeds of the term loan facility were used for general working capital purposes, including reduction of the Company’s outstanding balance on its unsecured credit facility. Borrowings under this facility bore interest at 2.5% plus one-month LIBOR. In June 2013, this term loan facility was paid in full and extinguished.
In April 2013, the Company entered into a modification of loan terms with the lender for the mortgage note payable jointly secured by the Company’s Burbank, California Residence Inn and Oceanside, California Residence Inn. The mortgage loan’s maturity was extended from January 2015 to January 2017, with an option for the Company to extend the maturity for one additional year. The mortgage loan’s variable interest rate was reduced from one-month LIBOR plus 4.25% to one-month LIBOR plus 3.24%. Additionally, effective in January 2015, the loan’s variable rate interest will be further reduced by 0.10% to an interest rate of one-month LIBOR plus 3.14%. The mortgage loan had a balance outstanding of approximately $39.5 million at September 30, 2013; interest and principal payments of $65,000 are payable each month through maturity of the loan. The Company incurred loan modification costs of approximately $0.2 million, which are being amortized as interest expense from date of modification to the loan’s January 2017 maturity date. To effectively fix the interest rate on the mortgage loan for the period from the original maturity date in January 2015 through the modified maturity date in January 2017, the Company entered into a forward interest rate swap agreement with the same commercial lender simultaneous with the loan modification agreement. Under terms of the interest rate swap agreement, the Company agrees, effective in January 2015, to pay a monthly fixed interest rate of 1.10% and receive a floating rate of interest equal to the one-month LIBOR, effectively fixing the interest rate of the modified mortgage loan at 4.24% for the period from January 2015 through maturity in January 2017. The Company also has an interest rate swap through the original maturity of January 2015 that effectively fixes the interest rate from the date of amendment through January 2015 at 4.24%. The notional amounts of the swaps will amortize in tandem with the amortization of the loan.
In June 2013, the Company entered into an $8.3 million secured revolving credit facility with a commercial bank that is available for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. This facility is jointly secured by the Company’s Texarkana, Texas Courtyard and Texarkana, Texas TownePlace Suites. The credit facility matures in June 2014. Interest payments are due monthly, and the interest rate is equal to the greater of the prime interest rate or 4.50%. The Company incurred loan origination costs of approximately $0.1 million, which are being amortized as interest expense from date of origination to the credit facility’s June 2014 maturity date. As of September 30, 2013, the credit facility had an outstanding principal balance of $0.1 million and an annual interest rate of 4.50%. The credit facility is subject to the same financial covenants as the Company’s unsecured credit facility.
4. Fair Value of Financial Instruments
The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit terms and credit characteristics, which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. As of September 30, 2013, the carrying value and estimated fair value of the Company’s debt was approximately $280.4 million and $290.6 million. As of December 31, 2012, the carrying value and estimated fair value of the Company’s debt was $264.0 million and $275.4 million.
As of September 30, 2013, the Company had three outstanding interest rate swap agreements that effectively fix the interest rate on two separate variable-rate mortgage loans. The notional amounts, effective dates, maturity dates, and fair values for these agreements are as follows (all dollars in thousands):
Related property/mortgage | | Effective date | | Notional amount at 9/30/13 | | Maturity date | | Fair value | |
Westford Residence Inn | | 10/1/2010 | | $ | 6,593 | | 10/1/2015 | | $ | (186 | ) |
Oceanside Residence Inn/Burbank Residence Inn | | 1/13/2012 | | | 39,480 | | 1/13/2015 | | | (357 | ) |
Oceanside Residence Inn/Burbank Residence Inn | | 1/13/2015 | | | 38,440 | | 1/13/2017 | | | 61 | |
Total | | | | | | | | | $ | (482 | ) |
At September 30, 2013 and December 31, 2012, the Company’s outstanding interest rate swap agreements were recorded at a fair value of $0.5 million (liability) and $0.8 million (liability), respectively and were included in accounts payable and accrued expenses. The fair value of the Company’s interest rate swap agreements are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts, which is considered a Level 2 measurement within the Accounting Standards Codification’s fair value hierarchy. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. These derivatives are not designated by the Company as hedges for accounting purposes, and the changes in the fair value are recorded to interest expense, net in the consolidated statements of operations. For each of the three-month periods ended September 30, 2013 and 2012, the change in fair value resulted in a net increase of $0.1 million to interest expense, net. For the nine months ended September 30, 2013 and 2012, the change in fair value resulted in a net decrease of approximately $0.3 million and a net increase of $0.1 million, respectively, to interest expense, net.
The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.
5. Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the nine months ended September 30, 2013 (other than the transactions related to the completion of Apple REIT Six, Inc.’s merger with a third party and the Merger Agreement and related transactions discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The term the “Apple REIT Entities” means Apple REIT Six, Inc. (“Apple Six”), Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”) and Apple REIT Ten, Inc. (“Apple Ten”). The term the “Advisors” means Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc. (“A8A”), Apple Nine Advisors, Inc. (“A9A”), Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. (“ASRG”) and Apple Six Realty Group, Inc. The Advisors are wholly owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple Seven, Apple Nine and Apple Ten. Members of the Company’s Board of Directors are also on the Board of Directors of Apple Seven, Apple Nine and Apple Ten.
On May 14, 2013, Apple Six merged with and into an entity that is not affiliated with the Apple REIT Entities or the Advisors. Pursuant to the terms and conditions of the merger agreement, dated as of November 29, 2012, upon completion of the merger, the separate corporate existence of Apple Six ceased (the “A6 Merger”). Prior to the A6 Merger, Glade M. Knight was Chairman and Chief Executive Office of Apple Six and members of the Company’s Board of Directors were also on the Board of Directors of Apple Six.
ASRG Agreement
The Company has a contract with ASRG to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. No fees or expenses were incurred by the Company during the nine months ended September 30, 2013 and 2012 under this contract.
A8A Agreement
The Company is party to an advisory agreement with A8A, pursuant to which A8A provides management services to the
Company. A8A provides these management services through Apple Fund Management, LLC (“AFM”), which immediately after the A6 Merger became a wholly-owned subsidiary of A9A. This transaction between A9A and Apple Six was made with no cash consideration exchanged between the entities. Prior to May 14, 2013, AFM was a wholly-owned subsidiary of Apple Six. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses as described below, are payable to A8A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $0.8 million for each of the nine-month periods ended September 30, 2013 and 2012.
Apple REIT Entities and Advisors Cost Sharing Structure
In addition to the fees payable to A8A, the Company reimbursed to A8A, or paid directly to AFM on behalf of A8A, approximately $1.3 million for both of the nine-month periods ended September 30, 2013 and 2012. The costs are included in general and administrative expenses and are for the Company’s allocated share of the staffing and related costs provided by AFM at the direction of A8A.
AFM is an affiliate of each of the Advisors. Each of the Advisors provides management services through the use of AFM to, respectively, Apple Six (prior to the A6 Merger), Apple Seven, Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, effective May 14, 2013, the entire membership interest of Apple Six in AFM was transferred and assigned to A9A, which then became the sole member of AFM. As part of the assignment, A9A and the other Advisors agreed to indemnify the buyer of Apple Six for liabilities related to AFM. The assignment of AFM’s interest to A9A had no impact on the Company’s advisory agreement with A8A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors as described below, except Apple Six and its advisors, Apple Six Advisors, Inc. and Apple Six Realty Group, Inc. (collectively “A6 Advisors”), no longer participate in the cost sharing arrangement, thereby increasing the remaining companies’ share of the allocated costs.
Also, in connection with the A6 Merger, on May 13, 2013, Apple Nine acquired from Apple Six the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and assumed the Fort Worth, Texas office lease agreement. As described below, any costs associated with the Headquarters and office lease, including office rent, utilities, office supplies, etc. (“Office Related Costs”) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors.
Prior to the A6 Merger, amounts reimbursed to AFM included both compensation for personnel and Office Related Costs used by the companies. As discussed above, as a result of the A6 Merger, beginning on May 14, 2013, Office Related Costs are now allocated from Apple Nine to the other Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors. Each of these companies has agreed to reimburse Apple Nine for its share of these costs. From the period May 14, 2013 through September 30, 2013, the Company reimbursed Apple Nine approximately $0.1 million for its share of Office Related Costs, which are included in general and administrative costs in the Company’s consolidated statements of operations.
All of the Office Related Costs and costs of AFM are allocated among the Apple REIT Entities and the Advisors, excluding Apple Six and A6 Advisors after the A6 Merger. The allocation of costs is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described above allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
As part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) are reimbursed or collected and are not significant in amount.
The Company has incurred legal fees associated with the Legal Proceedings and Related Matters discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities (excluding Apple Six after the A6 Merger). The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the Legal Proceedings and Related Matters discussed herein for all of the Apple REIT Entities was approximately $2.2 million for the nine months ended September 30, 2013, of which approximately $0.5 million was allocated to the Company. Total costs for the nine months ended September 30, 2012 for all of the Apple REIT Entities was approximately $5.7 million, of which approximately $1.2 million was allocated to the Company.
Apple Air Holding, LLC (“Apple Air”) Membership Interest
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air. The other current members of Apple Air are Apple Seven, Apple Nine and Apple Ten. In connection with the A6 Merger, on May 13, 2013, Apple Ten acquired its membership interest in Apple Air from Apple Six. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million as of September 30, 2013 and December 31, 2012. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the nine months ended September 30, 2013 and 2012, the Company recorded a loss of approximately $181,000 and $145,000 respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.
Merger Agreement and Related Transactions
Concurrently with the execution of the Merger Agreement (as discussed in note 2), on August 7, 2013, Apple Seven, Apple Eight and Apple Nine entered into a termination agreement, as amended (the “Termination Agreement”) with Apple Seven Advisors, Inc., A8A, A9A and ASRG, effective immediately before the completion of the mergers. Pursuant to the Termination Agreement, the existing advisory agreements and property acquisition/disposition agreements with respect to Apple Seven, Apple Eight and Apple Nine will be terminated. The Termination Agreement does not provide for any separate payments to be made in connection with the termination of the existing advisory agreements and property acquisition/disposition agreements. As a result, if the merger is completed, Apple Seven, Apple Eight and Apple Nine will no longer pay the various fees currently paid to its respective advisors.
6. Shareholder’s Equity
Unit Redemption Program
In October 2008, 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 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. On June 27, 2013, the Company announced the suspension of its Unit Redemption Program as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the program until the Merger Agreement is terminated or the mergers are completed.
Since inception of the program through September 30, 2013, the Company has redeemed approximately 8.5 million Units representing $91.3 million, including 1.1 million Units in the amount of $12.0 million and 1.3 million Units in the amount of $14.0 million redeemed during the nine months ended September 30, 2013 and 2012, respectively. Since the first quarter of 2011, the total redemption requests have exceeded the authorized amount of redemptions and, as a result, the Board of Directors has limited the amount of redemptions as deemed prudent. Therefore, as contemplated in the program, beginning with the first quarter 2011 redemption, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of Unit redemptions during 2012 and the first nine months of 2013:
Redemption Date | | Total Requested Unit Redemptions at Redemption Date | | | Units Redeemed | | | Total Redemption Requests not Redeemed at Redemption Date | |
First Quarter 2012 | | | 18,910,430 | | | | 454,405 | | | | 18,456,025 | |
Second Quarter 2012 | | | 18,397,381 | | | | 454,638 | | | | 17,942,743 | |
Third Quarter 2012 | | | 18,607,044 | | | | 362,553 | | | | 18,244,491 | |
Fourth Quarter 2012 | | | 19,112,925 | | | | 391,142 | | | | 18,721,783 | |
First Quarter 2013 | | | 19,485,287 | | | | 434,573 | | | | 19,050,714 | |
Second Quarter 2013 | | | 20,938,382 | | | | 657,736 | | | | 20,280,646 | |
Dividend Reinvestment Plan
In the second quarter of 2008, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. The Company has registered 10 million Units for potential issuance under the plan. Since inception of the plan through September 30, 2013, approximately 9.5 million Units, representing approximately $104.2 million in proceeds to the Company, were issued under the plan. During the nine months ended September 30, 2013 and 2012, approximately 0.4 million and 0.8 million Units were issued under the plan representing approximately $4.3 million and $8.4 million in proceeds to the Company, respectively. On June 27, 2013, the Company announced the suspension of its Dividend Reinvestment Plan as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the plan until the Merger Agreement is terminated or the mergers are completed.
Distributions
For the three months ended September 30, 2013 and 2012, the Company made distributions of $0.1169 and $0.1375 per common share, for a total of $10.8 million and $12.8 million, respectively. For the nine months ended September 30, 2013 and 2012, the Company made distributions of $0.3712 and $0.4125 per common share, for a total of $34.3 million and $38.4 million, respectively. In 2013, the Company’s Board of Directors approved a reduction of the monthly distribution rate to $0.038958 ($0.4675 on an annual basis) effective for the distribution paid in April 2013. The Company’s distributions continue to be paid monthly.
7. Industry Segments
The Company has two reportable segments: the New York hotel and all other hotels. The New York hotel is a full service hotel in New York City, New York. The Company’s other hotels are extended-stay and select service hotel properties throughout the United States that generate rental and other property related income. The Company separately evaluates the performance of each of its hotel properties. However, because each of the hotels has similar economic characteristics, facilities, and services, and each hotel is not individually significant, other than the New York hotel, the other properties have been aggregated into a single reportable segment. The Company does not allocate corporate-level accounts to its reportable segments, including corporate general and administrative expenses, non-operating interest income and interest expense. The following table summarizes the results of operations and assets for each segment for the three and nine months ended September 30, 2013 and 2012. Dollar amounts are in thousands.
| | For the three months ended September 30, 2013 | |
| | New York, | | | | | | | | | | |
| | New York | | | All Other | | | | | | | |
| | Hotel | | | Hotels | | | Corporate | | | Consolidated | |
Total revenue | | $ | 5,493 | | | $ | 51,402 | | | $ | 0 | | | $ | 56,895 | |
Hotel expenses | | | 5,255 | | | | 31,603 | | | | 0 | | | | 36,858 | |
General and administrative expense | | | 0 | | | | 0 | | | | 1,253 | | | | 1,253 | |
Merger transaction costs | | | 0 | | | | 0 | | | | 1,253 | | | | 1,253 | |
Depreciation expense | | | 1,620 | | | | 7,860 | | | | 0 | | | | 9,480 | |
Operating income/(loss) | | | (1,382 | ) | | | 11,939 | | | | (2,506 | ) | | | 8,051 | |
Interest expense, net | | | 0 | | | | (3,431 | ) | | | (573 | ) | | | (4,004 | ) |
Income tax expense | | | 0 | | | | (39 | ) | | | 0 | | | | (39 | ) |
Net income/(loss) | | $ | (1,382 | ) | | $ | 8,469 | | | $ | (3,079 | ) | | $ | 4,008 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | 103,167 | | | $ | 791,888 | | | $ | 2,353 | | | $ | 897,408 | |
| | For the nine months ended September 30, 2013 | |
| | New York, | | | | | | | | | | |
| | New York | | | All Other | | | | | | | |
| | Hotel | | | Hotels | | | Corporate | | | Consolidated | |
Total revenue | | $ | 16,463 | | | $ | 139,527 | | | $ | 0 | | | $ | 155,990 | |
Hotel expenses | | | 15,027 | | | | 89,027 | | | | 0 | | | | 104,054 | |
General and administrative expense | | | 0 | | | | 0 | | | | 3,990 | | | | 3,990 | |
Merger transaction costs | | | 0 | | | | 0 | | | | 1,305 | | | | 1,305 | |
Depreciation expense | | | 4,881 | | | | 23,412 | | | | 0 | | | | 28,293 | |
Operating income/(loss) | | | (3,445 | ) | | | 27,088 | | | | (5,295 | ) | | | 18,348 | |
Interest expense, net | | | 0 | | | | (9,524 | ) | | | (1,632 | ) | | | (11,156 | ) |
Income tax expense | | | 0 | | | | (141 | ) | | | 0 | | | | (141 | ) |
Net income/(loss) | | $ | (3,445 | ) | | $ | 17,423 | | | $ | (6,927 | ) | | $ | 7,051 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | 103,167 | | | $ | 791,888 | | | $ | 2,353 | | | $ | 897,408 | |
| | For the three months ended September 30, 2012 | |
| | New York, | | | | | | | | | | |
| | New York | | | All Other | | | | | | | |
| | Hotel | | | Hotels | | | Corporate | | | Consolidated | |
Total revenue | | $ | 5,558 | | | $ | 50,072 | | | $ | 0 | | | $ | 55,630 | |
Hotel expenses | | | 5,029 | | | | 30,534 | | | | 0 | | | | 35,563 | |
General and administrative expense | | | 0 | | | | 0 | | | | 1,548 | | | | 1,548 | |
Merger transaction costs | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Depreciation expense | | | 1,639 | | | | 7,648 | | | | 0 | | | | 9,287 | |
Operating income/(loss) | | | (1,110 | ) | | | 11,890 | | | | (1,548 | ) | | | 9,232 | |
Interest expense, net | | | 0 | | | | (3,255 | ) | | | (589 | ) | | | (3,844 | ) |
Income tax expense | | | 0 | | | | (53 | ) | | | 0 | | | | (53 | ) |
Net income/(loss) | | $ | (1,110 | ) | | $ | 8,582 | | | $ | (2,137 | ) | | $ | 5,335 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | 107,948 | | | $ | 815,157 | | | $ | 2,236 | | | $ | 925,341 | |
| | For the nine months ended September 30, 2012 | |
| | New York, | | | | | | | | | | |
| | New York | | | All Other | | | | | | | |
| | Hotel | | | Hotels | | | Corporate | | | Consolidated | |
Total revenue | | $ | 16,171 | | | $ | 136,307 | | | $ | 0 | | | $ | 152,478 | |
Hotel expenses | | | 15,131 | | | | 86,027 | | | | 0 | | | | 101,158 | |
General and administrative expense | | | 0 | | | | 0 | | | | 4,566 | | | | 4,566 | |
Merger transaction costs | | | 0 | | | | 0 | | | | 484 | | | | 484 | |
Depreciation expense | | | 4,930 | | | | 22,683 | | | | 0 | | | | 27,613 | |
Operating income/(loss) | | | (3,890 | ) | | | 27,597 | | | | (5,050 | ) | | | 18,657 | |
Interest expense, net | | | 0 | | | | (9,237 | ) | | | (1,647 | ) | | | (10,884 | ) |
Income tax expense | | | 0 | | | | (150 | ) | | | 0 | | | | (150 | ) |
Net income/(loss) | | $ | (3,890 | ) | | $ | 18,210 | | | $ | (6,697 | ) | | $ | 7,623 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | 107,948 | | | $ | 815,157 | | | $ | 2,236 | | | $ | 925,341 | |
8. Legal Proceedings and Related Matters
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc. et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The Securities and Exchange Commission (“SEC”) staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company's filings with the SEC beginning in 2008, as well as the Company's review of certain transactions involving the Company and the other Apple REIT Entities. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company's consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution.
9. Subsequent Events
In October 2013, the Company declared and paid approximately $3.6 million, or $0.038958 per outstanding common share, in distributions to its common shareholders.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential,” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company, Apple REIT Seven, Inc. or Apple REIT Nine, Inc. to obtain required shareholder or other third-party approvals required to consummate the proposed mergers, under which Apple REIT Seven, Inc. and Apple REIT Eight, Inc. would be merged with and into wholly owned subsidiaries of Apple REIT Nine, Inc.; the satisfaction or waiver of other conditions in the merger agreement; a material adverse effect on the Company, Apple REIT Seven, Inc. or Apple REIT Nine, Inc.; the outcome of any legal proceedings that may be instituted against the Company, Apple REIT Seven, Inc. or Apple REIT Nine, Inc. and others related to the merger agreement; the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classifications as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission (“SEC”). Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
Overview
Apple REIT Eight, Inc., together with its wholly owned subsidiaries (the “Company”), was formed to invest in income-producing real estate in the United States. The Company was initially capitalized on January 22, 2007, with its first investor closing on July 27, 2007. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in April 2008. The Company has elected to be treated as a Real Estate Investment Trust (“REIT”) for federal income tax purposes. As of September 30, 2013, the Company owned 51 hotels within different markets in the United States. The Company’s first hotels were acquired on November 9, 2007.
Hotel Operations
Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned. With the significant decline in economic conditions throughout the United States over the 2008 through 2010 time period, overall performance of the Company’s hotels has not met expectations since acquisition. The hotel industry and the Company continue to see improvement in revenue as compared to the prior year. The Company’s growth rate has trailed that of the industry due to certain of its markets trailing average growth. Most of the trailing markets have been impacted by declines in government spending. Although there is no way to predict future general economic conditions, and there are several key factors that may continue to negatively affect the economic recovery in the United States and add to general market uncertainty,
including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the ongoing uncertainty surrounding the fiscal policy of the United States (including the “sequester,” tax increases and potential government spending cuts), the Company and industry are forecasting a low to mid-single-digit percentage increase in revenue for 2013 as compared to 2012 revenue, which is expected to continue into 2014.
In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”), and market yield which compares an individual hotel’s results to others in its local market, and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.
The following is a summary of the Company’s results for the three and nine months ended September 30, 2013 and 2012:
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | | | Percent of | | | | | Percent of | | | Percent | | | | | Percent of | | | | | Percent of | | | Percent | |
(in thousands, except statistical data) | | 2013 | | Revenue | | | 2012 | | Revenue | | | Change | | | 2013 | | Revenue | | | 2012 | | Revenue | | | Change | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Total revenue | | $ | 56,895 | | 100 | % | | $ | 55,630 | | 100 | % | | 2 | % | | $ | 155,990 | | 100 | % | | $ | 152,478 | | 100 | % | | 2 | % |
Hotel operating expenses | | | 32,619 | | 57 | % | | | 31,480 | | 57 | % | | 4 | % | | | 91,772 | | 59 | % | | | 89,087 | | 58 | % | | 3 | % |
Property taxes, insurance and other expense | | | 2,639 | | 5 | % | | | 2,484 | | 4 | % | | 6 | % | | | 7,477 | | 5 | % | | | 7,269 | | 5 | % | | 3 | % |
Land lease expense | | | 1,600 | | 3 | % | | | 1,599 | | 3 | % | | 0 | % | | | 4,805 | | 3 | % | | | 4,802 | | 3 | % | | 0 | % |
General and administrative expense | | | 1,253 | | 2 | % | | | 1,548 | | 3 | % | | -19 | % | | | 3,990 | | 3 | % | | | 4,566 | | 3 | % | | -13 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Merger transaction costs | | | 1,253 | | | | | | 0 | | | | | n/a | | | | 1,305 | | | | | | 484 | | | | | 170 | % |
Depreciation | | | 9,480 | | | | | | 9,287 | | | | | 2 | % | | | 28,293 | | | | | | 27,613 | | | | | 2 | % |
Interest expense, net | | | 4,004 | | | | | | 3,844 | | | | | 4 | % | | | 11,156 | | | | | | 10,884 | | | | | 2 | % |
Income tax expense | | | 39 | | | | | | 53 | | | | | -26 | % | | | 141 | | | | | | 150 | | | | | -6 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Number of hotels | | | 51 | | | | | | 51 | | | | | 0 | % | | | 51 | | | | | | 51 | | | | | 0 | % |
Average Market Yield(1) | | | 125 | | | | | | 124 | | | | | 1 | % | | | 127 | | | | | | 126 | | | | | 1 | % |
ADR | | $ | 125 | | | | | $ | 121 | | | | | 3 | % | | $ | 120 | | | | | $ | 116 | | | | | 3 | % |
Occupancy | | | 78 | % | | | | | 78 | % | | | | 0 | % | | | 75 | % | | | | | 75 | % | | | | 0 | % |
RevPAR | | $ | 97 | | | | | $ | 94 | | | | | 3 | % | | $ | 90 | | | | | $ | 87 | | | | | 3 | % |
Room nights sold (2) | | | 423,313 | | | | | | 420,917 | | | | | 1 | % | | | 1,212,804 | | | | | | 1,208,246 | | | | | 0 | % |
Room nights available (3) | | | 543,996 | | | | | | 539,868 | | | | | 1 | % | | | 1,615,488 | | | | | | 1,608,466 | | | | | 0 | % |
(1) Calculated from data provided by Smith Travel Research, Inc.® Excludes hotels under renovation during the applicable periods. (2) Represents the number of room nights sold during the period. (3) Represents the number of rooms owned by the Company multiplied by the number of nights in the period. |
Merger Agreement
On August 7, 2013, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”), Apple Seven Acquisition Sub, Inc. (“Seven Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, and Apple Eight Acquisition Sub, Inc. (“Eight Acquisition Sub”), a wholly-owned subsidiary of Apple Nine, entered into an Agreement and Plan of Merger, as amended (the “Merger Agreement”). The Merger Agreement provides for the merger of Apple Seven and Apple Eight with and into Seven Acquisition Sub and Eight Acquisition Sub, respectively, which were formed solely for engaging in the mergers and have not conducted any prior activities. Upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight will cease and Seven Acquisition Sub and Eight Acquisition Sub will be the surviving corporations. Pursuant to the terms of the Merger Agreement, upon completion of the mergers, the current Apple Nine common shares totaling 182,784,131 will remain outstanding and:
· | Each issued and outstanding unit of Apple Seven (consisting of one Apple Seven common share together with one Apple Seven Series A preferred share) will be converted into one (the “Apple Seven exchange ratio”) common share of Apple Nine, or a total of approximately 90,613,633 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Seven will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Seven exchange ratio, or a total of 5,801,050 common shares; and |
· | Each issued and outstanding unit of Apple Eight (consisting of one Apple Eight common share together with one Apple Eight Series A preferred share) will be converted into 0.85 (the “Apple Eight exchange ratio”) common share of Apple Nine, or a total of approximately 78,319,004 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Eight will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Eight exchange ratio, or a total of 4,930,892 common shares. |
If the mergers are approved by the shareholders of each of Apple Seven, Apple Eight and Apple Nine and all of the other conditions to the mergers are completed, Apple Eight will record an expense related to the conversion of Apple Eight’s Series B convertible preferred shares into common shares of Apple Nine. Although the final estimate of fair value may vary significantly from these estimates, Apple Nine’s preliminary estimate of the fair value of $9.00 to $11.00 per Apple Nine common share would result in an expense to Apple Eight ranging from approximately $44 million to $54 million.
The Merger Agreement contains various closing conditions, including shareholder approval by Apple Seven, Apple Eight and Apple Nine. As a result, there is no assurance that the mergers will occur. Under the Merger Agreement, Apple Seven, Apple Eight and Apple Nine may terminate the Merger Agreement under certain circumstances; however, each of the companies may be required to pay a fee of $1.7 million, plus reasonable third party expenses, to each of the other companies upon such termination. All costs related to the proposed mergers are being expensed in the period they are incurred and are included in the merger transaction costs in the Company’s consolidated statements of operations. In connection with these activities, the Company incurred approximately $1.3 million in expenses for the nine months ended September 30, 2013.
Legal Proceedings
The term the “Apple REIT Entities” means Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc. et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
Hotels Owned
The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 51 hotels the Company owned at September 30, 2013. All dollar amounts are in thousands.
| | | | | | | | Date | | | | | Purchase | |
City | | State | | Brand | | Manager | | Acquired | | Rooms | | | Price | |
Birmingham | | AL | | Homewood Suites | | McKibbon | | 5/23/2008 | | | 95 | | | $ | 16,500 | |
Rogers | | AR | | Fairfield Inn & Suites | | Raymond | | 2/29/2008 | | | 99 | | | | 8,000 | |
Rogers | | AR | | Residence Inn | | Raymond | | 2/29/2008 | | | 88 | | | | 11,744 | |
Springdale | | AR | | Residence Inn | | Intermountain | | 3/14/2008 | | | 72 | | | | 5,606 | |
Burbank | | CA | | Residence Inn | | Marriott | | 5/13/2008 | | | 166 | | | | 50,500 | |
Cypress | | CA | | Courtyard | | Dimension | | 4/30/2008 | | | 180 | | | | 31,164 | |
Oceanside | | CA | | Residence Inn | | Marriott | | 5/13/2008 | | | 125 | | | | 28,750 | |
Sacramento | | CA | | Hilton Garden Inn | | Dimension | | 3/7/2008 | | | 154 | | | | 27,630 | |
San Jose | | CA | | Homewood Suites | | Dimension | | 7/2/2008 | | | 140 | | | | 21,862 | |
Tulare | | CA | | Hampton Inn & Suites | | Inn Ventures | | 6/26/2008 | | | 86 | | | | 10,331 | |
Jacksonville | | FL | | Homewood Suites | | McKibbon | | 6/17/2008 | | | 119 | �� | | | 23,250 | |
Sanford | | FL | | SpringHill Suites | | LBA | | 3/14/2008 | | | 105 | | | | 11,150 | |
Tallahassee | | FL | | Hilton Garden Inn | | LBA | | 1/25/2008 | | | 85 | | | | 13,200 | |
Tampa | | FL | | TownePlace Suites | | McKibbon | | 6/17/2008 | | | 95 | | | | 11,250 | |
Port Wentworth | | GA | | Hampton Inn | | Newport | | 1/2/2008 | | | 106 | | | | 10,780 | |
Savannah | | GA | | Hilton Garden Inn | | Newport | | 7/31/2008 | | | 105 | | | | 12,500 | |
Overland Park | | KS | | SpringHill Suites | | True North | | 3/17/2008 | | | 102 | | | | 8,850 | |
Overland Park | | KS | | Residence Inn | | True North | | 4/30/2008 | | | 120 | | | | 15,850 | |
Overland Park | | KS | | Fairfield Inn & Suites | | True North | | 8/20/2008 | | | 110 | | | | 12,050 | |
Wichita | | KS | | Courtyard | | Intermountain | | 6/13/2008 | | | 90 | | | | 8,874 | |
Bowling Green | | KY | | Hampton Inn | | Newport | | 12/6/2007 | | | 130 | | | | 18,832 | |
Marlborough | | MA | | Residence Inn | | True North | | 1/15/2008 | | | 112 | | | | 20,200 | |
Westford | | MA | | Hampton Inn & Suites | | True North | | 3/6/2008 | | | 110 | | | | 15,250 | |
Westford | | MA | | Residence Inn | | True North | | 4/30/2008 | | | 108 | | | | 14,850 | |
Annapolis | | MD | | Hilton Garden Inn | | White | | 1/15/2008 | | | 126 | | | | 25,000 | |
Kansas City | | MO | | Residence Inn | | True North | | 4/30/2008 | | | 106 | | | | 17,350 | |
Carolina Beach | | NC | | Courtyard | | Crestline | | 6/5/2008 | | | 144 | | | | 24,214 | |
Concord | | NC | | Hampton Inn | | Newport | | 3/7/2008 | | | 101 | | | | 9,200 | |
Dunn | | NC | | Hampton Inn | | McKibbon | | 1/24/2008 | | | 120 | | | | 12,500 | |
Fayetteville | | NC | | Residence Inn | | Intermountain | | 5/9/2008 | | | 92 | | | | 12,201 | |
Greensboro | | NC | | SpringHill Suites | | Newport | | 11/9/2007 | | | 82 | | | | 8,000 | |
Matthews | | NC | | Hampton Inn | | Newport | | 1/15/2008 | | | 92 | | | | 11,300 | |
Wilmington | | NC | | Fairfield Inn & Suites | | Crestline | | 12/11/2008 | | | 122 | | | | 14,800 | |
Winston-Salem | | NC | | Courtyard | | McKibbon | | 5/19/2008 | | | 122 | | | | 13,500 | |
Somerset | | NJ | | Courtyard | | Newport | | 11/9/2007 | | | 162 | | | | 16,000 | |
New York | | NY | | Renaissance | | Marriott | | 1/4/2008 | | | 204 | | | | 99,000 | |
Tulsa | | OK | | Hampton Inn & Suites | | Western | | 12/28/2007 | | | 102 | | | | 10,200 | |
Columbia | | SC | | Hilton Garden Inn | | Newport | | 9/22/2008 | | | 143 | | | | 21,200 | |
Greenville | | SC | | Residence Inn | | McKibbon | | 5/19/2008 | | | 78 | | | | 8,700 | |
Hilton Head | | SC | | Hilton Garden Inn | | McKibbon | | 5/29/2008 | | | 104 | | | | 13,500 | |
Chattanooga | | TN | | Homewood Suites | | LBA | | 12/14/2007 | | | 76 | | | | 8,600 | |
Texarkana | | TX | | Courtyard | | Intermountain | | 3/7/2008 | | | 90 | | | | 12,924 | |
Texarkana | | TX | | TownePlace Suites | | Intermountain | | 3/7/2008 | | | 85 | | | | 9,057 | |
Charlottesville | | VA | | Courtyard | | Crestline | | 6/5/2008 | | | 139 | | | | 27,900 | |
Chesapeake | | VA | | Marriott | | Crestline | | 10/21/2008 | | | 226 | | | | 38,400 | |
Harrisonburg | | VA | | Courtyard | | Newport | | 11/16/2007 | | | 125 | | | | 23,219 | |
Suffolk | | VA | | Courtyard | | Crestline | | 7/2/2008 | | | 92 | | | | 12,500 | |
Suffolk | | VA | | TownePlace Suites | | Crestline | | 7/2/2008 | | | 72 | | | | 10,000 | |
Virginia Beach | | VA | | Courtyard | | Crestline | | 6/5/2008 | | | 141 | | | | 27,100 | |
Virginia Beach | | VA | | Courtyard | | Crestline | | 6/5/2008 | | | 160 | | | | 39,700 | |
Tukwila | | WA | | Homewood Suites | | Dimension | | 7/2/2008 | | | 106 | | | | 15,707 | |
| | | | | | | | | | | 5,914 | | | $ | 950,745 | |
Results of Operations
As of September 30, 2013, the Company owned 51 hotels with 5,914 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. Although hampered by government spending uncertainty, economic indicators in the United States have shown evidence of a sustainable recovery, which continues to overall positively impact the lodging industry. As a result, the Company’s revenue improved in the three and nine-month periods ending September 30, 2013 as compared to the same periods of 2012 and the Company expects continued improvement in revenue in 2013 as compared to 2012 and into 2014. The Company’s hotels in general have shown results consistent with their markets.
The Company separately evaluates the performance of each of its hotel properties. Due to the significance of the New York, New York hotel, the Company has two reportable segments.
Revenues
The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue. For the three months ended September 30, 2013 and 2012, the Company had total revenue of $56.9 million and $55.6 million. Revenue for the hotel located in New York, New York (the “New York hotel”) was $5.5 million and $5.6 million, or 10% of total revenue for the three months ended September 30, 2013 and 2012. For the three months ended September 30, 2013, the hotels achieved combined average occupancy of approximately 78%, ADR of $125 and RevPAR of $97. The New York hotel had average occupancy of 81%, ADR of $289 and RevPAR of $236. For the three months ended September 30, 2012, the hotels achieved combined average occupancy of approximately 78%, ADR of $121 and RevPAR of $94. For the same period, the New York hotel had average occupancy of 87%, ADR of $264 and RevPAR of $229. RevPAR is calculated as ADR multiplied by the occupancy percentage. ADR is calculated as room revenue divided by the number of rooms sold.
For the nine months ended September 30, 2013 and 2012, the Company had total revenue of $156.0 million and $152.5 million. Revenue for the New York hotel was $16.5 million and $16.2 million, or 11% of total revenue for the nine months ended September 30, 2013 and 2012. For the nine months ended September 30, 2013, the hotels achieved combined average occupancy of approximately 75%, ADR of $120, and RevPAR of $90. The New York hotel had average occupancy of 85%, ADR of $286, and RevPAR of $243. For the nine months ended September 30, 2012, the hotels achieved combined average occupancy of approximately 75%, ADR of $116, and RevPAR of $87. For the same period, the New York hotel had average occupancy of 87%, ADR of $268, and RevPAR of $232.
During the first nine months of 2013, the Company experienced demand consistent with the same period of 2012. The Company experienced an increase in ADR of 3% for its hotels during the first nine months of 2013 as compared to the same period of 2012. This resulted in a 3% increase in RevPAR for the first nine months of 2013, in comparison to the same period of 2012. The Company continues to lag industry revenue growth rates due to a higher than average impact from reduced government spending and increased supply in certain markets, however with overall continued room rate improvement, the Company is forecasting a low to mid-single digit percentage increase in revenue for 2013 as compared to 2012. Although the industry is projecting a mid-single digit revenue increase in 2014 as compared to 2013, because of the uncertainty in government spending and new supply in certain markets, the Company is expecting low to mid-single digit increases in 2014. The Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for the first nine months of 2013 and 2012 was 127 and 126, respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue.
Expenses
Hotel operating expenses consist of direct room expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the three months ended September 30, 2013 and 2012, hotel operating expenses totaled $32.6 million and $31.5 million, or 57% of total revenue for each period. The New York hotel had operating expenses of $3.3 million and $3.3 million, or 61% and 59% of its total revenue for the three months ended September 30, 2013 and 2012. For the nine months ended September 30, 2013 and 2012, hotel operating expenses totaled $91.8 million and $89.1 million, or 59% and 58% of total revenue. The New York hotel had operating expenses of $9.5 million and $9.9 million, or 58% and 61% of its total revenue for the nine months ended September 30, 2013 and 2012. Overall results for the three and nine months ended September 30, 2013 reflect the impact of an increase in revenue
at the Company’s hotels and modest increases in room wages and healthcare costs relative to revenue. Certain operating costs, such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been able to reduce, relative to revenue, other more variable costs such as marketing expenses and other sales expenses. With the uncertainty associated with new government regulation surrounding healthcare, the Company does anticipate increases above revenue rate increases in healthcare costs. The New York hotel experienced a decrease in several operating costs during the first nine months of 2013, in comparison to the same period of 2012, in part reflecting cost control efforts by the Company and prior year expenses for repairs and maintenance and union contract negotiations. Although operating expenses will, in general, increase as occupancy or revenue increases, the Company has and will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
Property taxes, insurance, and other expense for the three months ended September 30, 2013 and 2012 totaled $2.6 million and $2.5 million, or 5% and 4% of total revenue for the respective periods (of which approximately $431,000 and $284,000 related to the New York hotel, for each respective period). Property taxes, insurance, and other expense for the nine months ended September 30, 2013 and 2012 totaled $7.5 million and $7.3 million, or 5% of total revenue for each of the periods (of which approximately $1,062,000 and $838,000 related to the New York hotel, for each respective period). Property tax expense increased for some properties in the first nine months of 2013, arising from upward reassessment of property values by the applicable localities, reflecting an improved economy. These increases were partially offset by successful appeals of tax assessments at certain locations. With the improved economy, the Company anticipates continued increases in real estate tax assessments during 2013. The Company’s New York property will also continue to experience increased costs in future periods, as real estate tax incentives in place at purchase will decline over time. The Company expects property insurance rates for 2013 to increase modestly over 2012.
Land lease expense was $1.6 million for both of the three-month periods ended September 30, 2013 and 2012, and $4.8 million for both of the nine-month periods ended September 30, 2013 and 2012. This expense represents the expense incurred by the Company to lease land for five hotel properties. Land lease expense for the New York hotel was $1.5 million for both of the three-month periods ended September 30, 2013 and 2012, and $4.4 million for both of the nine-month periods ended September 30, 2013 and 2012.
General and administrative expense for the three months ended September 30, 2013 and 2012 was $1.3 million and $1.5 million. For the nine months ended September 30, 2013 and 2012, general and administrative expense was $4.0 million and $4.6 million. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding LLC, and reporting expenses. During the nine months ended September 30, 2013 and 2012, the Company incurred approximately $0.5 million and $1.2 million, respectively in legal costs related to the legal matters discussed herein and continued costs related to responding to requests from the staff of the SEC. The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Entities. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company’s consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution. As discussed below under Related Parties, the Company shares legal counsel with the other Apple REIT Entities. Total costs for these legal matters for all of the Apple REIT Entities were approximately $2.2 million and $5.7 million during the nine months ended September 30, 2013 and 2012. The Company anticipates it will continue to incur costs associated with these matters.
Merger transaction costs for the three months ended September 30, 2013 and 2012 totaled $1.3 million and $0, and for the nine months ended September 30, 2013 and 2012, were $1.3 million and $0.5 million. Costs incurred during the three and nine months ended September 30, 2013 were in connection with the Merger Agreement discussed herein. The Company will continue to incur these costs until the mergers are completed or the Merger Agreement is terminated. Costs incurred during the nine months ended September 30, 2012 were associated with the Company’s evaluation of a prior potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc. (the “other Apple REITs”). In May 2012, it was determined by the Board of Directors of the Company and the Board of Directors of each of the other Apple REITs not to move forward with the prior potential consolidation transaction at that time.
Depreciation expense for the three months ended September 30, 2013 and 2012 was $9.5 million and $9.3 million (of which $1.6 million related to the New York hotel for both periods). For the nine months ended September 30, 2013 and 2012, depreciation expense was $28.3 million and $27.6 million (of which $4.9 million related to the New York hotel for both periods). Depreciation expense represents the expense of the Company’s hotel buildings and related improvements, and
associated furniture, fixtures and equipment, for the respective periods owned. The increase for the nine-month period ended September 30, 2013, in comparison to the same period of 2012, is a result of capital improvements made by the Company during 2012 and the first nine months of 2013.
Interest expense, net for the three months ended September 30, 2013 and 2012 was $4.0 million and $3.8 million. Interest expense, net for the nine months ended September 30, 2013 and 2012 was $11.2 million and $10.9 million. Interest expense for all periods primarily represents interest incurred on mortgage loans and the Company’s credit facilities outstanding during the applicable periods of 2013 and 2012, net of fair value changes to interest rate swaps. The increase in interest expense from 2012 to 2013 primarily reflects higher loan balances outstanding during the first nine months of 2013 compared to same period of 2012.
Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the nine months ended September 30, 2013 (other than the transactions related to the completion of Apple REIT Six, Inc.’s merger with a third party and the Merger Agreement and related transactions discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The term the “Apple REIT Entities” means Apple REIT Six, Inc. (“Apple Six”), Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”) and Apple REIT Ten, Inc. (“Apple Ten”). The term the “Advisors” means Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc. (“A8A”), Apple Nine Advisors, Inc. (“A9A”), Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. (“ASRG”) and Apple Six Realty Group, Inc. The Advisors are wholly owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple Seven, Apple Nine and Apple Ten. Members of the Company’s Board of Directors are also on the Board of Directors of Apple Seven, Apple Nine and Apple Ten.
On May 14, 2013, Apple Six merged with and into an entity that is not affiliated with the Apple REIT Entities or the Advisors. Pursuant to the terms and conditions of the merger agreement, dated as of November 29, 2012, upon completion of the merger, the separate corporate existence of Apple Six ceased (the “A6 Merger”). Prior to the A6 Merger, Glade M. Knight was Chairman and Chief Executive Office of Apple Six and members of the Company’s Board of Directors were also on the Board of Directors of Apple Six.
ASRG Agreement
The Company has a contract with ASRG to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. No fees or expenses were incurred by the Company during the nine months ended September 30, 2013 and 2012 under this contract.
A8A Agreement
The Company is party to an advisory agreement with A8A, pursuant to which A8A provides management services to the Company. A8A provides these management services through Apple Fund Management, LLC (“AFM”), which immediately after the A6 Merger became a wholly-owned subsidiary of A9A. This transaction between A9A and Apple Six was made with no cash consideration exchanged between the entities. Prior to May 14, 2013, AFM was a wholly-owned subsidiary of Apple Six. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses as described below, are payable to A8A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $0.8 million for each of the nine-month periods ended September 30, 2013 and 2012.
Apple REIT Entities and Advisors Cost Sharing Structure
In addition to the fees payable to A8A, the Company reimbursed to A8A, or paid directly to AFM on behalf of A8A, approximately $1.3 million for both of the nine-month periods ended September 30, 2013 and 2012. The costs are included in
general and administrative expenses and are for the Company’s allocated share of the staffing and related costs provided by AFM at the direction of A8A.
AFM is an affiliate of each of the Advisors. Each of the Advisors provides management services through the use of AFM to, respectively, Apple Six (prior to the A6 Merger), Apple Seven, Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, effective May 14, 2013, the entire membership interest of Apple Six in AFM was transferred and assigned to A9A, which then became the sole member of AFM. As part of the assignment, A9A and the other Advisors agreed to indemnify the buyer of Apple Six for liabilities related to AFM. The assignment of AFM’s interest to A9A had no impact on the Company’s advisory agreement with A8A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors as described below, except Apple Six and its advisors, Apple Six Advisors, Inc. and Apple Six Realty Group, Inc. (collectively “A6 Advisors”), no longer participate in the cost sharing arrangement, thereby increasing the remaining companies’ share of the allocated costs.
Also, in connection with the A6 Merger, on May 13, 2013, Apple Nine acquired from Apple Six the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and assumed the Fort Worth, Texas office lease agreement. As described below, any costs associated with the Headquarters and office lease, including office rent, utilities, office supplies, etc. (“Office Related Costs”) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors.
Prior to the A6 Merger, amounts reimbursed to AFM included both compensation for personnel and Office Related Costs used by the companies. As discussed above, as a result of the A6 Merger, beginning on May 14, 2013, Office Related Costs are now allocated from Apple Nine to the other Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors. Each of these companies has agreed to reimburse Apple Nine for its share of these costs. From the period May 14, 2013 through September 30, 2013, the Company reimbursed Apple Nine approximately $0.1 million for its share of Office Related Costs, which are included in general and administrative costs in the Company’s consolidated statements of operations.
All of the Office Related Costs and costs of AFM are allocated among the Apple REIT Entities and the Advisors, excluding Apple Six and A6 Advisors after the A6 Merger. The allocation of costs is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described above allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
As part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) are reimbursed or collected and are not significant in amount.
The Company has incurred legal fees associated with the Legal Proceedings and Related Matters discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities (excluding Apple Six after the A6 Merger). The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the Legal Proceedings and Related Matters discussed herein for all of the Apple REIT Entities was approximately $2.2 million for the nine months ended September 30, 2013, of which approximately $0.5 million was allocated to the Company. Total costs for the nine months ended September 30, 2012 for all of the Apple REIT Entities was approximately $5.7 million, of which approximately $1.2 million was allocated to the Company.
Apple Air Holding, LLC (“Apple Air”) Membership Interest
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air. The other current members of Apple Air are Apple Seven, Apple Nine and Apple Ten. In connection with the A6 Merger, on May 13, 2013, Apple Ten acquired its membership interest in Apple Air from Apple Six. Through its equity investment, the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million as of September 30, 2013 and December 31, 2012. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the nine months ended September 30, 2013 and 2012, the Company recorded a loss of approximately $181,000 and $145,000 respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.
Merger Agreement and Related Transactions
Concurrently with the execution of the Merger Agreement (as discussed in note 2), on August 7, 2013, Apple Seven, Apple Eight and Apple Nine entered into a termination agreement, as amended (the “Termination Agreement”) with Apple Seven Advisors, Inc., A8A, A9A and ASRG, effective immediately before the completion of the mergers. Pursuant to the Termination Agreement, the existing advisory agreements and property acquisition/disposition agreements with respect to Apple Seven, Apple Eight and Apple Nine will be terminated. The Termination Agreement does not provide for any separate payments to be made in connection with the termination of the existing advisory agreements and property acquisition/disposition agreements. As a result, if the merger is completed, Apple Seven, Apple Eight and Apple Nine will no longer pay the various fees currently paid to its respective advisors.
Liquidity and Capital Resources
Capital Resources
In March 2012, the Company entered into a $60 million unsecured revolving credit facility with a commercial bank that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part at any time. The Company entered into a modification of this facility during the second quarter of 2013 in order to extend the maturity date of the facility; the Company also increased the available borrowing commitment to $70 million. The credit facility, as amended, matures in April 2015; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to April 2016. Interest payments are due monthly, and the interest rate is equal to either one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 3.00%, depending on the Company’s leverage ratio as calculated under the terms of the credit agreement, or the prime interest rate plus a margin ranging from 1.25% to 2.00%, at the Company’s option. The Company is also required to pay an unused facility fee of 0.25% to 0.35% on the average unused portion of the credit facility.
As of September 30, 2013 and December 31, 2012, the credit facility had an outstanding principal balance of $64.5 million and $45.3 million and an annual interest rate of approximately 2.93% and 3.21%, respectively.
The credit facility, as amended, contains the following quarterly financial covenants (capitalized terms are defined in the loan agreement):
· | Tangible Net Worth must exceed $275 million; |
· | Total Debt to Asset Value must not exceed 55%; |
· | Distributions, net of proceeds from the Company’s Dividend Reinvestment Program, cannot exceed $16.5 million during the second quarter of 2013 and $12.5 million during any quarter thereafter, and quarterly dividends cannot exceed $0.1169 per share, effective with the second quarter of 2013, unless such Distributions are less than total Funds From Operations for the quarter; |
· | Loan balance must not exceed 50% of the Unencumbered Asset Value; |
· | Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed two; and |
· | Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two. |
The Company was in compliance with each of these covenants at September 30, 2013.
In June 2013, the Company entered into an $8.3 million secured revolving credit facility with a commercial bank that is available for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. This facility is jointly secured by the Company’s Texarkana, Texas Courtyard and Texarkana, Texas TownePlace Suites. The credit facility matures in June 2014. Interest payments are due monthly, and the interest rate is equal to the greater of the prime interest rate or 4.50%. The Company incurred loan origination costs of approximately $0.1 million, which are being amortized as interest expense from date of origination to the loan’s June 2014 maturity date. As of September 30, 2013, the credit facility had an outstanding principal balance of $0.1 million and an annual interest rate of 4.50%. The credit facility is subject to the same financial covenants as the Company’s unsecured credit facility.
Capital Uses
The Company anticipates that its principal sources of liquidity, cash flow from operations, availability under its credit facilities and access to credit markets, will be adequate to meet its anticipated liquidity requirements in 2013, including required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), planned Unit redemptions (if the mergers are not completed), capital expenditures and debt service. Although the Board of Directors reduced the Company’s annual distribution rate to $0.4675 effective with the April 2013 distribution, the Company’s goal is 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 has and will attempt if necessary 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 distributions further to required levels. If the Company were unable to refinance maturing debt or enter into new borrowing agreements, or if it were to default on its debt, it may be unable to make distributions.
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 2013 totaled $34.3 million, and were paid monthly at a rate of $0.045833 for the first three months of the year and at a rate of $0.038958 thereafter. For the same nine-month period, the Company’s cash generated from operations was approximately $33.9 million. This shortfall includes a return of capital and was funded primarily by additional borrowings by the Company. Since a portion of distributions has been funded with borrowed funds, the Company’s ability to maintain its current intended rate of distribution will be primarily based on the ability of the Company’s properties to generate cash from operations at this level, the Company’s ability to utilize currently available financing, or the Company’s ability to obtain additional financing. The Company intends to continue paying distributions on a monthly basis. 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. The Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make further adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company.
In October 2008, 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 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. On June 27, 2013, the Company announced the suspension of its Unit Redemption Program as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the program until the Merger Agreement is terminated or the mergers are completed.
Since inception of the program through September 30, 2013, the Company has redeemed approximately 8.5 million Units representing $91.3 million, including 1.1 million Units in the amount of $12.0 million and 1.3 million Units in the amount of $14.0 million redeemed during the nine months ended September 30, 2013 and 2012, respectively. Since the first quarter of 2011, the total redemption requests have exceeded the authorized amount of redemptions and, as a result, the Board of Directors has limited the amount of redemptions as deemed prudent. Therefore, as contemplated in the program, beginning with the first
quarter 2011 redemption, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of Unit redemptions during 2012 and the first nine months of 2013:
Redemption Date | | Total Requested Unit Redemptions at Redemption Date | | | Units Redeemed | | | Total Redemption Requests not Redeemed at Redemption Date | |
First Quarter 2012 | | | 18,910,430 | | | | 454,405 | | | | 18,456,025 | |
Second Quarter 2012 | | | 18,397,381 | | | | 454,638 | | | | 17,942,743 | |
Third Quarter 2012 | | | 18,607,044 | | | | 362,553 | | | | 18,244,491 | |
Fourth Quarter 2012 | | | 19,112,925 | | | | 391,142 | | | | 18,721,783 | |
First Quarter 2013 | | | 19,485,287 | | | | 434,573 | | | | 19,050,714 | |
Second Quarter 2013 | | | 20,938,382 | | | | 657,736 | | | | 20,280,646 | |
In the second quarter of 2008, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. The Company has registered 10 million Units for potential issuance under the plan. Since inception of the plan through September 30, 2013, approximately 9.5 million Units, representing approximately $104.2 million in proceeds to the Company, were issued under the plan. During the nine months ended September 30, 2013 and 2012, approximately 0.4 million and 0.8 million Units were issued under the plan representing approximately $4.3 million and $8.4 million in proceeds to the Company, respectively. On June 27, 2013, the Company announced the suspension of its Dividend Reinvestment Plan as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the plan until the Merger Agreement is terminated or the mergers are completed.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements, and under certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. The Company expects that this amount will be adequate to fund required repairs, replacements and refurbishments and to maintain the Company’s hotels in a competitive position. As of September 30, 2013, the Company held $13.8 million in reserve for capital expenditures. Total capital expenditures in the first nine months of 2013 were approximately $6.3 million. The Company anticipates an additional $15 to $20 million of capital expenditures through 2014. The Company does not currently have any existing or planned projects for new development.
As discussed above in Related Parties, as part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies.
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 historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or available credit to make distributions.
Subsequent Events
In October 2013, the Company declared and paid approximately $3.6 million, or $0.038958 per outstanding common share, in distributions to its common shareholders.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
With the exception of three interest rate swap transactions, the Company has not engaged in transactions in derivative financial instruments or derivative commodity instruments. The Company entered into an interest rate swap in October 2010, with a notional amount at September 30, 2013 of $6.6 million, and based on the London Offered Rate (“LIBOR”), to increase stability and manage interest rate fluctuations related to interest expense on a variable rate loan. The Company entered into a second interest rate swap in January 2012, with a notional amount at September 30, 2013 of $39.5 million, and based on LIBOR, to increase stability and manage interest rate fluctuations related to a newly originated variable rate loan. In connection with the extension of the January 2012 variable rate loan in April 2013, the Company entered into a third agreement, which is a forward interest rate swap that commences upon the maturity of the second interest rate swap discussed above. This third swap agreement had a notional amount of $38.4 million at September 30, 2013. None of these derivative instruments is designated as a hedge, therefore the changes in the fair market values of each swap transaction are recorded in earnings. The Company recognized a net gain of approximately $0.3 million in the first nine months of 2013 from the combined changes in fair value of the three derivative instruments.
As of September 30, 2013, the Company’s financial instruments were not exposed to significant market risk due to 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 on its credit facility and due to its variable interest rate term loans. The Company had an outstanding balance of $64.6 million on its credit facilities at September 30, 2013, and to the extent it utilizes the credit facilities, the Company will be exposed to changes in short-term interest rates. Additionally, the outstanding balance of the Company’s variable rate term loans was $46.1 million at September 30, 2013. Based on these outstanding balances at September 30, 2013, every 100 basis point change in interest rates can potentially impact the Company’s annual net income by approximately $1.1 million, with all other factors remaining the same. The Company’s cash balance at September 30, 2013 was $0.
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 were effective as of September 30, 2013. 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.
PART II. OTHER INFORMATION
The term the “Apple REIT Entities” means the Company, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc. et al. putative class action lawsuit, which was filed on June 20, 2011.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The
consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The Company faces many risks, a number of which are described under “Risk Factors” in Part I of its 2012 Annual Report and described below. The risks so described may not be the only risks the Company faces. Additional risks of which the Company is not yet aware, or that currently are not significant, may also impair its operations or financial results. If any of the events or circumstances described in the risk factors contained in the Company’s 2012 Annual Report or described below occurs, the business, financial condition or results of operations of the Company could be negatively impacted. The following updates the disclosures from Item 1A. “Risk Factors” previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, filed with the Securities and Exchange Commission, and should be read in conjunction with those risk factors.
The proposed mergers of Apple REIT Seven, Inc. and Apple REIT Eight, Inc. with and into Apple REIT Nine, Inc. present certain risks to the Company’s business and operations.
In August 2013, the Company entered into an agreement and plan of merger with Apple REIT Seven, Inc. and Apple REIT Nine, Inc. under which Apple REIT Seven, Inc. and Apple REIT Eight, Inc. would merge into wholly owned subsidiaries of Apple REIT Nine, Inc. The mergers are expected to be completed in the fourth quarter of 2013 or the first quarter of 2014, although there can be no assurance of completion by any particular date, if at all. Because the mergers are subject to a number of conditions, including required shareholder and other third party approvals and the receipt of certain consents and waivers from third parties, the exact timing of when the mergers will be completed, if at all, cannot be determined at this time.
Prior to closing, the mergers may present certain risks to the Company’s business and operations, including, among other things, that:
· | management’s attention to day-to-day business may be diverted; |
· | the Company expects to incur significant transaction costs related to the mergers; |
· | if the merger agreement is terminated under certain circumstances, the Company may be required to pay termination fees and reimburse certain expenses; and |
· | the merger agreement prohibits the Company from soliciting competing transactions, and places conditions on its ability to negotiate and accept a superior competing transaction. |
Exhibit Number | | Description of Documents |
| | | |
| 2.1 | | Agreement and Plan of Merger, dated as of August 7, 2013, as amended, among Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc., Apple Seven Acquisition Sub, Inc. and Apple Eight Acquisition Sub, Inc. (Incorporated by reference to Annex A to the joint proxy statement/prospectus included in Apple REIT Nine, Inc.’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
| 3.1 | | Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| 3.2 | | Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to amendment no. 1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| 10.53 | | Voting agreement, dated as of August 7, 2013, as amended, by and among Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Glade M. Knight (Incorporated by reference to Exhibit 10.7 to Apple REIT Nine, Inc.’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
| 10.54 | | Termination Agreement dated as of August 7, 2013, as amended, by and among Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Suites Realty Group, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. (Incorporated by reference to Annex G to the joint proxy statement/prospectus included in Apple REIT Nine, Inc.’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
| 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) |
| 101 | | The following materials from Apple REIT Eight, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text and in detail (FILED HEREWITH) |
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 Eight, Inc. | | |
| | | | |
By: | /s/ GLADE M. KNIGHT | | | Date: November 6, 2013 |
| Glade M. Knight, | | | |
| Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | | | |
| | | | |
By: | /s/ BRYAN PEERY | | | Date: November 6, 2013 |
| Bryan Peery, | | | |
| Chief Financial Officer (Principal Financial and Principal Accounting Officer) | | | |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2012
or
¨ | Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File Number 000-53603
APPLE REIT NINE, INC.
(Exact name of registrant as specified in its charter)
VIRGINIA | 26-1379210 |
(State of Organization) | (I.R.S. Employer Identification Number) |
| |
814 EAST MAIN STREET RICHMOND, VIRGINIA | 23219 |
(Address of principal executive offices) | (Zip Code) |
(804) 344-8121
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Units (Each Unit is equal to one common share, no par value, and one Series A preferred share)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer x | Smaller reporting company ¨ |
| | (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
There is currently no established public trading market in which the Company’s common shares are traded. Based upon the price that the Company’s common equity last sold through its dividend reinvestment plan, which was $10.25, on June 30, 2012, the aggregate market value of the voting common equity held by non-affiliates of the Company on such date was $1,868,472,000. Also, in June 2012, there were 74,010 Units acquired at $6.25 per Unit through a tender offer. The Company does not have any non-voting common equity.
The number of common shares outstanding on March 1, 2013 was 182,364,367.
Documents Incorporated by Reference
The information required by Part III of this report, to the extent not set forth herein, is incorporated by reference from the Company’s definitive proxy statement for the annual meeting of shareholders to be held on May 16, 2013.
APPLE REIT NINE, INC.
FORM 10-K
| Page | |
Part I | | | |
| Item 1. | | 3 | |
| Item 1A. | | 9 | |
| Item 1B. | | 13 | |
| Item 2. | | 13 | |
| Item 3. | | 15 | |
| Item 4. | | 16 | |
| | | | |
Part II | | | |
| Item 5. | | 17 | |
| Item 6. | | 20 | |
| Item 7. | | 23 | |
| Item 7A. | | 41 | |
| Item 8. | | 42 | |
| Item 9. | | 69 | |
| Item 9A. | | 69 | |
| Item 9B. | | 69 | |
| | | | |
Part III | | | |
| Item 10. | | 70 | |
| Item 11. | | 70 | |
| Item 12. | | 70 | |
| Item 13. | | 70 | |
| Item 14. | | 70 | |
| | | | |
Part IV | | | |
| Item 15. | | 71 | |
| | | | |
| | |
This Form 10-K includes references to certain trademarks or service marks. The Courtyard® by Marriott, Fairfield Inn® by Marriott, Fairfield Inn and Suites® by Marriott, TownePlace Suites® by Marriott, SpringHill Suites® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Hampton Inn®, Hampton Inn and Suites®, Homewood Suites® by Hilton, Embassy Suites Hotels®, Hilton Garden Inn®, Home2 Suites® by Hilton and Hilton® trademarks are the property of Hilton Worldwide or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.
PART I
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential,” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of Apple REIT Nine, Inc. (the “Company”) to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Annual Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission (“SEC”) and Item 1A in this report. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
The Company is a Virginia corporation that was formed in November 2007 to invest in income-producing real estate in the United States. Initial capitalization occurred on November 9, 2007, with its first investor closing under its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) on May 14, 2008. The Company began operations on July 31, 2008 when it purchased its first hotel. The Company completed its best-efforts offering of Units in December 2010. As of December 31, 2012, the Company owned 89 hotels operating in 27 states.
In April 2012, the Company completed the sale of its 406 acres of land and land improvements located on 110 sites in the Ft. Worth, Texas area (the “110 parcels”) for a total sale price of $198.4 million. The 110 parcels were acquired in April 2009 for a total purchase price of $147.3 million and were leased to a subsidiary of Chesapeake Energy Corporation under a long term lease for the production of natural gas. In conjunction with the sale, the Company received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser.
The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company has wholly-owned taxable REIT subsidiaries, which lease all of the Company’s hotels from wholly-owned qualified REIT subsidiaries. The hotels are operated and managed by affiliates of Dimension Development Two, LLC (“Dimension”), Gateway Hospitality Group, Inc. (“Gateway”), Hilton Management LLC (“Hilton”), Intermountain Management, LLC (“Intermountain”), LBAM-Investor Group, L.L.C. (“LBA”), Fairfield FMC, LLC and SpringHill SMC, LLC, subsidiaries of Marriott International (“Marriott”), MHH Management, LLC (“McKibbon”), Raymond Management Company, Inc. (“Raymond”), Stonebridge Realty Advisors, Inc. (“Stonebridge”), Tharaldson Hospitality Management, LLC (“Tharaldson”), Vista Host, Inc. (“Vista”), Texas Western Management Partners, L.P. (“Western”) and White Lodging Services Corporation (“White”) under separate hotel management agreements.
The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. Refer to Part II, Item 8 of this report, for the consolidated financial statements.
Website Access
The address of the Company’s Internet website is www.applereitnine.com. The Company makes available free of charge through its Internet website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. Information contained on the Company’s website is not incorporated by reference into this report.
Business Objectives
The Company’s primary objective is to enhance shareholder value by increasing funds from operations and cash available for distributions through internal growth and selective hotel renovation. The Company’s acquisition strategy, substantially complete as of December 31, 2012, included purchasing underdeveloped hotels and hotels in underdeveloped markets with strong brand recognition, high levels of customer satisfaction and the potential for cash flow growth. Although the Company’s primary focus is hotels, the Company has pursued other advantageous buying opportunities for income producing real estate, including the acquisition and subsequent sale of the 110 parcels. The internal growth strategy includes utilizing the Company’s asset management expertise to improve the performance of the Company’s hotels by aggressively managing room rates, partnering with industry leaders in hotel management and franchising the hotels with leading brands, thereby improving revenue and operating performance of each hotel in its individual market. When cost effective, the Company renovates its properties to increase its ability to compete in particular markets. Although there are many factors that influence profitability, including national and local economic conditions, the Company believes its completed acquisitions, planned renovations and strong asset management of its portfolio will continue to improve financial results over the long-term, although there can be no assurance of these results.
As of December 31, 2012, the Company owned 89 hotels (one acquired during 2012, 11 acquired and one newly constructed hotel opened during 2011, 43 acquired during 2010, 12 acquired during 2009 and 21 acquired during 2008).
The Company is currently engaged in a project for the development of adjoining Courtyard and Residence Inn hotels on a single site located in downtown Richmond, Virginia, which is expected to begin in early 2013 and be completed within two years. The Company expects to spend a total of approximately $30 million to develop the hotels and has spent approximately $1.1 million in development costs as of December 31, 2012.
Financing
The Company has 17 notes payable, 14 that were assumed with the acquisition of hotels and three that were originated during 2012. These notes had a total outstanding balance of $165.2 million ($163.2 million of secured debt and $2.0 million of unsecured debt) at December 31, 2012; maturity dates ranging from June 2015 to October 2032 and stated interest rates ranging from 0% to 6.9%. The Company also has a $50 million unsecured credit facility (the “Credit Agreement”) with a commercial bank that is available for working capital, hotel renovations and development and other general corporate purposes, including the payment of redemptions and distributions. The credit facility may be increased to $100 million, subject to certain conditions. Under the terms of the Credit Agreement, the Company may make voluntary prepayments in whole or in part, at any time. The Credit Agreement matures in November 2014; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to November 2015. Interest payments are due monthly and the interest rate, subject to certain exceptions, is equal to the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 2.75%, depending upon the Company’s leverage ratio, as calculated under the terms of the Credit Agreement. The Company is also required to pay an unused facility fee of 0.30% or 0.40% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during the quarter. As of December 31, 2012, there were no borrowings outstanding under the credit facility.
The Company’s cash balances at December 31, 2012 totaled $9.0 million. The Company’s principal sources of liquidity are cash on hand, the operating cash flow generated from the Company’s properties, interest received on the Company’s note receivables and its $50 million revolving credit facility. The Company anticipates that cash on hand, cash flow from operations, interest received from notes receivables and availability under its revolving credit facility will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, its one development project, required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions. The Company intends to maintain a relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles. If cash flow from operations and the credit facility are not adequate to meet liquidity requirements, the Company will attempt if necessary 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 distributions to required levels. If the Company were unable to extend its maturing debt in future periods or if it were to default on its debt, it may be unable to make distributions or redemptions. In connection with the sale of its 110 parcels, the Company made a special distribution of $0.75 per share in May 2012 and reduced its annualized distribution rate from $0.88 per common share to $0.83 per common share, payable in monthly distributions beginning June 2012. In August 2012, the annualized distribution rate was slightly increased to $0.83025 per common share.
Hotel Industry and Competition
The hotel industry is highly competitive. Each of the Company’s hotels is located in a developed area that includes other hotels and competes for guests primarily with other hotels in the Company’s immediate vicinity and secondarily with
other hotels in the Company’s geographic market. An increase in the number of competitive hotels in a particular area could have a material adverse effect on the occupancy, average daily rate (“ADR”) and revenue per available room (“RevPAR”) of the Company’s hotels in that area. The Company believes that brand recognition, location, price and quality (of both the hotel and the services provided) are the principal competitive factors affecting the Company’s hotels. Additionally, general economic conditions in a particular market and nationally impact the performance of the hotel industry.
Hotel Operating Performance
During the period from the Company’s initial formation on November 9, 2007 to July 30, 2008, the Company owned no properties, had no revenue, exclusive of interest income and was primarily engaged in capital formation activities. The Company began operations on July 31, 2008 when it purchased its first hotel. As of December 31, 2012, the Company owned 89 hotels (one acquired during 2012, 11 purchased and one newly constructed hotel opened during 2011, 43 purchased during 2010, 12 acquired during 2009 and 21 acquired during 2008). These hotels are located in 27 states with an aggregate of 11,371 rooms and consisted of the following: 13 Courtyard hotels, two Embassy Suites hotels, five Fairfield Inn hotels, 21 Hampton Inn hotels, one full service Hilton hotel, 18 Hilton Garden Inn hotels, two Home2 Suites hotel, seven Homewood Suites hotels, one full service Marriott hotel, eight Residence Inn hotels, seven SpringHill Suites hotels and four TownePlace Suites hotels.
Room revenue for these hotels for the year ended December 31, 2012 totaled $331.6 million, and the hotels achieved average occupancy of 72%, ADR of $111 and RevPAR of $80 for the period owned in 2012. Room revenue for the year ended December 31, 2011 totaled $291.9 million, and the hotels achieved average occupancy of 70%, ADR of $107 and RevPAR of $74 for the period owned during 2011. Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy had a considerable negative impact on both consumer and business travel. However, economic conditions have shown evidence of improvement in 2011 and have continued to improve in 2012. As a result, the industry and the Company have experienced improvements in its hotel occupancy levels, as reflected in the overall increase of the Company’s occupancy for comparable hotels during 2012 as compared to the prior year. In addition, also signifying a progressing economy, the Company experienced an increase in ADR for comparable hotels during 2012 as compared to the prior year. With continued improvement, in both demand and room rates, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 for comparable hotels. The Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for 2012 and 2011 was 123 and 122, respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation or open less than two years) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue. See the Company’s complete financial statements in Part II, Item 8 of this report.
Management and Franchise Agreements
Each of the Company’s 89 hotels are operated and managed under separate management agreements, by affiliates of one of the following companies: Dimension, Gateway, Hilton, Intermountain, LBA, Marriott, McKibbon, Raymond, Stonebridge, Tharaldson, Vista, Western or White. The agreements generally provide for initial terms of one to 30 years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. For the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $12.3 million, $10.6 million and $5.1 million in management fees.
Dimension, Gateway, Intermountain, LBA, McKibbon, Raymond, Stonebridge, Tharaldson, Vista, Western and White are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for an initial term of 10 to 21 years. Fees associated with the agreements generally include the payment of royalty fees and program fees. The Marriott franchise agreements generally provide for initial terms of 13 to 28 years. Fees associated with the agreements generally include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. For the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $14.5 million, $12.8 million and $6.2 million in franchise fees.
The franchise and/or management agreements provide a variety of benefits for the Company, which include national advertising, publicity, and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards, centralized reservation systems and best practices within the industry.
Hotel Maintenance and Renovation
The Company’s hotels have an ongoing need for renovation and refurbishment. Under various hotel management agreements, the Company has agreed to fund expenditures for periodic repairs, replacement or refurbishment of furniture, fixtures and equipment for the hotels in an amount equal to a certain percentage of gross revenues. In addition, other capital improvement projects may be directly funded by the Company. During 2012 and 2011, the Company’s capital improvements on existing hotels were approximately $16.2 million and $9.9 million.
Employees
The Company does not have any employees. During 2012, all employees involved in the day-to-day operation of the Company’s hotels were employed by third party management companies engaged pursuant to the hotel management agreements. The Company utilizes, through an advisory agreement for corporate and strategic support, personnel from Apple Nine Advisors, Inc. which in turn utilizes personnel from Apple Fund Management, LLC, a subsidiary of Apple REIT Six, Inc.
Environmental Matters
In connection with each of the Company’s acquisitions, the Company obtains a Phase I Environmental Report and additional environmental reports and surveys, as are necessitated by the preliminary report. Based on the reports, the Company is not aware of any environmental situations requiring remediation at the Company’s properties, which have not been, or are not currently being remediated as necessary. No material remediation costs have occurred or are expected to occur. Under various laws, owners as well as tenants and operators of real estate may be required to investigate and clean up or remove hazardous substances present at or migrating from properties they own, lease or operate and may be held liable for property damage or personal injuries that result from hazardous substances. These laws also expose the Company to the possibility that it may become liable to reimburse governments for damages and costs they incur in connection with hazardous substances.
Seasonality
The hotel industry historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or available credit to make distributions.
Property Acquisition
On May 31, 2012, the same day the hotel opened for business, the Company purchased a newly constructed Home2 Suites by Hilton hotel located in Nashville, Tennessee for $16.7 million. The hotel has 119 rooms and is managed by Vista. In conjunction with the acquisition, the Company paid approximately $0.3 million, representing 2% of the gross purchase price, as a brokerage commission to Apple Suites Realty Group, Inc. (“ASRG”), which is 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive Officer.
Development Project
On October 14, 2009, the Company entered into a ground lease for approximately one acre of land located in downtown Richmond, Virginia. In February 2012, the Company terminated the lease and entered into a contract to purchase the land for $3.0 million, which was completed in July 2012. In conjunction with the acquisition, the Company paid as a brokerage commission to ASRG approximately $0.06 million, representing 2% of the gross purchase price, which was capitalized as part of the acquisition cost of the land. The Company acquired the land for the development of adjoining Courtyard and Residence Inn hotels, which is expected to begin in early 2013 and be completed within two years. Upon completion, the Courtyard and Residence Inn are expected to contain approximately 135 and 75 guest rooms, respectively and are planned to be managed by White. The Company expects to spend a total of approximately $30 million to develop the hotels and has spent approximately $1.1 million in development costs as of December 31, 2012. If the Company does not begin vertical construction by July 2013, the seller of the property has an option to acquire the land equal to the amount of the Company’s total cost.
Related Parties
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 if these
transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during 2012 (other than the loan guarantee and assignment and transfer agreements discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with ASRG, to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for fees under the terms of this contract related to the acquisition of assets have totaled approximately $33.5 million since inception. Of this amount, the Company incurred approximately $0.4 million, $4.0 million and $15.6 million for years ended December 31, 2012, 2011 and 2010. In addition, the Company incurred a brokerage commission to ASRG totaling approximately $4.0 million related to the sale of the Company’s 110 parcels in April 2012, which has been recorded as a reduction to the deferred gain on sale. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60 million note.
The Company is party to an advisory agreement with Apple Nine Advisors, Inc. (“A9A”), pursuant to which A9A provides management services to the Company. A9A provides these management services through an affiliate called Apple Fund Management LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A9A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $2.9 million, $3.0 million and $1.5 million for the years ended December 31, 2012, 2011 and 2010. The increase in 2012 and 2011 is due to the Company reaching the next fee tier under the advisory agreement due to improved results of operations for the Company during those periods. At December 31, 2011, $1.0 million of the 2011 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. This amount was paid during the first quarter of 2012. No amounts were outstanding at December 31, 2012.
In addition to the fees payable to ASRG and A9A, the Company reimbursed to A9A or ASRG or paid directly to AFM on behalf of A9A or ASRG approximately $2.2 million, $2.1 million and $2.1 million for the years ended December 31, 2012, 2011 and 2010. The expenses reimbursed were approximately $0.2 million, $0.3 million and $1.1 million, respectively for costs reimbursed under the contract with ASRG and approximately $2.0 million, $1.8 million and $1.0 million, respectively for costs reimbursed under the contract with A9A. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A9A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Ten, Inc. and the Company (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, A9A entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, A9A and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to A9A, if it occurs, will have no impact on the Company’s advisory agreement with A9A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors, excluding Apple REIT Six, Inc. as described above, which will increase the remaining companies’ share of the allocated costs.
Also, on November 29, 2012, in connection with the merger, the Company entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. Also, as part of the purchase, the Company agreed to indemnify Apple REIT Six, Inc. for any liabilities related to the Headquarters or office lease. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
ASRG and A9A are 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 Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the Board of Directors of Apple REIT Six, Inc., Apple REIT Seven, Inc., and Apple REIT Eight, Inc.
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for acquisition, asset management and renovation purposes. The Company’s equity investment was approximately $1.9 million and $2.1 million as of December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.8 million respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. See Item 7 Management’s Discussion and Analysis of Expenses for the years 2012 and 2011 for more information on legal fees incurred.
Due to the significant discount offered by the original lender, in October 2010, the Company purchased a mortgage note with an outstanding balance of approximately $11.3 million for a total purchase price of approximately $10.8 million from an unrelated third party. In accordance with the terms of the note, in December 2011, the borrower repaid the remaining outstanding balance totaling $11.0 million. The interest rate on this mortgage was a variable rate based on the 3-month LIBOR, and averaged 5% during the period held. The note required monthly payments of principal and interest. The borrower on the note was Apple Eight SPE Columbia, Inc., an indirect wholly owned subsidiary of Apple REIT Eight, Inc. and the note was secured by a Hilton Garden Inn hotel located in Columbia, South Carolina. Total interest income, including the accretion of the note discount, recorded by the Company for the years ended December 31, 2012, 2011 and 2010 was approximately $0, $0.9 million and $0.2 million.
In May 2012, the Company entered into a Loan Agreement (the “Loan Agreement”) with a commercial bank, which provided for a $30 million non-revolving line of credit with a maturity date of November 15, 2012. During the third quarter of 2012, the line of credit was extinguished and the outstanding principal balance totaling $30 million, plus accrued interest was paid in full. The Loan Agreement was guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and was secured by assets of Mr. Knight. Mr. Knight did not receive any consideration in exchange for providing this guaranty and security. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement.
The following describes several risk factors which are applicable to the Company. There are many factors that may affect the Company’s business and results of operations, which would affect the Company’s operating cash flow and value. You should carefully consider, in addition to the other information contained in this report, the risks described below.
Hotel Operations
The Company’s hotels are subject to all of the risks common to the hotel industry. These risks could adversely affect hotel occupancy and the rates that can be charged for hotel rooms as well as hotel operating expenses, and generally include:
| • | increases in supply of hotel rooms that exceed increases in demand; |
| • | increases in energy costs and other travel expenses that reduce business and leisure travel; |
| • | reduced business and leisure travel due to continued geo-political uncertainty, including terrorism; |
| • | adverse effects of declines in general and local economic activity; and |
| • | adverse effects of a downturn in the hotel industry. |
General Local and National Economic Conditions
Changes in general local or national economic or market conditions, increased costs of energy, increased costs of insurance, increased costs of products, increased costs and shortages of labor, competitive factors, fuel shortages, quality of management, the ability of a hotel chain to fulfill any obligations to operators of its hotel business, limited alternative uses for the building, changing consumer habits, condemnation or uninsured losses, changing demographics, changing traffic patterns, inability to remodel outmoded buildings as required by the franchise or lease agreement and other factors beyond the Company’s control may reduce operating results and the value of properties that the Company owns. Additionally, these items, among others, may reduce the availability of capital to the Company. As a result, cash available to make distributions to shareholders may be affected.
Current General Economic Environment in the Lodging Industry
The United States continues to be in a low-growth economic environment and continues to experience historically high levels of unemployment. Uncertainty over the depth and duration of this economic environment continues to have a negative impact on the lodging industry. Although operating results have improved, high levels of unemployment and sluggish business and consumer travel trends have been evident during the past three years. Accordingly, the Company’s financial results have been impacted by the economic environment, and future financial results and growth could be further depressed until a more expansive national economic environment is prevalent. A weaker than anticipated economic recovery, or a return to a recessionary national economic environment, could result in low or decreased levels of business and consumer travel, negatively impacting the lodging industry, and, in turn, negatively impacting the Company’s future growth prospects and results of operations.
Hospitality Industry
The success of the Company’s properties will depend largely on the property operators’ ability to adapt to dominant trends in the hotel industry as well as greater competitive pressures, increased consolidation, industry overbuilding, dependence on consumer spending patterns and changing demographics, the introduction of new concepts and products, availability of labor, price levels and general economic conditions. The success of a particular hotel brand, the ability of a hotel brand to fulfill any obligations to operators of its business, and trends in the hotel industry may affect the Company’s income and the funds it has available to distribute to shareholders.
The hospitality industry could also experience a significant decline in occupancy and average daily rates due to a reduction in both business and leisure travel. General economic conditions, increased fuel costs, natural disasters and terrorist attacks are a few factors that could affect an individual’s willingness to travel. The Company’s property insurance will typically cover losses for property damage due to terrorist attacks or natural disasters (subject to policy deductibles). However, the Company is not insured against the potential negative effect a terrorist attack or natural disaster would have on the hospitality industry as a whole.
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 and the Company may need to enter into short-term borrowing arrangements in certain periods in order to offset these fluctuations in revenues and to make distributions to shareholders.
Franchise Agreements
The Company’s wholly-owned taxable REIT subsidiaries (or subsidiaries thereof), operate all of the properties pursuant to franchise or license agreements with nationally recognized hotel brands. These franchise agreements contain specific standards for, and restrictions and limitations on, the operation and maintenance of the Company’s properties in order to maintain uniformity within the franchisor system. These standards could potentially conflict with the Company’s ability to create specific business plans tailored to each property and to each market.
Competition
The hotel industry is highly competitive. Each of the Company’s hotels is located in a developed area that includes other hotels and competes for guests primarily with other hotels in the Company’s immediate vicinity and secondarily with other hotels in the Company’s geographic market. An increase in the number of competitive hotels in a particular area could have a material adverse effect on the occupancy, average daily rate and revenue per available room of the Company’s hotels in that area.
Note Receivable
In April 2012, the Company completed the sale of its 406 acres of land and land improvements located on 110 sites in the Ft. Worth, Texas area for a total sale price of $198.4 million. In conjunction with the sale, the Company received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser. The note is secured by a junior lien on the 110 parcels. The note requires interest only payments for the first three years of the note. After the first three years, interest is accrued and payments will only be received once the purchaser extinguishes its senior loan with a third party (the “senior loan”). Once the senior loan is repaid, the Company will receive all payments from the existing lease on the 110 parcels until fully repaid or the note reaches maturity which is April 2049. If the purchaser defaults under the Company’s note or the senior loan, the Company may not recover some or all of its note receivable.
Illiquidity of Shares
There is and will be no public trading market for the common shares and the Series A preferred shares for an indefinite period of time, if ever. Therefore, the Units are and will be highly illiquid and very difficult to trade. There is no definite time frame to provide liquidity. There also is no definite value for the Units when a liquidity event occurs. In addition, there are restrictions on the transfer of the common shares. In order to qualify as a REIT, the shares must be beneficially owned by 100 or more persons and no more than 50% of the value of the Company’s issued and outstanding shares may be owned directly or indirectly by five or fewer individuals. Therefore, the Company’s bylaws provide that no person may own more than 9.8% of the issued and outstanding Units. Any purported transfer of the Company’s shares that would result in a violation of either of these limits will be declared null and void.
Qualification as a REIT
The rules governing a REIT are highly technical and complex. They require ongoing compliance with and interpretation of a variety of tests and regulations that depend on, among other things, future operations. While the Company expects to satisfy these tests, it cannot ensure it will qualify as a REIT for any particular year. There is also the risk that the applicable laws governing a REIT could be changed, which could adversely affect the Company and its shareholders.
Distributions to Shareholders
If the Company’s properties do not generate sufficient revenue to meet operating expenses, the Company’s cash flow and the Company’s ability to make distributions to shareholders may be adversely affected. The Company is subject to all operating risks common to hotels. These risks might adversely affect occupancy or room rates. Increases in operating costs due to inflation and other factors may not necessarily be offset by increased room rates. The local, regional and national hotel markets may limit the extent to which room rates may be increased to meet increased operating expenses without decreasing occupancy rates. While the Company intends to make monthly distributions to shareholders, there can be no assurance that the Company will be able to make distributions at any particular time or rate, or at all. Further, there is
no assurance that a distribution rate achieved for a particular period will be maintained in the future. Also, while management may establish goals as to particular rates of distribution or have an intention to make distributions at a particular rate, there can be no assurance that such goals or intentions will be realized.
The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions and capital improvements, ramp up of new properties and varying economic cycles. The Company anticipates that it may need to utilize debt, offering proceeds and cash from operations to meet this objective. The Company evaluates the distribution rate on an ongoing basis and may make changes at any time if the Company feels the rate is not appropriate based on available cash resources.
While the Company generally seeks to make distributions from its operating cash flows, distributions may be made (although there is no obligation to do so) in certain circumstances in part from financing proceeds or other sources, such as proceeds from the offering of Units. While distributions from such sources would result in the shareholder receiving cash, the consequences to the shareholders would differ from a distribution from the Company’s operating cash flows. For example, if financing is the source of a distribution, that financing would have to be repaid, and if proceeds from the offering of Units are distributed, those proceeds would not then be available for other uses (such as property acquisitions or improvements).
Financing Risks
Although the Company anticipates maintaining relatively low levels of debt, it may periodically use short-term financing to complete planned development projects, perform renovations to its properties, make shareholder distributions or planned Unit redemptions in periods of fluctuating income from its properties. The debt markets have been volatile and subject to increased regulation, and as a result, the Company may not be able to use debt to meet its cash requirements, including refinancing any scheduled debt maturities.
Compliance with Financial Covenants
The Company’s $50 million unsecured revolving credit facility entered into in November 2012 contains financial covenants that could require the outstanding borrowings to be prepaid prior to the scheduled maturity or restrict the amount and timing of distributions to shareholders. The covenants include, among others, a minimum tangible net worth, maximum debt limits, and minimum debt service and fixed charge coverage ratios.
Securities Class Action Lawsuits and Governmental Regulatory Oversight Risks
As a result of regulatory inquiries or other regulatory actions, or as a result of being publicly held, the Company may become subject to lawsuits. The Company is currently subject to one securities class action lawsuit and other suits may be filed against the Company in the future. Due to the uncertainties related to litigation, the Company is unable at this time to evaluate the likelihood of either a favorable or unfavorable outcome or to estimate the range of potential exposure. If the outcome is unfavorable, the Company may be required to pay damages and/or change its business practices, any of which could have a material adverse effect on the Company’s financial condition, results of operations and cash flows. The ability of the Company to access capital markets, including commercial debt markets, could be negatively impacted by unfavorable, or the possibility of unfavorable, outcomes to lawsuits or adverse regulatory actions.
The Company has been and may continue to be subject to regulatory inquiries, which have resulted in and which could continue to result in costs and personnel time commitment to respond. It may also be subject to action by governing regulatory agencies, as a result of its activities, which could result in costs to respond and fines or changes in the Company’s business practices, any of which could have a material adverse effect on the financial condition, results of operations, liquidity and capital resources, and cash flows of the Company.
Technology is used in operations, and any material failure, inadequacy, interruption or security failure of that technology could harm the business
The Company and its hotel managers and franchisors rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information, and to manage or support a variety of business processes, including financial transactions and records, personal identifying information, reservations, billing and operating data. Some of the information technology is purchased from vendors, on whom the systems depend. The Company and its hotel managers and franchisors rely on commercially available and internally developed systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential operator and other customer information, such as individually identifiable information, including information relating to financial accounts. Although the Company and its hotel managers and franchisors have taken steps necessary to protect the security of their information systems and the data maintained in those systems, it is possible that the safety and security measures taken will not be able to prevent the systems’ improper functioning or damage, or the improper access or disclosure of
personally identifiable information such as in the event of cyber attacks. Security breaches, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure of confidential information. Any failure to maintain proper function, security and availability of information systems could interrupt operations, damage reputation, subject the Company to liability claims or regulatory penalties and could have a material adverse effect on the business, financial condition and results of operations of the Company.
Potential losses not covered by Insurance
The Company maintains comprehensive insurance coverage for general liability, property, business interruption and other risks with respect to all of its hotels. These policies offer coverage features and insured limits that the Company believes are customary for similar types of properties. There are no assurances that coverage will be available at reasonable rates. Also, various types of catastrophic losses, like earthquakes, hurricanes, or certain types of terrorism, may not be insurable or may not be economically insurable. Even when insurable, these policies may have high deductibles and/or high premiums. There also can be risks such as certain environmental hazards that may be deemed to fall outside the coverage. In the event of a substantial loss, the Company’s insurance coverage may not be sufficient to cover the full current market value or replacement cost of its lost investment. Should an uninsured loss or a loss in excess of insured limits occur, the Company could lose all or a portion of the capital it has invested in a hotel, as well as the anticipated future revenue from the hotel. In that event, the Company might nevertheless remain obligated for any mortgage debt or other financial obligations related to the hotel. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep the Company from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. The Company also may encounter challenges with an insurance provider regarding whether it will pay a particular claim that the Company believes to be covered under its policy.Under those circumstances, the insurance proceeds the Company receives might be inadequate to restore its economic position on the damaged or destroyed hotel, which could have a material adverse effect on the Company.
Item 1B. Unresolved Staff Comments
Not applicable.
As of December 31, 2012, the Company owned 89 hotels located in 27 states with an aggregate of 11,371 rooms, consisting of the following:
| | Total by | | | Number of | |
Brand | | Brand | | | Rooms | |
Hampton Inn | | | 21 | | | | 2,529 | |
Hilton Garden Inn | | | 18 | | | | 2,509 | |
Courtyard | | | 13 | | | | 1,689 | |
Homewood Suites | | | 7 | | | | 735 | |
Fairfield Inn | | | 5 | | | | 613 | |
TownePlace Suites | | | 4 | | | | 453 | |
Residence Inn | | | 8 | | | | 874 | |
SpringHill Suites | | | 7 | | | | 986 | |
Marriott | | | 1 | | | | 206 | |
Embassy Suites | | | 2 | | | | 316 | |
Home2 Suites | | | 2 | | | | 237 | |
Hilton | | | 1 | | | | 224 | |
| | | 89 | | | | 11,371 | |
The following table includes the location of each hotel, the date of construction, the date acquired, encumbrances (if any), initial acquisition cost, gross carrying value and the number of rooms of each hotel.
Real Estate and Accumulated Depreciation
As of December 31, 2012
(dollars in thousands)
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Capitalized | | | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | | Bldg. | | | Total | | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | | Imp. & | | | Gross | | | Acc. | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Description | | Encumbrances | | | Land (1) | | | FF&E /Other | | | FF&E | | | Cost | | | Deprec. | | Construction | | Acquired | | Life | | Rooms | |
Anchorage | | AK | | Embassy Suites | | $ | 23,154 | | | $ | 2,955 | | | $ | 39,053 | | | $ | 108 | | | $ | 42,116 | | | $ | (3,529 | ) | | 2008 | | Apr-10 | | 3 - 39 yrs. | | | 169 | |
Dothan | | AL | | Hilton Garden Inn | | | 0 | | | | 1,037 | | | | 10,581 | | | | 14 | | | | 11,632 | | | | (1,480 | ) | | 2009 | | Jun-09 | | 3 - 39 yrs. | | | 104 | |
Troy | | AL | | Courtyard | | | 0 | | | | 582 | | | | 8,270 | | | | 18 | | | | 8,870 | | | | (1,200 | ) | | 2009 | | Jun-09 | | 3 - 39 yrs. | | | 90 | |
Rogers | | AR | | Hampton Inn | | | 7,958 | | | | 961 | | | | 8,483 | | | | 86 | | | | 9,530 | | | | (780 | ) | | 1998 | | Aug-10 | | 3 - 39 yrs. | | | 122 | |
Rogers | | AR | | Homewood Suites | | | 0 | | | | 1,375 | | | | 9,514 | | | | 247 | | | | 11,136 | | | | (1,052 | ) | | 2006 | | Apr-10 | | 3 - 39 yrs. | | | 126 | |
Chandler | | AZ | | Courtyard | | | 0 | | | | 1,061 | | | | 16,008 | | | | 57 | | | | 17,126 | | | | (1,204 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 150 | |
Chandler | | AZ | | Fairfield Inn & Suites | | | 0 | | | | 778 | | | | 11,272 | | | | 42 | | | | 12,092 | | | | (834 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 110 | |
Phoenix | | AZ | | Courtyard | | | 0 | | | | 1,413 | | | | 14,669 | | | | 51 | | | | 16,133 | | | | (1,033 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 164 | |
Phoenix | | AZ | | Residence Inn | | | 0 | | | | 1,111 | | | | 12,953 | | | | 88 | | | | 14,152 | | | | (969 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 129 | |
Tucson | | AZ | | Hilton Garden Inn | | | 0 | | | | 1,005 | | | | 17,925 | | | | 84 | | | | 19,014 | | | | (2,863 | ) | | 2008 | | Jul-08 | | 3 - 39 yrs. | | | 125 | |
Tucson | | AZ | | TownePlace Suites | | | 0 | | | | 992 | | | | 14,563 | | | | 41 | | | | 15,596 | | | | (637 | ) | | 2011 | | Oct-11 | | 3 - 39 yrs. | | | 124 | |
Clovis | | CA | | Hampton Inn & Suites | | | 0 | | | | 1,287 | | | | 9,888 | | | | 27 | | | | 11,202 | | | | (1,233 | ) | | 2009 | | Jul-09 | | 3 - 39 yrs. | | | 86 | |
Clovis | | CA | | Homewood Suites | | | 0 | | | | 1,500 | | | | 10,970 | | | | 24 | | | | 12,494 | | | | (1,154 | ) | | 2010 | | Feb-10 | | 3 - 39 yrs. | | | 83 | |
San Bernardino | | CA | | Residence Inn | | | 0 | | | | 0 | | | | 13,662 | | | | 160 | | | | 13,822 | | | | (781 | ) | | 2006 | | Feb-11 | | 3 - 39 yrs. | | | 95 | |
Santa Ana | | CA | | Courtyard | | | 0 | | | | 3,082 | | | | 21,051 | | | | 0 | | | | 24,133 | | | | (1,206 | ) | | 2011 | | May-11 | | 3 - 39 yrs. | | | 155 | |
Santa Clarita | | CA | | Courtyard | | | 0 | | | | 4,568 | | | | 18,721 | | | | 77 | | | | 23,366 | | | | (2,869 | ) | | 2007 | | Sep-08 | | 3 - 39 yrs. | | | 140 | |
Santa Clarita | | CA | | Fairfield Inn | | | 0 | | | | 1,864 | | | | 7,753 | | | | 515 | | | | 10,132 | | | | (1,086 | ) | | 1996 | | Oct-08 | | 3 - 39 yrs. | | | 66 | |
Santa Clarita | | CA | | Hampton Inn | | | 0 | | | | 1,812 | | | | 15,761 | | | | 1,348 | | | | 18,921 | | | | (2,742 | ) | | 1987 | | Oct-08 | | 3 - 39 yrs. | | | 128 | |
Santa Clarita | | CA | | Residence Inn | | | 0 | | | | 2,539 | | | | 14,493 | | | | 1,199 | | | | 18,231 | | | | (2,241 | ) | | 1996 | | Oct-08 | | 3 - 39 yrs. | | | 90 | |
Pueblo | | CO | | Hampton Inn & Suites | | | 0 | | | | 894 | | | | 7,423 | | | | 1,275 | | | | 9,592 | | | | (1,473 | ) | | 2000 | | Oct-08 | | 3 - 39 yrs. | | | 81 | |
Ft. Lauderdale | | FL | | Hampton Inn | | | 0 | | | | 2,235 | | | | 17,590 | | | | 1,206 | | | | 21,031 | | | | (2,513 | ) | | 2000 | | Dec-08 | | 3 - 39 yrs. | | | 109 | |
Miami | | FL | | Hampton Inn & Suites | | | 0 | | | | 1,972 | | | | 9,987 | | | | 1,889 | | | | 13,848 | | | | (1,449 | ) | | 2000 | | Apr-10 | | 3 - 39 yrs. | | | 121 | |
Orlando | | FL | | Fairfield Inn & Suites | | | 0 | | | | 3,140 | | | | 22,580 | | | | 262 | | | | 25,982 | | | | (2,763 | ) | | 2009 | | Jul-09 | | 3 - 39 yrs. | | | 200 | |
Orlando | | FL | | SpringHill Suites | | | 0 | | | | 3,141 | | | | 25,779 | | | | 76 | | | | 28,996 | | | | (3,191 | ) | | 2009 | | Jul-09 | | 3 - 39 yrs. | | | 200 | |
Panama City | | FL | | TownePlace Suites | | | 0 | | | | 908 | | | | 9,549 | | | | 3 | | | | 10,460 | | | | (1,046 | ) | | 2010 | | Jan-10 | | 3 - 39 yrs. | | | 103 | |
Panama City Beach | | FL | | Hampton Inn & Suites | | | 0 | | | | 1,605 | | | | 9,995 | | | | 21 | | | | 11,621 | | | | (1,394 | ) | | 2009 | | Mar-09 | | 3 - 39 yrs. | | | 95 | |
Tampa | | FL | | Embassy Suites | | | 0 | | | | 1,824 | | | | 20,034 | | | | 315 | | | | 22,173 | | | | (1,387 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 147 | |
Albany | | GA | | Fairfield Inn & Suites | | | 0 | | | | 899 | | | | 7,263 | | | | 10 | | | | 8,172 | | | | (822 | ) | | 2010 | | Jan-10 | | 3 - 39 yrs. | | | 87 | |
Boise | | ID | | Hampton Inn & Suites | | | 0 | | | | 1,335 | | | | 21,114 | | | | 139 | | | | 22,588 | | | | (1,932 | ) | | 2007 | | Apr-10 | | 3 - 39 yrs. | | | 186 | |
Mettawa | | IL | | Hilton Garden Inn | | | 0 | | | | 2,246 | | | | 28,328 | | | | 35 | | | | 30,609 | | | | (1,898 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 170 | |
Mettawa | | IL | | Residence Inn | | | 0 | | | | 1,722 | | | | 21,843 | | | | 9 | | | | 23,574 | | | | (1,458 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 130 | |
Schaumburg | | IL | | Hilton Garden Inn | | | 0 | | | | 1,450 | | | | 19,122 | | | | 24 | | | | 20,596 | | | | (1,376 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 166 | |
Warrenville | | IL | | Hilton Garden Inn | | | 0 | | | | 1,171 | | | | 20,894 | | | | 19 | | | | 22,084 | | | | (1,416 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 135 | |
| | | | | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Capitalized | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Initial Cost | | | Bldg. | | | Total | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Bldg./ | | | Imp. & | | | Gross | | | Acc. | | Date of | | Date | | Depreciable | | # of | |
City | | State | | Description | | Encumbrances | | | Land (1) | | | FF&E /Other | | | FF&E | | | Cost | | | Deprec. | | Construction | | Acquired | | Life | | Rooms | |
Indianapolis | | IN | | SpringHill Suites | | | 0 | | | | 1,310 | | | | 11,542 | | | | 36 | | | | 12,888 | | | | (799 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 130 | |
Mishawaka | | IN | | Residence Inn | | | 0 | | | | 898 | | | | 12,862 | | | | 52 | | | | 13,812 | | | | (885 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 106 | |
Alexandria | | LA | | Courtyard | | | 0 | | | | 1,099 | | | | 8,708 | | | | 6 | | | | 9,813 | | | | (784 | ) | | 2010 | | Sep-10 | | 3 - 39 yrs. | | | 96 | |
Baton Rouge | | LA | | SpringHill Suites | | | 0 | | | | 1,280 | | | | 13,870 | | | | 50 | | | | 15,200 | | | | (1,691 | ) | | 2009 | | Sep-09 | | 3 - 39 yrs. | | | 119 | |
Lafayette | | LA | | Hilton Garden Inn | | | 0 | | | | 0 | | | | 17,898 | | | | 1,875 | | | | 19,773 | | | | (1,621 | ) | | 2006 | | Jul-10 | | 3 - 39 yrs. | | | 153 | |
Lafayette | | LA | | SpringHill Suites | | | 0 | | | | 709 | | | | 9,400 | | | | 6 | | | | 10,115 | | | | (554 | ) | | 2011 | | Jun-11 | | 3 - 39 yrs. | | | 103 | |
West Monroe | | LA | | Hilton Garden Inn | | | 0 | | | | 832 | | | | 14,872 | | | | 1,405 | | | | 17,109 | | | | (1,406 | ) | | 2007 | | Jul-10 | | 3 - 39 yrs. | | | 134 | |
Andover | | MA | | SpringHill Suites | | | 0 | | | | 702 | | | | 5,799 | | | | 1,792 | | | | 8,293 | | | | (637 | ) | | 2000 | | Nov-10 | | 3 - 39 yrs. | | | 136 | |
Silver Spring | | MD | | Hilton Garden Inn | | | 0 | | | | 1,361 | | | | 16,094 | | | | 5 | | | | 17,460 | | | | (1,377 | ) | | 2010 | | Jul-10 | | 3 - 39 yrs. | | | 107 | |
Novi | | MI | | Hilton Garden Inn | | | 0 | | | | 1,213 | | | | 15,052 | | | | 56 | | | | 16,321 | | | | (1,126 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 148 | |
Rochester | | MN | | Hampton Inn & Suites | | | 0 | | | | 916 | | | | 13,225 | | | | 39 | | | | 14,180 | | | | (1,681 | ) | | 2009 | | Aug-09 | | 3 - 39 yrs. | | | 124 | |
Kansas City | | MO | | Hampton Inn | | | 6,235 | | | | 727 | | | | 9,363 | | | | 91 | | | | 10,181 | | | | (871 | ) | | 1999 | | Aug-10 | | 3 - 39 yrs. | | | 122 | |
St. Louis | | MO | | Hampton Inn | | | 13,293 | | | | 1,758 | | | | 20,954 | | | | 1,165 | | | | 23,877 | | | | (1,750 | ) | | 2003 | | Aug-10 | | 3 - 39 yrs. | | | 190 | |
St. Louis | | MO | | Hampton Inn & Suites | | | 0 | | | | 758 | | | | 15,287 | | | | 108 | | | | 16,153 | | | | (1,299 | ) | | 2006 | | Apr-10 | | 3 - 39 yrs. | | | 126 | |
Hattiesburg | | MS | | Residence Inn | | | 0 | | | | 906 | | | | 9,151 | | | | 25 | | | | 10,082 | | | | (1,429 | ) | | 2008 | | Dec-08 | | 3 - 39 yrs. | | | 84 | |
Charlotte | | NC | | Homewood Suites | | | 0 | | | | 1,059 | | | | 4,937 | | | | 4,012 | | | | 10,008 | | | | (2,304 | ) | | 1990 | | Sep-08 | | 3 - 39 yrs. | | | 112 | |
Durham | | NC | | Homewood Suites | | | 0 | | | | 1,232 | | | | 18,343 | | | | 1,942 | | | | 21,517 | | | | (2,746 | ) | | 1999 | | Dec-08 | | 3 - 39 yrs. | | | 122 | |
Fayetteville | | NC | | Home2 Suites | | | 0 | | | | 746 | | | | 10,563 | | | | 0 | | | | 11,309 | | | | (808 | ) | | 2011 | | Feb-11 | | 3 - 39 yrs. | | | 118 | |
Holly Springs | | NC | | Hampton Inn & Suites | | | 0 | | | | 1,620 | | | | 13,260 | | | | 11 | | | | 14,891 | | | | (1,077 | ) | | 2010 | | Nov-10 | | 3 - 39 yrs. | | | 124 | |
Jacksonville | | NC | | TownePlace Suites | | | 0 | | | | 632 | | | | 8,608 | | | | 37 | | | | 9,277 | | | | (864 | ) | | 2008 | | Feb-10 | | 3 - 39 yrs. | | | 86 | |
Mt. Laurel | | NJ | | Homewood Suites | | | 0 | | | | 1,589 | | | | 13,476 | | | | 300 | | | | 15,365 | | | | (828 | ) | | 2006 | | Jan-11 | | 3 - 39 yrs. | | | 118 | |
West Orange | | NJ | | Courtyard | | | 0 | | | | 2,054 | | | | 19,513 | | | | 1,501 | | | | 23,068 | | | | (1,305 | ) | | 2005 | | Jan-11 | | 3 - 39 yrs. | | | 131 | |
Twinsburg | | OH | | Hilton Garden Inn | | | 0 | | | | 1,419 | | | | 16,614 | | | | 1,709 | | | | 19,742 | | | | (2,703 | ) | | 1999 | | Oct-08 | | 3 - 39 yrs. | | | 142 | |
Oklahoma City | | OK | | Hampton Inn & Suites | | | 0 | | | | 1,430 | | | | 31,327 | | | | 29 | | | | 32,786 | | | | (2,719 | ) | | 2009 | | May-10 | | 3 - 39 yrs. | | | 200 | |
Collegeville | | PA | | Courtyard | | | 12,587 | | | | 2,115 | | | | 17,953 | | | | 1,687 | | | | 21,755 | | | | (1,398 | ) | | 2005 | | Nov-10 | | 3 - 39 yrs. | | | 132 | |
Malvern | | PA | | Courtyard | | | 7,530 | | | | 996 | | | | 20,374 | | | | 77 | | | | 21,447 | | | | (1,316 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 127 | |
Pittsburgh | | PA | | Hampton Inn | | | 0 | | | | 2,503 | | | | 18,537 | | | | 1,203 | | | | 22,243 | | | | (2,605 | ) | | 1990 | | Dec-08 | | 3 - 39 yrs. | | | 132 | |
Jackson | | TN | | Courtyard | | | 0 | | | | 986 | | | | 14,656 | | | | 51 | | | | 15,693 | | | | (2,058 | ) | | 2008 | | Dec-08 | | 3 - 39 yrs. | | | 94 | |
Jackson | | TN | | Hampton Inn & Suites | | | 0 | | | | 692 | | | | 12,281 | | | | 87 | | | | 13,060 | | | | (1,665 | ) | | 2007 | | Dec-08 | | 3 - 39 yrs. | | | 83 | |
Johnson City | | TN | | Courtyard | | | 0 | | | | 1,105 | | | | 8,632 | | | | 17 | | | | 9,754 | | | | (1,109 | ) | | 2009 | | Sep-09 | | 3 - 39 yrs. | | | 90 | |
Nashville | | TN | | Hilton Garden Inn | | | 0 | | | | 2,754 | | | | 39,997 | | | | 30 | | | | 42,781 | | | | (2,978 | ) | | 2009 | | Sep-10 | | 3 - 39 yrs. | | | 194 | |
Nashville | | TN | | Home2 Suites | | | 0 | | | | 1,153 | | | | 15,206 | | | | 0 | | | | 16,359 | | | | (371 | ) | | 2012 | | May-12 | | 3 - 39 yrs. | | | 119 | |
Allen | | TX | | Hampton Inn & Suites | | | 0 | | | | 1,442 | | | | 11,456 | | | | 318 | | | | 13,216 | | | | (1,948 | ) | | 2006 | | Sep-08 | | 3 - 39 yrs. | | | 103 | |
Allen | | TX | | Hilton Garden Inn | | | 10,004 | | | | 2,130 | | | | 16,731 | | | | 2,900 | | | | 21,761 | | | | (3,494 | ) | | 2002 | | Oct-08 | | 3 - 39 yrs. | | | 150 | |
Arlington | | TX | | Hampton Inn & Suites | | | 0 | | | | 1,217 | | | | 8,738 | | | | 378 | | | | 10,333 | | | | (647 | ) | | 2007 | | Dec-10 | | 3 - 39 yrs. | | | 98 | |
| | | | | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Capitalized | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Initial Cost | | Bldg. | | Total | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Bldg./ | | Imp. & | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Description | | Encumbrances | | Land (1) | | FF&E /Other | | FF&E | | Cost | | Deprec. | | Construction | | Acquired | | Life | | Rooms |
Austin | | TX | | Courtyard | | | 0 | | | | 1,579 | | | | 18,487 | | | | 24 | | | | 20,090 | | | | (1,330 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 145 | |
Austin | | TX | | Fairfield Inn & Suites | | | 0 | | | | 1,306 | | | | 16,504 | | | | 11 | | | | 17,821 | | | | (1,197 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 150 | |
Austin | | TX | | Hampton Inn | | | 6,901 | | | | 1,459 | | | | 17,184 | | | | 1,684 | | | | 20,327 | | | | (2,505 | ) | | 1997 | | Apr-09 | | 3 - 39 yrs. | | | 124 | |
Austin | | TX | | Hilton Garden Inn | | | 0 | | | | 1,614 | | | | 14,451 | | | | 36 | | | | 16,101 | | | | (1,029 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 117 | |
Austin | | TX | | Homewood Suites | | | 6,907 | | | | 1,898 | | | | 16,462 | | | | 2,096 | | | | 20,456 | | | | (2,542 | ) | | 1997 | | Apr-09 | | 3 - 39 yrs. | | | 97 | |
Beaumont | | TX | | Residence Inn | | | 0 | | | | 1,177 | | | | 16,180 | | | | 34 | | | | 17,391 | | | | (2,530 | ) | | 2008 | | Oct-08 | | 3 - 39 yrs. | | | 133 | |
Dallas | | TX | | Hilton | | | 20,136 | | | | 2,221 | | | | 40,350 | | | | 6,254 | | | | 48,825 | | | | (2,533 | ) | | 2001 | | May-11 | | 3 - 39 yrs. | | | 224 | |
Duncanville | | TX | | Hilton Garden Inn | | | 13,139 | | | | 2,378 | | | | 15,935 | | | | 586 | | | | 18,899 | | | | (2,975 | ) | | 2005 | | Oct-08 | | 3 - 39 yrs. | | | 142 | |
El Paso | | TX | | Hilton Garden Inn | | | 0 | | | | 1,244 | | | | 18,300 | | | | 3 | | | | 19,547 | | | | (730 | ) | | 2011 | | Dec-11 | | 3 - 39 yrs. | | | 145 | |
Frisco | | TX | | Hilton Garden Inn | | | 0 | | | | 2,507 | | | | 12,981 | | | | 13 | | | | 15,501 | | | | (1,926 | ) | | 2008 | | Dec-08 | | 3 - 39 yrs. | | | 102 | |
Ft. Worth | | TX | | TownePlace Suites | | | 0 | | | | 2,104 | | | | 16,311 | | | | 10 | | | | 18,425 | | | | (1,379 | ) | | 2010 | | Jul-10 | | 3 - 39 yrs. | | | 140 | |
Grapevine | | TX | | Hilton Garden Inn | | | 11,751 | | | | 1,522 | | | | 15,543 | | | | 38 | | | | 17,103 | | | | (1,265 | ) | | 2009 | | Sep-10 | | 3 - 39 yrs. | | | 110 | |
Houston | | TX | | Marriott | | | 0 | | | | 4,143 | | | | 46,623 | | | | 14 | | | | 50,780 | | | | (4,796 | ) | | 2010 | | Jan-10 | | 3 - 39 yrs. | | | 206 | |
Irving | | TX | | Homewood Suites | | | 5,763 | | | | 705 | | | | 9,610 | | | | 229 | | | | 10,544 | | | | (668 | ) | | 2006 | | Dec-10 | | 3 - 39 yrs. | | | 77 | |
Lewisville | | TX | | Hilton Garden Inn | | | 0 | | | | 3,361 | | | | 23,919 | | | | 134 | | | | 27,414 | | | | (3,914 | ) | | 2007 | | Oct-08 | | 3 - 39 yrs. | | | 165 | |
Round Rock | | TX | | Hampton Inn | | | 3,813 | | | | 865 | | | | 10,999 | | | | 1,337 | | | | 13,201 | | | | (1,662 | ) | | 2001 | | Mar-09 | | 3 - 39 yrs. | | | 94 | |
Texarkana | | TX | | Hampton Inn & Suites | | | 4,822 | | | | 636 | | | | 8,723 | | | | 936 | | | | 10,295 | | | | (614 | ) | | 2004 | | Jan-11 | | 3 - 39 yrs. | | | 81 | |
Salt Lake City | | UT | | SpringHill Suites | | | 0 | | | | 1,092 | | | | 16,465 | | | | 30 | | | | 17,587 | | | | (1,183 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 143 | |
Alexandria | | VA | | SpringHill Suites | | | 0 | | | | 5,968 | | | | 0 | | | | 18,918 | | | | 24,886 | | | | (1,393 | ) | | 2011 | | Mar-09 | | 3 - 39 yrs. | | | 155 | |
Bristol | | VA | | Courtyard | | | 9,239 | | | | 1,723 | | | | 19,162 | | | | 1,584 | | | | 22,469 | | | | (3,035 | ) | | 2004 | | Nov-08 | | 3 - 39 yrs. | | | 175 | |
Manassas | | VA | | Residence Inn | | | 0 | | | | 0 | | | | 14,962 | | | | 164 | | | | 15,126 | | | | (857 | ) | | 2006 | | Feb-11 | | 3 - 39 yrs. | | | 107 | |
| | | | | | | 163,232 | | | | 137,309 | | | | 1,401,521 | | | | 66,604 | | | | 1,605,434 | | | | (145,927 | ) | | | | | | | | | 11,371 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other real estate investments: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Richmond | | VA | | Hotel under construction | | | 0 | | | | 3,115 | | | | 0 | | | | 1,058 | | | | 4,173 | | | | 0 | | | | | Jul-12 | | | | | 0 | |
Other | | | | | | | 0 | | | | 0 | | | | 0 | | | | 214 | | | | 214 | | | | 0 | | | | | | | | | | 0 | |
| | | | | | $ | 163,232 | | | $ | 140,424 | | | $ | 1,401,521 | | | $ | 67,876 | | | $ | 1,609,821 | | | $ | (145,927 | ) | | | | | | | | | 11,371 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(1) Land is owned fee simple unless cost is $0, which means the property is subject to a ground lease. | | | | | | | | | | | | | | | | | | | |
Investment in real estate at December 31, 2012, consisted of the following (in thousands):
Land | | $ | 140,424 | |
Building and Improvements | | | 1,349,246 | |
Furniture, Fixtures and Equipment | | | 114,501 | |
Franchise Fees | | | 4,592 | |
Construction in Progress | | | 1,058 | |
| | | 1,609,821 | |
Less Accumulated Depreciation | | | (145,927 | ) |
Investment in Real Estate, net | | $ | 1,463,894 | |
For additional information about the Company’s properties, refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Legal Proceedings
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in all three of the above mentioned class action lawsuits.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Item 4. Mine Safety Disclosures
Not Applicable.
PART II
Item 5. Market For Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Common Shares
There is currently no established public trading market in which the Company’s common shares are traded. As of December 31, 2012 there were 182.6 million Units outstanding. Each Unit consists of one common share, no par value, and one Series A preferred share of the Company. As of February 28, 2013, the Units were held by approximately 38,100 beneficial shareholders.
The Company is currently selling Units to its existing shareholders at a price of $10.25 per share through its Dividend Reinvestment Plan. This price is based on the most recent price at which an unrelated person purchased the Company’s Units from the Company. The Company also uses the original price paid for Units less Special Distributions ($10.25 per Unit in most cases) for redemptions under its Unit Redemption Program with the intention of providing limited liquidity based on those interested in purchasing additional Units through the Company’s Dividend Reinvestment Plan. As discussed further below, since inception of its Dividend Reinvestment Plan and Unit Redemption Program, 10.1 million Units have been issued and 9.8 million Units redeemed. The price of $10.25 per share is not based on an appraisal or valuation of the Company or its assets. In 2012, there was a tender offer made for the Units of the Company by a group of bidders. In June 2012, the bidders announced they acquired 74,010 Units for $6.25 a Unit. The Units acquired by the tender offer were approximately .04% of the Company’s outstanding shares. The weighted average price paid for shares through the tender offer and the Company’s Unit Redemption Program in 2012 was $10.29 per Unit.
Special Distribution
On April 27, 2012, the Company completed the sale of its 110 parcels for a total sale price of $198.4 million and received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser. In conjunction with the sale, the Board of Directors approved a special distribution of $0.75 per Unit, totaling $136.1 million on May 17, 2012 to shareholders of record on May 11, 2012 (the “Special Distribution”). In accordance with the Company’s Articles of Incorporation, the liquidation preference of each share of Series A preferred stock was reduced by the amount of the Special Distribution, or from $11.00 to $10.25 per share.
Distribution Policy
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions (excluding the Special Distribution) during 2012, 2011 and 2010 totaled approximately $155.0 million, $160.4 million and $118.1 million, respectively. Distributions for August 2012 through December 31, 2012 were paid at a monthly rate of $0.0691875 per common share, June and July 2012 distributions were paid at a monthly rate of $0.069167 per common share and prior to the June 2012, distributions were paid monthly at a rate of $0.073334 per share. In conjunction with the Special Distribution, in May 2012 the Company’s Board of Directors reduced the annual distribution rate from $0.88 per common share to $0.83 per common share. The reduction was effective with the June 2012 distribution. In August 2012, the Board of Directors slightly increased the annualized distribution rate from $0.83 per common share to $0.83025 per common share. Although the Company intends to continue paying distributions on a monthly basis, the amount and timing of distributions to shareholders are within the discretion of the Company’s Board of Directors. The amount and frequency of future distributions will depend on the Company’s results of operations, cash flow from operations, economic conditions, working capital requirements, cash requirements to fund investing and financing activities, capital expenditure requirements, including improvements to and expansions of properties, planned development projects and the acquisition of additional properties, as well as the distribution requirements under federal income tax provisions for qualification as a REIT. The Company’s Credit Agreement can potentially limit distributions to $152 million annually, subject to operational results, unless the Company is required to distribute more to meet REIT requirements.
Dividend Reinvestment Plan
In December 2010, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. As a result of the Special Distribution, beginning in May 2012, the offering price per Unit under the Company’s Dividend Reinvestment Plan was adjusted by the amount of the Special Distribution (from $11.00 to $10.25). The Company has registered 20.0 million Units for potential issuance under the plan. During the year ended December 31, 2012 and 2011, approximately 4.8 million Units, representing $50.0 million in proceeds to the Company, and 5.4 million Units, representing $59.1 million in proceeds to the Company, were issued under
the plan. No Units were issued under the plan as of December 31, 2010. Since inception of the plan through December 31, 2012, approximately 10.1 million Units, representing $109.1 million in proceeds to the Company, were issued under the plan. As of December 31, 2012, the Company had approximately 55.9 million Units participating in the Dividend Reinvestment Plan, which has declined from a high in June 2011 of 75.4 million Units. Since there continues to be demand for the Units at $10.25 per Unit, the Company’s Board of Directors does not believe the current offering price under the Dividend Reinvestment Plan should be changed at this time. However, the Board of Directors could change the price as it determines appropriate.
Unit Redemption Program
In July 2009, 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. Since the inception of the program through April 2012, shareholders were permitted to request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. In May 2012, as a result of the Special Distribution, the purchase price per Unit under the Company’s Unit Redemption Program was adjusted by the amount of the Special Distribution (from $11.00 to $10.25 for the maximum purchase price, based on the original purchase price and length of time such Units have been held by the shareholder). The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. As noted below, since July 2011 total redemption requests have exceeded the authorized amount of redemptions and the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.
Since inception of the program through December 31, 2012, the Company has redeemed approximately 9.8 million Units representing $101.2 million. During the year ended December 31, 2012, the Company redeemed approximately 5.0 million Units in the amount of $52.0 million. As contemplated in the program, beginning with the July 2011 redemption, the Company redeemed Units on a pro-rata basis with approximately 41%, 18%, 14%, 13%, 9% and 9% of the amounts requested redeemed in the third and fourth quarters of 2011 and the first, second, third and fourth quarters of 2012, respectively, leaving approximately 10.2 million Units requested but not redeemed as of the last scheduled redemption date in the fourth quarter of 2012 (October 2012). Prior to July 2011, the Company had redeemed 100% of redemption requests. The Company has a number of cash sources including cash from operations, dividend reinvestment plan proceeds, proceeds from borrowings and asset sales from which it can make redemptions. See the Company’s complete consolidated statements of cash flows for the years ended December 31, 2012, 2011 and 2010 included in the Company’s audited financial statements in Item 8 of this Form 10-K for a further description of the sources and uses of the Company’s cash flows. The following is a summary of the Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 318,891 | | | | 318,891 | | | | 0 | |
April 2011 | | | 378,367 | | | | 378,367 | | | | 0 | |
July 2011 | | | 3,785,039 | | | | 1,549,058 | | | | 2,235,981 | |
October 2011 | | | 8,410,322 | | | | 1,511,997 | | | | 6,898,325 | |
January 2012 | | | 10,689,219 | | | | 1,507,187 | | | | 9,182,032 | |
April 2012 | | | 11,229,890 | | | | 1,509,922 | | | | 9,719,968 | |
July 2012 | | | 10,730,084 | | | | 1,004,365 | | | | 9,725,719 | |
October 2012 | | | 11,155,269 | | | | 1,003,267 | | | | 10,152,002 | |
The following is a summary of redemptions during the fourth quarter of 2012 (no redemptions occurred in November and December of 2012).
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 | |
October 2012 | | | 1,003,267 | | | $ | 9.97 | | | | 1,003,267 | | | | (1) | |
(1) | The maximum number of Units that may be redeemed in any 12 month period is limited to up to five percent (5.0%) of |
| the weighted average number of Units outstanding from the beginning of the 12 month period, subject to the Company’s right to change the number of Units to be redeemed. |
Series A Preferred Shares
The Series A preferred shares have no voting rights and no conversion rights. In addition, the Series A preferred shares are not separately tradable from the common shares to which they relate. The Series A preferred shares do not have any distribution rights except a priority distribution upon the sale of the Company’s assets. In accordance with the Company’s Articles of Incorporation, the priority distribution (“Priority Distribution”) of each share of Series A preferred stock was reduced by the amount of the Special Distribution, or from $11.00 to $10.25 per share. The Priority Distribution will be paid before any distribution will be made to the holders of any other shares. Upon the Priority Distribution the Series A preferred shares will have no other distribution rights.
Series B Convertible Preferred Shares
In November 2007, the Company issued 480,000 Series B convertible preferred shares to Glade M. Knight, the Company’s Chairman and Chief Executive Officer. There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the Articles of Incorporation that would adversely affect the Series B convertible preferred shares. Upon liquidation, each holder of the Series B convertible preferred shares is entitled to a priority liquidation payment. However the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11 per number of common shares into which each Series B convertible preferred share would convert. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis. The Series B convertible preferred shares are convertible into common shares of the Company upon and for 180 days following the occurrence of any of the following events: (1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company’s business; or (2) the termination or expiration without renewal of the advisory agreement with A9A or if the Company ceases to use ASRG to provide property acquisition and disposition services; or (3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Preferred Shares
The Company’s articles of incorporation authorize issuance of up to 30 million additional preferred shares. No preferred shares other than the Series A preferred shares and the Series B convertible preferred shares (discussed above) have been issued. The Company believes that the authorization to issue additional preferred shares benefits the Company and its shareholders by permitting flexibility in financing additional growth, giving the Company additional financing options in corporate planning and in responding to developments in business, including financing of additional acquisitions and other general corporate purposes. Having authorized preferred shares available for issuance in the future gives the Company the ability to respond to future developments and allows preferred shares to be issued without the expense and delay of a special shareholders’ meeting. At present, the Company has no specific financing or acquisition plans involving the issuance of additional preferred shares and the Company does not propose to fix the characteristics of any series of preferred shares in anticipation of issuing preferred shares other than the Series A preferred shares and Series B convertible preferred shares discussed above. The Company cannot now predict whether or to what extent, if any, additional preferred shares will be used or if so used what the characteristics of a particular series may be. The voting rights and rights to distributions of the holders of common shares will be subject to the prior rights of the holders of any subsequently-issued preferred shares. Unless otherwise required by applicable law or regulation, the preferred shares would be issuable without further authorization by holders of the common shares and on such terms and for such consideration as may be determined by the Board of Directors. The preferred shares could be issued in one or more series having varying voting rights, redemption and conversion features, distribution (including liquidating distribution) rights and preferences, and other rights, including rights of approval of specified transactions. A series of preferred shares could be given rights that are superior to rights of holders of common shares and a series having preferential distribution rights could limit common share distributions and reduce the amount holders of common shares would otherwise receive on dissolution.
Non-Employee Directors’ Stock Option Plan
The Company’s Board of Directors has adopted and the Company’s shareholders have approved a non-employee directors’ stock option plan (the “Directors’ Plan”) to provide incentives to attract and retain directors. The options issued under the Directors’ Plan convert upon exercise of the options to Units. Each Unit consists of one common share and one Series A preferred share of the Company. The following is a summary of securities issued under the Directors’ Plan as of December 31, 2012:
Plan Category | | Number of securities to be issued upon exercise of outstanding options, warrants and rights | | | Weighted-average exercise price of outstanding options, warrants and rights | | | Number of securities remaining available for future issuance under equity compensation plans | |
Equity Compensation plans approved by security holders | | | | | | | | | |
Non-Employee Directors’ Stock Option Plan | | | 475,820 | | | $ | 10.77 | | | | 2,678,271 | |
Item 6. Selected Financial Data
The following table sets forth selected financial data for the five years ended December 31, 2012. Certain information in the table has been derived from the Company’s audited financial statements and notes thereto. This data should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, the Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Annual Report on Form 10-K. During the period from the Company’s initial capitalization on November 9, 2007 to July 30, 2008, the Company owned no properties, had no revenue exclusive of interest income, and was primarily engaged in capital formation activities. Operations commenced on July 31, 2008 with the Company’s first property acquisition.
(in thousands except per share and statistical data) | | Year Ended December 31, 2012 | | Year Ended December 31, 2011 | | Year Ended December 31, 2010 | | Year Ended December 31, 2009 | | Year Ended December 31, 2008 |
| | | | | | | | | | | | | | | |
Revenues: | | | | | | | | | | | | | | | |
Room revenue | | $ | 331,610 | | | $ | 291,858 | | | $ | 144,988 | | | $ | 76,163 | | | $ | 9,501 | |
Other revenue | | | 33,976 | | | | 28,642 | | | | 15,147 | | | | 9,043 | | | | 2,023 | |
Total revenue | | | 365,586 | | | | 320,500 | | | | 160,135 | | | | 85,206 | | | | 11,524 | |
| | | | | | | | | | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | | | | | | | | | |
Hotel operating expenses | | | 206,568 | | | | 184,641 | | | | 97,292 | | | | 52,297 | | | | 7,422 | |
Taxes, insurance and other | | | 21,150 | | | | 19,455 | | | | 10,273 | | | | 5,953 | | | | 731 | |
General and administrative | | | 9,227 | | | | 8,189 | | | | 6,472 | | | | 4,079 | | | | 1,288 | |
Acquisition related costs | | | 464 | | | | 5,275 | | | | 19,379 | | | | 4,951 | | | | - | |
Depreciation | | | 52,748 | | | | 48,415 | | | | 28,391 | | | | 14,095 | | | | 2,277 | |
Interest (income) expense, net | | | 6,745 | | | | 4,371 | | | | 931 | | | | 1,018 | | | | (2,346 | ) |
Total expenses | | | 296,902 | | | | 270,346 | | | | 162,738 | | | | 82,393 | | | | 9,372 | |
Income (loss) from continuing operations | | | 68,684 | | | | 50,154 | | | | (2,603 | ) | | | 2,813 | | | | 2,152 | |
Income from discontinued operations | | | 6,792 | | | | 19,834 | | | | 18,860 | | | | 14,041 | | | | - | |
Net income | | $ | 75,476 | | | $ | 69,988 | | | $ | 16,257 | | | $ | 16,854 | | | $ | 2,152 | |
| | | | | | | | | | | | | | | | | | | | |
Per Share: | | | | | | | | | | | | | | | | | | | | |
Income (loss) from continuing operations per common share | | $ | 0.37 | | | $ | 0.27 | | | $ | (0.02 | ) | | $ | 0.05 | | | $ | 0.14 | |
Income from discontinued operations per common share | | | 0.04 | | | | 0.11 | | | | 0.14 | | | | 0.21 | | | | - | |
Net income per common share | | $ | 0.41 | | | $ | 0.38 | | | $ | 0.12 | | | $ | 0.26 | | | $ | 0.14 | |
Distributions paid per common share (a) | | $ | 1.60 | | | $ | 0.88 | | | $ | 0.88 | | | $ | 0.88 | | | $ | 0.51 | |
Weighted-average common shares outstanding - basic and diluted | | | 182,222 | | | | 182,396 | | | | 135,825 | | | | 66,041 | | | | 15,852 | |
| | | | | | | | | | | | | | | | | | | | |
Balance Sheet Data (at end of period): | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 9,027 | | | $ | 30,733 | | | $ | 224,108 | | | $ | 272,913 | | | $ | 75,193 | |
Investment in real estate, net | | $ | 1,463,894 | | | $ | 1,480,722 | | | $ | 1,461,922 | | | $ | 687,509 | | | $ | 346,423 | |
Real estate held for sale | | $ | - | | | $ | 158,552 | | | $ | - | | | $ | - | | | $ | - | |
Total assets | | $ | 1,526,017 | | | $ | 1,700,967 | | | $ | 1,745,942 | | | $ | 982,513 | | | $ | 431,619 | |
Notes payable | | $ | 166,783 | | | $ | 124,124 | | | $ | 99,649 | | | $ | 58,688 | | | $ | 38,647 | |
Shareholders' equity | | $ | 1,346,133 | | | $ | 1,563,590 | | | $ | 1,634,039 | | | $ | 917,405 | | | $ | 389,740 | |
Net book value per share | | $ | 7.37 | | | $ | 8.55 | | | $ | 9.01 | | | $ | 9.31 | | | $ | 9.50 | |
| | | | | | | | | | | | | | | | | | | | |
Other Data: | | | | | | | | | | | | | | | | | | | | |
Cash Flow From (Used In): | | | | | | | | | | | | | | | | | | | | |
Operating activities | | $ | 122,966 | | | $ | 116,044 | | | $ | 38,758 | | | $ | 29,137 | | | $ | 3,317 | |
Investing activities | | $ | 105,951 | | | $ | (166,085 | ) | | $ | (786,103 | ) | | $ | (341,131 | ) | | $ | (315,322 | ) |
Financing activities | | $ | (250,623 | ) | | $ | (143,334 | ) | | $ | 698,540 | | | $ | 509,714 | | | $ | 387,178 | |
Number of hotels owned at end of period | | | 89 | | | | 88 | | | | 76 | | | | 33 | | | | 21 | |
Average Daily Rate (ADR) (b) | | $ | 111 | | | $ | 107 | | | $ | 102 | | | $ | 104 | | | $ | 110 | |
Occupancy | | | 72 | % | | | 70 | % | | | 65 | % | | | 62 | % | | | 59 | % |
Revenue Per Available Room (RevPAR) (c) | | $ | 80 | | | $ | 74 | | | $ | 66 | | | $ | 64 | | | $ | 65 | |
Total rooms sold (d) | | | 2,985,543 | | | | 2,733,381 | | | | 1,421,276 | | | | 732,553 | | | | 86,196 | |
Total rooms available (e) | | | 4,140,462 | | | | 3,924,417 | | | | 2,179,566 | | | | 1,183,837 | | | | 146,227 | |
| | | | | | | | | | | | | | | | | | | | |
Modified Funds From Operations | | | | | | | | | | | | | | | | | | | | |
Calculation (f): | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 75,476 | | | $ | 69,988 | | | $ | 16,257 | | | $ | 16,854 | | | $ | 2,152 | |
Depreciation of real estate owned | | | 52,748 | | | | 49,815 | | | | 30,749 | | | | 15,936 | | | | 2,277 | |
Funds from operations | | | 128,224 | | | | 119,803 | | | | 47,006 | | | | 32,790 | | | | 4,429 | |
Acquisition related costs | | | 464 | | | | 5,275 | | | | 19,379 | | | | 4,951 | | | | - | |
Straight-line rental income | | | (1,975 | ) | | | (6,158 | ) | | | (6,104 | ) | | | (4,618 | ) | | | - | |
Interest earned on note receivable | | | 4,270 | | | | - | | | | - | | | | - | | | | - | |
Modified funds from operations | | $ | 130,983 | | | $ | 118,920 | | | $ | 60,281 | | | $ | 33,123 | | | $ | 4,429 | |
(a) 2012 distributions include a special distribution of $0.75 per common share paid in May 2012. | |
(b) Total room revenue divided by number of rooms sold. | |
(c) ADR multiplied by occupancy percentage. | |
(d) Represents the number of room nights sold during the period. | |
(e) Represents the number of rooms owned by the Company multiplied by the number of nights in the period. | |
(f) Funds from operations (FFO) is defined as net income (computed in accordance with generally accepted accounting principals — GAAP) excluding gains and losses from sales of depreciable property, plus depreciation and amortization. Modified FFO (MFFO) excludes rental revenue earned, but not received during the period or straight-line rental income and costs associated with the acquisition of real estate and includes interest earned on a note receivable that is not included in net income. The Company considers FFO and MFFO in evaluating property acquisitions and its operating performance and believes that FFO and MFFO should be considered along with, but not as an alternative to, net income and cash flows as a measure of the Company’s activities in accordance with GAAP. The Company considers FFO and MFFO as supplemental measures of operating performance in the real estate industry, and along with the other financial measures included in this Form 10-K, including net income, cash flow from operating activities, financing activities and investing activities, they provide investors with an indication of the performance of the Company. The Company's definition of FFO and MFFO are not necessarily the same as such terms that are used by other companies. FFO and MFFO are not necessarily indicative of cash available to fund cash needs. | |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential,” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation,
regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this Annual Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission and Item 1A in this report. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
Overview
Apple REIT Nine, Inc., together with its wholly owned subsidiaries (the “Company”), was formed to invest in income-producing real estate in the United States. The Company was initially capitalized November 9, 2007, with its first investor closing on May 14, 2008. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in December 2010. The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. Prior to the Company’s first hotel acquisition on July 31, 2008, the Company had no revenue, exclusive of interest income. As of December 31, 2012, the Company owned 89 hotels (one acquired during 2012, 11 acquired and one newly constructed hotel opened during 2011, 43 acquired during 2010, 12 acquired during 2009 and 21 acquired during 2008). Accordingly, the results of operations include only results from the date of ownership of the properties.
In August 2011, the Company entered into a contract for the potential sale of its 406 acres of land and land improvements located on 110 sites in the Ft. Worth, Texas area (the “110 parcels”) for a total sale price of $198.4 million. The 110 parcels were acquired in April 2009 for a total purchase price of $147.3 million and were leased to a subsidiary of Chesapeake Energy Corporation under a long term lease for the production of natural gas. On April 27, 2012, the Company completed the sale of its 110 parcels and received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser. The operating results related to the 110 parcels have been included in discontinued operations and are not included in the results of operations summary below.
Hotel Operations
Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned. With the significant decline in economic conditions throughout the United States over the 2008 through 2010 time period, overall performance of the Company’s hotels has not met expectations since acquisition. Beginning in 2011 and continuing throughout 2012, the hotel industry and Company’s revenues and operating income have shown improvement from the significant decline in the industry during 2008 through 2010. Although there is no way to predict future general economic conditions, and there are several key factors that continue to negatively affect the economic recovery in the United States and add to general market uncertainty, including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the uncertainty surrounding the fiscal policy of the United States, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 for comparable hotels.
In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”) and market yield which compares an individual hotel’s results to others in its local market, and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.
The following is a summary of the results from continuing operations of the 89 hotels owned as of December 31, 2012 for their respective periods of ownership by the Company:
| | Years Ended December 31, |
(in thousands, except statistical data) | | 2012 | | Percent of Revenue | | 2011 | | Percent of Revenue | | Percent Change |
| | | | | | | | | | | | | | | |
Total revenue | | $ | 365,586 | | | | 100 | % | | $ | 320,500 | | | | 100 | % | | | 14 | % |
Hotel operating expenses | | | 206,568 | | | | 57 | % | | | 184,641 | | | | 58 | % | | | 12 | % |
Taxes, insurance and other expense | | | 21,150 | | | | 6 | % | | | 19,455 | | | | 6 | % | | | 9 | % |
General and administrative expense | | | 9,227 | | | | 3 | % | | | 8,189 | | | | 3 | % | | | 13 | % |
| | | | | | | | | | | | | | | | | | | | |
Acquisition related costs | | | 464 | | | | | | | | 5,275 | | | | | | | | -91 | % |
Depreciation | | | 52,748 | | | | | | | | 48,415 | | | | | | | | 9 | % |
Interest expense, net | | | 6,745 | | | | | | | | 4,371 | | | | | | | | 54 | % |
| | | | | | | | | | | | | | | | | | | | |
Number of hotels | | | 89 | | | | | | | | 88 | | | | | | | | 1 | % |
Average Market Yield(1) | | | 123 | | | | | | | | 122 | | | | | | | | 1 | % |
ADR | | $ | 111 | | | | | | | $ | 107 | | | | | | | | 4 | % |
Occupancy | | | 72 | % | | | | | | | 70 | % | | | | | | | 3 | % |
RevPAR | | $ | 80 | | | | | | | $ | 74 | | | | | | | | 8 | % |
| | | | | | | | | | | | | | | | | | | | | |
(1) Calculated from data provided by Smith Travel Research, Inc.® Excludes hotels under renovation or opened less than two years during the applicable periods. | |
Legal Proceedings
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in all three of the above mentioned class action lawsuits.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and
suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Hotels Owned
As noted above, the Company commenced operations in July 2008 upon the purchase of its first hotel property. The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 89 hotels the Company owned as of December 31, 2012. All dollar amounts are in thousands.
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | Gross Purchase Price |
Tucson | | AZ | | Hilton Garden Inn | | Western | | 7/31/2008 | | | 125 | | | $ | 18,375 | |
Santa Clarita | | CA | | Courtyard | | Dimension | | 9/24/2008 | | | 140 | | | | 22,700 | |
Charlotte | | NC | | Homewood Suites | | McKibbon | | 9/24/2008 | | | 112 | | | | 5,750 | |
Allen | | TX | | Hampton Inn & Suites | | Gateway | | 9/26/2008 | | | 103 | | | | 12,500 | |
Twinsburg | | OH | | Hilton Garden Inn | | Gateway | | 10/7/2008 | | | 142 | | | | 17,792 | |
Lewisville | | TX | | Hilton Garden Inn | | Gateway | | 10/16/2008 | | | 165 | | | | 28,000 | |
Duncanville | | TX | | Hilton Garden Inn | | Gateway | | 10/21/2008 | | | 142 | | | | 19,500 | |
Santa Clarita | | CA | | Hampton Inn | | Dimension | | 10/29/2008 | | | 128 | | | | 17,129 | |
Santa Clarita | | CA | | Residence Inn | | Dimension | | 10/29/2008 | | | 90 | | | | 16,600 | |
Santa Clarita | | CA | | Fairfield Inn | | Dimension | | 10/29/2008 | | | 66 | | | | 9,337 | |
Beaumont | | TX | | Residence Inn | | Western | | 10/29/2008 | | | 133 | | | | 16,900 | |
Pueblo | | CO | | Hampton Inn & Suites | | Dimension | | 10/31/2008 | | | 81 | | | | 8,025 | |
Allen | | TX | | Hilton Garden Inn | | Gateway | | 10/31/2008 | | | 150 | | | | 18,500 | |
Bristol | | VA | | Courtyard | | LBA | | 11/7/2008 | | | 175 | | | | 18,650 | |
Durham | | NC | | Homewood Suites | | McKibbon | | 12/4/2008 | | | 122 | | | | 19,050 | |
Hattiesburg | | MS | | Residence Inn | | LBA | | 12/11/2008 | | | 84 | | | | 9,793 | |
Jackson | | TN | | Courtyard | | Vista | | 12/16/2008 | | | 94 | | | | 15,200 | |
Jackson | | TN | | Hampton Inn & Suites | | Vista | | 12/30/2008 | | | 83 | | | | 12,600 | |
Pittsburgh | | PA | | Hampton Inn | | Vista | | 12/31/2008 | | | 132 | | | | 20,458 | |
Fort Lauderdale | | FL | | Hampton Inn | | Vista | | 12/31/2008 | | | 109 | | | | 19,290 | |
Frisco | | TX | | Hilton Garden Inn | | Western | | 12/31/2008 | | | 102 | | | | 15,050 | |
Round Rock | | TX | | Hampton Inn | | Vista | | 3/6/2009 | | | 94 | | | | 11,500 | |
Panama City | | FL | | Hampton Inn & Suites | | LBA | | 3/12/2009 | | | 95 | | | | 11,600 | |
Austin | | TX | | Homewood Suites | | Vista | | 4/14/2009 | | | 97 | | | | 17,700 | |
Austin | | TX | | Hampton Inn | | Vista | | 4/14/2009 | | | 124 | | | | 18,000 | |
Dothan | | AL | | Hilton Garden Inn | | LBA | | 6/1/2009 | | | 104 | | | | 11,601 | |
Troy | | AL | | Courtyard | | LBA | | 6/18/2009 | | | 90 | | | | 8,696 | |
Orlando | | FL | | Fairfield Inn & Suites | | Marriott | | 7/1/2009 | | | 200 | | | | 25,800 | |
Orlando | | FL | | SpringHill Suites | | Marriott | | 7/1/2009 | | | 200 | | | | 29,000 | |
Clovis | | CA | | Hampton Inn & Suites | | Dimension | | 7/31/2009 | | | 86 | | | | 11,150 | |
Rochester | | MN | | Hampton Inn & Suites | | Raymond | | 8/3/2009 | | | 124 | | | | 14,136 | |
Johnson City | | TN | | Courtyard | | LBA | | 9/25/2009 | | | 90 | | | | 9,880 | |
Baton Rouge | | LA | | SpringHill Suites | | Dimension | | 9/25/2009 | | | 119 | | | | 15,100 | |
Houston | | TX | | Marriott | | Western | | 1/8/2010 | | | 206 | | | | 50,750 | |
Albany | | GA | | Fairfield Inn & Suites | | LBA | | 1/14/2010 | | | 87 | | | | 7,920 | |
Panama City | | FL | | TownePlace Suites | | LBA | | 1/19/2010 | | | 103 | | | | 10,640 | |
Clovis | | CA | | Homewood Suites | | Dimension | | 2/2/2010 | | | 83 | | | | 12,435 | |
Jacksonville | | NC | | TownePlace Suites | | LBA | | 2/16/2010 | | | 86 | | | | 9,200 | |
Miami | | FL | | Hampton Inn & Suites | | Dimension | | 4/9/2010 | | | 121 | | | | 11,900 | |
Anchorage | | AK | | Embassy Suites | | Stonebridge | | 4/30/2010 | | | 169 | | | | 42,000 | |
Boise | | ID | | Hampton Inn & Suites | | Raymond | | 4/30/2010 | | | 186 | | | | 22,370 | |
Rogers | | AR | | Homewood Suites | | Raymond | | 4/30/2010 | | | 126 | | | | 10,900 | |
St. Louis | | MO | | Hampton Inn & Suites | | Raymond | | 4/30/2010 | | | 126 | | | | 16,000 | |
Oklahoma City | | OK | | Hampton Inn & Suites | | Raymond | | 5/28/2010 | | | 200 | | | | 32,657 | |
Ft. Worth | | TX | | TownePlace Suites | | Western | | 7/19/2010 | | | 140 | | | | 18,435 | |
Lafayette | | LA | | Hilton Garden Inn | | LBA | | 7/30/2010 | | | 153 | | | | 17,261 | |
West Monroe | | LA | | Hilton Garden Inn | | InterMountain | | 7/30/2010 | | | 134 | | | | 15,639 | |
Silver Spring | | MD | | Hilton Garden Inn | | White | | 7/30/2010 | | | 107 | | | | 17,400 | |
Rogers | | AR | | Hampton Inn | | Raymond | | 8/31/2010 | | | 122 | | | | 9,600 | |
St. Louis | | MO | | Hampton Inn | | Raymond | | 8/31/2010 | | | 190 | | | | 23,000 | |
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price |
Kansas City | | MO | | Hampton Inn | | Raymond | | 8/31/2010 | | | 122 | | | $ | 10,130 | |
Alexandria | | LA | | Courtyard | | LBA | | 9/15/2010 | | | 96 | | | | 9,915 | |
Grapevine | | TX | | Hilton Garden Inn | | Western | | 9/24/2010 | | | 110 | | | | 17,000 | |
Nashville | | TN | | Hilton Garden Inn | | Vista | | 9/30/2010 | | | 194 | | | | 42,667 | |
Indianapolis | | IN | | SpringHill Suites | | White | | 11/2/2010 | | | 130 | | | | 12,800 | |
Mishawaka | | IN | | Residence Inn | | White | | 11/2/2010 | | | 106 | | | | 13,700 | |
Phoenix | | AZ | | Courtyard | | White | | 11/2/2010 | | | 164 | | | | 16,000 | |
Phoenix | | AZ | | Residence Inn | | White | | 11/2/2010 | | | 129 | | | | 14,000 | |
Mettawa | | IL | | Residence Inn | | White | | 11/2/2010 | | | 130 | | | | 23,500 | |
Mettawa | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 170 | | | | 30,500 | |
Austin | | TX | | Hilton Garden Inn | | White | | 11/2/2010 | | | 117 | | | | 16,000 | |
Novi | | MI | | Hilton Garden Inn | | White | | 11/2/2010 | | | 148 | | | | 16,200 | |
Warrenville | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 135 | | | | 22,000 | |
Schaumburg | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 166 | | | | 20,500 | |
Salt Lake City | | UT | | SpringHill Suites | | White | | 11/2/2010 | | | 143 | | | | 17,500 | |
Austin | | TX | | Fairfield Inn & Suites | | White | | 11/2/2010 | | | 150 | | | | 17,750 | |
Austin | | TX | | Courtyard | | White | | 11/2/2010 | | | 145 | | | | 20,000 | |
Chandler | | AZ | | Courtyard | | White | | 11/2/2010 | | | 150 | | | | 17,000 | |
Chandler | | AZ | | Fairfield Inn & Suites | | White | | 11/2/2010 | | | 110 | | | | 12,000 | |
Tampa | | FL | | Embassy Suites | | White | | 11/2/2010 | | | 147 | | | | 21,800 | |
Andover | | MA | | SpringHill Suites | | Marriott | | 11/5/2010 | | | 136 | | | | 6,500 | |
Philadelphia (Collegeville) | | PA | | Courtyard | | White | | 11/15/2010 | | | 132 | | | | 20,000 | |
Holly Springs | | NC | | Hampton Inn & Suites | | LBA | | 11/30/2010 | | | 124 | | | | 14,880 | |
Philadelphia (Malvern) | | PA | | Courtyard | | White | | 11/30/2010 | | | 127 | | | | 21,000 | |
Arlington | | TX | | Hampton Inn & Suites | | Western | | 12/1/2010 | | | 98 | | | | 9,900 | |
Irving | | TX | | Homewood Suites | | Western | | 12/29/2010 | | | 77 | | | | 10,250 | |
Mount Laurel | | NJ | | Homewood Suites | | Tharaldson | | 1/11/2011 | | | 118 | | | | 15,000 | |
West Orange | | NJ | | Courtyard | | Tharaldson | | 1/11/2011 | | | 131 | | | | 21,500 | |
Texarkana | | TX | | Hampton Inn & Suites | | InterMountain | | 1/31/2011 | | | 81 | | | | 9,100 | |
Fayetteville | | NC | | Home2 Suites | | LBA | | 2/3/2011 | | | 118 | | | | 11,397 | |
Manassas | | VA | | Residence Inn | | Tharaldson | | 2/16/2011 | | | 107 | | | | 14,900 | |
San Bernardino | | CA | | Residence Inn | | Tharaldson | | 2/16/2011 | | | 95 | | | | 13,600 | |
Alexandria (1) | | VA | | SpringHill Suites | | Marriott | | 3/28/2011 | | | 155 | | | | 24,863 | |
Dallas | | TX | | Hilton | | Hilton | | 5/17/2011 | | | 224 | | | | 42,000 | |
Santa Ana | | CA | | Courtyard | | Dimension | | 5/23/2011 | | | 155 | | | | 24,800 | |
Lafayette | | LA | | SpringHill Suites | | LBA | | 6/23/2011 | | | 103 | | | | 10,232 | |
Tucson | | AZ | | TownePlace Suites | | Western | | 10/6/2011 | | | 124 | | | | 15,852 | |
El Paso | | TX | | Hilton Garden Inn | | Western | | 12/19/2011 | | | 145 | | | | 19,974 | |
Nashville | | TN | | Home2 Suites | | Vista | | 5/31/2012 | | | 119 | | | | 16,660 | |
Total | | | | | | | | | | | 11,371 | | | $ | 1,546,839 | |
| | | | | | | | | | | | | | | | |
(1) The Company acquired land and began construction for this hotel during 2009. Hotel construction was completed by the Company and the hotel opened for business on March 28, 2011. The gross purchase price includes the acquisition of land and construction costs. |
The purchase price for the properties acquired through December 31, 2012, net of debt assumed, was funded primarily by the Company’s best-efforts offering of Units, completed in December 2010. The Company assumed approximately $122.4 million of debt secured by 13 of its hotel properties and $3.8 million of unsecured debt in connection with one of its hotel properties. The Company also used the proceeds of its best-efforts offering to pay approximately $30.5 million, representing 2% of the gross purchase price for these properties, as a brokerage commission to Apple Suites Realty Group, Inc. (“ASRG”), 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive. The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary (or a subsidiary thereof) under master hotel lease agreements. No goodwill was recorded in connection with any of the acquisitions.
Development Project
On October 14, 2009, the Company entered into a ground lease for approximately one acre of land located in downtown Richmond, Virginia. In February 2012, the Company terminated the lease and entered into a contract to purchase the land for $3.0 million, which was completed in July 2012. In conjunction with the acquisition, the Company paid as a brokerage commission to ASRG approximately $0.06 million, representing 2% of the gross purchase price, which was capitalized as part of the acquisition cost of the land. The Company acquired the land for the development of adjoining Courtyard and Residence Inn hotels, which is expected to begin in early 2013 and be completed within two years. Upon completion, the Courtyard and Residence Inn are expected to contain approximately 135 and 75 guest rooms, respectively and are planned to be managed by White. The Company expects to spend a total of approximately $30 million to develop
the hotels and has spent approximately $1.1 million in development costs as of December 31, 2012. If the Company does not begin vertical construction by July 2013, the seller of the property has an option to acquire the land equal to the amount of the Company’s total cost.
Management and Franchise Agreements
Each of the Company’s 89 hotels are operated and managed under separate management agreements, by affiliates of one of the following companies: Dimension Development Two, LLC (“Dimension”), Gateway Hospitality Group, Inc. (“Gateway”), Hilton Management LLC (“Hilton”), Intermountain Management, LLC (“Intermountain”), LBAM-Investor Group, L.L.C. (“LBA”), Fairfield FMC, LLC and SpringHill SMC, LLC, subsidiaries of Marriott International (“Marriott”), MHH Management, LLC (“McKibbon”), Raymond Management Company, Inc. (“Raymond”), Stonebridge Realty Advisors, Inc. (“Stonebridge”), Tharaldson Hospitality Management, LLC (“Tharaldson”), Vista Host, Inc. (“Vista”), Texas Western Management Partners, L.P. (“Western”) or White Lodging Services Corporation (“White”). The agreements generally provide for initial terms of one to 30 years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. For the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $12.3 million, $10.6 million and $5.1 million in management fees.
Dimension, Gateway, Intermountain, LBA, McKibbon, Raymond, Stonebridge, Tharaldson, Vista, Western and White are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for an initial term of 10 to 21 years. Fees associated with the agreements generally include the payment of royalty fees and program fees. The Marriott franchise agreements generally provide for initial terms of 13 to 28 years. Fees associated with the agreements generally include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. For the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $14.5 million, $12.8 million and $6.2 million in franchise fees.
Results of Operations for Years 2012 and 2011
During the period from the Company’s initial capitalization on November 9, 2007 to July 30, 2008, the Company owned no properties, had no revenue, exclusive of interest income and was primarily engaged in capital formation activities. The Company began operations on July 31, 2008 when it purchased its first hotel. As of December 31, 2012, the Company owned 89 hotels with 11,371 rooms as compared to 88 hotels (of which 11 were purchased and one newly constructed hotel opened during 2011), with a total of 11,252 rooms as of December 31, 2011. As a result of the acquisition activity during 2011 and 2012, a comparison of operations for 2012 to prior periods is not representative of the results that would have occurred if all properties had been owned for the entire periods presented.
Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy had a considerable negative impact on both consumer and business travel. However, economic conditions have shown evidence of improvement during the past two years. As a result, the Company expects continued improvement in revenue and operating income in 2013 as compared to 2012. 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 revenue consisting of room and other related revenue. For the years ended December 31, 2012 and 2011, the Company had hotel revenue of $365.6 million and $320.5 million, respectively. This revenue reflects hotel operations for the 89 hotels owned as of December 31, 2012 for their respective periods of ownership by the Company. For the year ended December 31, 2012, the hotels achieved combined average occupancy of approximately 72%, ADR of $111 and RevPAR of $80. For the year ended December 31, 2011, the hotels achieved combined average occupancy of approximately 70%, ADR of $107 and RevPAR of $74. ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.
During 2012, the Company experienced an increase in demand as demonstrated by the improvement in average occupancy for its comparable hotels of 3% in 2012 as compared to 2011. In addition, also signifying a progressing economy, the Company experienced an increase in ADR of 4% for comparable hotels during 2012 as compared to the prior year. With continued demand and room rate improvement, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 for comparable hotels. The Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for 2012 and 2011 was 123 and 122,
respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation or open less than two years) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue.
In addition, seven of the hotels owned as of December 31, 2012 have opened since the beginning of 2011. Generally, newly constructed hotels require 12-24 months to establish themselves in their respective markets. Therefore, revenue is below anticipated or market levels for this period of time.
Expenses
Hotel operating expenses relate to the 89 hotels owned as of December 31, 2012 for their respective periods owned and consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the years ended December 31, 2012 and 2011, hotel operating expenses totaled $206.6 million or 57% of total revenue and $184.6 million or 58% of total revenue. Seven of the hotels owned have opened since the beginning of 2011 and as a result, hotel operating expenses as a percentage of total revenue for these hotels are higher than is expected once the properties have established themselves within their respective markets. In addition, operating expenses were impacted by several hotel renovations, with approximately 22,000 room nights out of service during 2012 and 16,000 room nights out of service during 2011 due to such renovations. Although operating expenses will increase as revenue increases, the Company will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
Taxes, insurance, and other expense for the years ended December 31, 2012 and 2011 totaled $21.2 million or 6% of total revenue and $19.5 million or 6% of total revenue. For comparable hotels, real estate taxes decreased in 2012 due to successful appeals of tax assessments at certain locations. These decreases were partially offset by higher taxes for certain properties due to the reassessment of property values by localities resulting from the improved economy. Also, for comparable hotels, 2012 insurance rates increased due to property and casualty carriers’ losses world-wide in the past year. With the improved economy, the Company anticipates continued increases in property tax assessments in 2013 and a moderate increase in insurance rates.
General and administrative expense for the years ended December 31, 2012 and 2011 was $9.2 million and $8.2 million. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expenses. During 2012 and 2011, the Company incurred approximately $1.7 million and $1.1 million, respectively in legal costs related to the legal matters discussed herein and continued costs related to responding to requests from the staff of the Securities and Exchange Commission (“SEC”). The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company's consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution. As discussed below under Related Parties, the Company shares legal counsel with the other Apple REIT Companies. Total costs for these legal matters for all of the Apple REIT Companies was approximately $7.3 million in 2012. The Company anticipates it will continue to incur significant legal costs at least during the first half of 2013 related to these matters. Also, during the fourth quarter of 2011, the Company began to incur costs associated with its evaluation of a potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc. (the “other Apple REITs”). Total costs incurred during 2012 and 2011 were approximately $0.6 million and $0.1 million. In May 2012, it was determined by the Board of Directors of the Company and the Board of Directors of each of the other Apple REITs not to move forward with the potential consolidation transaction at that time.
Acquisition related costs for the years ended December 31, 2012 and 2011 were $0.5 million and $5.3 million. The decline was due to the reduction in acquisitions from 11 hotels and one newly constructed hotel in 2011 to one acquisition in 2012. The costs include title, legal, accounting, pre-opening and other related costs, as well as the brokerage commission paid to ASRG for the properties acquired or newly opened during the respective period.
Depreciation expense for the years ended December 31, 2012 and 2011 was $52.7 million and $48.4 million. Depreciation expense primarily represents expense of the Company’s 89 hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment) for their respective periods owned. The increase was due to the increase in the number of properties owned and renovations completed throughout 2012 and 2011.
Interest expense for the years ended December 31, 2012 and 2011 was $7.4 million and $6.0 million, respectively and is net of approximately $0.7 million and $0.5 million of interest capitalized associated with renovation and construction
projects. Interest expense primarily arose from debt assumed with the acquisition of 14 of the Company’s hotels, the origination of three mortgage loans during the third quarter 2012 totaling $47.7 million, and borrowings on the Company’s $30 million non-revolving line of credit that was extinguished and paid off during the third quarter of 2012 with a portion of the proceeds from the newly originated mortgage loans. During the years ended December 31, 2012 and 2011, the Company also recognized $0.6 million and $1.6 million in interest income, primarily representing interest on excess cash invested in short-term money market instruments and two mortgage notes acquired during 2010, of which one of the notes totaling $11.0 million was repaid by the borrower in December 2011.
Results of Operations for Years 2011 and 2010
As of December 31, 2011, the Company owned 88 hotels (of which 11 were purchased and one newly constructed hotel opened during 2011) with 11,252 rooms as compared to 76 hotels (of which 43 were acquired during 2010, including 22 acquisitions during the fourth quarter of 2010), with a total of 9,695 rooms as of December 31, 2010. As a result of the acquisition activity during 2010 and 2011, a comparison of operations for 2011 to prior periods is not representative of the results that would have occurred if all properties had been owned for the entire periods presented.
Revenues
For the years ended December 31, 2011 and 2010, the Company had hotel revenue of $320.5 million and $160.1 million, respectively. This revenue reflects hotel operations for the 88 hotels owned as of December 31, 2011 for their respective periods of ownership by the Company. For the year ended December 31, 2011, the hotels achieved combined average occupancy of approximately 70%, ADR of $107 and RevPAR of $74. For the year ended December 31, 2010, the hotels achieved combined average occupancy of approximately 65%, ADR of $102 and RevPAR of $66. Since the beginning of 2010 the Company has experienced an increase in demand as demonstrated by the improvement in average occupancy for its comparable hotels of 7% in 2011 as compared to 2010. In addition, also signifying a stabilizing economy, the Company experienced an increase in ADR of 3% for comparable hotels during 2011 as compared to the prior year. The Company’s average Market Yield for 2011 and 2010 was 126 and 123, respectively and excludes hotels under renovation or opened less than two years. In addition, 14 of the hotels owned as of December 31, 2011 have opened since the beginning of 2010. Generally, newly constructed hotels require 12-24 months to establish themselves in their respective markets. Therefore, revenue is below anticipated or market levels for this period of time.
Expenses
Hotel operating expenses relate to the 88 hotels owned as of December 31, 2011 for their respective periods owned. For the years ended December 31, 2011 and 2010, hotel operating expenses totaled $184.6 million or 58% of total revenue and $97.3 million or 61% of total revenue. Eight of the 43 hotels acquired in 2010 and six of the 12 new hotels in 2011 are newly opened hotels and as a result, hotel operating expenses as a percentage of total revenue for these hotels are higher than is expected once the properties have established themselves within their respective markets. In addition, operating expenses were impacted by several hotel renovations, with approximately 16,000 room nights out of service during 2011 and 14,400 room nights out of service during 2010 due to such renovations.
Taxes, insurance, and other expense for the years ended December 31, 2011 and 2010 totaled $19.5 million or 6% of total revenue and $10.3 million or 6% of total revenue. As discussed above, with the addition of 14 new hotels in the past two years, taxes, insurance and other expense as a percentage of revenue is anticipated to decline as the properties become established in their respective markets.
General and administrative expense for the years ended December 31, 2011 and 2010 was $8.2 million and $6.5 million. During 2011 and 2010, the Company incurred approximately $1.1 million and $0.5 million, respectively in legal costs related to the legal matters discussed herein and costs related to responding to requests from the staff of the SEC as discussed above. Also, during the fourth quarter of 2011, the Company incurred costs totaling $0.1 million associated with its evaluation of a potential consolidation transaction with the other Apple REITs as discussed above.
Acquisition related costs for the years ended December 31, 2011 and 2010 were $5.3 million and $19.4 million. The decline was due to the reduction in acquisitions from 43 in 2010 to 11 in 2011. The costs include title, legal, accounting, pre-opening and other related costs, as well as the brokerage commission paid to ASRG for the properties acquired or newly opened during the respective period.
Depreciation expense for the years ended December 31, 2011 and 2010 was $48.4 million and $28.4 million. Depreciation expense primarily represents expense of the Company’s 88 hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment) for their respective periods owned. The increase was due to the increase in the number of properties owned and renovations completed throughout 2011 and 2010.
Interest expense for the years ended December 31, 2011 and 2010 was $6.0 million and $2.9 million, respectively and is net of approximately $0.5 million and $0.6 million of interest capitalized associated with renovation and construction projects. Interest expense primarily arose from debt assumed with the acquisition of 14 of the Company’s hotels (two loans were assumed in 2011 and five in 2010). During the years ended December 31, 2011 and 2010, the Company also recognized $1.6 million and $2.0 million in interest income, primarily representing interest on excess cash invested in short-term money market instruments and two mortgage notes acquired during 2010, of which one of the notes totaling $11.0 million was repaid by the borrower in December 2011.
Discontinued Operations
In April 2009, the Company acquired from a subsidiary of Chesapeake Energy Corporation (“Chesapeake”) approximately 417 acres of land and land improvements located on 113 sites in the Ft. Worth, Texas area and simultaneously entered into a ground lease with Chesapeake. The land is used by Chesapeake for the production of natural gas. The lease has an initial term of 40 years from its commencement date of April 2009, and remaining annual rent ranging from $15.0 million to $26.7 million. Under the lease, the tenant is responsible for all operating costs associated with the real estate. Chesapeake Energy Corporation is a publicly held company that is traded on the New York Stock Exchange.
In February 2010, the Company agreed to sell back to Chesapeake two of the sites originally purchased from Chesapeake and release Chesapeake from their associated lease obligation. The sales price for the two sites was equal to the Company’s original purchase price, approximately $2.6 million. The Company earned and received rental income for the period held totaling approximately $240,000.
In July 2011, the Company agreed to sell back to Chesapeake one of the sites originally purchased from Chesapeake and release Chesapeake from their associated lease obligation. The sales price for the site was $1.4 million, which approximates the net book value of the site. The Company earned and received rental income for the period held totaling approximately $310,000.
In August 2011, the Company entered into a contract for the potential sale of its remaining 110 parcels (which were acquired for a total purchase price of $147.3 million) and the assignment of the lease with Chesapeake for a total sale price of $198.4 million. On April 27, 2012, the Company completed the sale of its 110 parcels and the assignment of the lease with Chesapeake and received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser (the “note”). The note, which approximates fair market value, is secured by a junior lien on the 110 parcels. The stated interest rate on the note is 10.5%. The note requires interest only payments for the first three years of the note. After the first three years, interest is accrued and payments will only be received once the purchaser extinguishes its senior loan with a third party. Once the senior loan is repaid, the Company will receive all payments from the existing lease on the 110 parcels until fully repaid or the note reaches maturity which is April 2049. Although the purchaser is not affiliated with the Company, a partner of the purchaser is also a member of the Board of Directors of Apple REIT Ten, Inc. In conjunction with the sale, the Company incurred a brokerage commission to ASRG totaling approximately $4.0 million, representing 2% of the gross sales price. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60.0 million note. The $4.0 million commission has been recorded as a reduction to the deferred gain on sale as described below.
The total gain on sale was approximately $33.4 million (total sale price of $198.4 million less carrying value totaling $160.5 million, ASRG fee totaling $4.0 million, closing costs totaling $0.2 million and related franchise taxes totaling $0.3 million). In accordance with the Accounting Standards Codification on real estate sales, the sales transaction is being accounted for under the cost recovery method, therefore the gain on sale and interest earned on the note will be deferred until cash payments by the purchaser, including principal and interest on the note due to the Company and the payment of the $138.4 million at closing exceed the Company’s cost basis of the 110 parcels sold. The note receivable is included in the Company’s consolidated balance sheets, net of the total deferred gain. As of December 31, 2012, the note receivable, net was $22.4 million, including $60 million note receivable, offset by $33.4 million deferred gain and $4.3 million deferred interest earned. Prior to the sale, the 110 parcels were classified in the consolidated balance sheets as real estate held for sale and were recorded at their carrying amount, totaling approximately $158.6 million as of December 31, 2011, which included real estate net book value totaling $141.8 million and straight-line rent receivable totaling $16.8 million. The 110 parcels was a separate reportable segment and the results of operations for these properties have been classified in the consolidated statements of operations in the line item income from discontinued operations.
The following table sets forth the components of income from discontinued operations for the years ended December 31, 2012, 2011 and 2010 (in thousands):
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
Rental revenue | | $ | 6,826 | | | $ | 21,357 | | | $ | 21,325 | |
Operating expenses | | | 34 | | | | 123 | | | | 107 | |
Depreciation expense | | | 0 | | | | 1,400 | | | | 2,358 | |
Income from discontinued operations | | $ | 6,792 | | | $ | 19,834 | | | $ | 18,860 | |
Prior to the sale, the lease was classified as an operating lease and rental income was recognized on a straight-line basis over the initial term of the lease. Rental revenue includes approximately $2.0 million, $6.2 million and $6.1 million of adjustments to record rent on the straight-line basis for the years ended December 31, 2012, 2011 and 2010, respectively.
Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during 2012 (other than the loan guarantee and assignment and transfer agreements discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with ASRG, to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for fees under the terms of this contract related to the acquisition of assets have totaled approximately $33.5 million since inception. Of this amount, the Company incurred approximately $0.4 million, $4.0 million and $15.6 million for years ended December 31, 2012, 2011 and 2010. In addition, the Company incurred a brokerage commission to ASRG totaling approximately $4.0 million related to the sale of the Company’s 110 parcels in April 2012, which has been recorded as a reduction to the deferred gain on sale. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60 million note.
The Company is party to an advisory agreement with Apple Nine Advisors, Inc. (“A9A”), pursuant to which A9A provides management services to the Company. A9A provides these management services through an affiliate called Apple Fund Management LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A9A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $2.9 million, $3.0 million and $1.5 million for the years ended December 31, 2012, 2011 and 2010. The increase in 2012 and 2011 is due to the Company reaching the next fee tier under the advisory agreement due to improved results of operations for the Company during those periods. At December 31, 2011, $1.0 million of the 2011 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. This amount was paid during the first quarter of 2012. No amounts were outstanding at December 31, 2012.
In addition to the fees payable to ASRG and A9A, the Company reimbursed to A9A or ASRG or paid directly to AFM on behalf of A9A or ASRG approximately $2.2 million, $2.1 million and $2.1 million for the years ended December 31, 2012, 2011 and 2010. The expenses reimbursed were approximately $0.2 million, $0.3 million and $1.1 million, respectively for costs reimbursed under the contract with ASRG and approximately $2.0 million, $1.8 million and $1.0 million, respectively for costs reimbursed under the contract with A9A. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A9A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Ten, Inc. and the Company (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company
believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, A9A entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, A9A and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM. The assignment of AFM’s interest to A9A, if it occurs, will have no impact on the Company’s advisory agreement with A9A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors, excluding Apple REIT Six, Inc. as described above, which will increase the remaining companies’ share of the allocated costs.
Also, on November 29, 2012, in connection with the merger, the Company entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. Also, as part of the purchase, the Company agreed to indemnify Apple REIT Six, Inc. for any liabilities related to the Headquarters or office lease. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
ASRG and A9A are 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 Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the Board of Directors of Apple REIT Six, Inc., Apple REIT Seven, Inc., and Apple REIT Eight, Inc.
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for acquisition, asset management and renovation purposes. The Company’s equity investment was approximately $1.9 million and $2.1 million as of December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.8 million respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services.
Due to the significant discount offered by the original lender, in October 2010, the Company purchased a mortgage note with an outstanding balance of approximately $11.3 million for a total purchase price of approximately $10.8 million
from an unrelated third party. In accordance with the terms of the note, in December 2011, the borrower repaid the remaining outstanding balance totaling $11.0 million. The interest rate on this mortgage was a variable rate based on the 3-month LIBOR, and averaged 5% during the period held. The note required monthly payments of principal and interest. The borrower on the note was Apple Eight SPE Columbia, Inc., an indirect wholly owned subsidiary of Apple REIT Eight, Inc. and the note was secured by a Hilton Garden Inn hotel located in Columbia, South Carolina. Total interest income, including the accretion of the note discount, recorded by the Company for the years ended December 31, 2012, 2011 and 2010 was approximately $0, $0.9 million and $0.2 million.
In May 2012, the Company entered into a Loan Agreement (the “Loan Agreement”) with a commercial bank, which provided for a $30 million non-revolving line of credit with a maturity date of November 15, 2012. During the third quarter of 2012, the line of credit was extinguished and the outstanding principal balance totaling $30 million, plus accrued interest was paid in full. The Loan Agreement was guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and was secured by assets of Mr. Knight. Mr. Knight did not receive any consideration in exchange for providing this guaranty and security. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement.
Series B Convertible Preferred Stock
The Company has issued 480,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $48,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with A9A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/100 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $100 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to the issuance of 480,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the
Series B convertible preferred shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred as of December 31, 2012, expense would have ranged from $0 to in excess of $127.6 million (assumes $11 per common share fair market value) which represents approximately 11.6 million shares of common stock.
Liquidity and Capital Resources
Contractual Commitments
The following is a summary of the Company’s significant contractual obligations as of December 31, 2012:
| | | | | Amount of Commitments Expiring per Period | |
(000's) | | Total | | | Less than 1 Year | | | 2-3 Years | | | 4-5 Years | | | Over 5 Years | |
Property Purchase Commitments | | $ | 4,500 | | | $ | 4,500 | | | $ | - | | | $ | - | | | $ | - | |
Debt (including interest of $42.5 million) | | | 207,731 | | | | 12,999 | | | | 78,103 | | | | 65,156 | | | | 51,473 | |
Ground Leases | | | 13,899 | | | | 244 | | | | 503 | | | | 508 | | | | 12,644 | |
| | $ | 226,130 | | | $ | 17,743 | | | $ | 78,606 | | | $ | 65,664 | | | $ | 64,117 | |
Capital Resources
In November 2012, the Company entered into an unsecured Credit Agreement (the “Credit Agreement”) with a commercial bank, which provides for an initial $50 million revolving credit facility that may be increased to $100 million, subject to certain conditions. The credit facility will be utilized for working capital, hotel renovations and development, and other general corporate funding purposes, including the payment of redemptions and distributions. Under the terms of the Credit Agreement, the Company may make voluntary prepayments in whole or in part, at any time. The Credit Agreement matures in November 2014; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to November 2015. Interest payments are due monthly and the interest rate, subject to certain exceptions, is equal to the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 2.75%, depending upon the Company’s leverage ratio, as calculated under the terms of the Credit Agreement. The Company is also required to pay an unused facility fee of 0.30% or 0.40% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during the quarter. As of December 31, 2012, there were no borrowings outstanding under the credit facility. Loan origination costs totaling approximately $0.3 million are being amortized as interest expense through the November 2014 maturity date.
The Credit Agreement requires the Company to maintain a specific pool of Unencumbered Borrowing Base Properties (must be a minimum of ten properties and must satisfy conditions as defined in the Credit Agreement). The obligations of the Lenders to make any advances under the Credit Agreement are subject to certain conditions, including that the outstanding borrowings do not exceed the Borrowing Base Availability. The credit facility contains customary affirmative covenants and negative covenants and events of default. In addition, the credit facility contains the following quarterly financial covenants (capitalized terms are defined in the Credit Agreement):
· | A maximum Consolidated Total Indebtedness limit of 45% of the aggregate Real Estate Values for all Eligible Real Estate that is or qualifies as an Unencumbered Borrowing Base Property; |
· | A maximum Consolidated Total Indebtedness limit of 50% of the Consolidated Total Asset Value; |
· | A minimum Adjusted Consolidated EBITDA to Consolidated Fixed Charges covenant of 1.75 to 1.00 for the total of the four trailing quarterly periods; |
· | A minimum Consolidated Tangible Net Worth of $1.0 billion; |
· | A maximum Consolidated Secured Debt limit of 40% of Consolidated Total Asset Value; |
· | A minimum Adjusted NOI for all Eligible Real Estate that is or qualifies as an Unencumbered Borrowing Base Property to Implied Debt Service covenant of 2.25 to 1.00; |
· | A maximum Consolidated Secured Recourse Indebtedness of $10 million; and |
· | Restricted Payments (including Distributions and Unit Redemptions), net of proceeds from the Company’s Dividend Reinvestment Plan, cannot exceed $38 million during any calendar quarter and |
| quarterly Distributions cannot exceed $0.21 per share for the period from October 1, 2012 through and including June 30, 2013, and thereafter must not exceed $152 million in any cumulative 12 month period and Distributions cannot exceed $0.83025 per share for any calendar year, unless such Restricted Payments are less than the Company’s Funds From Operations for any cumulative four calendar quarters. |
The Company was in compliance with each of these covenants at December 31, 2012.
During the third quarter of 2012, the Company entered into three mortgage loan agreements with a commercial bank for a total of $47.7 million. Each loan is secured by one of the following Company hotels: Grapevine, Texas Hilton Garden Inn; Collegeville, Pennsylvania Courtyard; and Anchorage, Alaska Embassy Suites. Two loans mature in September 2022 and one matures in October 2022, and all three loans will amortize based on a 25 year term with a balloon payment due at maturity. Interest is payable monthly on the outstanding balance of each loan at an annual rate of 4.89% to 4.97%. At closing, the Company used a portion of the total proceeds of the loans to extinguish and payoff its $30 million non-revolving line of credit and to pay transaction costs. The remaining proceeds will be used for general corporate purposes, including capital expenditures, redemptions and distributions. Loan origination costs totaling approximately $0.3 million are being amortized as interest expense through each loan’s respective maturity date.
Capital Uses
The Company’s principal sources of liquidity are cash on hand, the operating cash flow generated from the Company’s properties, interest received on the Company’s note receivables and the $50 million revolving credit facility. The Company anticipates that cash on hand, cash flow from operations, interest received from notes receivables and availability under its revolving credit facility will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements (including its development project discussed herein), required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions.
As a result of the sale of its 110 parcels, the Board of Directors approved a special distribution of $0.75 per Unit, totaling $136.1 million on May 17, 2012 to shareholders of record on May 11, 2012 (the “Special Distribution”). In accordance with the Company’s Articles of Incorporation, the liquidation preference of each share of Series A preferred stock was reduced by the amount of the Special Distribution, from $11.00 to $10.25 per share. Also, as a result of the sale and Special Distribution, the Company’s Board of Directors changed the annualized distribution rate from $0.88 per Unit to $0.83 per Unit beginning with the June 2012 distribution, and in August 2012, the Board of Directors slightly increased the annualized distribution rate from $0.83 per Unit to $0.83025 per Unit. Additionally, the offering price per Unit under the Company’s Dividend Reinvestment Plan was adjusted by the amount of the Special Distribution (from $11.00 to $10.25), and the purchase price per Unit under the Company’s Unit Redemption Program was adjusted by the amount of the Special Distribution (from $11.00 to $10.25 for the maximum purchase price, based on the original purchase price and length of time such Units have been held by the shareholder).
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions (excluding the Special Distribution discussed above) during 2012 totaled approximately $155.0 million and were paid at a monthly rate of $0.073334 per common share during the first five months of 2012, $0.069167 per common share for June and July 2012, and $0.0691875 per common share for the last five months of 2012. For the same period the Company’s net cash generated from operations was approximately $123.0 million. Due to the inherent delay between raising capital and investing that same capital in income producing real estate, a portion of the distributions to date have been funded from proceeds from the Company’s completed initial public offering of Units (completed in December 2010) and from additional borrowings by the Company, and this portion of distributions is expected to be treated as a return of capital for federal income tax purposes.
The Company’s objective in setting an annualized distribution rate is to project a rate that will provide consistency over the life of the Company taking into account acquisitions, dispositions, capital improvements, ramp up of new properties, completion of planned development projects and varying economic cycles. To meet this objective, the Company may require the use of debt and offering proceeds, in addition to cash from operations. Since a portion of distributions has to date been funded with proceeds from the offering of Units, proceeds from the sale of the 110 parcels and borrowings, the Company’s ability to maintain its current intended rate of distribution will be primarily based on the ability of the Company’s properties to generate cash from operations at this level, as well as the Company’s ability to utilize currently available financing, or the Company’s ability to obtain additional financing. Since there can be no assurance of the Company’s ability to obtain additional financing or that the properties owned by the Company will provide income at this level, there can be no assurance as to the classification or duration of distributions at the current rate. Proceeds of the offering which were distributed are not available for investment in properties.
In July 2009, 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. Since the inception of the program through April 2012,
shareholders were permitted to request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. In May 2012, as a result of the Special Distribution, the purchase price per Unit under the Company’s Unit Redemption Program was adjusted by the amount of the Special Distribution (from $11.00 to $10.25 for the maximum purchase price, based on the original purchase price and length of time such Units have been held by the shareholder). The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. Since inception of the program through December 31, 2012, the Company has redeemed approximately 9.8 million Units representing $101.2 million, including 5.0 million Units in the amount of $52.0 million, 3.8 million Units in the amount of $39.2 million and $0.7 million Units in the amount of $7.5 million redeemed during 2012, 2011 and 2010, respectively. As contemplated in the program, beginning with the July 2011 redemption, the scheduled redemption date for the third quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to July 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 318,891 | | | | 318,891 | | | | 0 | |
April 2011 | | | 378,367 | | | | 378,367 | | | | 0 | |
July 2011 | | | 3,785,039 | | | | 1,549,058 | | | | 2,235,981 | |
October 2011 | | | 8,410,322 | | | | 1,511,997 | | | | 6,898,325 | |
January 2012 | | | 10,689,219 | | | | 1,507,187 | | | | 9,182,032 | |
April 2012 | | | 11,229,890 | | | | 1,509,922 | | | | 9,719,968 | |
July 2012 | | | 10,730,084 | | | | 1,004,365 | | | | 9,725,719 | |
October 2012 | | | 11,155,269 | | | | 1,003,267 | | | | 10,152,002 | |
As noted in the table above, beginning with the July 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent. Currently, the Company plans to redeem under its Units Redemption Program approximately 2% of weighted average Units during 2013.
In December 2010, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. As a result of the Special Distribution, beginning in May 2012, the offering price per Unit under the Company’s Dividend Reinvestment Plan was adjusted by the amount of the Special Distribution (from $11.00 to $10.25). The Company has registered 20.0 million Units for potential issuance under the plan. During the years ended December 31, 2012 and 2011, approximately 4.8 million Units, representing $50.0 million in proceeds to the Company, and 5.4 million Units, representing $59.1 million in proceeds to the Company, were issued under the plan. No Units were issued under the plan as of December 31, 2010. Since inception of the plan through December 31, 2012, approximately 10.1 million Units, representing $109.1 million in proceeds to the Company, were issued under the plan.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. As of December 31, 2012, the Company held $7.5 million in reserves for capital expenditures. During 2012, the Company spent approximately $16.2 million on capital expenditures for existing hotels and anticipates spending approximately $20 to $25 million during 2013. Additionally, the Company acquired land in Richmond, Virginia for the development of adjoining Courtyard and Residence Inn hotels, which is expected to begin in early 2013 and be completed within two years. The Company expects to spend a total of approximately $30 million to develop the hotels and has spent approximately $1.1 million in development costs as of December 31, 2012, of which approximately $0.3 million was incurred during 2012. If the Company does not begin vertical construction by July 2013, the seller of the property has an option to acquire the land equal to the amount of the Company’s total cost.
On November 29, 2012, and as a result of the merger, the Company entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. Also, as part of the purchase, the Company agreed to
indemnify Apple REIT Six, Inc. for any liabilities related to the Headquarters or office lease. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above. Since there can be no assurance at this time that the merger will occur, there can be no assurance that the closing will occur under the transfer agreement.
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 historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.
Critical Accounting Policies
The following contains a discussion of what the Company believes to be critical accounting policies. These items should be read to gain a further understanding of the principles used to prepare the Company’s financial statements. These principles include application of judgment; therefore, changes in judgments may have a significant impact on the Company’s reported results of operations and financial condition.
Investment Policy
Upon acquisition of real estate properties, the Company estimates the fair value of acquired tangible assets (consisting of land, land improvements, buildings and improvements) and identified intangible assets and liabilities, in-place leases and assumed debt based on evaluation of information and estimates available at that date. Generally, the Company does not acquire hotel properties that have significant in-place leases as lease terms for hotel properties are very short term in nature. The Company has not assigned any value to intangible assets such as management contracts and franchise agreements as such contracts are generally at current market rates and any other value attributable to these contracts is not considered material. Beginning January 1, 2009, the Company has expensed as incurred all transaction costs associated with the acquisitions of existing businesses, including title, legal, accounting and other related costs, as well as the brokerage commission paid to ASRG. For acquisitions of existing businesses prior to January 1, 2009, these costs were capitalized as part of the cost of the acquisition.
Capitalization Policy
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; and (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
Impairment Losses Policy
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may
not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that recently opened, were recently renovated or experienced other short-term business disruption. Since the Company’s planned initial hold period for each property is 39 years the Company’s ongoing analysis and annual recoverability analysis have not identified any impairment losses and no impairment losses have been recorded to date. If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.
Subsequent Events
In January 2013, the Company declared and paid approximately $12.6 million or $0.0691875 per outstanding common share, in distributions to its common shareholders, of which approximately $3.8 million or 371,000 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 1.0 million Units in the amount of $10.0 million. As contemplated in the program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 8% of the total 12.1 million requested Units to be redeemed, with approximately 11.1 million requested Units not redeemed.
In February 2013, the Company declared and paid approximately $12.6 million or $0.0691875 per outstanding common share, in distributions to its common shareholders, of which approximately $3.7 million or 364,000 Units were issued under the Company’s Dividend Reinvestment Plan.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of December 31, 2012, the Company’s financial instruments were not exposed to significant market risk due to 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. Based on the Company’s cash invested at December 31, 2012, of $9.0 million, every 100 basis points change in interest rates will impact the Company’s annual net income by approximately $90,000, all other factors remaining the same. Although the Company had no outstanding balance on its $50 million revolving credit facility at December 31, 2012, the Company will be exposed to changes in short-term interest rates to the extent that it utilizes the credit facility.
The Company has assumed or originated fixed interest rate notes payable to lenders under permanent financing arrangements. The following table summarizes the annual maturities and average interest rates of the Company’s fixed rate notes payable outstanding at December 31, 2012. All dollar amounts are in thousands.
| | 2013 | | | 2014 | | | 2015 | | | 2016 | | | 2017 | | | Thereafter | | | Total | | | Fair Market Value | |
Maturities | | $ | 3,714 | | | $ | 3,935 | | | $ | 57,298 | | | $ | 39,780 | | | $ | 18,382 | | | $ | 42,123 | | | $ | 165,232 | | | $ | 173,343 | |
Average interest rates | | | 5.6 | % | | | 5.6 | % | | | 5.6 | % | | | 5.4 | % | | | 5.1 | % | | | 4.9 | % | | | | | | | | |
Item 8. Financial Statements and Supplementary Data
Report of Management
on Internal Control Over Financial Reporting
March 7, 2013
To the Shareholders
Apple REIT Nine, Inc.
Management of Apple REIT Nine, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
The Company’s internal control over financial reporting is supported by written policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the Company’s transactions and dispositions of the Company’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with generally accepted accounting principles, and the receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In connection with the preparation of the Company’s annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of those controls.
Based on this assessment, management has concluded that as of December 31, 2012, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Ernst & Young LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this report, has issued an attestation report on the Company’s internal control over financial reporting, a copy of which appears on the next page of this annual report.
/s/ GLADE M. KNIGHT | | /s/ BRYAN PEERY |
Glade M. Knight | | Bryan Peery |
Chairman and Chief Executive Officer | | Chief Financial Officer (Principal Accounting Officer) |
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
The Board of Directors and Shareholders of
Apple REIT Nine, Inc.
We have audited Apple REIT Nine, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Apple REIT Nine, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Apple REIT Nine, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2012 consolidated financial statements of Apple REIT Nine, Inc. and our report dated March 7, 2013 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Richmond, Virginia
March 7, 2013
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Apple REIT Nine, Inc.
We have audited the accompanying consolidated balance sheets of Apple REIT Nine, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Apple REIT Nine, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Apple REIT Nine, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2013 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Richmond, Virginia
March 7, 2013
APPLE REIT NINE, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)
| | As of December 31, | |
| | 2012 | | | 2011 | |
Assets | | | | | | |
Investment in real estate, net of accumulated depreciation of $145,927 and $93,179, respectively | | $ | 1,463,894 | | | $ | 1,480,722 | |
Real estate held for sale | | | 0 | | | | 158,552 | |
Cash and cash equivalents | | | 9,027 | | | | 30,733 | |
Note receivable, net | | | 22,375 | | | | 0 | |
Due from third party managers, net | | | 10,751 | | | | 9,605 | |
Other assets, net | | | 19,970 | | | | 21,355 | |
Total Assets | | $ | 1,526,017 | | | $ | 1,700,967 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Notes payable | | $ | 166,783 | | | $ | 124,124 | |
Accounts payable and accrued expenses | | | 13,101 | | | | 13,253 | |
Total Liabilities | | | 179,884 | | | | 137,377 | |
| | | | | | | | |
Shareholders' Equity | | | | | | | | |
Preferred stock, authorized 30,000,000 shares; none issued and outstanding | | | 0 | | | | 0 | |
Series A preferred stock, no par value, authorized 400,000,000 shares; issued and outstanding 182,619,400 and 182,883,617 shares, respectively | | | 0 | | | | 0 | |
Series B convertible preferred stock, no par value, authorized 480,000 shares; issued and outstanding 480,000 shares | | | 48 | | | | 48 | |
Common stock, no par value, authorized 400,000,000 shares; issued and outstanding 182,619,400 and 182,883,617 shares, respectively | | | 1,805,335 | | | | 1,807,175 | |
Distributions greater than net income | | | (459,250 | ) | | | (243,633 | ) |
Total Shareholders' Equity | | | 1,346,133 | | | | 1,563,590 | |
| | | | | | | | |
Total Liabilities and Shareholders' Equity | | $ | 1,526,017 | | | $ | 1,700,967 | |
See notes to consolidated financial statements.
APPLE REIT NINE, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
Revenues: | | | | | | | | | |
Room revenue | | $ | 331,610 | | | $ | 291,858 | | | $ | 144,988 | |
Other revenue | | | 33,976 | | | | 28,642 | | | | 15,147 | |
Total revenue | | | 365,586 | | | | 320,500 | | | | 160,135 | |
| | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | |
Operating expense | | | 94,103 | | | | 82,514 | | | | 44,713 | |
Hotel administrative expense | | | 27,048 | | | | 24,973 | | | | 12,688 | |
Sales and marketing | | | 31,263 | | | | 27,210 | | | | 13,938 | |
Utilities | | | 14,034 | | | | 13,814 | | | | 7,708 | |
Repair and maintenance | | | 13,355 | | | | 12,703 | | | | 6,944 | |
Franchise fees | | | 14,503 | | | | 12,797 | | | | 6,230 | |
Management fees | | | 12,262 | | | | 10,630 | | | | 5,071 | |
Taxes, insurance and other | | | 21,150 | | | | 19,455 | | | | 10,273 | |
General and administrative | | | 9,227 | | | | 8,189 | | | | 6,472 | |
Acquisition related costs | | | 464 | | | | 5,275 | | | | 19,379 | |
Depreciation expense | | | 52,748 | | | | 48,415 | | | | 28,391 | |
Total expenses | | | 290,157 | | | | 265,975 | | | | 161,807 | |
| | | | | | | | | | | | |
Operating income (loss) | | | 75,429 | | | | 54,525 | | | | (1,672 | ) |
| | | | | | | | | | | | |
Interest expense, net | | | (6,745 | ) | | | (4,371 | ) | | | (931 | ) |
| | | | | | | | | | | | |
Income (loss) from continuing operations | | | 68,684 | | | | 50,154 | | | | (2,603 | ) |
| | | | | | | | | | | | |
Income from discontinued operations | | | 6,792 | | | | 19,834 | | | | 18,860 | |
| | | | | | | | | | | | |
Net income | | $ | 75,476 | | | $ | 69,988 | | | $ | 16,257 | |
| | | | | | | | | | | | |
Basic and diluted net income (loss) per common share | | | | | | | | | | | | |
From continuing operations | | $ | 0.37 | | | $ | 0.27 | | | $ | (0.02 | ) |
From discontinued operations | | | 0.04 | | | | 0.11 | | | | 0.14 | |
Total basic and diluted net income per common share | | $ | 0.41 | | | $ | 0.38 | | | $ | 0.12 | |
| | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 182,222 | | | | 182,396 | | | | 135,825 | |
See notes to consolidated financial statements.
APPLE REIT NINE, INC.CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY(in thousands, except per share data)
| | | | | | | | Series B Convertible | | | | | | | |
| | Common Stock | | | Preferred Stock | | | Distributions | | | | |
| | Number of Shares | | | Amount | | | Number of Shares | | | Amount | | | Greater Than Net Income | | | Total | |
| | | | | | | | | | | | | | | | | | |
Balance at December 31, 2009 | | | 98,510 | | | $ | 968,710 | | | | 480 | | | $ | 48 | | | $ | (51,353 | ) | | $ | 917,405 | |
Net proceeds from the sale of common shares | | | 83,489 | | | | 825,833 | | | | 0 | | | | 0 | | | | 0 | | | | 825,833 | |
Common shares redeemed | | | (726 | ) | | | (7,462 | ) | | | 0 | | | | 0 | | | | 0 | | | | (7,462 | ) |
Stock options granted | | | 0 | | | | 132 | | | | 0 | | | | 0 | | | | 0 | | | | 132 | |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 16,257 | | | | 16,257 | |
Cash monthly distributions declared and paid to shareholders ($0.88 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (118,126 | ) | | | (118,126 | ) |
Balance at December 31, 2010 | | | 181,273 | | | | 1,787,213 | | | | 480 | | | | 48 | | | | (153,222 | ) | | | 1,634,039 | |
Net proceeds from the sale of common shares | | | 5,369 | | | | 58,948 | | | | 0 | | | | 0 | | | | 0 | | | | 58,948 | |
Common shares redeemed | | | (3,758 | ) | | | (39,168 | ) | | | 0 | | | | 0 | | | | 0 | | | | (39,168 | ) |
Stock options granted | | | 0 | | | | 182 | | | | 0 | | | | 0 | | | | 0 | | | | 182 | |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 69,988 | | | | 69,988 | |
Cash monthly distributions declared and paid to shareholders ($0.88 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (160,399 | ) | | | (160,399 | ) |
Balance at December 31, 2011 | | | 182,884 | | | | 1,807,175 | | | | 480 | | | | 48 | | | | (243,633 | ) | | | 1,563,590 | |
Net proceeds from the sale of common shares | | | 4,760 | | | | 50,007 | | | | 0 | | | | 0 | | | | 0 | | | | 50,007 | |
Common shares redeemed | | | (5,025 | ) | | | (51,987 | ) | | | 0 | | | | 0 | | | | 0 | | | | (51,987 | ) |
Stock options granted | | | 0 | | | | 140 | | | | 0 | | | | 0 | | | | 0 | | | | 140 | |
Net income | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 75,476 | | | | 75,476 | |
Special distribution paid to shareholders ($0.75 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (136,113 | ) | | | (136,113 | ) |
Cash monthly distributions declared and paid to shareholders ($0.85 per share) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | (154,980 | ) | | | (154,980 | ) |
Balance at December 31, 2012 | | | 182,619 | | | $ | 1,805,335 | | | | 480 | | | $ | 48 | | | $ | (459,250 | ) | | $ | 1,346,133 | |
See notes to consolidated financial statements.
APPLE REIT NINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
Cash flows from operating activities: | | | | | | | | | |
Net income | | $ | 75,476 | | | $ | 69,988 | | | $ | 16,257 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | | | | | |
Depreciation, including discontinued operations | | | 52,748 | | | | 49,815 | | | | 30,749 | |
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net | | | 304 | | | | 354 | | | | 304 | |
Straight-line rental income | | | (1,975 | ) | | | (6,158 | ) | | | (6,104 | ) |
Changes in operating assets and liabilities: | | | | | | | | | | | | |
Increase in due from third party managers, net | | | (1,146 | ) | | | (1,326 | ) | | | (5,944 | ) |
Decrease (increase) in other assets, net | | | (588 | ) | | | 612 | | | | 1,911 | |
Increase (decrease) in accounts payable and accrued expenses | | | (1,853 | ) | | | 2,759 | | | | 1,585 | |
Net cash provided by operating activities | | | 122,966 | | | | 116,044 | | | | 38,758 | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Cash paid for acquisitions, net | | | (18,017 | ) | | | (161,645 | ) | | | (740,735 | ) |
Proceeds from sale of assets, net | | | 135,410 | | | | 1,396 | | | | 2,606 | |
Deposits and other disbursements for potential acquisitions, net | | | 0 | | | | (760 | ) | | | (12,345 | ) |
Capital improvements and development costs | | | (16,526 | ) | | | (15,734 | ) | | | (22,736 | ) |
Decrease (increase) in capital improvement reserves | | | 569 | | | | (126 | ) | | | 3,558 | |
Interest received on note receivable | | | 4,515 | | | | 0 | | | | 0 | |
Repayment (investment) in other assets | | | 0 | | | | 10,784 | | | | (16,451 | ) |
Net cash provided by (used in) investing activities | | | 105,951 | | | | (166,085 | ) | | | (786,103 | ) |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net proceeds related to issuance of Units | | | 50,007 | | | | 58,843 | | | | 825,857 | |
Redemptions of Units | | | (51,987 | ) | | | (39,168 | ) | | | (7,462 | ) |
Special distribution paid to common shareholders | | | (136,113 | ) | | | 0 | | | | 0 | |
Monthly distributions paid to common shareholders | | | (154,980 | ) | | | (160,399 | ) | | | (118,126 | ) |
Proceeds from notes payable | | | 77,690 | | | | 0 | | | | 0 | |
Payments of notes payable | | | (34,512 | ) | | | (2,200 | ) | | | (1,135 | ) |
Deferred financing costs | | | (728 | ) | | | (410 | ) | | | (594 | ) |
Net cash used in financing activities | | | (250,623 | ) | | | (143,334 | ) | | | 698,540 | |
| | | | | | | | | | | | |
Decrease in cash and cash equivalents | | | (21,706 | ) | | | (193,375 | ) | | | (48,805 | ) |
| | | | | | | | | | | | |
Cash and cash equivalents, beginning of period | | | 30,733 | | | | 224,108 | | | | 272,913 | |
| | | | | | | | | | | | |
Cash and cash equivalents, end of period | | $ | 9,027 | | | $ | 30,733 | | | $ | 224,108 | |
| | | | | | | | | | | | |
Supplemental information: | | | | | | | | | | | | |
Interest paid | | $ | 7,973 | | | $ | 6,545 | | | $ | 3,571 | |
| | | | | | | | | | | | |
Non-cash transactions: | | | | | | | | | | | | |
Notes payable assumed in acquisitions | | $ | 0 | | | $ | 25,942 | | | $ | 42,715 | |
Other assets assumed in acquisitions | | $ | 0 | | | $ | 550 | | | $ | 293 | |
Other liabilities assumed in acquisitions | | $ | 0 | | | $ | 1,243 | | | $ | 2,912 | |
Note receivable issued from sale of assets | | $ | 60,000 | | | $ | 0 | | | $ | 0 | |
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1
Organization and Summary of Significant Accounting Policies
Organization
Apple REIT Nine, Inc., together with its wholly owned subsidiaries (the “Company”), is a Virginia corporation formed to invest in income-producing real estate in the United States. Initial capitalization occurred on November 9, 2007 and operations began on July 31, 2008 when the Company acquired its first hotel. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in December 2010. The Company’s fiscal year end is December 31. The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. Although the Company has an interest in a variable interest entity through its note receivable, it is not the primary beneficiary as the Company does not have any elements of power in the decision making process of the entity and does not share in any of the benefits, and therefore does not consolidate the entity. As of December 31, 2012, the Company owned 89 hotels located in 27 states with an aggregate of 11,371 rooms.
The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The REIT Modernization Act, effective January 1, 2001, permits real estate investment trusts to establish taxable businesses to conduct certain previously disallowed business activities. The Company has a wholly-owned taxable REIT subsidiary (or subsidiary thereof) (collectively, the “Lessee”), which leases all of the Company’s hotels.
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less. The fair market value of cash and cash equivalents approximates their carrying value. Cash balances may at times exceed federal depository insurance limits.
Investment in Real Estate and Related Depreciation
Real estate is stated at cost, net of depreciation. Repair and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements are capitalized. Depreciation is computed using the straight-line method over average estimated useful lives of the assets, which are 39 years for buildings, 17 years for franchise fees, ten years for major improvements and three to seven years for furniture and equipment.
The Company considers expenditures to be capital in nature based on the following criteria: (1) for a single asset, the cost must be at least $500, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; (2) for group purchases of 10 or more identical assets, the unit cost for each asset must be at least $50, including all normal and necessary costs to place the asset in service, and the useful life must be at least one year; and (3) for major repairs to a single asset, the repair must be at least $2,500 and the useful life of the asset must be substantially extended.
Upon acquisition of real estate properties, the Company estimates the fair value of acquired tangible assets (consisting of land, buildings and improvements) and identified intangible assets and liabilities, in-place leases and assumed debt based on evaluation of information and estimates available at that date. Generally, the Company does not acquire hotel properties that have significant in-place leases as lease terms for hotel properties are very short term in nature. The Company has not assigned any value to management contracts and franchise agreements as such contracts are generally at current market rates and any other value attributable to these contracts is not considered material. Beginning January 1, 2009, the Company has expensed as incurred all transaction costs associated with the acquisitions of existing businesses, including title, legal, accounting and other related costs, as well as the brokerage commission paid to Apple Suites Realty Group, Inc. (“ASRG”), a related party 100% owned by Glade M. Knight, the Chairman and Chief Executive Officer of the Company. For acquisitions of existing businesses prior to January 1, 2009, these costs were capitalized as part of the cost of the acquisition.
The Company records impairment losses on hotel properties used in operations if indicators of impairment are present, and the sum of the undiscounted cash flows estimated to be generated by the respective properties over their estimated remaining useful life, based on historical and industry data, is less than the properties’ carrying amount. Indicators of impairment include a property with current or potential losses from operations, when it becomes more likely than not that a property will be sold before the end of its previously estimated useful life or when events, trends, contingencies or changes in circumstances indicate that a triggering event has occurred and an asset’s carrying value may
not be recoverable. The Company monitors its properties on an ongoing basis by analytically reviewing financial performance and considers each property individually for purposes of reviewing for indicators of impairment. As many indicators of impairment are subjective, such as general economic and market declines, the Company also prepares an annual recoverability analysis for each of its properties to assist with its evaluation of impairment indicators. The analysis compares each property’s net book value to each property’s estimated operating income using current operating results for each stabilized property and projected stabilized operating results based on the property’s market for properties that recently opened, were recently renovated or experienced other short-term business disruption. Since the Company’s planned initial hold period for each property is 39 years the Company’s ongoing analysis and annual recoverability analysis have not identified any impairment losses and no impairment losses have been recorded to date. If events or circumstances change such as the Company’s intended hold period for a property or if the operating performance of a property declines substantially for an extended period of time, the Company’s carrying value for a particular property may not be recoverable and an impairment loss will be recorded. Impairment losses are measured as the difference between the asset’s fair value and its carrying value.
Disposition and Discontinued Operations
In August 2011, the Company entered into a contract for the potential sale of its 406 acres of land and land improvements located on 110 sites in the Ft. Worth, Texas area (the “110 parcels”) and the assignment of its lease with Chesapeake Energy Corporation, at which time the 110 parcels were classified in the consolidated balance sheet as real estate held for sale and were recorded at their carrying amount, including real estate net book value and straight-line rent receivable. The operating results for the 110 parcels, which was a separate reportable segment, have been classified in the consolidated statements of operations in the line item income from discontinued operations. In April 2012, the Company completed the sale of its 110 parcels and the assignment of the lease with Chesapeake and received a portion of the total sales price in cash proceeds and issued a note receivable to the purchaser for the remaining balance. The note is secured by a junior lien on the 110 parcels. The sale resulted in a gain, which was calculated as the total sales price, less the carrying amount of the properties, the brokerage commission to ASRG, closing costs and related franchise taxes. In accordance with the Accounting Standards Codification on real estate sales, the sales transaction is being accounted for under the cost recovery method, therefore the gain on sale and interest earned on the note will be deferred until cash payments by the purchaser, including principal and interest on the note due to the Company and the cash payment at closing exceed the Company’s cost basis of the 110 parcels sold. The note receivable is included in the Company’s consolidated balance sheet, net of the total deferred gain.
Revenue Recognition
Hotel revenue is recognized as earned, which is generally defined as the date upon which a guest occupies a room or utilizes the hotel’s services.
Comprehensive Income
The Company recorded no comprehensive income other than net income for the periods reported.
Earnings Per Common Share
Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the year. Diluted earnings per share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the year. There were no potential common shares with a dilutive effect for the years ended December 31, 2012, 2011 and 2010. As a result, basic and dilutive outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares.
Federal Income Taxes
The Company is operated as, and has elected to be taxed as, a REIT under Sections 856 to 860 of the Internal Revenue Code. Earnings and profits, which will determine the taxability of distributions to shareholders, will differ from income reported for financial reporting purposes primarily due to the differences for federal income tax purposes in the estimated useful lives used to compute depreciation, straight-line rent and acquisition related costs. Total distributions in 2012 of $1.60 per share for tax purposes were 28% ordinary income, 16% long-term capital gain and 56% return of capital. The characterization of 2011 distributions of $0.88 per share for tax purposes was 52% ordinary income and 48% return of capital. The characterization of 2010 distributions of $0.88 per share for tax purposes was 38% ordinary income and 62% return of capital.
The Lessee, as a taxable REIT subsidiary of the Company, is subject to federal and state income taxes. The taxable REIT subsidiary had taxable income for the year ended December 31, 2012 and incurred a loss for the years ended
December 31, 2011 and 2010. Due to the availability of net operating losses from prior years the Company did not have any federal tax expense in 2012. No operating loss benefit has been recorded in the consolidated balance sheet since realization is uncertain due to the history of operating losses. The total net operating loss carry forward for federal income tax purposes was approximately $22.3 million as of December 31, 2012. The net operating losses expire beginning in 2028. There are no material differences between the book and tax cost basis of the Company’s assets and liabilities, except for acquisition related costs which are capitalized for tax purposes and the deferred gain and interest from discontinued operations which are recognized as income for tax purposes.
As of December 31, 2012 the tax years that remain subject to examination by major tax jurisdictions generally include 2009-2012.
Sales and Marketing Costs
Sales and marketing costs are expensed when incurred. These costs represent the expense for franchise advertising and reservation systems under the terms of the hotel management and franchise agreements and general and administrative expenses that are directly attributable to advertising and promotion.
Use of Estimates
The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Note 2
Investment in Real Estate
The Company’s investment in real estate consisted of the following (in thousands):
| | December 31, | | | December 31, | |
| | 2012 | | | 2011 | |
| | | | | | |
Land | | $ | 140,424 | | | $ | 137,339 | |
Building and Improvements | | | 1,349,246 | | | | 1,325,915 | |
Furniture, Fixtures and Equipment | | | 114,501 | | | | 105,335 | |
Franchise Fees | | | 4,592 | | | | 4,589 | |
Construction in Progress | | | 1,058 | | | | 723 | |
| | | 1,609,821 | | | | 1,573,901 | |
Less Accumulated Depreciation | | | (145,927 | ) | | | (93,179 | ) |
Investment in Real Estate, net | | $ | 1,463,894 | | | $ | 1,480,722 | |
Hotels Owned
As of December 31, 2012, the Company owned 89 hotels, located in 27 states, consisting of the following:
| | Total by | | | Number of | |
Brand | | Brand | | | Rooms | |
Hampton Inn | | | 21 | | | | 2,529 | |
Hilton Garden Inn | | | 18 | | | | 2,509 | |
Courtyard | | | 13 | | | | 1,689 | |
Homewood Suites | | | 7 | | | | 735 | |
Fairfield Inn | | | 5 | | | | 613 | |
TownePlace Suites | | | 4 | | | | 453 | |
Residence Inn | | | 8 | | | | 874 | |
SpringHill Suites | | | 7 | | | | 986 | |
Marriott | | | 1 | | | | 206 | |
Embassy Suites | | | 2 | | | | 316 | |
Home2 Suites | | | 2 | | | | 237 | |
Hilton | | | 1 | | | | 224 | |
| | | 89 | | | | 11,371 | |
The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 89 hotels the Company owned as of December 31, 2012. All dollar amounts are in thousands.
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price | |
Tucson | | AZ | | Hilton Garden Inn | | Western | | 7/31/2008 | | | 125 | | | $ | 18,375 | |
Santa Clarita | | CA | | Courtyard | | Dimension | | 9/24/2008 | | | 140 | | | | 22,700 | |
Charlotte | | NC | | Homewood Suites | | McKibbon | | 9/24/2008 | | | 112 | | | | 5,750 | |
Allen | | TX | | Hampton Inn & Suites | | Gateway | | 9/26/2008 | | | 103 | | | | 12,500 | |
Twinsburg | | OH | | Hilton Garden Inn | | Gateway | | 10/7/2008 | | | 142 | | | | 17,792 | |
Lewisville | | TX | | Hilton Garden Inn | | Gateway | | 10/16/2008 | | | 165 | | | | 28,000 | |
Duncanville | | TX | | Hilton Garden Inn | | Gateway | | 10/21/2008 | | | 142 | | | | 19,500 | |
Santa Clarita | | CA | | Hampton Inn | | Dimension | | 10/29/2008 | | | 128 | | | | 17,129 | |
Santa Clarita | | CA | | Residence Inn | | Dimension | | 10/29/2008 | | | 90 | | | | 16,600 | |
Santa Clarita | | CA | | Fairfield Inn | | Dimension | | 10/29/2008 | | | 66 | | | | 9,337 | |
Beaumont | | TX | | Residence Inn | | Western | | 10/29/2008 | | | 133 | | | | 16,900 | |
Pueblo | | CO | | Hampton Inn & Suites | | Dimension | | 10/31/2008 | | | 81 | | | | 8,025 | |
Allen | | TX | | Hilton Garden Inn | | Gateway | | 10/31/2008 | | | 150 | | | | 18,500 | |
Bristol | | VA | | Courtyard | | LBA | | 11/7/2008 | | | 175 | | | | 18,650 | |
Durham | | NC | | Homewood Suites | | McKibbon | | 12/4/2008 | | | 122 | | | | 19,050 | |
Hattiesburg | | MS | | Residence Inn | | LBA | | 12/11/2008 | | | 84 | | | | 9,793 | |
Jackson | | TN | | Courtyard | | Vista | | 12/16/2008 | | | 94 | | | | 15,200 | |
Jackson | | TN | | Hampton Inn & Suites | | Vista | | 12/30/2008 | | | 83 | | | | 12,600 | |
Pittsburgh | | PA | | Hampton Inn | | Vista | | 12/31/2008 | | | 132 | | | | 20,458 | |
Fort Lauderdale | | FL | | Hampton Inn | | Vista | | 12/31/2008 | | | 109 | | | | 19,290 | |
Frisco | | TX | | Hilton Garden Inn | | Western | | 12/31/2008 | | | 102 | | | | 15,050 | |
Round Rock | | TX | | Hampton Inn | | Vista | | 3/6/2009 | | | 94 | | | | 11,500 | |
Panama City | | FL | | Hampton Inn & Suites | | LBA | | 3/12/2009 | | | 95 | | | | 11,600 | |
Austin | | TX | | Homewood Suites | | Vista | | 4/14/2009 | | | 97 | | | | 17,700 | |
Austin | | TX | | Hampton Inn | | Vista | | 4/14/2009 | | | 124 | | | | 18,000 | |
Dothan | | AL | | Hilton Garden Inn | | LBA | | 6/1/2009 | | | 104 | | | | 11,601 | |
Troy | | AL | | Courtyard | | LBA | | 6/18/2009 | | | 90 | | | | 8,696 | |
Orlando | | FL | | Fairfield Inn & Suites | | Marriott | | 7/1/2009 | | | 200 | | | | 25,800 | |
Orlando | | FL | | SpringHill Suites | | Marriott | | 7/1/2009 | | | 200 | | | | 29,000 | |
Clovis | | CA | | Hampton Inn & Suites | | Dimension | | 7/31/2009 | | | 86 | | | | 11,150 | |
Rochester | | MN | | Hampton Inn & Suites | | Raymond | | 8/3/2009 | | | 124 | | | | 14,136 | |
Johnson City | | TN | | Courtyard | | LBA | | 9/25/2009 | | | 90 | | | | 9,880 | |
Baton Rouge | | LA | | SpringHill Suites | | Dimension | | 9/25/2009 | | | 119 | | | | 15,100 | |
Houston | | TX | | Marriott | | Western | | 1/8/2010 | | | 206 | | | | 50,750 | |
Albany | | GA | | Fairfield Inn & Suites | | LBA | | 1/14/2010 | | | 87 | | | | 7,920 | |
Panama City | | FL | | TownePlace Suites | | LBA | | 1/19/2010 | | | 103 | | | | 10,640 | |
Clovis | | CA | | Homewood Suites | | Dimension | | 2/2/2010 | | | 83 | | | | 12,435 | |
Jacksonville | | NC | | TownePlace Suites | | LBA | | 2/16/2010 | | | 86 | | | | 9,200 | |
Miami | | FL | | Hampton Inn & Suites | | Dimension | | 4/9/2010 | | | 121 | | | | 11,900 | |
Anchorage | | AK | | Embassy Suites | | Stonebridge | | 4/30/2010 | | | 169 | | | | 42,000 | |
Boise | | ID | | Hampton Inn & Suites | | Raymond | | 4/30/2010 | | | 186 | | | | 22,370 | |
Rogers | | AR | | Homewood Suites | | Raymond | | 4/30/2010 | | | 126 | | | | 10,900 | |
St. Louis | | MO | | Hampton Inn & Suites | | Raymond | | 4/30/2010 | | | 126 | | | | 16,000 | |
Oklahoma City | | OK | | Hampton Inn & Suites | | Raymond | | 5/28/2010 | | | 200 | | | | 32,657 | |
Ft. Worth | | TX | | TownePlace Suites | | Western | | 7/19/2010 | | | 140 | | | | 18,435 | |
Lafayette | | LA | | Hilton Garden Inn | | LBA | | 7/30/2010 | | | 153 | | | | 17,261 | |
West Monroe | | LA | | Hilton Garden Inn | | InterMountain | | 7/30/2010 | | | 134 | | | | 15,639 | |
Silver Spring | | MD | | Hilton Garden Inn | | White | | 7/30/2010 | | | 107 | | | | 17,400 | |
Rogers | | AR | | Hampton Inn | | Raymond | | 8/31/2010 | | | 122 | | | | 9,600 | |
St. Louis | | MO | | Hampton Inn | | Raymond | | 8/31/2010 | | | 190 | | | | 23,000 | |
Kansas City | | MO | | Hampton Inn | | Raymond | | 8/31/2010 | | | 122 | | | | 10,130 | |
Alexandria | | LA | | Courtyard | | LBA | | 9/15/2010 | | | 96 | | | | 9,915 | |
Grapevine | | TX | | Hilton Garden Inn | | Western | | 9/24/2010 | | | 110 | | | | 17,000 | |
Nashville | | TN | | Hilton Garden Inn | | Vista | | 9/30/2010 | | | 194 | | | | 42,667 | |
Indianapolis | | IN | | SpringHill Suites | | White | | 11/2/2010 | | | 130 | | | | 12,800 | |
Mishawaka | | IN | | Residence Inn | | White | | 11/2/2010 | | | 106 | | | | 13,700 | |
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price | |
Phoenix | | AZ | | Courtyard | | White | | 11/2/2010 | | | 164 | | | $ | 16,000 | |
Phoenix | | AZ | | Residence Inn | | White | | 11/2/2010 | | | 129 | | | | 14,000 | |
Mettawa | | IL | | Residence Inn | | White | | 11/2/2010 | | | 130 | | | | 23,500 | |
Mettawa | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 170 | | | | 30,500 | |
Austin | | TX | | Hilton Garden Inn | | White | | 11/2/2010 | | | 117 | | | | 16,000 | |
Novi | | MI | | Hilton Garden Inn | | White | | 11/2/2010 | | | 148 | | | | 16,200 | |
Warrenville | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 135 | | | | 22,000 | |
Schaumburg | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 166 | | | | 20,500 | |
Salt Lake City | | UT | | SpringHill Suites | | White | | 11/2/2010 | | | 143 | | | | 17,500 | |
Austin | | TX | | Fairfield Inn & Suites | | White | | 11/2/2010 | | | 150 | | | | 17,750 | |
Austin | | TX | | Courtyard | | White | | 11/2/2010 | | | 145 | | | | 20,000 | |
Chandler | | AZ | | Courtyard | | White | | 11/2/2010 | | | 150 | | | | 17,000 | |
Chandler | | AZ | | Fairfield Inn & Suites | | White | | 11/2/2010 | | | 110 | | | | 12,000 | |
Tampa | | FL | | Embassy Suites | | White | | 11/2/2010 | | | 147 | | | | 21,800 | |
Andover | | MA | | SpringHill Suites | | Marriott | | 11/5/2010 | | | 136 | | | | 6,500 | |
Philadelphia (Collegeville) | | PA | | Courtyard | | White | | 11/15/2010 | | | 132 | | | | 20,000 | |
Holly Springs | | NC | | Hampton Inn & Suites | | LBA | | 11/30/2010 | | | 124 | | | | 14,880 | |
Philadelphia (Malvern) | | PA | | Courtyard | | White | | 11/30/2010 | | | 127 | | | | 21,000 | |
Arlington | | TX | | Hampton Inn & Suites | | Western | | 12/1/2010 | | | 98 | | | | 9,900 | |
Irving | | TX | | Homewood Suites | | Western | | 12/29/2010 | | | 77 | | | | 10,250 | |
Mount Laurel | | NJ | | Homewood Suites | | Tharaldson | | 1/11/2011 | | | 118 | | | | 15,000 | |
West Orange | | NJ | | Courtyard | | Tharaldson | | 1/11/2011 | | | 131 | | | | 21,500 | |
Texarkana | | TX | | Hampton Inn & Suites | | InterMountain | | 1/31/2011 | | | 81 | | | | 9,100 | |
Fayetteville | | NC | | Home2 Suites | | LBA | | 2/3/2011 | | | 118 | | | | 11,397 | |
Manassas | | VA | | Residence Inn | | Tharaldson | | 2/16/2011 | | | 107 | | | | 14,900 | |
San Bernardino | | CA | | Residence Inn | | Tharaldson | | 2/16/2011 | | | 95 | | | | 13,600 | |
Alexandria (1) | | VA | | SpringHill Suites | | Marriott | | 3/28/2011 | | | 155 | | | | 24,863 | |
Dallas | | TX | | Hilton | | Hilton | | 5/17/2011 | | | 224 | | | | 42,000 | |
Santa Ana | | CA | | Courtyard | | Dimension | | 5/23/2011 | | | 155 | | | | 24,800 | |
Lafayette | | LA | | SpringHill Suites | | LBA | | 6/23/2011 | | | 103 | | | | 10,232 | |
Tucson | | AZ | | TownePlace Suites | | Western | | 10/6/2011 | | | 124 | | | | 15,852 | |
El Paso | | TX | | Hilton Garden Inn | | Western | | 12/19/2011 | | | 145 | | | | 19,974 | |
Nashville | | TN | | Home2 Suites | | Vista | | 5/31/2012 | | | 119 | | | | 16,660 | |
Total | | | | | | | | | | | 11,371 | | | $ | 1,546,839 | |
(1) The Company acquired land and began construction for this hotel during 2009. Hotel construction was completed by the Company and the hotel opened for business on March 28, 2011. The gross purchase price includes the acquisition of land and construction costs. |
Of the Company’s 89 hotels owned at December 31, 2012, 21 were purchased during 2008, 12 were acquired during 2009, 43 were acquired in 2010, 11 were acquired in 2011 and one was acquired in 2012. Also, as noted in the table above, during March 2011, the Company completed the construction of a SpringHill Suites hotel in Alexandria, Virginia which opened for business on March 28, 2011. For the one hotel acquired during 2012, the amount of revenue and operating income (excluding acquisition related costs totaling $0.4 million) included in the Company’s consolidated income statement from the acquisition date to the period ending December 31, 2012 was approximately $2.7 million and $1.0 million, respectively. For the 11 hotels acquired during 2011, the amount of revenue and operating income (excluding acquisition related costs totaling $4.6 million) included in the Company’s consolidated income statement from the acquisition date to the period ending December 31, 2011 was approximately $30.5 million and $6.7 million, respectively. For the 43 hotels acquired during 2010, the amount of revenue and operating income (excluding acquisition related costs totaling $19.1 million) included in the Company’s consolidated income statement from the acquisition date to the period ending December 31, 2010 was approximately $57.4 million and $10.1 million, respectively.
The purchase price for the properties acquired through December 31, 2012, net of debt assumed, was funded primarily by the Company’s best-efforts offering of Units, completed in December 2010. The Company assumed approximately $122.4 million of debt secured by 13 of its hotel properties and $3.8 million of unsecured debt in connection with one of its hotel properties. The Company also used the proceeds of its best-efforts offering to pay approximately $40 million in acquisition related costs, including $30.5 million, representing 2% of the gross purchase price for these
properties, as a brokerage commission to ASRG, 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive Officer, approximately $0.5 million in pre-opening costs related to the opening of the Alexandria SpringHill Suites hotel and approximately $9.0 million in other acquisition related costs, including title, legal and other related costs. These costs totaled $0.5 million, $5.3 million and $19.4 million for the years ended December 31, 2012, 2011 and 2010, and are included in acquisition related costs in the Company’s consolidated statements of operations.
No goodwill was recorded in connection with any of the acquisitions.
Development Project
On October 14, 2009, the Company entered into a ground lease for approximately one acre of land located in downtown Richmond, Virginia. In February 2012, the Company terminated the lease and entered into a contract to purchase the land for $3.0 million, which was completed in July 2012. In conjunction with the acquisition, the Company paid as a brokerage commission to ASRG approximately $0.06 million, representing 2% of the gross purchase price, which was capitalized as part of the acquisition cost of the land. The Company acquired the land for the development of adjoining Courtyard and Residence Inn hotels, which is expected to begin in early 2013 and be completed within two years. Upon completion, the Courtyard and Residence Inn are expected to contain approximately 135 and 75 guest rooms, respectively and are planned to be managed by White. The Company expects to spend a total of approximately $30 million to develop the hotels and has spent approximately $1.1 million in development costs as of December 31, 2012. If the Company does not begin vertical construction by July 2013, the seller of the property has an option to acquire the land equal to the amount of the Company’s total cost.
Note 3
Disposition and Discontinued Operations
In April 2009, the Company acquired from a subsidiary of Chesapeake Energy Corporation (“Chesapeake”) approximately 417 acres of land and land improvements located on 113 sites in the Ft. Worth, Texas area and simultaneously entered into a ground lease with Chesapeake. The land is used by Chesapeake for the production of natural gas. The lease has an initial term of 40 years from its commencement date of April 2009, and remaining annual rent ranging from $15.0 million to $26.7 million. Under the lease, the tenant is responsible for all operating costs associated with the real estate. Chesapeake Energy Corporation is a publicly held company that is traded on the New York Stock Exchange.
In February 2010, the Company agreed to sell back to Chesapeake two of the sites originally purchased from Chesapeake and release Chesapeake from their associated lease obligation. The sales price for the two sites was equal to the Company’s original purchase price, approximately $2.6 million. The Company earned and received rental income for the period held totaling approximately $240,000.
In July 2011, the Company agreed to sell back to Chesapeake one of the sites originally purchased from Chesapeake and release Chesapeake from their associated lease obligation. The sales price for the site was $1.4 million, which approximates the net book value of the site. The Company earned and received rental income for the period held totaling approximately $310,000.
In August 2011, the Company entered into a contract for the potential sale of its remaining 110 parcels (which were acquired for a total purchase price of $147.3 million) and the assignment of the lease with Chesapeake for a total sale price of $198.4 million. On April 27, 2012, the Company completed the sale of its 110 parcels and the assignment of the lease with Chesapeake and received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser (the “note”). The note, which approximates fair market value, is secured by a junior lien on the 110 parcels. The stated interest rate on the note is 10.5%. The note requires interest only payments for the first three years of the note. After the first three years, interest is accrued and payments will only be received once the purchaser extinguishes its senior loan with a third party. Once the senior loan is repaid, the Company will receive all payments from the existing lease on the 110 parcels until fully repaid or the note reaches maturity which is April 2049. Although the purchaser is not affiliated with the Company, a partner of the purchaser is also a member of the Board of Directors of Apple REIT Ten, Inc. In conjunction with the sale, the Company incurred a brokerage commission to ASRG totaling approximately $4.0 million, representing 2% of the gross sales price. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60.0 million note. The $4.0 million commission has been recorded as a reduction to the deferred gain on sale as described below.
The total gain on sale was approximately $33.4 million (total sale price of $198.4 million less carrying value totaling $160.5 million, ASRG fee totaling $4.0 million, closing costs totaling $0.2 million and related franchise taxes totaling $0.3 million). In accordance with the Accounting Standards Codification on real estate sales, the sales transaction is being accounted for under the cost recovery method, therefore the gain on sale and interest earned on the note will be deferred until cash payments by the purchaser, including principal and interest on the note due to the Company and the payment of
the $138.4 million at closing exceed the Company’s cost basis of the 110 parcels sold. The note receivable is included in the Company’s consolidated balance sheets, net of the total deferred gain. As of December 31, 2012, the note receivable, net was $22.4 million, including $60 million note receivable, offset by $33.4 million deferred gain and $4.3 million deferred interest earned. Prior to the sale, the 110 parcels were classified in the consolidated balance sheets as real estate held for sale and were recorded at their carrying amount, totaling approximately $158.6 million as of December 31, 2011, which included real estate net book value totaling $141.8 million and straight-line rent receivable totaling $16.8 million. The 110 parcels was a separate reportable segment and the results of operations for these properties have been classified in the consolidated statements of operations in the line item income from discontinued operations.
The following table sets forth the components of income from discontinued operations for the years ended December 31, 2012, 2011 and 2010 (in thousands):
| | Years Ended December 31, | |
| | 2012 | | | 2011 | | | 2010 | |
Rental revenue | | $ | 6,826 | | | $ | 21,357 | | | $ | 21,325 | |
Operating expenses | | | 34 | | | | 123 | | | | 107 | |
Depreciation expense | | | 0 | | | | 1,400 | | | | 2,358 | |
Income from discontinued operations | | $ | 6,792 | | | $ | 19,834 | | | $ | 18,860 | |
Prior to the sale, the lease was classified as an operating lease and rental income was recognized on a straight-line basis over the initial term of the lease. Rental revenue includes approximately $2.0 million, $6.2 million and $6.1 million of adjustments to record rent on the straight-line basis for the years ended December 31, 2012, 2011 and 2010, respectively.
Note 4
Credit Facility and Notes Payable
Revolving Credit Facility
In November 2012, the Company entered into an unsecured Credit Agreement (the “Credit Agreement”) with a commercial bank, which provides for an initial $50 million revolving credit facility that may be increased to $100 million, subject to certain conditions. The credit facility will be utilized for working capital, hotel renovations and development, and other general corporate funding purposes, including the payment of redemptions and distributions. Under the terms of the Credit Agreement, the Company may make voluntary prepayments in whole or in part, at any time. The Credit Agreement matures in November 2014; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to November 2015. Interest payments are due monthly and the interest rate, subject to certain exceptions, is equal to the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 2.75%, depending upon the Company’s leverage ratio, as calculated under the terms of the Credit Agreement. The Company is also required to pay an unused facility fee of 0.30% or 0.40% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during the quarter. As of December 31, 2012, there were no borrowings outstanding under the credit facility.
The Credit Agreement requires the Company to maintain a specific pool of Unencumbered Borrowing Base Properties (must be a minimum of ten properties and must satisfy conditions as defined in the Credit Agreement). The obligations of the Lenders to make any advances under the Credit Agreement are subject to certain conditions, including that the outstanding borrowings do not exceed the Borrowing Base Availability. The credit facility contains customary affirmative covenants and negative covenants and events of default. In addition, the credit facility contains the following quarterly financial covenants (capitalized terms are defined in the Credit Agreement):
· | A maximum Consolidated Total Indebtedness limit of 45% of the aggregate Real Estate Values for all Eligible Real Estate that is or qualifies as an Unencumbered Borrowing Base Property; |
· | A maximum Consolidated Total Indebtedness limit of 50% of the Consolidated Total Asset Value; |
· | A minimum Adjusted Consolidated EBITDA to Consolidated Fixed Charges covenant of 1.75 to 1.00 for the total of the four trailing quarterly periods; |
· | A minimum Consolidated Tangible Net Worth of $1 billion; |
· | A maximum Consolidated Secured Debt limit of 40% of Consolidated Total Asset Value; |
· | A minimum Adjusted NOI for all Eligible Real Estate that is or qualifies as an Unencumbered Borrowing Base Property to Implied Debt Service covenant of 2.25 to 1.00; |
· | A maximum Consolidated Secured Recourse Indebtedness of $10 million; and |
· | Restricted Payments (including Distributions and Unit Redemptions), net of proceeds from the Company’s Dividend Reinvestment Plan, cannot exceed $38 million during any calendar quarter and quarterly Distributions cannot exceed $0.21 per share for the period from October 1, 2012 through and including June 30, 2013, and thereafter must not exceed $152 million in any cumulative 12 month period and Distributions cannot exceed $0.83025 per share for any calendar year, unless such Restricted Payments are less than the Company’s Funds From Operations for any cumulative four calendar quarters. |
The Company was in compliance with each of these covenants at December 31, 2012.
Non-revolving Line of Credit
In May 2012, the Company entered into a Loan Agreement (the “Loan Agreement”) with a commercial bank, which provided for a $30 million non-revolving line of credit with a maturity date of November 15, 2012. During the third quarter of 2012, the line of credit was extinguished and the outstanding principal balance totaling $30 million, plus accrued interest was paid in full. Interest was payable quarterly and based on an annual rate of Daily LIBOR (the London Interbank Offered Rate) plus 2.75%. The Loan Agreement was guaranteed by Glade M. Knight, the Company’s Chairman and Chief Executive Officer and was secured by assets of Mr. Knight. Mr. Knight did not receive any consideration in exchange for providing this guaranty and security. Proceeds of the loan were used by the Company for general working capital purposes, including the purchase of a hotel in May 2012, capital expenditures, distributions and redemptions. The independent directors of the Company’s Board of Directors approved Mr. Knight providing a guaranty under the Loan Agreement.
Notes Payable
In conjunction with the acquisition of 14 hotel properties, the Company assumed approximately $126.2 million in debt. With the exception of the Lewisville, Texas Hilton Garden Inn, the notes are secured by the applicable hotel. In addition, during 2012, the Company entered into three mortgage loan agreements with a commercial bank, secured by three hotel properties for a total of $47.7 million. The following table summarizes the hotel property securing each loan, the interest rate, loan assumption or origination date, maturity date, the principal amount assumed or originated, and the outstanding balance as of December 31, 2012 and 2011 for each of the Company’s debt obligations. All dollar amounts are in thousands.
Location | | Brand | | Interest Rate (1) | | Acquisition or Loan Origination Date | | Maturity Date | | Principal Assumed or Originated | | | Outstanding balance as of December 31, 2012 | | | Outstanding balance as of December 31, 2011 | |
Lewisville, TX | | Hilton Garden Inn | | | 0.00 | % | | 10/16/2008 | | 12/31/2016 | | | $ | 3,750 | | | $ | 2,000 | | | $ | 3,750 | |
Duncanville, TX | | Hilton Garden Inn | | | 5.88 | % | | 10/21/2008 | | 5/11/2017 | | | | 13,966 | | | | 13,139 | | | | 13,355 | |
Allen, TX | | Hilton Garden Inn | | | 5.37 | % | | 10/31/2008 | | 10/11/2015 | | | | 10,787 | | | | 10,004 | | | | 10,207 | |
Bristol, VA | | Courtyard | | | 6.59 | % | | 11/7/2008 | | 8/1/2016 | | | | 9,767 | | | | 9,239 | | | | 9,380 | |
Round Rock, TX | | Hampton Inn | | | 5.95 | % | | 3/6/2009 | | 5/1/2016 | | | | 4,175 | | | | 3,813 | | | | 3,917 | |
Austin, TX | | Homewood Suites | | | 5.99 | % | | 4/14/2009 | | 3/1/2016 | | | | 7,556 | | | | 6,907 | | | | 7,098 | |
Austin, TX | | Hampton Inn | | | 5.95 | % | | 4/14/2009 | | 3/1/2016 | | | | 7,553 | | | | 6,901 | | | | 7,092 | |
Rogers, AR | | Hampton Inn | | | 5.20 | % | | 8/31/2010 | | 9/1/2015 | | | | 8,337 | | | | 7,958 | | | | 8,126 | |
St. Louis, MO | | Hampton Inn | | | 5.30 | % | | 8/31/2010 | | 9/1/2015 | | | | 13,915 | | | | 13,293 | | | | 13,568 | |
Kansas City, MO | | Hampton Inn | | | 5.45 | % | | 8/31/2010 | | 10/1/2015 | | | | 6,517 | | | | 6,235 | | | | 6,360 | |
Philadelphia (Malvern), PA | | Courtyard | | | 6.50 | % | | 11/30/2010 | | 10/1/2032 | (2) | | | 7,894 | | | | 7,530 | | | | 7,711 | |
Irving, TX | | Homewood Suites | | | 5.83 | % | | 12/29/2010 | | 4/11/2017 | | | | 6,052 | | | | 5,763 | | | | 5,911 | |
Location | | Brand | | Interest Rate (1) | | Acquisition or Loan Origination Date | | Maturity Date | | | Principal Assumed or Originated | | | Outstanding balance as of December 31, 2012 | | | Outstanding balance as of December 31, 2011 | |
Texarkana, TX | | Hampton Inn & Suites | | | 6.90 | % | | 1/31/2011 | | 7/8/2016 | | | | 4,954 | | | | 4,822 | | | | 4,893 | |
Dallas, TX | | Hilton | | | 6.63 | % | | 5/17/2011 | | 6/6/2015 | | | | 20,988 | | | | 20,136 | | | | 20,686 | |
Grapevine, TX | | Hilton Garden Inn | | | 4.89 | % | | 8/29/2012 | | 9/1/2022 | | | | 11,810 | | | | 11,751 | | | | 0 | |
Collegeville, PA | | Courtyard | | | 4.89 | % | | 8/30/2012 | | 9/1/2022 | | | | 12,650 | | | | 12,587 | | | | 0 | |
Anchorage, AK | | Embassy Suites | | | 4.97 | % | | 9/13/2012 | | 10/1/2022 | | | | 23,230 | | | | 23,154 | | | | 0 | |
Total | | | | | | | | | | | | | $ | 173,901 | | | $ | 165,232 | | | $ | 122,054 | |
| | | | | | | | | | | | | |
(1) These rates are the rates per the loan agreement. At acquisition, the Company adjusted the interest rates on the loans assumed to market rates and is amortizing the adjustments to interest expense over the life of the loan. |
(2) Outstanding principal balance is callable by lender or prepayable by the Company beginning on October 1, 2016, and every five years thereafter until maturity, subject to certain conditions. |
The aggregate amounts of principal payable under the Company’s debt obligations, for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
2013 | | $ | 3,714 | |
2014 | | | 3,935 | |
2015 | | | 57,298 | |
2016 | | | 39,780 | |
2017 | | | 18,382 | |
Thereafter | | | 42,123 | |
| | | 165,232 | |
Fair Value Adjustment of Assumed Debt | | | 1,551 | |
Total | | $ | 166,783 | |
A fair value adjustment was recorded upon the assumption of above or below market rate loans in connection with the Company’s hotel acquisitions. These fair value adjustments will be amortized into interest expense over the remaining term of the related indebtedness using a method approximating the effective interest rate method. The effective interest rates on the applicable debt obligations assumed ranged from 3.9% to 6.5% at the date of assumption. The total adjustment to interest expense was a decrease of $0.5 million, $0.4 million and $0.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. The unamortized balance of the fair value adjustment was $1.6 million and $2.1 million at December 31, 2012 and 2011, respectively.
The Company incurred loan origination costs related to the assumption of the mortgage obligations on purchased hotels totaling $1.7 million, the origination of three mortgage loans during 2012 totaling $0.3 million and the origination of its current corporate unsecured revolving credit facility totaling $0.3 million. Such costs are amortized over the period to maturity of the applicable mortgage loan or credit facility, as an addition to interest expense. Amortization of such costs totaled $0.4 million, $0.3 million and $0.1 million for the years ended December 31, 2012, 2011 and 2010, respectively.
The Company’s interest expense in 2012, 2011 and 2010 is net of interest capitalized in conjunction with hotel renovations and construction totaling $0.7 million, $0.5 million and $0.6 million, respectively.
Note 5
Fair Value of Financial Instruments
The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit terms and credit characteristics which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. As of December 31, 2012, the carrying value and estimated fair value of the Company’s debt was $166.8 million and $173.3 million. As of December 31, 2011, the carrying value and estimated fair value of the Company’s debt was $124.1 million and $121.9 million. As of December 31, 2012, the carrying value of the $60 million note receivable as discussed in note 3 approximates fair market value. The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.
Note 6
Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during 2012 (other than the loan guarantee discussed above and assignment and transfer agreements discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The Company has a contract with ASRG, to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of December 31, 2012, payments to ASRG for fees under the terms of this contract related to the acquisition of assets have totaled approximately $33.5 million since inception. Of this amount, the Company incurred approximately $0.4 million, $4.0 million and $15.6 million for years ended December 31, 2012, 2011 and 2010. In addition, the Company incurred a brokerage commission to ASRG totaling approximately $4.0 million related to the sale of the Company’s 110 parcels in April 2012, which has been recorded as a reduction to the deferred gain on sale. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60 million note.
The Company is party to an advisory agreement with Apple Nine Advisors, Inc. (“A9A”), pursuant to which A9A provides management services to the Company. A9A provides these management services through an affiliate called Apple Fund Management LLC (“AFM”), which is a wholly-owned subsidiary of Apple REIT Six, Inc. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A9A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $2.9 million, $3.0 million and $1.5 million for the years ended December 31, 2012, 2011 and 2010. The increase in 2012 and 2011 is due to the Company reaching the next fee tier under the advisory agreement due to improved results of operations for the Company during those periods. At December 31, 2011, $1.0 million of the 2011 advisory fee had not been paid and was included in accounts payable and accrued expenses in the Company’s consolidated balance sheet. This amount was paid during the first quarter of 2012. No amounts were outstanding at December 31, 2012.
In addition to the fees payable to ASRG and A9A, the Company reimbursed to A9A or ASRG or paid directly to AFM on behalf of A9A or ASRG approximately $2.2 million, $2.1 million and $2.1 million for the years ended December 31, 2012, 2011 and 2010. The expenses reimbursed were approximately $0.2 million, $0.3 million and $1.1 million, respectively for costs reimbursed under the contract with ASRG and approximately $2.0 million, $1.8 million and $1.0 million respectively for costs reimbursed under the contract with A9A. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A9A.
AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight). As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Ten, Inc. and the Company (collectively the “Apple REIT Entities”). Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors. The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the
services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
On November 29, 2012, Apple REIT Six, Inc. entered into a merger agreement with a potential buyer that is not affiliated with the Apple REIT Entities or its Advisors (“the merger”). To maintain the current cost sharing structure, on November 29, 2012, A9A entered into an assignment and transfer agreement with Apple REIT Six, Inc. for the transfer of Apple REIT Six, Inc.’s interest in AFM. The assignment and transfer is expected to occur immediately after the closing of the merger. As part of the assignment, A9A and the other Advisors agreed to indemnify the potential buyer for any liabilities related to AFM The assignment of AFM’s interest to A9A, if it occurs, will have no impact on the Company’s advisory agreement with A9A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors, excluding Apple REIT Six, Inc. as described above, which will increase the remaining companies’ share of the allocated costs.
Also, on November 29, 2012, in connection with the merger, the Company entered into a transfer agreement with Apple REIT Six, Inc. for the potential acquisition of the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and the assignment of the Fort Worth, Texas office lease agreement for approximately $4.5 million which is expected to close immediately prior to the closing of the merger. Also, as part of the purchase, the Company agreed to indemnify Apple REIT Six, Inc. for any liabilities related to the Headquarters or office lease. If the closing occurs, any costs associated with the Headquarters and office lease (i.e. office rent, utilities, office supplies, etc.) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple REIT Six, Inc. as described above.
ASRG and A9A are 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 Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the Board of Directors of Apple REIT Six, Inc., Apple REIT Seven, Inc., and Apple REIT Eight, Inc.
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc. Through its equity investment, the Company has access to Apple Air’s aircraft for acquisition, asset management and renovation purposes. The Company’s equity investment was approximately $1.9 million and $2.1 million as of December 31, 2012 and 2011. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the years ended December 31, 2012, 2011 and 2010, the Company recorded a loss of approximately $0.2 million, $0.2 million and $0.8 million respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft and the reduction in basis of the aircraft in 2010 due to the planned trade in for one new airplane in 2011, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.
The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the legal matters discussed herein for all of the Apple REIT Companies was approximately $7.3 million in 2012, of which approximately $1.7 million was allocated to the Company.
Due to the significant discount offered by the original lender, in October 2010, the Company purchased a mortgage note with an outstanding balance of approximately $11.3 million for a total purchase price of approximately $10.8 million from an unrelated third party. In accordance with the terms of the note, in December 2011, the borrower repaid the remaining outstanding balance totaling $11.0 million. The interest rate on this mortgage was a variable rate based on the 3-month LIBOR, and averaged 5% during the period held. The note required monthly payments of principal and interest. The borrower on the note was Apple Eight SPE Columbia, Inc., an indirect wholly owned subsidiary of Apple REIT Eight, Inc. and the note was secured by a Hilton Garden Inn hotel located in Columbia, South Carolina. Total interest income, including the accretion of the note discount, recorded by the Company for the years ended December 31, 2012, 2011 and 2010 was approximately $0, $0.9 million and $0.2 million.
Note 7
Shareholders’ Equity
Best-efforts Offering
The Company concluded its best-efforts offering of Units in December 2010. The Company registered its Units on Registration Statement Form S-11 (File No. 333-147414) filed on April 23, 2008 and was declared effective by the Securities and Exchange Commission on April 25, 2008. The Company began its best-efforts offering of Units the same day the registration statement was declared effective. Each Unit consists of one common share and one Series A preferred share.
Special Distribution
On April 27, 2012, the Company completed the sale of its 110 parcels for a total sale price of $198.4 million and received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser. In conjunction with the sale, the Board of Directors approved a special distribution of $0.75 per Unit, totaling $136.1 million on May 17, 2012 to shareholders of record on May 11, 2012 (the “Special Distribution”). In accordance with the Company’s Articles of Incorporation, the liquidation preference of each share of Series A preferred stock was reduced by the amount of the Special Distribution, or from $11.00 to $10.25 per share.
Monthly Distributions
In conjunction with the Special Distribution, in May 2012 the Company’s Board of Directors reduced the annual distribution rate from $0.88 per common share to $0.83 per common share. The reduction was effective with the June 2012 distribution. In August 2012, the Board of Directors slightly increased the annualized distribution rate from $0.83 per common share to $0.83025 per common share. The distribution will continue to be paid monthly. For the years ended December 31, 2012, 2011 and 2010, the Company made distributions (excluding the Special Distribution discussed above) of $0.85, $0.88 and $0.88 per common share for a total of approximately $155.0 million, $160.4 million and $118.1 million, respectively. Total distributions (including the Special Distribution) for the years ended December 31, 2012, 2011 and 2010 totaled approximately $291.1 million, $160.4 million and $118.1 million.
Series A Preferred Shares
The Series A preferred shares have no voting rights and no conversion rights. In addition, the Series A preferred shares are not separately tradable from the common shares to which they relate. The Series A preferred shares do not have any distribution rights except a priority distribution upon the sale of the Company’s assets. In accordance with the Company’s Articles of Incorporation, the priority distribution (“Priority Distribution”) of each share of Series A preferred stock was reduced by the amount of the Special Distribution, or from $11.00 to $10.25 per share. The Priority Distribution will be paid before any distribution will be made to the holders of any other shares. Upon the Priority Distribution the Series A preferred shares will have no other distribution rights.
Series B Convertible Preferred Stock
The Company has issued 480,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $48,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.
There are no dividends payable on the Series B convertible preferred shares. Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.
Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.
Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:
(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;
(2) the termination or expiration without renewal of the advisory agreement with A9A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 24.17104 common shares. In the event the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/100 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $100 million.
No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests and the termination of the Series A preferred shares.
Expense related to the issuance of 480,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B convertible preferred shares can be converted and the amounts paid for the Series B convertible preferred shares. If a conversion event had occurred as of December 31, 2012, expense would have ranged from $0 to in excess of $127.6 million (assumes $11 per common share fair market value) which represents approximately 11.6 million shares of common stock.
Preferred Shares
The Company’s articles of incorporation authorize issuance of up to 30 million additional preferred shares. No preferred shares other than the Series A preferred shares and the Series B convertible preferred shares (discussed above) have been issued. The Company believes that the authorization to issue additional preferred shares benefits the Company and its shareholders by permitting flexibility in financing additional growth, giving the Company additional financing options in corporate planning and in responding to developments in business, including financing of additional acquisitions and other general corporate purposes. Having authorized preferred shares available for issuance in the future gives the Company the ability to respond to future developments and allows preferred shares to be issued without the expense and delay of a special shareholders’ meeting. At present, the Company has no specific financing or acquisition plans involving the issuance of additional preferred shares and the Company does not propose to fix the characteristics of any series of preferred shares in anticipation of issuing preferred shares other than the Series A preferred shares and Series B convertible preferred shares discussed above. The Company cannot now predict whether or to what extent, if any, additional preferred shares will be used or if so used what the characteristics of a particular series may be. The voting rights and rights to distributions of the holders of common shares will be subject to the prior rights of the holders of any subsequently-issued preferred shares. Unless otherwise required by applicable law or regulation, the preferred shares would be issuable without further authorization by holders of the common shares and on such terms and for such consideration as may be determined by the Board of Directors. The preferred shares could be issued in one or more series having varying voting rights, redemption and conversion features, distribution (including liquidating distribution) rights and preferences, and other rights, including rights of approval of specified transactions. A series of preferred shares could be given rights that are superior to rights of holders of common shares and a series having preferential distribution rights could limit common share distributions and reduce the amount holders of common shares would otherwise receive on dissolution.
Unit Redemption Program
In July 2009, 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. Since the inception of the program through April 2012, shareholders were permitted to request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. In May 2012, as a result of the Special Distribution, the purchase price per Unit under the Company’s Unit Redemption Program was adjusted by the amount of the Special Distribution (from $11.00 to $10.25 for the maximum
purchase price, based on the original purchase price and length of time such Units have been held by the shareholder). The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. Since inception of the program through December 31, 2012, the Company has redeemed approximately 9.8 million Units representing $101.2 million, including 5.0 million Units in the amount of $52.0 million, 3.8 million Units in the amount of $39.2 million and 0.7 million in the amount of $7.5 million redeemed during 2012, 2011 and 2010, respectively. As contemplated in the program, beginning with the July 2011 redemption, the scheduled redemption date for the third quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to July 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and 2012:
Redemption Date | | Requested Unit Redemptions | | | Units Redeemed | | | Redemption Requests Not Redeemed | |
| | | | | | | | | |
January 2011 | | | 318,891 | | | | 318,891 | | | | 0 | |
April 2011 | | | 378,367 | | | | 378,367 | | | | 0 | |
July 2011 | | | 3,785,039 | | | | 1,549,058 | | | | 2,235,981 | |
October 2011 | | | 8,410,322 | | | | 1,511,997 | | | | 6,898,325 | |
January 2012 | | | 10,689,219 | | | | 1,507,187 | | | | 9,182,032 | |
April 2012 | | | 11,229,890 | | | | 1,509,922 | | | | 9,719,968 | |
July 2012 | | | 10,730,084 | | | | 1,004,365 | | | | 9,725,719 | |
October 2012 | | | 11,155,269 | | | | 1,003,267 | | | | 10,152,002 | |
As noted in the table above, beginning with the July 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result, the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.
Dividend Reinvestment Plan
In December 2010, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. As a result of the Special Distribution, beginning in May 2012, the offering price per Unit under the Company’s Dividend Reinvestment Plan was adjusted by the amount of the Special Distribution (from $11.00 to $10.25). The Company has registered 20.0 million Units for potential issuance under the plan. During the years ended December 31, 2012 and 2011, approximately 4.8 million Units, representing $50.0 million in proceeds to the Company, and 5.4 million Units, representing $59.1 million in proceeds to the Company, were issued under the plan. No Units were issued under the plan as of December 31, 2010. Since inception of the plan through December 31, 2012, approximately 10.1 million Units, representing $109.1 million in proceeds to the Company, were issued under the plan.
Note 8
Stock Option Plan
During 2008, the Company adopted a non-employee directors’ stock option plan (the “Directors’ Plan”) to provide incentives to attract and retain directors. The Directors’ Plan provides for an automatic grant of options to purchase a specified number of Units (“Options”) to directors, who are not employees of the Company. The Company’s Compensation Committee (“Committee”) is responsible for administering the Directors’ Plan. The Committee is responsible for granting Options and for establishing the exercise price of Options. Under the Directors’ Plan, the number of Units authorized for issuance is equal to 45,000 plus 1.8% of the number of Units sold in excess of the minimum offering of 9,523,810 Units. This plan currently relates to the initial public offering of 182,251,082 Units. Therefore, the maximum number of Units authorized under the Directors’ Plan is currently 3,154,091.
The Directors’ Plan generally provides, among other things, that options be granted at exercise prices not lower than the market value of the Units on the date of grant. The options are 100% vested upon issuance and are exercisable six months after the date of grant and will expire 10 years from the date of grant. During 2012, 2011 and 2010, the Company granted options to purchase 145,528, 146,212 and 102,472 Units under the Directors’ Plan and recorded compensation expense totaling $140,000 in 2012, $182,000 in 2011 and $132,000 in 2010. Options issued during 2012 have an exercise price of $10.25 per Unit. All of the options issued prior to 2012 have an exercise price of $11 per Unit. Activity in the Company Directors’ Plan during 2012, 2011 and 2010 is summarized in the following table:
| | 2012 | | | 2011 | | | 2010 | |
Outstanding, beginning of year: | | | 330,292 | | | | 184,080 | | | | 81,608 | |
Granted | | | 145,528 | | | | 146,212 | | | | 102,472 | |
Exercised | | | 0 | | | | 0 | | | | 0 | |
Expired or canceled | | | 0 | | | | 0 | | | | 0 | |
Outstanding, end of year: | | | 475,820 | | | | 330,292 | | | | 184,080 | |
Exercisable, end of year: | | | 475,820 | | | | 330,292 | | | | 184,080 | |
The weighted-average exercise price of outstanding options: | | $ | 10.77 | | | $ | 11.00 | | | $ | 11.00 | |
Note 9
Management and Franchise Agreements
Each of the Company’s 89 hotels are operated and managed under separate management agreements, by affiliates of one of the following companies: Dimension Development Two, LLC (“Dimension”) (10), Gateway Hospitality Group, Inc. (“Gateway”) (5), Hilton Management LLC (“Hilton”) (1), Intermountain Management, LLC (“Intermountain”) (2), LBAM-Investor Group, L.L.C. (“LBA”) (14), Fairfield FMC, LLC and SpringHill SMC, LLC, subsidiaries of Marriott International (“Marriott”) (4), MHH Management, LLC (“McKibbon”) (2), Raymond Management Company, Inc. (“Raymond”) (8), Stonebridge Realty Advisors, Inc. (“Stonebridge”) (1), Tharaldson Hospitality Management, LLC (“Tharaldson”) (4), Vista Host, Inc. (“Vista”) (9), Texas Western Management Partners, L.P. (“Western”) (10) or White Lodging Services Corporation (“White”) (19). The agreements generally provide for initial terms of one to 30 years. Fees associated with the agreements generally include the payment of base management fees, incentive management fees, accounting fees, and other fees for centralized services which are allocated among all of the hotels that receive the benefit of such services. Base management fees are calculated as a percentage of gross revenues. Incentive management fees are calculated as a percentage of operating profit in excess of a priority return to the Company, as defined in the management agreements. The Company has the option to terminate the management agreements if specified performance thresholds are not satisfied. For the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $12.3 million, $10.6 million and $5.1 million in management fees.
Dimension, Gateway, Intermountain, LBA, McKibbon, Raymond, Stonebridge, Tharaldson, Vista, Western and White are not affiliated with either Marriott or Hilton, and as a result, the hotels they manage were required to obtain separate franchise agreements with each respective franchisor. The Hilton franchise agreements generally provide for an initial term of 10 to 21 years. Fees associated with the agreements generally include the payment of royalty fees and program fees. The Marriott franchise agreements generally provide for initial terms of 13 to 28 years. Fees associated with the agreements generally include the payment of royalty fees, marketing fees, reservation fees and a communications support fee based on room revenues. For the years ended December 31, 2012, 2011 and 2010, the Company incurred approximately $14.5 million, $12.8 million and $6.2 million in franchise fees.
Note 10
Lease Commitments
In connection with the acquisition of three hotels, the Company assumed three land leases. One of the leases has a remaining initial lease term of 11 years, with four 15 year renewal options and is subject to an annual base rental payment and monthly payments based on a percentage of room and food and beverage sales. The other two leases have remaining initial lease terms of 47 years, with no renewal options and are subject to monthly base rental payments with defined escalations over the life of the leases. Under these two leases the Company has the option to purchase the properties during the initial lease term at three specific dates as defined by the lease based on a multiple of the annual net base rent in effect under the lease at the time the option is exercised. The aggregate amounts of the estimated minimum lease payments pertaining to all land leases, for the five years subsequent to December 31, 2012 and thereafter are as follows (in thousands):
| | Total | |
2013 | | $ | 244 | |
2014 | | | 249 | |
2015 | | | 254 | |
2016 | | | 254 | |
2017 | | | 254 | |
Thereafter | | | 12,644 | |
Total | | $ | 13,899 | |
Note 11
Pro Forma Information (Unaudited)
The following unaudited pro forma information for the years ended December 31, 2012 and 2011 is presented as if the acquisitions of the Company’s hotels acquired after December 31, 2010, had occurred on the latter of January 1, 2011 or the opening date of the hotel. The pro forma information does not purport to represent what the Company’s results of operations would actually have been if such transactions, in fact, had occurred on these applicable dates, nor does it purport to represent the results of operations for future periods. Amounts are in thousands, except per share data.
| | Years Ended December 31, | |
| | 2012 | | | 2011 | |
Total revenues | | $ | 365,586 | | | $ | 326,436 | |
| | | | | | | | |
Income from continuing operations | | $ | 68,684 | | | $ | 51,214 | |
Income from discontinued operations | | | 6,792 | | | | 19,834 | |
Net income | | $ | 75,476 | | | $ | 71,048 | |
| | | | | | | | |
Basic and diluted net income per common share | | | | | |
From continuing operations | | $ | 0.37 | | | $ | 0.28 | |
From discontinued operations | | | 0.04 | | | | 0.11 | |
Total basic and diluted net income per common share | | $ | 0.41 | | | $ | 0.39 | |
The pro forma information reflects adjustments for actual revenues and expenses of the 12 hotels acquired during the two years ended December 31, 2012 for the respective period owned prior to acquisition by the Company. Net income has been adjusted as follows: (1) interest income and expense have been adjusted to reflect the reduction in cash and cash equivalents required to fund the acquisitions; (2) interest expense related to prior owners’ debt which was not assumed has been eliminated; (3) depreciation has been adjusted based on the Company’s basis in the hotels; and (4) transaction costs have been adjusted for the acquisition of existing businesses.
Note 12
Industry Segments
The Company owns extended-stay and limited service hotel properties throughout the United States that generate rental and other property related income. The Company separately evaluates the performance of each of its hotel properties. However, because each of the hotels has similar economic characteristics, facilities, and services, and each hotel is not individually significant, the properties have been aggregated into a single operating segment. All segment disclosures are included in, or can be derived from the Company’s consolidated financial statements.
Note 13
Legal Proceedings and Related Matters
The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in all three of the above mentioned class action lawsuits.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company
and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933. The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation. The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint. The briefing period for any motion to dismiss was completed on July 13, 2012.
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company's filings with the SEC beginning in 2008, as well as the Company's review of certain transactions involving the Company and the other Apple REIT Companies. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company's consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution.
On October 22, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued an order against David Lerner Associates, Inc. (“DLA”) and David Lerner, individually, requiring DLA to pay approximately $12 million in restitution to certain investors in Units of Apple REIT Ten, Inc. In addition, David Lerner, individually, was fined $250,000 and suspended for one year from the securities industry, followed by a two year suspension from acting as a principal. The Company relies on DLA for the administration of its Units and does not believe this settlement will affect the administration of its Units. The Company intends to continue to cooperate with regulatory or governmental inquiries.
Note 14
Quarterly Financial Data (Unaudited)
The following is a summary of quarterly results of operations for the years ended December 31, 2012 and 2011.
2012 (in thousands except per share data) | | First Quarter | | | Second Quarter (1) | | | Third Quarter | | | Fourth Quarter | |
Revenues | | $ | 88,091 | | | $ | 97,110 | | | $ | 93,653 | | | $ | 86,732 | |
Income from continuing operations | | $ | 16,592 | | | $ | 21,033 | | | $ | 17,927 | | | $ | 13,132 | |
Income from discontinued operations | | $ | 5,267 | | | $ | 1,525 | | | $ | 0 | | | $ | 0 | |
Net income | | $ | 21,859 | | | $ | 22,558 | | | $ | 17,927 | | | $ | 13,132 | |
Basic and diluted net income per common share | | $ | 0.12 | | | $ | 0.12 | | | $ | 0.10 | | | $ | 0.07 | |
Distributions declared and paid per common share | | $ | 0.22 | | | $ | 0.9658 | | | $ | 0.2075 | | | $ | 0.2076 | |
2011 (in thousands except per share data) | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | |
Revenues | | $ | 72,038 | | | $ | 84,392 | | | $ | 85,668 | | | $ | 78,402 | |
Income from continuing operations | | $ | 10,233 | | | $ | 15,680 | | | $ | 15,634 | | | $ | 8,607 | |
Income from discontinued operations | | $ | 4,716 | | | $ | 4,716 | | | $ | 5,128 | | | $ | 5,274 | |
Net income | | $ | 14,949 | | | $ | 20,396 | | | $ | 20,762 | | | $ | 13,881 | |
Basic and diluted net income per common share | | $ | 0.08 | | | $ | 0.11 | | | $ | 0.11 | | | $ | 0.08 | |
Distributions declared and paid per common share | | $ | 0.22 | | | $ | 0.22 | | | $ | 0.22 | | | $ | 0.22 | |
| | | | | | | | | | | | | | | | |
(1) Second quarter 2012 distributions includes a Special Distribution paid in May 2012 totaling $0.75 per common share. | |
Note 15
Subsequent Events
In January 2013, the Company declared and paid approximately $12.6 million or $0.0691875 per outstanding common share, in distributions to its common shareholders, of which approximately $3.8 million or 371,000 Units were issued under the Company’s Dividend Reinvestment Plan.
In January 2013, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 1.0 million Units in the amount of $10.0 million. As contemplated in the program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 8% of the total 12.1 million requested Units to be redeemed, with approximately 11.1 million requested Units not redeemed.
In February 2013, the Company declared and paid approximately $12.6 million or $0.0691875 per outstanding common share, in distributions to its common shareholders, of which approximately $3.7 million or 364,000 Units were issued under the Company’s Dividend Reinvestment Plan.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. 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 were effective as of December 31, 2012. 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.
See Item 8 for the Report of Management on Internal Control over Financial Reporting and the Company’s Independent Registered Public Accounting Firm’s attestation report regarding internal control over financial reporting, which are incorporated herein by reference.
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by Items 401, 405, 406 and 407(c)(3), (d)(4) and (d)(5) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 10, the 2013 Proxy Statement is incorporated herein by this reference.
Item 11. Executive Compensation
The information required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 11, the 2013 Proxy Statement is incorporated herein by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information required by Items 201(d) and 403 of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 12, the 2013 Proxy Statement is incorporated herein by this reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Items 404 and 407(a) of Regulation S-K will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 13, the 2013 Proxy Statement is incorporated herein by this reference.
Item 14. Principal Accounting Fees and Services
The information required by Item 9(e) of Schedule 14A will be set forth in the Company’s 2013 Proxy Statement. For the limited purpose of providing the information necessary to comply with this Item 14, the 2013 Proxy Statement is incorporated herein by this reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules
1. Financial Statements of Apple REIT Nine, Inc.
Report of Management on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting—Ernst & Young LLP
Report of Independent Registered Public Accounting Firm—Ernst & Young LLP
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2012, 2011 and 2010
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010
Notes to Consolidated Financial Statements
These financial statements are set forth in Item 8 of this report and are hereby incorporated by reference.
2. Financial Statement Schedules
Schedule III—Real Estate and Accumulated Depreciation (Included at the end of this Part IV of this report.)
Financial statement schedules not listed are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
3. Exhibits
Incorporated herein by reference are the exhibits listed under “Exhibits Index” to this Report available at www.sec.gov.
SCHEDULE IIIReal Estate and Accumulated DepreciationAs of December 31, 2012(dollars in thousands)
| | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Capitalized | | | | | | | | | | | | | | | |
| | | | | | | | | Initial Cost | | Bldg. | | Total | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | Imp. & | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Description | | Encumbrances | | Land | | FF&E /Other | | FF&E | | Cost (1) | | Deprec. | | Construction | | Acquired | | Life | | Rooms |
Anchorage | | AK | | Embassy Suites | | $ | 23,154 | | | $ | 2,955 | | | $ | 39,053 | | | $ | 108 | | | $ | 42,116 | | | $ | (3,529 | ) | | 2008 | | Apr-10 | | 3 - 39 yrs. | | | 169 | |
Dothan | | AL | | Hilton Garden Inn | | | 0 | | | | 1,037 | | | | 10,581 | | | | 14 | | | | 11,632 | | | | (1,480 | ) | | 2009 | | Jun-09 | | 3 - 39 yrs. | | | 104 | |
Troy | | AL | | Courtyard | | | 0 | | | | 582 | | | | 8,270 | | | | 18 | | | | 8,870 | | | | (1,200 | ) | | 2009 | | Jun-09 | | 3 - 39 yrs. | | | 90 | |
Rogers | | AR | | Hampton Inn | | | 7,958 | | | | 961 | | | | 8,483 | | | | 86 | | | | 9,530 | | | | (780 | ) | | 1998 | | Aug-10 | | 3 - 39 yrs. | | | 122 | |
Rogers | | AR | | Homewood Suites | | | 0 | | | | 1,375 | | | | 9,514 | | | | 247 | | | | 11,136 | | | | (1,052 | ) | | 2006 | | Apr-10 | | 3 - 39 yrs. | | | 126 | |
Chandler | | AZ | | Courtyard | | | 0 | | | | 1,061 | | | | 16,008 | | | | 57 | | | | 17,126 | | | | (1,204 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 150 | |
Chandler | | AZ | | Fairfield Inn & Suites | | | 0 | | | | 778 | | | | 11,272 | | | | 42 | | | | 12,092 | | | | (834 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 110 | |
Phoenix | | AZ | | Courtyard | | | 0 | | | | 1,413 | | | | 14,669 | | | | 51 | | | | 16,133 | | | | (1,033 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 164 | |
Phoenix | | AZ | | Residence Inn | | | 0 | | | | 1,111 | | | | 12,953 | | | | 88 | | | | 14,152 | | | | (969 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 129 | |
Tucson | | AZ | | Hilton Garden Inn | | | 0 | | | | 1,005 | | | | 17,925 | | | | 84 | | | | 19,014 | | | | (2,863 | ) | | 2008 | | Jul-08 | | 3 - 39 yrs. | | | 125 | |
Tucson | | AZ | | TownePlace Suites | | | 0 | | | | 992 | | | | 14,563 | | | | 41 | | | | 15,596 | | | | (637 | ) | | 2011 | | Oct-11 | | 3 - 39 yrs. | | | 124 | |
Clovis | | CA | | Hampton Inn & Suites | | | 0 | | | | 1,287 | | | | 9,888 | | | | 27 | | | | 11,202 | | | | (1,233 | ) | | 2009 | | Jul-09 | | 3 - 39 yrs. | | | 86 | |
Clovis | | CA | | Homewood Suites | | | 0 | | | | 1,500 | | | | 10,970 | | | | 24 | | | | 12,494 | | | | (1,154 | ) | | 2010 | | Feb-10 | | 3 - 39 yrs. | | | 83 | |
San Bernardino | | CA | | Residence Inn | | | 0 | | | | 0 | | | | 13,662 | | | | 160 | | | | 13,822 | | | | (781 | ) | | 2006 | | Feb-11 | | 3 - 39 yrs. | | | 95 | |
Santa Ana | | CA | | Courtyard | | | 0 | | | | 3,082 | | | | 21,051 | | | | 0 | | | | 24,133 | | | | (1,206 | ) | | 2011 | | May-11 | | 3 - 39 yrs. | | | 155 | |
Santa Clarita | | CA | | Courtyard | | | 0 | | | | 4,568 | | | | 18,721 | | | | 77 | | | | 23,366 | | | | (2,869 | ) | | 2007 | | Sep-08 | | 3 - 39 yrs. | | | 140 | |
Santa Clarita | | CA | | Fairfield Inn | | | 0 | | | | 1,864 | | | | 7,753 | | | | 515 | | | | 10,132 | | | | (1,086 | ) | | 1996 | | Oct-08 | | 3 - 39 yrs. | | | 66 | |
Santa Clarita | | CA | | Hampton Inn | | | 0 | | | | 1,812 | | | | 15,761 | | | | 1,348 | | | | 18,921 | | | | (2,742 | ) | | 1987 | | Oct-08 | | 3 - 39 yrs. | | | 128 | |
Santa Clarita | | CA | | Residence Inn | | | 0 | | | | 2,539 | | | | 14,493 | | | | 1,199 | | | | 18,231 | | | | (2,241 | ) | | 1996 | | Oct-08 | | 3 - 39 yrs. | | | 90 | |
Pueblo | | CO | | Hampton Inn & Suites | | | 0 | | | | 894 | | | | 7,423 | | | | 1,275 | | | | 9,592 | | | | (1,473 | ) | | 2000 | | Oct-08 | | 3 - 39 yrs. | | | 81 | |
Ft. Lauderdale | | FL | | Hampton Inn | | | 0 | | | | 2,235 | | | | 17,590 | | | | 1,206 | | | | 21,031 | | | | (2,513 | ) | | 2000 | | Dec-08 | | 3 - 39 yrs. | | | 109 | |
Miami | | FL | | Hampton Inn & Suites | | | 0 | | | | 1,972 | | | | 9,987 | | | | 1,889 | | | | 13,848 | | | | (1,449 | ) | | 2000 | | Apr-10 | | 3 - 39 yrs. | | | 121 | |
Orlando | | FL | | Fairfield Inn & Suites | | | 0 | | | | 3,140 | | | | 22,580 | | | | 262 | | | | 25,982 | | | | (2,763 | ) | | 2009 | | Jul-09 | | 3 - 39 yrs. | | | 200 | |
Orlando | | FL | | SpringHill Suites | | | 0 | | | | 3,141 | | | | 25,779 | | | | 76 | | | | 28,996 | | | | (3,191 | ) | | 2009 | | Jul-09 | | 3 - 39 yrs. | | | 200 | |
Panama City | | FL | | TownePlace Suites | | | 0 | | | | 908 | | | | 9,549 | | | | 3 | | | | 10,460 | | | | (1,046 | ) | | 2010 | | Jan-10 | | 3 - 39 yrs. | | | 103 | |
Panama City Beach | | FL | | Hampton Inn & Suites | | | 0 | | | | 1,605 | | | | 9,995 | | | | 21 | | | | 11,621 | | | | (1,394 | ) | | 2009 | | Mar-09 | | 3 - 39 yrs. | | | 95 | |
Tampa | | FL | | Embassy Suites | | | 0 | | | | 1,824 | | | | 20,034 | | | | 315 | | | | 22,173 | | | | (1,387 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 147 | |
Albany | | GA | | Fairfield Inn & Suites | | | 0 | | | | 899 | | | | 7,263 | | | | 10 | | | | 8,172 | | | | (822 | ) | | 2010 | | Jan-10 | | 3 - 39 yrs. | | | 87 | |
Boise | | ID | | Hampton Inn & Suites | | | 0 | | | | 1,335 | | | | 21,114 | | | | 139 | | | | 22,588 | | | | (1,932 | ) | | 2007 | | Apr-10 | | 3 - 39 yrs. | | | 186 | |
Mettawa | | IL | | Hilton Garden Inn | | | 0 | | | | 2,246 | | | | 28,328 | | | | 35 | | | | 30,609 | | | | (1,898 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 170 | |
Mettawa | | IL | | Residence Inn | | | 0 | | | | 1,722 | | | | 21,843 | | | | 9 | | | | 23,574 | | | | (1,458 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 130 | |
| | | | | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Capitalized | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Initial Cost | | Bldg. | | Total | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Bldg./ | | Imp. & | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Description | | Encumbrances | | Land | | | FF&E /Other | | FF&E | | Cost (1) | | Deprec. | | Construction | | Acquired | | Life | | Rooms |
Schaumburg | | IL | | Hilton Garden Inn | | | 0 | | | | 1,450 | | | | 19,122 | | | | 24 | | | | 20,596 | | | | (1,376 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 166 | |
Warrenville | | IL | | Hilton Garden Inn | | | 0 | | | | 1,171 | | | | 20,894 | | | | 19 | | | | 22,084 | | | | (1,416 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 135 | |
Indianapolis | | IN | | SpringHill Suites | | | 0 | | | | 1,310 | | | | 11,542 | | | | 36 | | | | 12,888 | | | | (799 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 130 | |
Mishawaka | | IN | | Residence Inn | | | 0 | | | | 898 | | | | 12,862 | | | | 52 | | | | 13,812 | | | | (885 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 106 | |
Alexandria | | LA | | Courtyard | | | 0 | | | | 1,099 | | | | 8,708 | | | | 6 | | | | 9,813 | | | | (784 | ) | | 2010 | | Sep-10 | | 3 - 39 yrs. | | | 96 | |
Baton Rouge | | LA | | SpringHill Suites | | | 0 | | | | 1,280 | | | | 13,870 | | | | 50 | | | | 15,200 | | | | (1,691 | ) | | 2009 | | Sep-09 | | 3 - 39 yrs. | | | 119 | |
Lafayette | | LA | | Hilton Garden Inn | | | 0 | | | | 0 | | | | 17,898 | | | | 1,875 | | | | 19,773 | | | | (1,621 | ) | | 2006 | | Jul-10 | | 3 - 39 yrs. | | | 153 | |
Lafayette | | LA | | SpringHill Suites | | | 0 | | | | 709 | | | | 9,400 | | | | 6 | | | | 10,115 | | | | (554 | ) | | 2011 | | Jun-11 | | 3 - 39 yrs. | | | 103 | |
West Monroe | | LA | | Hilton Garden Inn | | | 0 | | | | 832 | | | | 14,872 | | | | 1,405 | | | | 17,109 | | | | (1,406 | ) | | 2007 | | Jul-10 | | 3 - 39 yrs. | | | 134 | |
Andover | | MA | | SpringHill Suites | | | 0 | | | | 702 | | | | 5,799 | | | | 1,792 | | | | 8,293 | | | | (637 | ) | | 2000 | | Nov-10 | | 3 - 39 yrs. | | | 136 | |
Silver Spring | | MD | | Hilton Garden Inn | | | 0 | | | | 1,361 | | | | 16,094 | | | | 5 | | | | 17,460 | | | | (1,377 | ) | | 2010 | | Jul-10 | | 3 - 39 yrs. | | | 107 | |
Novi | | MI | | Hilton Garden Inn | | | 0 | | | | 1,213 | | | | 15,052 | | | | 56 | | | | 16,321 | | | | (1,126 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 148 | |
Rochester | | MN | | Hampton Inn & Suites | | | 0 | | | | 916 | | | | 13,225 | | | | 39 | | | | 14,180 | | | | (1,681 | ) | | 2009 | | Aug-09 | | 3 - 39 yrs. | | | 124 | |
Kansas City | | MO | | Hampton Inn | | | 6,235 | | | | 727 | | | | 9,363 | | | | 91 | | | | 10,181 | | | | (871 | ) | | 1999 | | Aug-10 | | 3 - 39 yrs. | | | 122 | |
St. Louis | | MO | | Hampton Inn | | | 13,293 | | | | 1,758 | | | | 20,954 | | | | 1,165 | | | | 23,877 | | | | (1,750 | ) | | 2003 | | Aug-10 | | 3 - 39 yrs. | | | 190 | |
St. Louis | | MO | | Hampton Inn & Suites | | | 0 | | | | 758 | | | | 15,287 | | | | 108 | | | | 16,153 | | | | (1,299 | ) | | 2006 | | Apr-10 | | 3 - 39 yrs. | | | 126 | |
Hattiesburg | | MS | | Residence Inn | | | 0 | | | | 906 | | | | 9,151 | | | | 25 | | | | 10,082 | | | | (1,429 | ) | | 2008 | | Dec-08 | | 3 - 39 yrs. | | | 84 | |
Charlotte | | NC | | Homewood Suites | | | 0 | | | | 1,059 | | | | 4,937 | | | | 4,012 | | | | 10,008 | | | | (2,304 | ) | | 1990 | | Sep-08 | | 3 - 39 yrs. | | | 112 | |
Durham | | NC | | Homewood Suites | | | 0 | | | | 1,232 | | | | 18,343 | | | | 1,942 | | | | 21,517 | | | | (2,746 | ) | | 1999 | | Dec-08 | | 3 - 39 yrs. | | | 122 | |
Fayetteville | | NC | | Home2 Suites | | | 0 | | | | 746 | | | | 10,563 | | | | 0 | | | | 11,309 | | | | (808 | ) | | 2011 | | Feb-11 | | 3 - 39 yrs. | | | 118 | |
Holly Springs | | NC | | Hampton Inn & Suites | | | 0 | | | | 1,620 | | | | 13,260 | | | | 11 | | | | 14,891 | | | | (1,077 | ) | | 2010 | | Nov-10 | | 3 - 39 yrs. | | | 124 | |
Jacksonville | | NC | | TownePlace Suites | | | 0 | | | | 632 | | | | 8,608 | | | | 37 | | | | 9,277 | | | | (864 | ) | | 2008 | | Feb-10 | | 3 - 39 yrs. | | | 86 | |
Mt. Laurel | | NJ | | Homewood Suites | | | 0 | | | | 1,589 | | | | 13,476 | | | | 300 | | | | 15,365 | | | | (828 | ) | | 2006 | | Jan-11 | | 3 - 39 yrs. | | | 118 | |
West Orange | | NJ | | Courtyard | | | 0 | | | | 2,054 | | | | 19,513 | | | | 1,501 | | | | 23,068 | | | | (1,305 | ) | | 2005 | | Jan-11 | | 3 - 39 yrs. | | | 131 | |
Twinsburg | | OH | | Hilton Garden Inn | | | 0 | | | | 1,419 | | | | 16,614 | | | | 1,709 | | | | 19,742 | | | | (2,703 | ) | | 1999 | | Oct-08 | | 3 - 39 yrs. | | | 142 | |
SCHEDULE III
Real Estate and Accumulated Depreciation – (Continued)
As of December 31, 2012
(dollars in thousands)
| | | | | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Capitalized | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Initial Cost | | Bldg. | | Total | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Bldg./ | | Imp. & | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Description | | Encumbrances | | Land | | FF&E /Other | | FF&E | | Cost (1) | | Deprec. | | Construction | | Acquired | | Life | | Rooms |
Oklahoma City | | OK | | Hampton Inn & Suites | | $ | 0 | | | $ | 1,430 | | | $ | 31,327 | | | $ | 29 | | | $ | 32,786 | | | $ | (2,719 | ) | | 2009 | | May-10 | | 3 - 39 yrs. | | | 200 | |
Collegeville | | PA | | Courtyard | | | 12,587 | | | | 2,115 | | | | 17,953 | | | | 1,687 | | | | 21,755 | | | | (1,398 | ) | | 2005 | | Nov-10 | | 3 - 39 yrs. | | | 132 | |
Malvern | | PA | | Courtyard | | | 7,530 | | | | 996 | | | | 20,374 | | | | 77 | | | | 21,447 | | | | (1,316 | ) | | 2007 | | Nov-10 | | 3 - 39 yrs. | | | 127 | |
Pittsburgh | | PA | | Hampton Inn | | | 0 | | | | 2,503 | | | | 18,537 | | | | 1,203 | | | | 22,243 | | | | (2,605 | ) | | 1990 | | Dec-08 | | 3 - 39 yrs. | | | 132 | |
Jackson | | TN | | Courtyard | | | 0 | | | | 986 | | | | 14,656 | | | | 51 | | | | 15,693 | | | | (2,058 | ) | | 2008 | | Dec-08 | | 3 - 39 yrs. | | | 94 | |
Jackson | | TN | | Hampton Inn & Suites | | | 0 | | | | 692 | | | | 12,281 | | | | 87 | | | | 13,060 | | | | (1,665 | ) | | 2007 | | Dec-08 | | 3 - 39 yrs. | | | 83 | |
Johnson City | | TN | | Courtyard | | | 0 | | | | 1,105 | | | | 8,632 | | | | 17 | | | | 9,754 | | | | (1,109 | ) | | 2009 | | Sep-09 | | 3 - 39 yrs. | | | 90 | |
Nashville | | TN | | Hilton Garden Inn | | | 0 | | | | 2,754 | | | | 39,997 | | | | 30 | | | | 42,781 | | | | (2,978 | ) | | 2009 | | Sep-10 | | 3 - 39 yrs. | | | 194 | |
Nashville | | TN | | Home2 Suites | | | 0 | | | | 1,153 | | | | 15,206 | | | | 0 | | | | 16,359 | | | | (371 | ) | | 2012 | | May-12 | | 3 - 39 yrs. | | | 119 | |
Allen | | TX | | Hampton Inn & Suites | | | 0 | | | | 1,442 | | | | 11,456 | | | | 318 | | | | 13,216 | | | | (1,948 | ) | | 2006 | | Sep-08 | | 3 - 39 yrs. | | | 103 | |
Allen | | TX | | Hilton Garden Inn | | | 10,004 | | | | 2,130 | | | | 16,731 | | | | 2,900 | | | | 21,761 | | | | (3,494 | ) | | 2002 | | Oct-08 | | 3 - 39 yrs. | | | 150 | |
Arlington | | TX | | Hampton Inn & Suites | | | 0 | | | | 1,217 | | | | 8,738 | | | | 378 | | | | 10,333 | | | | (647 | ) | | 2007 | | Dec-10 | | 3 - 39 yrs. | | | 98 | |
Austin | | TX | | Courtyard | | | 0 | | | | 1,579 | | | | 18,487 | | | | 24 | | | | 20,090 | | | | (1,330 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 145 | |
Austin | | TX | | Fairfield Inn & Suites | | | 0 | | | | 1,306 | | | | 16,504 | | | | 11 | | | | 17,821 | | | | (1,197 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 150 | |
Austin | | TX | | Hampton Inn | | | 6,901 | | | | 1,459 | | | | 17,184 | | | | 1,684 | | | | 20,327 | | | | (2,505 | ) | | 1997 | | Apr-09 | | 3 - 39 yrs. | | | 124 | |
Austin | | TX | | Hilton Garden Inn | | | 0 | | | | 1,614 | | | | 14,451 | | | | 36 | | | | 16,101 | | | | (1,029 | ) | | 2008 | | Nov-10 | | 3 - 39 yrs. | | | 117 | |
Austin | | TX | | Homewood Suites | | | 6,907 | | | | 1,898 | | | | 16,462 | | | | 2,096 | | | | 20,456 | | | | (2,542 | ) | | 1997 | | Apr-09 | | 3 - 39 yrs. | | | 97 | |
Beaumont | | TX | | Residence Inn | | | 0 | | | | 1,177 | | | | 16,180 | | | | 34 | | | | 17,391 | | | | (2,530 | ) | | 2008 | | Oct-08 | | 3 - 39 yrs. | | | 133 | |
Dallas | | TX | | Hilton | | | 20,136 | | | | 2,221 | | | | 40,350 | | | | 6,254 | | | | 48,825 | | | | (2,533 | ) | | 2001 | | May-11 | | 3 - 39 yrs. | | | 224 | |
Duncanville | | TX | | Hilton Garden Inn | | | 13,139 | | | | 2,378 | | | | 15,935 | | | | 586 | | | | 18,899 | | | | (2,975 | ) | | 2005 | | Oct-08 | | 3 - 39 yrs. | | | 142 | |
El Paso | | TX | | Hilton Garden Inn | | | 0 | | | | 1,244 | | | | 18,300 | | | | 3 | | | | 19,547 | | | | (730 | ) | | 2011 | | Dec-11 | | 3 - 39 yrs. | | | 145 | |
Frisco | | TX | | Hilton Garden Inn | | | 0 | | | | 2,507 | | | | 12,981 | | | | 13 | | | | 15,501 | | | | (1,926 | ) | | 2008 | | Dec-08 | | 3 - 39 yrs. | | | 102 | |
Ft. Worth | | TX | | TownePlace Suites | | | 0 | | | | 2,104 | | | | 16,311 | | | | 10 | | | | 18,425 | | | | (1,379 | ) | | 2010 | | Jul-10 | | 3 - 39 yrs. | | | 140 | |
Grapevine | | TX | | Hilton Garden Inn | | | 11,751 | | | | 1,522 | | | | 15,543 | | | | 38 | | | | 17,103 | | | | (1,265 | ) | | 2009 | | Sep-10 | | 3 - 39 yrs. | | | 110 | |
Houston | | TX | | Marriott | | | 0 | | | | 4,143 | | | | 46,623 | | | | 14 | | | | 50,780 | | | | (4,796 | ) | | 2010 | | Jan-10 | | 3 - 39 yrs. | | | 206 | |
Irving | | TX | | Homewood Suites | | | 5,763 | | | | 705 | | | | 9,610 | | | | 229 | | | | 10,544 | | | | (668 | ) | | 2006 | | Dec-10 | | 3 - 39 yrs. | | | 77 | |
Lewisville | | TX | | Hilton Garden Inn | | | 0 | | | | 3,361 | | | | 23,919 | | | | 134 | | | | 27,414 | | | | (3,914 | ) | | 2007 | | Oct-08 | | 3 - 39 yrs. | | | 165 | |
Round Rock | | TX | | Hampton Inn | | | 3,813 | | | | 865 | | | | 10,999 | | | | 1,337 | | | | 13,201 | | | | (1,662 | ) | | 2001 | | Mar-09 | | 3 - 39 yrs. | | | 94 | |
Texarkana | | TX | | Hampton Inn & Suites | | | 4,822 | | | | 636 | | | | 8,723 | | | | 936 | | | | 10,295 | | | | (614 | ) | | 2004 | | Jan-11 | | 3 - 39 yrs. | | | 81 | |
Salt Lake City | | UT | | SpringHill Suites | | | 0 | | | | 1,092 | | | | 16,465 | | | | 30 | | | | 17,587 | | | | (1,183 | ) | | 2009 | | Nov-10 | | 3 - 39 yrs. | | | 143 | |
SCHEDULE III
Real Estate and Accumulated Depreciation – (Continued)
As of December 31, 2012
(dollars in thousands)
| | | | | | | | | | | | | | | | | | Subsequently | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Capitalized | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Initial Cost | | Bldg. | | Total | | | | | | | | | | | | | | |
| | | | | | | | | | | | Bldg./ | | Imp. & | | Gross | | Acc. | | Date of | | Date | | Depreciable | | # of |
City | | State | | Description | | Encumbrances | | Land | | FF&E /Other | | FF&E | | Cost (1) | | Deprec. | | Construction | | Acquired | | Life | | Rooms |
Alexandria | | VA | | SpringHill Suites | | | 0 | | | | 5,968 | | | | 0 | | | | 18,918 | | | | 24,886 | | | | (1,393 | ) | | 2011 | | Mar-09 | | 3 - 39 yrs. | | | 155 | |
Bristol | | VA | | Courtyard | | | 9,239 | | | | 1,723 | | | | 19,162 | | | | 1,584 | | | | 22,469 | | | | (3,035 | ) | | 2004 | | Nov-08 | | 3 - 39 yrs. | | | 175 | |
Manassas | | VA | | Residence Inn | | | 0 | | | | 0 | | | | 14,962 | | | | 164 | | | | 15,126 | | | | (857 | ) | | 2006 | | Feb-11 | | 3 - 39 yrs. | | | 107 | |
| | | | | | | 163,232 | | | | 137,309 | | | | 1,401,521 | | | | 66,604 | | | | 1,605,434 | | | | (145,927 | ) | | | | | | | | | 11,371 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other real estate investments: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Richmond | | VA | | Hotel under construction | | | 0 | | | | 3,115 | | | | 0 | | | | 1,058 | | | | 4,173 | | | | 0 | | | | | Jul-12 | | | | | 0 | |
Other | | | | | | | 0 | | | | 0 | | | | 0 | | | | 214 | | | | 214 | | | | 0 | | | | | | | | | | 0 | |
| | | | | | $ | 163,232 | | | $ | 140,424 | | | $ | 1,401,521 | | | $ | 67,876 | | | $ | 1,609,821 | | | $ | (145,927 | ) | | | | | | | | | 11,371 | |
(1) The aggregate cost for federal income tax purposes is approximately $1.6 billion at December 31, 2012 (unaudited).
| | 2012 | | | 2011 | | | 2010 | |
Real estate owned: | | | | | | | | | |
Balance as of January 1 | | $ | 1,573,901 | | | $ | 1,510,884 | | | $ | 705,722 | |
Acquisitions | | | 19,461 | | | | 197,695 | | | | 784,102 | |
Disposals | | | 0 | | | | (1,339 | ) | | | (2,658 | ) |
Discontinued Operations | | | 0 | | | | (147,346 | ) | | | 0 | |
Improvements and Development Costs | | | 16,459 | | | | 14,007 | | | | 23,718 | |
Balance at December 31 | | $ | 1,609,821 | | | $ | 1,573,901 | | | $ | 1,510,884 | |
| | 2012 | | | 2011 | | | 2010 | |
Accumulated depreciation: | | | | | | | | | |
Balance as of January 1 | | $ | (93,179 | ) | | $ | (48,962 | ) | | $ | (18,213 | ) |
Depreciation expense | | | (52,748 | ) | | | (49,815 | ) | | | (30,749 | ) |
Disposals | | | 0 | | | | 50 | | | | 0 | |
Discontinued Operations | | | 0 | | | | 5,548 | | | | 0 | |
Balance at December 31 | | $ | (145,927 | ) | | $ | (93,179 | ) | | $ | (48,962 | ) |
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 NINE, INC. | | |
| | | |
By: | /s/ Glade M. Knight | | Date: March 7, 2013 |
| Glade M. Knight, | | |
| Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | | |
| | | |
By: | /s/ Bryan Peery | | Date: March 7, 2013 |
| Bryan Peery, | | |
| Chief Financial Officer (Principal Financial and Principal Accounting Officer) | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.
By: | /s/ Glade M. Knight | | Date: March 7, 2013 |
| Glade M. Knight, Director | | |
| | | |
By: | /s/ Bruce H. Matson | | Date: March 7, 2013 |
| Bruce H. Matson, Director | | |
| | | |
By: | /s/ Michael S. Waters | | Date: March 7, 2013 |
| Michael S. Waters, Director | | |
| | | |
By: | /s/ Robert M. Wily | | Date: March 7, 2013 |
| Robert M. Wily, Director | | |
EXHIBIT INDEX
Exhibit Number | | Description of Documents |
| | |
3.1 | | Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008) |
| | |
3.2 | | Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008) |
| | |
10.1 | | Advisory Agreement between the Registrant and Apple Nine Advisors, Inc. (Incorporated by reference to Exhibit 10.1 to amendment no. 4 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed April 23, 2008 and effective April 25, 2008) |
| | |
10.2 | | Property Acquisition/Disposition Agreement between the Registrant and Apple Suites Realty Group, Inc. (Incorporated by reference to Exhibit 10.2 to amendment no. 4 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed April 23, 2008 and effective April 25, 2008) |
| | |
10.3 | | Omitted |
| | |
10.4 | | Apple REIT Nine, Inc. 2008 Non-Employee Directors Stock Option Plan. (Incorporated by reference to Exhibit 10.4 to registrant’s quarterly report on Form 10-Q (SEC File No. 333-147414) filed May 8, 2008)* |
| | |
10.5 | | Purchase Contract dated as of June 5, 2008 between Valencia Tucson, L.L.C. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.5 to the registrant’s quarterly report on Form 10-Q (SEC File No. 333-147414) filed August 4, 2008) |
| | |
10.6 | | Management Agreement dated as of July 31, 2008 between Texas Western Management Partners, L.P. and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.6 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.7 | | Franchise License Agreement dated as of July 31, 2008 between Hilton Garden Inns Franchise LLC and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.7 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.8 | | Hotel Lease Agreement effective as of July 31, 2008 between Apple Nine Hospitality Ownership, Inc. and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.8 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.9 | | Agreement of Purchase and Sale and Joint Escrow Instructions dated as of July 24, 2008 between Ocean Park Hotels-MMM, L.L.C. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.9 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.10 | | Management Agreement dated as of September 24, 2008 between Dimension Development Two, LLC and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.10 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.11 | | Courtyard by Marriott Relicensing Franchise Agreement dated as of September 24, 2008 between Marriott International, Inc. and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.11 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.12 | | Hotel Lease Agreement effective as of September 24, 2008 between Apple Nine Hospitality Ownership, Inc. and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.12 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
Exhibit Number | | Description of Documents |
| | |
10.13 | | Purchase Contract dated as of August 1, 2008 between Charlotte Lakeside Hotel Limited Partnership and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.13 to the registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.14 | | Management Agreement dated as of September 24, 2008 between MHH Management, LLC and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.14 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.15 | | Franchise License Agreement dated as of September 25, 2008 between Homewood Suites Franchise LLC and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.15 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.16 | | Hotel Lease Agreement effective as of September 24, 2008 between Apple Nine Hospitality Ownership, Inc. and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.16 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.17 | | Purchase Contract dated as of August 1, 2008 between RSV Twinsburg Hotel LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.17 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.18 | | Management Agreement dated as of October 6, 2008 between Gateway Hospitality Group, Inc. and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.18 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.19 | | Franchise License Agreement dated as of October 7, 2008 between Hilton Garden Inns Franchise LLC and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.19 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.20 | | Hotel Lease Agreement effective as of October 6, 2008 between Apple Nine Hospitality Ownership, Inc. and Apple Nine Hospitality Management, Inc. (Incorporated by reference to Exhibit 10.20 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.21 | | Purchase Contract dated as of August 1, 2008 between SCI Allen Hotel LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.21 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.22 | | Purchase Contract dated as of August 1, 2008 between Allen Stacy Hotel LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.22 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.23 | | Management Agreement dated as of September 26, 2008 between Gateway Hospitality Group, Inc. and Apple Nine Hospitality Texas Services, Inc. (Incorporated by reference to Exhibit 10.23 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.24 | | Franchise License Agreement dated as of September 26, 2008 between Hampton Inns Franchise LLC and Apple Nine Hospitality Texas Services, Inc. (Incorporated by reference to Exhibit 10.24 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
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10.25 | | Hotel Lease Agreement effective as of September 26, 2008 between Apple Nine Hospitality Ownership, Inc. and Apple Nine Hospitality Texas Services, Inc. (Incorporated by reference to Exhibit 10.25 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.26 | | Purchase Contract dated as of August 1, 2008 between SCI Lewisville Hotel LTD. and Apple Nine |
Exhibit Number | | Description of Documents |
| | |
| | Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.26 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
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10.27 | | Management Agreement dated as of October 16, 2008 between Gateway Hospitality Group, Inc. and Apple Nine Hospitality Texas Services, Inc. (Incorporated by reference to Exhibit 10.27 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
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10.28 | | Franchise License Agreement dated as of October 16, 2008 between Hilton Garden Inns Franchise LLC and Apple Nine Hospitality Texas Services, Inc. (Incorporated by reference to Exhibit 10.28 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.29 | | Hotel Lease Agreement effective as of October 16, 2008 between Apple Nine Hospitality Ownership, Inc. and Apple Nine Hospitality Texas Services, Inc. (Incorporated by reference to Exhibit 10.29 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.30 | | Purchase Contract dated as of August 1, 2008 between SCI Duncanville Hotel LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.30 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.31 | | Management Agreement dated as of October 21, 2008 between Gateway Hospitality Group, Inc. and Apple Nine Services Duncanville, Inc. (Incorporated by reference to Exhibit 10.31 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.32 | | Franchise License Agreement dated as of October 21, 2008 between Hilton Garden Inns Franchise LLC and Apple Nine Services Duncanville, Inc. (Incorporated by reference to Exhibit 10.32 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.33 | | Hotel Lease Agreement effective as of October 21, 2008 between Apple Nine SPE Duncanville, Inc. and Apple Nine Services Duncanville, Inc. (Incorporated by reference to Exhibit 10.33 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.34 | | Purchase Contract dated as of August 7, 2008 between Linden Hotel Properties, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.34 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.35 | | Agreement of Purchase and Sale dated as of August 29, 2008 between RT Clarita Two, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.35 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.36 | | Agreement of Purchase and Sale dated as of August 29, 2008 between RT Clarita, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.36 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.37 | | Purchase Contract dated as of September 11, 2008 between RI Beaumont Property, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.37 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.38 | | Purchase Contract dated as of October 3, 2008 between ES/HIS Hillsboro, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.38 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
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10.39 | | Purchase Contract dated as of October 3, 2008 between ES/HIS Hillsboro, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.39 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.40 | | Purchase Contract dated as of October 6, 2008 between Brothers Hospitality Development, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.40 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
Exhibit Number | | Description of Documents |
| | |
10.41 | | Purchase Contract dated as of October 10, 2008 between Ralham, L.L.C. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.41 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.42 | | Purchase Contract dated as of October 17, 2008 between Grand Shangrila International, Inc. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.42 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.43 | | Purchase Contract dated as of October 17, 2008 between Grand Shangrila International, Inc. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.43 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.44 | | Purchase Contract dated as of October 17, 2008 between ADH LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.44 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.45 | | Purchase Contract dated as of October 20, 2008 between Sunbelt-CTY, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.45 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
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10.46 | | Purchase Contract dated as of October 20, 2008 between Sunbelt-RPC, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.46 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.47 | | Purchase Contract dated as of October 20, 2008 between Sunbelt-CJT, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.47 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.48 | | Purchase Contract dated as of October 20, 2008 between Sunbelt-RHM, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.48 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.49 | | Purchase Contract dated as of October 20, 2008 between Sunbelt-GDA, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.49 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.50 | | Purchase Contract dated as of October 20, 2008 between Sunbelt-RAG, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.50 to registrant’s Post-effective Amendment No. 1 to Form S-11 (SEC File No. 333-147414) filed October 23, 2008) |
| | |
10.51 | | Purchase Contract dated as of October 29, 2008 between MWE Houston Property, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.51 to the registrant’s quarterly report on Form 10-Q (SEC File No. 333-147414) filed November 4, 2008) |
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10.52 | | Purchase Contract dated as of November 12, 2008 between Austin FRH, LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.52 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.53 | | Purchase Contract dated as of November 12, 2008 between FRH Braker, LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.53 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.54 | | Purchase Contract dated as of November 12, 2008 between RR Hotel Investments, LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.54 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.55 | | Purchase Contract dated as of November 12, 2008 between VH Fort Lauderdale Investment, LTD. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.55 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
Exhibit Number | | Description of Documents |
10.56 | | Purchase Contract dated as of November 12, 2008 between MILLROC Portsmouth NH, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.56 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.57 | | Purchase Contract dated as of November 12, 2008 between Playhouse Square Hotel Associates, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.57 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.58 | | Purchase Contract dated as of November 12, 2008 between RMRVH Jackson, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.58 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
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10.59 | | Purchase Contract dated as of November 12, 2008 between CYRMR Jackson, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.59 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.60 | | Purchase Contract dated as of September 27, 2007 between Grove Street Orlando, LLC and Apple Eight Hospitality, Inc. (Incorporated by reference to Exhibit 10.60 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.61 | | Assignment of Contract dated as of November 14, 2008 between Apple Eight Hospitality, Inc. and Apple Nine Hospitality, Inc. (Incorporated by reference to Exhibit 10.61 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.62 | | Purchase Contract dated as of December 14, 2007 between Viking Fund Baton Rouge (LA), LLC and Apple Eight Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.62 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
| | |
10.63 | | Assignment of Contract dated as of November 14, 2008 between Apple Eight Hospitality Ownership, Inc. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.63 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
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10.64 | | Purchase Contract dated as of January 25, 2008 between Viking Fund Rochester (MN), LLC and Apple Eight Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.64 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
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10.65 | | Assignment of Contract dated as of November 14, 2008 between Apple Eight Hospitality Ownership, Inc. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.65 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
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10.66 | | Purchase Contract dated as of December 12, 2008 between Moody National Hospitality I, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.66 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
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10.67 | | Purchase Contract dated as of January 5, 2009 between Yuma One Limited Partnership and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.67 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
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10.68 | | Purchase Contract dated as of January 6, 2009 between Viking Fund Holly Springs (NC), LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.68 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
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10.69 | | Purchase and Sale Contract dated as of January 21, 2009 between Chesapeake Land Development Company, L.L.C. and Apple Nine Ventures, Inc. (Incorporated by reference to Exhibit 10.69 to the registrant’s Post-effective Amendment No. 2 to Form S-11 (SEC File No. 333-147414) filed January 23, 2009) |
Exhibit Number | | Description of Documents |
10.70 | | First Amendment to Purchase and Sale Contract dated as of March 31, 2009 between Chesapeake Land Development Company, L.L.C. and Apple Nine Ventures, Inc. (Incorporated by reference to Exhibit 10.70 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.71 | | Ground Lease Agreement dated as of April 7, 2009 between Chesapeake Operating, Inc., and Apple Nine Ventures Ownership, Inc. (Incorporated by reference to Exhibit 10.71 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.72 | | Purchase Agreement dated as of March 16, 2010 between Denali Lodging, LLC and Apple Nine Services Anchorage, LLC (Incorporated by reference to Exhibit 10.72 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.73 | | Purchase Contract dated as of March 16, 2010 between Boise Lodging Investors, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.73 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.74 | | Purchase Contract dated as of March 16, 2010 between Forest Park Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.74 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.75 | | Purchase Contract dated as of March 16, 2010 between Liberty Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.75 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.76 | | Purchase Contract dated as of March 16, 2010 between OKC-Bricktown Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.76 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.77 | | Purchase Contract dated as of March 16, 2010 between Rodgers Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.77 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.78 | | Purchase Contract dated as of March 16, 2010 between Rodgers Lodging Associates 58, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.78 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.79 | | Purchase Contract dated as of March 16, 2010 between St. Louis Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.79 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010) |
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10.80 | | Purchase Contract dated as of May 28, 2010 between Lodging America of West Monroe, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.80 to registrant’s Post-effective Amendment No. 9 to Form S-11 (SEC File No. 333-147414) filed July 21, 2010) |
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10.81 | | Purchase Contract dated as of May 28, 2010 between Jackie’s International, Inc. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.81 to registrant’s Post-effective Amendment No. 9 to Form S-11 (SEC File No. 333-147414) filed July 21, 2010) |
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10.82 | | Purchase Contract dated as of August 5, 2010 between Rochelle Lodging, LP and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.82 to registrant’s Post-effective Amendment No. 10 to Form S-11 (SEC File No. 333-147414) filed October 21, 2010) |
Exhibit Number | | Description of Documents |
10.83 | | Purchase Contract dated as of August 5, 2010 between Redwood Hospitality, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.83 to registrant’s Post-effective Amendment No. 10 to Form S-11 (SEC File No. 333-147414) filed October 21, 2010) |
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10.84 | | Purchase Contract dated as of September 10, 2010 between Fishspring, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.84 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.85 | | Purchase Contract dated as of September 10, 2010 between Mishares, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.85 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.86 | | Purchase Contract dated as of September 10, 2010 between Happy Valley Res, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.86 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.87 | | Purchase Contract dated as of September 10, 2010 between Mettares, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.87 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.88 | | Purchase Contract dated as of September 10, 2010 between Mettawhite, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.88 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.89 | | Purchase Contract dated as of September 10, 2010 between Parmer Lane Associates III, L.P. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.89 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.90 | | Purchase Contract dated as of September 10, 2010 between Etkin White Novi, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.90 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.91 | | Purchase Contract dated as of September 10, 2010 between Warriwhite, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.91 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.92 | | Purchase Contract dated as of September 10, 2010 between Schwhite, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.92 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.93 | | Purchase Contract dated as of September 10, 2010 between Slicspring, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.93 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.94 | | Purchase Contract dated as of September 10, 2010 between Ausnorth FFIS Hotel, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.94 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.95 | | Purchase Contract dated as of September 10, 2010 between Ausnorth CY Hotel, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.95 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.96 | | Purchase Contract dated as of September 10, 2010 between Chanprice, LLC and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.96 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
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10.97 | | Purchase Contract dated as of September 10, 2010 between Whiteco Industries, Inc. and Apple Nine Hospitality Ownership, Inc. (Incorporated by reference to Exhibit 10.97 to registrant’s annual report on Form 10-K (SEC File No. 000-53603) filed March 11, 2011) |
Exhibit Number | | Description of Documents |
| | |
10.98 | | Purchase and Sale Contract dated as of August 3, 2011 between Apple Nine Ventures Ownership, Inc. and 111 Realty Investors, LP (Incorporated by reference to Exhibit 10.98 to registrant’s quarterly report on Form 10-Q (SEC File No. 000-53603) filed November 9, 2011) |
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10.99 | | Third Amendment to Purchase and Sale Contract dated as of January 31, 2012 between Apple Nine Ventures Ownership, Inc. and 111 Realty Investors, LP (Incorporated by reference to Exhibit 10.99 to the registrant’s quarterly report on Form 10Q (SEC File No. 000-53603) filed May 7, 2012) |
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10.100 | | Fourth Amendment to Purchase and Sale Contract dated as of April 12, 2012 between Apple Nine Ventures Ownership, Inc. and 111 Realty Investors, LP (Incorporated by reference to Exhibit 10.100 to the registrant’s quarterly report on Form 10Q (SEC File No. 000-53603) filed August 13, 2012) |
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10.101 | | Junior Secured Note dated as of April 27, 2012 between Apple Nine Ventures Ownership, Inc. and 111 Realty Investors, LP (Incorporated by reference to Exhibit 10.101 to the registrant’s quarterly report on Form 10Q (SEC File No. 000-53603) filed August 13, 2012) |
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10.102 | | Loan Agreement dated as of April 27, 2012 between Apple Nine Ventures Ownership, Inc. and 111 Realty Partners, LP (Incorporated by reference to Exhibit 10.102 to the registrant’s quarterly report on Form 10Q (SEC File No. 000-53603) filed August 13, 2012) |
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21.1 | | Subsidiaries of the Registrant (FILED HEREWITH) |
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23.1 | | Consent of Ernst & Young LLP (FILED HEREWITH) |
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31.1 | | Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH) |
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31.2 | | Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH) |
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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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101 | | The following materials from Apple REIT Nine, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) related notes to these financial statements, tagged as blocks of text and in detail (FURNISHED HEREWITH) |
________________
* Denotes Compensation Plan.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2013
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ |
Commission File Number 000-53603
Apple REIT Nine, Inc.
(Exact name of registrant as specified in its charter)
Virginia | | 26-1379210 |
(State or other jurisdiction of incorporation or organization) | | (IRS Employer Identification No.) |
| | |
814 East Main Street Richmond, Virginia | | 23219 |
(Address of principal executive offices) | | (Zip Code) |
(804) 344-8121
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | | Accelerated filer ¨ | | Non-accelerated filer x | | Smaller reporting company ¨ |
| | | | (Do not check if a smaller reporting company) | | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of registrant’s common shares outstanding as of November 1, 2013:182,784,131
FORM 10-Q
INDEX
| Page Number |
PART I. FINANCIAL INFORMATION | | |
| | |
| Item 1. | | | |
| | | | |
| | | 3 | |
| | | | |
| | | 4 | |
| | | | |
| | | 5 | |
| | | | |
| | | 6 | |
| | | | |
| Item 2. | | 16 | |
| | | | |
| Item 3. | | 30 | |
| | | | |
| Item 4. | | 30 | |
| | | | |
PART II. OTHER INFORMATION | | |
| | |
| Item 1. | | 31 | |
| | | | |
| Item 1A. | | 32 | |
| | | | |
| Item 6. | | 33 | |
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| 34 | |
This Form 10-Q includes references to certain trademarks or service marks. The Courtyard® by Marriott, Fairfield Inn® by Marriott, Fairfield Inn and Suites® by Marriott, TownePlace Suites® by Marriott, SpringHill Suites® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates. The Hampton Inn®, Hampton Inn and Suites®, Homewood Suites® by Hilton, Embassy Suites Hotels®, Hilton Garden Inn®, Home2 Suites® by Hilton and Hilton® trademarks are the property of Hilton Worldwide or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPLE REIT NINE, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)
| | September 30, | | | December 31, | |
| | 2013 | | | 2012 | |
| | (unaudited) | | | | |
Assets | | | | | | |
Investment in real estate, net of accumulated depreciation of $186,792 and $145,927, respectively | | $ | 1,443,024 | | | $ | 1,463,894 | |
Cash and cash equivalents | | | 0 | | | | 9,027 | |
Restricted cash-furniture, fixtures and other escrows | | | 10,360 | | | | 9,922 | |
Note receivable, net | | | 17,675 | | | | 22,375 | |
Due from third party managers, net | | | 15,855 | | | | 10,751 | |
Other assets, net | | | 9,802 | | | | 10,048 | |
Total Assets | | $ | 1,496,716 | | | $ | 1,526,017 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Credit facility | | $ | 22,000 | | | $ | 0 | |
Notes payable | | | 163,635 | | | | 166,783 | |
Accounts payable and accrued expenses | | | 18,087 | | | | 13,101 | |
Total Liabilities | | | 203,722 | | | | 179,884 | |
| | | | | | | | |
Shareholders' Equity | | | | | | | | |
Preferred stock, authorized 30,000,000 shares; none issued and outstanding | | | 0 | | | | 0 | |
Series A preferred stock, no par value, authorized 400,000,000 shares; issued and outstanding 182,784,131 and 182,619,400 shares, respectively | | | 0 | | | | 0 | |
Series B convertible preferred stock, no par value, authorized 480,000 shares; issued and outstanding 480,000 shares | | | 48 | | | | 48 | |
Common stock, no par value, authorized 400,000,000 shares; issued and outstanding 182,784,131 and 182,619,400 shares, respectively | | | 1,807,236 | | | | 1,805,335 | |
Distributions greater than net income | | | (514,290 | ) | | | (459,250 | ) |
Total Shareholders' Equity | | | 1,292,994 | | | | 1,346,133 | |
| | | | | | | | |
Total Liabilities and Shareholders' Equity | | $ | 1,496,716 | | | $ | 1,526,017 | |
See notes to consolidated financial statements.
APPLE REIT NINE, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)(in thousands, except per share data)
| | Three Months Ended | | | Nine Months Ended | |
| | September 30, | | | September 30, | |
| | 2013 | | | 2012 | | | 2013 | | | 2012 | |
Revenues: | | | | | | | | | | | | |
Room revenue | | $ | 91,936 | | | $ | 85,900 | | | $ | 271,324 | | | $ | 253,500 | |
Other revenue | | | 8,301 | | | | 7,753 | | | | 25,888 | | | | 25,354 | |
Total revenue | | | 100,237 | | | | 93,653 | | | | 297,212 | | | | 278,854 | |
| | | | | | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | | | | | |
Operating expense | | | 25,800 | | | | 24,162 | | | | 75,318 | | | | 70,813 | |
Hotel administrative expense | | | 7,218 | | | | 6,616 | | | | 21,287 | | | | 20,197 | |
Sales and marketing | | | 8,369 | | | | 7,947 | | | | 24,968 | | | | 23,529 | |
Utilities | | | 4,213 | | | | 4,074 | | | | 11,153 | | | | 10,778 | |
Repair and maintenance | | | 3,807 | | | | 3,364 | | | | 11,136 | | | | 9,882 | |
Franchise fees | | | 4,185 | | | | 3,642 | | | | 12,248 | | | | 11,037 | |
Management fees | | | 3,567 | | | | 3,267 | | | | 10,329 | | | | 9,513 | |
Property taxes, insurance and other | | | 4,843 | | | | 5,168 | | | | 15,632 | | | | 15,122 | |
General and administrative | | | 1,778 | | | | 2,149 | | | | 5,815 | | | | 6,443 | |
Acquisition related costs | | | 0 | | | | 3 | | | | 74 | | | | 464 | |
Merger transaction costs | | | 1,908 | | | | 0 | | | | 1,970 | | | | 637 | |
Depreciation expense | | | 13,732 | | | | 13,329 | | | | 40,865 | | | | 39,338 | |
Total expenses | | | 79,420 | | | | 73,721 | | | | 230,795 | | | | 217,753 | |
| | | | | | | | | | | | | | | | |
Operating income | | | 20,817 | | | | 19,932 | | | | 66,417 | | | | 61,101 | |
| | | | | | | | | | | | | | | | |
Interest expense, net | | | (2,287 | ) | | | (1,709 | ) | | | (6,701 | ) | | | (4,664 | ) |
| | | | | | | | | | | | | | | | |
Income before income taxes | | | 18,530 | | | | 18,223 | | | | 59,716 | | | | 56,437 | |
| | | | | | | | | | | | | | | | |
Income tax expense | | | (365 | ) | | | (296 | ) | | | (1,110 | ) | | | (885 | ) |
| | | | | | | | | | | | | | | | |
Income from continuing operations | | | 18,165 | | | | 17,927 | | | | 58,606 | | | | 55,552 | |
| | | | | | | | | | | | | | | | |
Income from discontinued operations | | | 0 | | | | 0 | | | | 0 | | | | 6,792 | |
| | | | | | | | | | | | | | | | |
Net income | | $ | 18,165 | | | $ | 17,927 | | | $ | 58,606 | | | $ | 62,344 | |
| | | | | | | | | | | | | | | | |
Basic and diluted net income per common share | | | | | | | | | | | | | | | | |
From continuing operations | | $ | 0.10 | | | $ | 0.10 | | | $ | 0.32 | | | $ | 0.30 | |
From discontinued operations | | | 0.00 | | | | 0.00 | | | | 0.00 | | | | 0.04 | |
Total basic and diluted net income per common share | | $ | 0.10 | | | $ | 0.10 | | | $ | 0.32 | | | $ | 0.34 | |
| | | | | | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 182,784 | | | | 182,130 | | | | 182,560 | | | | 182,200 | |
See notes to consolidated financial statements.
APPLE REIT NINE, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS
| | Nine Months Ended | |
| | September 30, | |
| | 2013 | | | 2012 | |
Cash flows from operating activities: | | | | | | |
Net income | | $ | 58,606 | | | $ | 62,344 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | |
Depreciation | | | 40,865 | | | | 39,338 | |
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net | | | 264 | | | | 264 | |
Straight-line rental income | | | 0 | | | | (1,975 | ) |
Changes in operating assets and liabilities: | | | | | | | | |
Increase in due from third party managers, net | | | (5,104 | ) | | | (5,516 | ) |
Increase in other assets, net | | | (523 | ) | | | (1,203 | ) |
Increase in accounts payable and accrued expenses | | | 3,914 | | | | 678 | |
Net cash provided by operating activities | | | 98,022 | | | | 93,930 | |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Cash paid for acquisitions, net | | | (7,225 | ) | | | (18,015 | ) |
Net proceeds (costs) from sale of assets | | | (353 | ) | | | 135,410 | |
Capital improvements and development costs | | | (11,370 | ) | | | (13,520 | ) |
Increase in capital improvement reserves | | | (207 | ) | | | (372 | ) |
Payments received on note receivable | | | 4,725 | | | | 2,940 | |
Net cash provided by (used in) investing activities | | | (14,430 | ) | | | 106,443 | |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Net proceeds related to issuance of Units | | | 21,778 | | | | 38,239 | |
Redemptions of Units | | | (19,992 | ) | | | (41,988 | ) |
Special distribution paid to common shareholders | | | 0 | | | | (136,113 | ) |
Monthly distributions paid to common shareholders | | | (113,646 | ) | | | (117,164 | ) |
Net proceeds from credit facility | | | 22,000 | | | | 0 | |
Proceeds from notes payable | | | 0 | | | | 77,690 | |
Payments of notes payable | | | (2,759 | ) | | | (31,899 | ) |
Deferred financing costs | | | 0 | | | | (358 | ) |
Net cash used in financing activities | | | (92,619 | ) | | | (211,593 | ) |
| | | | | | | | |
Decrease in cash and cash equivalents | | | (9,027 | ) | | | (11,220 | ) |
| | | | | | | | |
Cash and cash equivalents, beginning of period | | | 9,027 | | | | 30,733 | |
| | | | | | | | |
Cash and cash equivalents, end of period | | $ | 0 | | | $ | 19,513 | |
| | | | | | | | |
Non-cash transactions: | | | | | | | | |
Note receivable issued from sale of assets | | $ | 0 | | | $ | 60,000 | |
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Summary of Significant Accounting Policies
Organization
Apple REIT Nine, Inc., together with its wholly owned subsidiaries (the “Company”), is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company was formed to invest in income-producing real estate in the United States. Initial capitalization occurred on November 9, 2007 and operations began on July 31, 2008 when the Company acquired its first hotel. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in December 2010. The Company’s fiscal year end is December 31. The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. Although the Company has an interest in a variable interest entity through its note receivable, it is not the primary beneficiary as the Company does not have any elements of power in the decision making process of the entity and does not share in any of the benefits, and therefore does not consolidate the entity. As of September 30, 2013, the Company owned 89 hotels located in 27 states with an aggregate of 11,371 rooms.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not include all of the information required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its 2012 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2013.
Use of Estimates
The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain amounts in the 2012 consolidated financial statements have been reclassified to conform with the 2013 presentation with no effect on previously reported net income or shareholders’ equity.
Restricted Cash
Restricted cash includes reserves for debt service, real estate taxes, and insurance, and reserves for furniture, fixtures, and equipment replacements of up to 5% of property revenue for certain hotels, as required by certain management or mortgage debt agreement restrictions and provisions.
Earnings Per Common Share
Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the period. Diluted earnings per common share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period. There were no potential common shares with a dilutive effect for the three and nine months ended September 30, 2013 or 2012. As a result, basic and dilutive outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares.
2. Merger Agreement
On August 7, 2013, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”), Apple Seven Acquisition Sub, Inc. (“Seven Acquisition Sub”) a wholly owned subsidiary of Apple Nine, and Apple Eight Acquisition Sub, Inc. (“Eight Acquisition Sub”) a wholly owned subsidiary of Apple Nine,
entered into an Agreement and Plan of Merger, as amended (the “Merger Agreement”). The Merger Agreement provides for the merger of Apple Seven and Apple Eight with and into Seven Acquisition Sub and Eight Acquisition Sub, respectively, which were formed solely for engaging in the mergers and have not conducted any prior activities. Upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight will cease and Seven Acquisition Sub and Eight Acquisition Sub will be the surviving corporations. Pursuant to the terms of the Merger Agreement, upon completion of the mergers, the current Apple Nine common shares totaling 182,784,131 will remain outstanding and:
· | Each issued and outstanding unit of Apple Seven (consisting of one Apple Seven common share together with one Apple Seven Series A preferred share) will be converted into one (the “Apple Seven exchange ratio”) common share of Apple Nine, or a total of approximately 90,613,633 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Seven will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Seven exchange ratio, or a total of 5,801,050 common shares; and |
· | Each issued and outstanding unit of Apple Eight (consisting of one Apple Eight common share together with one Apple Eight Series A preferred share) will be converted into 0.85 (the “Apple Eight exchange ratio”) common share of Apple Nine, or a total of approximately 78,319,004 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Eight will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Eight exchange ratio, or a total of 4,930,892 common shares. |
As contemplated in the Merger Agreement, in connection with completion of the mergers, Apple Nine will become self-advised and the existing advisory agreements between Apple Nine and Apple Nine Advisors, Inc. and Apple Suites Realty Group, Inc. will be terminated. The termination of the advisory agreements will result in the conversion of each issued and outstanding Series B convertible preferred share of Apple Nine into the right to receive 24.17104 common shares of Apple Nine, or a total of 11,602,099 common shares. As a result of the conversion, all of Apple Nine’s Series A preferred shares will terminate. In addition, upon termination of the advisory agreements, Apple Nine will record an expense related to the conversion of Apple Nine’s Series B convertible preferred shares into common shares. Although the final estimate of fair value may vary significantly from these estimates, Apple Nine’s preliminary estimate of the fair value of $9.00 to $11.00 per common share would result in an expense ranging from approximately $104 million to $128 million.
The Merger Agreement contains various closing conditions, including shareholder approval by Apple Seven, Apple Eight and Apple Nine. As a result, there is no assurance that the mergers will occur. Under the Merger Agreement, Apple Seven, Apple Eight and Apple Nine may terminate the Merger Agreement under certain circumstances; however, each of the companies may be required to pay a fee of $1.7 million, plus reasonable third party expenses to each of the other companies upon such termination. All costs related to the proposed mergers are being expensed in the period they are incurred and are included in the merger transaction costs in the Company’s consolidated statements of operations. In connection with these activities, the Company incurred approximately $2.0 million in expenses for the nine months ended September 30, 2013.
3. Disposition and Discontinued Operations
On April 27, 2012, the Company completed the sale of its 406 acres of land and land improvements located on 110 sites in the Ft. Worth, Texas area (the “110 parcels”) and the assignment of the lease for a total sale price of $198.4 million. The 110 parcels were acquired in April 2009 for a total purchase price of $147.3 million and were leased to a subsidiary of Chesapeake Energy Corporation (“Chesapeake”) under a long term lease for the production of natural gas. At closing, the Company received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser (the “note”). The note, which approximated fair market value, is secured by a junior lien on the land and land improvements owned by the purchaser. The stated interest rate on the note is 10.5%. The note requires interest only payments for the first three years of the note. After the first three years, interest is accrued and payments will only be received once the purchaser extinguishes its senior loan with a third party. Once the senior loan is repaid, the Company will receive all payments from the existing lease until fully repaid or the note reaches maturity which is April 2049. Although the purchaser is not affiliated with the Company, a partner of the purchaser is also a member of the Board of Directors of Apple REIT Ten, Inc. In conjunction with the sale, the Company incurred a brokerage commission to Apple Suites Realty Group, Inc. (“ASRG”) totaling approximately $4.0 million, representing 2% of the gross sales price. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60.0 million note. The $4.0 million commission has been recorded as a reduction to the deferred gain on sale as described below.
The total gain on sale was approximately $33.3 million (total sale price of $198.4 million less carrying value totaling $160.5 million, ASRG fee totaling $4.0 million, closing costs totaling $0.3 million and related franchise taxes totaling $0.3 million). In accordance with the Accounting Standards Codification on real estate sales, the sales transaction is being
accounted for under the cost recovery method, therefore the gain on sale and interest earned on the note will be deferred until cash payments by the purchaser, including principal and interest on the note due to the Company and the payment of the $138.4 million at closing exceed the Company’s cost basis of the 110 parcels sold. The note receivable is included in the Company’s consolidated balance sheets, net of the total deferred gain. As of September 30, 2013, the note receivable, net was $17.7 million, including $60.0 million note receivable offset by $33.3 million deferred gain and $9.0 million deferred interest earned. As of December 31, 2012, the note receivable, net was $22.4 million, including $60.0 million note receivable offset by $33.4 million deferred gain and $4.3 million deferred interest earned. The 110 parcels was a separate reportable segment and the results of operations for these properties have been classified in the consolidated statements of operations in the line item income from discontinued operations.
The following table sets forth the components of income from discontinued operations for the three and nine months ended September 30, 2012 (in thousands):
| | Three Months | | | Nine Months | |
| | Ended | | | Ended | |
| | September 30, 2012 | | | September 30, 2012 | |
Rental revenue | | $ | 0 | | | $ | 6,826 | |
Operating expenses | | | 0 | | | | 34 | |
Depreciation expense | | | 0 | | | | 0 | |
Income from discontinued operations | | $ | 0 | | | $ | 6,792 | |
Prior to the sale, the lease was classified as an operating lease and rental income was recognized on a straight-line basis over the initial term of the lease. Rental revenue includes approximately $2.0 million of adjustments to record rent on the straight-line basis for the nine months ended September 30, 2012.
4. Credit Facility
In November 2012, the Company entered into a $50 million credit facility with a commercial bank that is utilized for working capital, hotel renovations and development, and other general corporate funding purposes, including the payment of redemptions and distributions. The credit facility may be increased to $100 million, subject to certain conditions. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part at any time. The credit facility matures in November 2014; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to November 2015. Interest payments are due monthly and the interest rate, subject to certain exceptions, is equal to the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 2.75%, depending upon the Company’s leverage ratio, as calculated under the terms of the credit agreement. The Company is also required to pay an unused facility fee of 0.30% or 0.40% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during the quarter. As of September 30, 2013, the credit facility had an outstanding principal balance of $22.0 million and an annual interest rate of approximately 2.43%. As of December 31, 2012, there were no borrowings outstanding under the credit facility.
The credit agreement requires the Company to maintain a specific pool of Unencumbered Borrowing Base Properties (must be a minimum of ten properties and must satisfy conditions as defined in the credit agreement). The obligations of the lender to make any advances under the credit facility are subject to certain conditions, including that the outstanding borrowings do not exceed the Borrowing Base Availability, as defined in the credit agreement. The credit facility contains customary affirmative covenants, negative covenants and events of defaults. It also contains quarterly financial covenants, which include, among others, a minimum tangible net worth, maximum debt limits, and minimum debt service and fixed charge coverage ratios. The Company was in compliance with each of these covenants at September 30, 2013.
5. Fair Value of Financial Instruments
The Company estimates the fair value of its debt and note receivable by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of an instrument with similar credit terms and credit characteristics which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. As of September 30, 2013, the carrying value and estimated fair value of the Company’s debt was approximately $185.6 million and $190.1 million. As of December 31, 2012, the carrying value and estimated fair value of the Company’s debt was approximately $166.8 million and $173.3 million. As of September 30, 2013 and December 31, 2012, the carrying value of the $60 million note receivable as discussed in note 3 approximates fair market value. The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.
6. Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the nine months ended September 30, 2013 (other than the transactions related to the completion of Apple REIT Six, Inc.’s merger with a third party and the Merger Agreement and related transactions discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The term the “Apple REIT Entities” means Apple REIT Six, Inc. (“Apple Six”), Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”) and Apple REIT Ten, Inc. (“Apple Ten”). The term the “Advisors” means Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc. (“A9A”), Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. (“ASRG”) and Apple Six Realty Group, Inc. The Advisors are wholly owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple Seven, Apple Eight and Apple Ten. Members of the Company’s Board of Directors are also on the Board of Directors of Apple Seven and Apple Eight.
On May 14, 2013, Apple Six merged with and into an entity that is not affiliated with the Apple REIT Entities or the Advisors. Pursuant to the terms and conditions of the merger agreement, dated as of November 29, 2012, upon completion of the merger, the separate corporate existence of Apple Six ceased (the “A6 Merger”). Prior to the A6 Merger, Glade M. Knight was Chairman and Chief Executive Office of Apple Six and members of the Company’s Board of Directors were also on the Board of Directors of Apple Six.
ASRG Agreement
The Company has a contract with ASRG, to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of September 30, 2013, payments to ASRG for fees under the terms of this contract related to the acquisition of assets have totaled approximately $33.6 million since inception. Of this amount, the Company incurred approximately $0.1 million and $0.4 million during the nine months ended September 30, 2013 and 2012. During the second quarter of 2013, the Company paid fees to ASRG for the purchase of two land parcels located at the Residence Inn hotels in Manassas, Virginia and San Bernardino, California, both which had previously been leased from a third party. In addition, the Company incurred a brokerage commission to ASRG totaling approximately $4.0 million related to the sale of the Company’s 110 parcels in April 2012, which has been recorded as a reduction to the deferred gain on sale. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60 million note.
A9A Agreement
The Company is party to an advisory agreement with A9A, pursuant to which A9A provides management services to the Company. A9A provides these management services through Apple Fund Management, LLC (“AFM”), which immediately after the A6 Merger became a wholly-owned subsidiary of A9A. This transaction between A9A and Apple Six was made with no cash consideration exchanged between the entities. Prior to May 14, 2013, AFM was a wholly-owned subsidiary of Apple Six. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses as described below, are payable to A9A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $2.1 million and $2.2 million for the nine months ended September 30, 2013 and 2012.
Apple REIT Entities and Advisors Cost Sharing Structure
In addition to the fees payable to ASRG or A9A, the Company reimbursed to ASRG or A9A, or paid directly to AFM on behalf of ASRG or A9A, approximately $1.6 million for both the nine months ended September 30, 2013 and 2012. The expenses reimbursed were approximately $0 and $0.1 million, respectively, for costs reimbursed under the contract with ASRG and approximately $1.6 million and $1.5 million, respectively, for costs reimbursed under the contract with A9A. The costs are included in general and administrative expenses and are for the Company’s allocated share of the staffing and related costs provided by AFM at the direction of A9A.
AFM is an affiliate of each of the Advisors. Each of the Advisors provides management services through the use of AFM to, respectively, Apple Six (prior to the A6 Merger), Apple Seven, Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, effective May 14, 2013, the entire membership interest of Apple Six in AFM was transferred and assigned to A9A, which then became the sole member of AFM. As part of the assignment, A9A and the other Advisors agreed to indemnify the buyer of Apple Six for liabilities related to AFM. The assignment of AFM’s interest to A9A had no impact on the Company’s advisory agreement with A9A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors as described below, except Apple Six and its advisors, Apple Six Advisors, Inc. and Apple Six Realty Group, Inc. (collectively “A6 Advisors”), no longer participate in the cost sharing arrangement, thereby increasing the remaining companies’ share of the allocated costs.
Also, in connection with the A6 Merger, on May 13, 2013, the Company acquired from Apple Six the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and assumed the Fort Worth, Texas office lease agreement for approximately $4.5 million, which approximated fair value at the time of acquisition based on third party market comparisons. As part of the purchase, the Company agreed to release Apple Six from any liabilities related to the Headquarters or office lease. As described below, any costs associated with the Headquarters and office lease, including office rent, utilities, office supplies, etc. (“Office Related Costs”) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors.
Prior to the A6 Merger, amounts reimbursed to AFM included both compensation for personnel and Office Related Costs used by the companies. As discussed above, as a result of the A6 Merger, beginning on May 14, 2013, Office Related Costs are now allocated from the Company to the other Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors. Each of these companies has agreed to reimburse the Company for its share of these costs. From the period May 14, 2013 through September 30, 2013, the Company received reimbursement of its costs totaling approximately $0.4 million from the participating entities. The Company’s net allocated Office Related Costs were approximately $0.1 million and is included in general and administrative costs in the Company’s consolidated statements of operations.
All of the Office Related Costs and costs of AFM are allocated among the Apple REIT Entities and the Advisors, excluding Apple Six and A6 Advisors after the A6 Merger. The allocation of costs is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described above allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
As part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) are reimbursed or collected and are not significant in amount.
The Company has incurred legal fees associated with the Legal Proceedings and Related Matters discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the Legal Proceedings and Related Matters discussed herein for all of the Apple REIT Entities (excluding Apple Six after the A6 Merger) was approximately $2.2 million for the nine months ended September 30, 2013, of which approximately $0.5 million was allocated to the Company. Total costs for the nine months ended September 30, 2012 for all of the Apple REIT Entities was approximately $5.7 million, of which approximately $1.3 million was allocated to the Company.
Apple Air Holding, LLC (“Apple Air”) Membership Interest
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air. The other current members of Apple Air are Apple Seven, Apple Eight and Apple Ten. In connection with the A6 Merger,
on May 13, 2013, Apple Ten acquired its membership interest in Apple Air from Apple Six. Through its equity investment, the Company has access to Apple Air’s aircraft for acquisition, asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million as of September 30, 2013 and December 31, 2012. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the nine months ended September 30, 2013 and 2012, the Company recorded a loss of approximately $181,000 and $145,000 respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.
Merger Agreement and Related Transactions
Concurrently with the execution of the Merger Agreement (as discussed in note 2), on August 7, 2013, the following agreements were entered into by the Company:
· | Apple Seven, Apple Eight and Apple Nine entered into a termination agreement, as amended (the “Termination Agreement”) with Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., A9A and ASRG, effective immediately before the completion of the mergers. Pursuant to the Termination Agreement, the existing advisory agreements and property acquisition/disposition agreements with respect to Apple Seven, Apple Eight and Apple Nine will be terminated. The Termination Agreement does not provide for any separate payments to be made in connection with the termination of the existing advisory agreements and property acquisition/disposition agreements. As a result, if the mergers are completed, Apple Seven, Apple Eight and Apple Nine will no longer pay the various fees currently paid to its respective advisors. |
· | Apple Nine entered into a subcontract agreement, as amended (the “Subcontract Agreement”) with Apple Ten Advisors, Inc. (“A10A”). Pursuant to the Subcontract Agreement, A10A will subcontract its obligations under the advisory agreement between A10A and Apple Ten to Apple Nine. The Subcontract Agreement provides that, from and after the completion of the mergers, Apple Nine will provide to Apple Ten the advisory services contemplated under the A10A advisory agreement and will receive the fees and expenses payable under the A10A advisory agreement from Apple Ten. |
· | Apple Nine entered into an assignment and transfer agreement, as amended (the “Transfer Agreement”) with A9A and AFM. Pursuant to the Transfer Agreement, Apple Nine will acquire all of the membership interests in AFM from A9A effective immediately following the completion of the mergers. The Transfer Agreement provides that Apple Nine will assume all of the obligations of the predecessor owners of AFM under prior transfer agreements involving the transfer of the membership interests in AFM (including Apple Hospitality Two, Inc., Apple Hospitality Five, Inc., Apple Six and A9A) and relieve the predecessor owners and the other advisory companies of any liability with respect to AFM. |
7. Shareholders’ Equity
Special Distribution
As a result of the sale of its 110 parcels, the Board of Directors approved a special distribution of $0.75 per Unit, totaling $136.1 million on May 17, 2012 to shareholders of record on May 11, 2012 (the “Special Distribution”).
Monthly Distributions
For the three months ended September 30, 2013 and 2012, the Company made distributions of $0.2076 and $0.2075 per common share for a total of $37.9 million and $37.8 million. For the nine months ended September 30, 2013 and 2012, the Company made distributions (excluding the Special Distribution discussed above) of $0.6227 and $0.6434 per common share for a total of $113.6 million and $117.2 million. In conjunction with the Special Distribution, in May 2012 the Company’s Board of Directors reduced the annual distribution rate from $0.88 per common share to $0.83 per common share. The reduction was effective with the June 2012 distribution. In August 2012, the Board of Directors increased the annualized distribution rate from $0.83 per common share to $0.83025 per common share. The distribution will continue to be paid monthly. Total distributions (including the Special Distribution) for the nine months ended September 30, 2013 and 2012 totaled $113.6 million and $253.3 million.
Unit Redemption Program
In July 2009, 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. Since the inception of the program through April 2012, shareholders were permitted to request redemption of Units for a purchase price equal to 92% of the price paid per Unit if
the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. In May 2012, as a result of the Special Distribution, the purchase price per Unit under the Company’s Unit Redemption Program was adjusted by the amount of the Special Distribution (from $11.00 to $10.25 for the maximum purchase price, based on the original purchase price and length of time such Units have been held by the shareholder). The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. On June 27, 2013, the Company announced the suspension of its Unit Redemption Program as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the program until the Merger Agreement is terminated or the mergers are completed.
Since inception of the program through September 30, 2013, the Company has redeemed approximately 11.7 million Units representing $121.2 million, including 2.0 million Units in the amount of $20.0 million and 4.0 million Units in the amount of $42.0 million redeemed during the nine months ended September 30, 2013 and 2012, respectively. Since July 2011, the total redemption requests have exceeded the authorized amount of redemptions and, as a result, the Board of Directors has limited the amount of redemptions as deemed prudent. Therefore, as contemplated in the program, beginning with the July 2011 redemption, the scheduled redemption date for the third quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to July 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2012 and the first nine months of 2013:
Redemption Date | | Total Requested Unit Redemptions at Redemption Date | | | Units Redeemed | | | Total Redemption Requests Not Redeemed at Redemption Date | |
| | | | | | | | | |
First Quarter 2012 | | | 10,689,219 | | | | 1,507,187 | | | | 9,182,032 | |
Second Quarter 2012 | | | 11,229,890 | | | | 1,509,922 | | | | 9,719,968 | |
Third Quarter 2012 | | | 10,730,084 | | | | 1,004,365 | | | | 9,725,719 | |
Fourth Quarter 2012 | | | 11,155,269 | | | | 1,003,267 | | | | 10,152,002 | |
First Quarter 2013 | | | 12,135,251 | | | | 990,324 | | | | 11,144,927 | |
Second Quarter 2013 | | | 13,039,019 | | | | 988,095 | | | | 12,050,924 | |
Dividend Reinvestment Plan
In December 2010, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. As a result of the Special Distribution, beginning in May 2012, the offering price per Unit under the Company’s Dividend Reinvestment Plan was adjusted by the amount of the Special Distribution (from $11.00 to $10.25). The Company has registered 20.0 million Units for potential issuance under the plan. Since inception of the plan through September 30, 2013, approximately 12.3 million Units, representing $131.0 million in proceeds to the Company, were issued under the plan. During the nine months ended September 30, 2013 and 2012, approximately 2.1 million Units, representing $22.0 million in proceeds to the Company, and 3.6 million Units, representing $38.2 million in proceeds to the Company, were issued under the plan. On June 27, 2013, the Company announced the suspension of its Dividend Reinvestment Plan as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the plan until the Merger Agreement is terminated or the mergers are completed.
8. Legal Proceedings and Related Matters
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in all three of the above mentioned class action lawsuits.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine
Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The Securities and Exchange Commission (“SEC”) staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company's filings with the SEC beginning in 2008, as well as the Company's review of certain transactions involving the Company and the other Apple REIT Entities. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the SEC staff affect the material accuracy of the Company's consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution.
9. Subsequent Events
In October 2013, the Company declared and paid approximately $12.6 million, or $0.0691875 per outstanding common share, in distributions to its common shareholders.
On November 1, 2013, the $60 million note receivable, as discussed in note 3 was repaid by the purchaser in full and the purchaser was released from all liability and obligations under the note. In exchange for the early payment and waiver by the purchaser of certain terms of the note, the Company agreed to waive approximately $0.5 million of interest for the month of October 2013. As a result of the repayment of the note, the Company will recognize the deferred gain on sale totaling $33.3 million and deferred interest earned totaling $9.0 million for a total gain of approximately $42.3 million as of September 30, 2013 in the fourth quarter of 2013. The Company plans to use the proceeds from the repayment of the note to reduce the outstanding balance under its $50 million credit facility and to fund general corporate purposes, including working capital, renovations and hotel development.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential,” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company, Apple REIT Seven, Inc. or Apple REIT Eight, Inc. to obtain required shareholder or other third-party approvals required to consummate the proposed mergers, under which Apple REIT Seven, Inc. and Apple REIT Eight, Inc. would be merged with and into wholly owned subsidiaries of Apple REIT Nine, Inc.; the satisfaction or waiver of other conditions in the merger agreement; a material adverse effect on the Company, Apple REIT Seven, Inc. or Apple REIT Eight, Inc.; the outcome of any legal proceedings that may be instituted against the Company, Apple REIT Seven, Inc. or Apple REIT Eight, Inc. and others related to the merger agreement; the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; financing risks; the outcome of current and future litigation, regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; and competition within the hotel and real estate industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission (“SEC”). Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.
Overview
Apple REIT Nine, Inc., together with its wholly owned subsidiaries (the “Company”) was formed to invest in income-producing real estate in the United States. The Company was initially capitalized on November 9, 2007, with its first investor closing on May 14, 2008. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in December 2010. The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company’s first hotel was acquired on July 31, 2008. As of September 30, 2013, the Company owned 89 hotels (one acquired during 2012, 11 acquired and one newly constructed hotel opened during 2011, 43 acquired during 2010, 12 acquired during 2009 and 21 acquired during 2008). Accordingly, the results of operations include only results from the date of ownership of the properties.
Hotel Operations
Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned. The hotel industry and the Company continue to see improvement in both revenues and operating income as compared to the prior year. Although there is no way to predict future general economic conditions, and there are several key factors that may continue to negatively affect the economic recovery in the United States and add to general market uncertainty, including but not limited to, the continued high levels of unemployment, the slow pace of the economic recovery in the United States and the ongoing uncertainty surrounding the fiscal policy of the United States (including the “sequester,” tax increases and potential government spending cuts), the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 for comparable hotels with the trend expected to continue in 2014.
In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”) and market yield which compares an individual hotel’s results to others in its local market, and expenses, such as hotel operating expenses, general and administrative expenses and other expenses described below.
The following is a summary of the results from continuing operations of the 89 hotels owned as of September 30, 2013 for their respective periods of ownership by the Company:
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
(in thousands, except statistical data) | | 2013 | | | Percent of Revenue | | | 2012 | | | Percent of Revenue | | | Percent Change | | | 2013 | | | Percent of Revenue | | | 2012 | | | Percent of Revenue | | | Percent Change | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total revenue | | $ | 100,237 | | | | 100 | % | | $ | 93,653 | | | | 100 | % | | | 7 | % | | $ | 297,212 | | | | 100 | % | | $ | 278,854 | | | | 100 | % | | | 7 | % |
Hotel operating expenses | | | 57,159 | | | | 57 | % | | | 53,072 | | | | 57 | % | | | 8 | % | | | 166,439 | | | | 56 | % | | | 155,749 | | | | 56 | % | | | 7 | % |
Property taxes, insurance and other expense | | | 4,843 | | | | 5 | % | | | 5,168 | | | | 6 | % | | | -6 | % | | | 15,632 | | | | 5 | % | | | 15,122 | | | | 5 | % | | | 3 | % |
General and administrative expense | | | 1,778 | | | | 2 | % | | | 2,149 | | | | 2 | % | | | -17 | % | | | 5,815 | | | | 2 | % | | | 6,443 | | | | 2 | % | | | -10 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Acquisition related costs | | | - | | | | | | | | 3 | | | | | | | | n/a | | | 74 | | | | | | | | 464 | | | | | | | | -84 | % |
Merger transaction costs | | | 1,908 | | | | | | | | - | | | | | | | | n/a | | | 1,970 | | | | | | | | 637 | | | | | | | | 209 | % |
Depreciation | | | 13,732 | | | | | | | | 13,329 | | | | | | | | 3 | % | | | 40,865 | | | | | | | | 39,338 | | | | | | | | 4 | % |
Interest expense, net | | | 2,287 | | | | | | | | 1,709 | | | | | | | | 34 | % | | | 6,701 | | | | | | | | 4,664 | | | | | | | | 44 | % |
Income tax expense | | | 365 | | | | | | | | 296 | | | | | | | | 23 | % | | | 1,110 | | | | | | | | 885 | | | | | | | | 25 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Number of hotels | | | 89 | | | | | | | | 89 | | | | | | | | 0 | % | | | 89 | | | | | | | | 89 | | | | | | | | 0 | % |
Average Market Yield(1) | | | 124 | | | | | | | | 122 | | | | | | | | 2 | % | | | 123 | | | | | | | | 121 | | | | | | | | 2 | % |
ADR | | $ | 115 | | | | | | | $ | 111 | | | | | | | | 4 | % | | $ | 115 | | | | | | | $ | 112 | | | | | | | | 3 | % |
Occupancy | | | 77 | % | | | | | | | 74 | % | | | | | | | 4 | % | | | 76 | % | | | | | | | 73 | % | | | | | | | 4 | % |
RevPAR | | $ | 88 | | | | | | | $ | 82 | | | | | | | | 7 | % | | $ | 87 | | | | | | | $ | 82 | | | | | | | | 6 | % |
Total rooms sold(2) | | | 801,732 | | | | | | | | 768,609 | | | | | | | | 4 | % | | | 2,358,269 | | | | | | | | 2,260,943 | | | | | | | | 4 | % |
Total rooms available(3) | | | 1,045,086 | | | | | | | | 1,039,558 | | | | | | | | 1 | % | | | 3,106,356 | | | | | | | | 3,081,556 | | | | | | | | 1 | % |
(1) Calculated from data provided by Smith Travel Research, Inc.® Excludes hotels under renovation or opened less than two years during the applicable periods. |
(2) Represents the number of room nights sold during the period. |
(3) Represents the number of rooms owned by the Company multiplied by the number of nights in the period. |
Merger Agreement
On August 7, 2013, Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”), Apple Seven Acquisition Sub, Inc. (“Seven Acquisition Sub”) a wholly owned subsidiary of Apple Nine, and Apple Eight Acquisition Sub, Inc. (“Eight Acquisition Sub”) a wholly owned subsidiary of Apple Nine, entered into an Agreement and Plan of Merger, as amended (the “Merger Agreement”). The Merger Agreement provides for the merger of Apple Seven and Apple Eight with and into Seven Acquisition Sub and Eight Acquisition Sub, respectively, which were formed solely for engaging in the mergers and have not conducted any prior activities. Upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight will cease and Seven Acquisition Sub and Eight Acquisition Sub will be the surviving corporations. Pursuant to the terms of the Merger Agreement, upon completion of the mergers, the current Apple Nine common shares totaling 182,784,131 will remain outstanding and:
· | Each issued and outstanding unit of Apple Seven (consisting of one Apple Seven common share together with one Apple Seven Series A preferred share) will be converted into one (the “Apple Seven exchange ratio”) common share of Apple Nine, or a total of approximately 90,613,633 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Seven will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Seven exchange ratio, or a total of 5,801,050 common shares; and |
· | Each issued and outstanding unit of Apple Eight (consisting of one Apple Eight common share together with one Apple Eight Series A preferred share) will be converted into 0.85 (the “Apple Eight exchange ratio”) common share of Apple Nine, or a total of approximately 78,319,004 common shares (assuming no dissenting shares), and each issued and outstanding Series B convertible preferred share of Apple Eight will be converted into a number of Apple Nine’s common shares equal to 24.17104 multiplied by the Apple Eight exchange ratio, or a total of 4,930,892 common shares. |
As contemplated in the Merger Agreement, in connection with completion of the mergers, Apple Nine will become self-advised and the existing advisory agreements between Apple Nine and Apple Nine Advisors, Inc. and Apple Suites Realty Group, Inc. will be terminated. The termination of the advisory agreements will result in the conversion of each issued and outstanding Series B convertible preferred share of Apple Nine into the right to receive 24.17104 common shares of Apple Nine, or a total of 11,602,099 common shares. As a result of the conversion, all of Apple Nine’s Series A preferred shares will terminate. In addition, upon termination of the advisory agreements, Apple Nine will record an expense related to the conversion of Apple Nine’s Series B convertible preferred shares into common shares. Although the final estimate of fair value may vary significantly from these estimates, Apple Nine’s preliminary estimate of the fair value of $9.00 to $11.00 per common share would result in an expense ranging from approximately $104 million to $128 million.
The Merger Agreement contains various closing conditions, including shareholder approval by Apple Seven, Apple Eight and Apple Nine. As a result, there is no assurance that the mergers will occur. Under the Merger Agreement, Apple Seven, Apple Eight and Apple Nine may terminate the Merger Agreement under certain circumstances; however, each of the companies may be required to pay a fee of $1.7 million, plus reasonable third party expenses to each of the other companies upon such termination. All costs related to the proposed mergers are being expensed in the period they are incurred and are included in the merger transaction costs in the Company’s consolidated statements of operations. In connection with these activities, the Company incurred approximately $2.0 million in expenses for the nine months ended September 30, 2013.
Legal Proceedings
The term the “Apple REIT Entities” means Apple REIT Six, Inc., Apple Seven, Apple Eight, Apple Nine and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in all three of the above mentioned class action lawsuits.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
Hotels Owned
The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 89 hotels the Company owned as of September 30, 2013. All dollar amounts are in thousands.
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price | |
Tucson | | AZ | | Hilton Garden Inn | | Western | | 7/31/2008 | | | 125 | | | $ | 18,375 | |
Santa Clarita | | CA | | Courtyard | | Dimension | | 9/24/2008 | | | 140 | | | | 22,700 | |
Charlotte | | NC | | Homewood Suites | | McKibbon | | 9/24/2008 | | | 112 | | | | 5,750 | |
Allen | | TX | | Hampton Inn & Suites | | Gateway | | 9/26/2008 | | | 103 | | | | 12,500 | |
Twinsburg | | OH | | Hilton Garden Inn | | Gateway | | 10/7/2008 | | | 142 | | | | 17,792 | |
Lewisville | | TX | | Hilton Garden Inn | | Gateway | | 10/16/2008 | | | 165 | | | | 28,000 | |
Duncanville | | TX | | Hilton Garden Inn | | Gateway | | 10/21/2008 | | | 142 | | | | 19,500 | |
Santa Clarita | | CA | | Hampton Inn | | Dimension | | 10/29/2008 | | | 128 | | | | 17,129 | |
Santa Clarita | | CA | | Residence Inn | | Dimension | | 10/29/2008 | | | 90 | | | | 16,600 | |
Santa Clarita | | CA | | Fairfield Inn | | Dimension | | 10/29/2008 | | | 66 | | | | 9,337 | |
Beaumont | | TX | | Residence Inn | | Western | | 10/29/2008 | | | 133 | | | | 16,900 | |
Pueblo | | CO | | Hampton Inn & Suites | | Dimension | | 10/31/2008 | | | 81 | | | | 8,025 | |
Allen | | TX | | Hilton Garden Inn | | Gateway | | 10/31/2008 | | | 150 | | | | 18,500 | |
Bristol | | VA | | Courtyard | | LBA | | 11/7/2008 | | | 175 | | | | 18,650 | |
Durham | | NC | | Homewood Suites | | McKibbon | | 12/4/2008 | | | 122 | | | | 19,050 | |
Hattiesburg | | MS | | Residence Inn | | LBA | | 12/11/2008 | | | 84 | | | | 9,793 | |
Jackson | | TN | | Courtyard | | Vista | | 12/16/2008 | | | 94 | | | | 15,200 | |
Jackson | | TN | | Hampton Inn & Suites | | Vista | | 12/30/2008 | | | 83 | | | | 12,600 | |
Pittsburgh | | PA | | Hampton Inn | | Vista | | 12/31/2008 | | | 132 | | | | 20,458 | |
Fort Lauderdale | | FL | | Hampton Inn | | Vista | | 12/31/2008 | | | 109 | | | | 19,290 | |
Frisco | | TX | | Hilton Garden Inn | | Western | | 12/31/2008 | | | 102 | | | | 15,050 | |
Round Rock | | TX | | Hampton Inn | | Vista | | 3/6/2009 | | | 94 | | | | 11,500 | |
Panama City | | FL | | Hampton Inn & Suites | | LBA | | 3/12/2009 | | | 95 | | | | 11,600 | |
Austin | | TX | | Homewood Suites | | Vista | | 4/14/2009 | | | 97 | | | | 17,700 | |
Austin | | TX | | Hampton Inn | | Vista | | 4/14/2009 | | | 124 | | | | 18,000 | |
Dothan | | AL | | Hilton Garden Inn | | LBA | | 6/1/2009 | | | 104 | | | | 11,601 | |
Troy | | AL | | Courtyard | | LBA | | 6/18/2009 | | | 90 | | | | 8,696 | |
Orlando | | FL | | Fairfield Inn & Suites | | Marriott | | 7/1/2009 | | | 200 | | | | 25,800 | |
Orlando | | FL | | SpringHill Suites | | Marriott | | 7/1/2009 | | | 200 | | | | 29,000 | |
Clovis | | CA | | Hampton Inn & Suites | | Dimension | | 7/31/2009 | | | 86 | | | | 11,150 | |
Rochester | | MN | | Hampton Inn & Suites | | Raymond | | 8/3/2009 | | | 124 | | | | 14,136 | |
Johnson City | | TN | | Courtyard | | LBA | | 9/25/2009 | | | 90 | | | | 9,880 | |
Baton Rouge | | LA | | SpringHill Suites | | Dimension | | 9/25/2009 | | | 119 | | | | 15,100 | |
Houston | | TX | | Marriott | | Western | | 1/8/2010 | | | 206 | | | | 50,750 | |
Albany | | GA | | Fairfield Inn & Suites | | LBA | | 1/14/2010 | | | 87 | | | | 7,920 | |
Panama City | | FL | | TownePlace Suites | | LBA | | 1/19/2010 | | | 103 | | | | 10,640 | |
Clovis | | CA | | Homewood Suites | | Dimension | | 2/2/2010 | | | 83 | | | | 12,435 | |
Jacksonville | | NC | | TownePlace Suites | | LBA | | 2/16/2010 | | | 86 | | | | 9,200 | |
Miami | | FL | | Hampton Inn & Suites | | Dimension | | 4/9/2010 | | | 121 | | | | 11,900 | |
Anchorage | | AK | | Embassy Suites | | Stonebridge | | 4/30/2010 | | | 169 | | | | 42,000 | |
Boise | | ID | | Hampton Inn & Suites | | Raymond | | 4/30/2010 | | | 186 | | | | 22,370 | |
Rogers | | AR | | Homewood Suites | | Raymond | | 4/30/2010 | | | 126 | | | | 10,900 | |
St. Louis | | MO | | Hampton Inn & Suites | | Raymond | | 4/30/2010 | | | 126 | | | | 16,000 | |
Oklahoma City | | OK | | Hampton Inn & Suites | | Raymond | | 5/28/2010 | | | 200 | | | | 32,657 | |
Ft. Worth | | TX | | TownePlace Suites | | Western | | 7/19/2010 | | | 140 | | | | 18,435 | |
Lafayette | | LA | | Hilton Garden Inn | | LBA | | 7/30/2010 | | | 153 | | | | 17,261 | |
West Monroe | | LA | | Hilton Garden Inn | | InterMountain | | 7/30/2010 | | | 134 | | | | 15,639 | |
Silver Spring | | MD | | Hilton Garden Inn | | White | | 7/30/2010 | | | 107 | | | | 17,400 | |
Rogers | | AR | | Hampton Inn | | Raymond | | 8/31/2010 | | | 122 | | | | 9,600 | |
St. Louis | | MO | | Hampton Inn | | Raymond | | 8/31/2010 | | | 190 | | | | 23,000 | |
Kansas City | | MO | | Hampton Inn | | Raymond | | 8/31/2010 | | | 122 | | | | 10,130 | |
Alexandria | | LA | | Courtyard | | LBA | | 9/15/2010 | | | 96 | | | | 9,915 | |
Grapevine | | TX | | Hilton Garden Inn | | Western | | 9/24/2010 | | | 110 | | | | 17,000 | |
Nashville | | TN | | Hilton Garden Inn | | Vista | | 9/30/2010 | | | 194 | | | | 42,667 | |
Indianapolis | | IN | | SpringHill Suites | | White | | 11/2/2010 | | | 130 | | | | 12,800 | |
Mishawaka | | IN | | Residence Inn | | White | | 11/2/2010 | | | 106 | | | | 13,700 | |
Phoenix | | AZ | | Courtyard | | White | | 11/2/2010 | | | 164 | | | | 16,000 | |
Phoenix | | AZ | | Residence Inn | | White | | 11/2/2010 | | | 129 | | | | 14,000 | |
Mettawa | | IL | | Residence Inn | | White | | 11/2/2010 | | | 130 | | | | 23,500 | |
City | | State | | Brand | | Manager | | Date Acquired | | Rooms | | | Gross Purchase Price | |
Mettawa | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 170 | | | $ | 30,500 | |
Austin | | TX | | Hilton Garden Inn | | White | | 11/2/2010 | | | 117 | | | | 16,000 | |
Novi | | MI | | Hilton Garden Inn | | White | | 11/2/2010 | | | 148 | | | | 16,200 | |
Warrenville | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 135 | | | | 22,000 | |
Schaumburg | | IL | | Hilton Garden Inn | | White | | 11/2/2010 | | | 166 | | | | 20,500 | |
Salt Lake City | | UT | | SpringHill Suites | | White | | 11/2/2010 | | | 143 | | | | 17,500 | |
Austin | | TX | | Fairfield Inn & Suites | | White | | 11/2/2010 | | | 150 | | | | 17,750 | |
Austin | | TX | | Courtyard | | White | | 11/2/2010 | | | 145 | | | | 20,000 | |
Chandler | | AZ | | Courtyard | | White | | 11/2/2010 | | | 150 | | | | 17,000 | |
Chandler | | AZ | | Fairfield Inn & Suites | | White | | 11/2/2010 | | | 110 | | | | 12,000 | |
Tampa | | FL | | Embassy Suites | | White | | 11/2/2010 | | | 147 | | | | 21,800 | |
Andover | | MA | | SpringHill Suites | | Marriott | | 11/5/2010 | | | 136 | | | | 6,500 | |
Philadelphia (Collegeville) | | PA | | Courtyard | | White | | 11/15/2010 | | | 132 | | | | 20,000 | |
Holly Springs | | NC | | Hampton Inn & Suites | | LBA | | 11/30/2010 | | | 124 | | | | 14,880 | |
Philadelphia (Malvern) | | PA | | Courtyard | | White | | 11/30/2010 | | | 127 | | | | 21,000 | |
Arlington | | TX | | Hampton Inn & Suites | | Western | | 12/1/2010 | | | 98 | | | | 9,900 | |
Irving | | TX | | Homewood Suites | | Western | | 12/29/2010 | | | 77 | | | | 10,250 | |
Mount Laurel | | NJ | | Homewood Suites | | Tharaldson | | 1/11/2011 | | | 118 | | | | 15,000 | |
West Orange | | NJ | | Courtyard | | Tharaldson | | 1/11/2011 | | | 131 | | | | 21,500 | |
Texarkana | | TX | | Hampton Inn & Suites | | InterMountain | | 1/31/2011 | | | 81 | | | | 9,100 | |
Fayetteville | | NC | | Home2 Suites | | LBA | | 2/3/2011 | | | 118 | | | | 11,397 | |
Manassas | | VA | | Residence Inn | | Tharaldson | | 2/16/2011 | | | 107 | | | | 14,900 | |
San Bernardino | | CA | | Residence Inn | | Tharaldson | | 2/16/2011 | | | 95 | | | | 13,600 | |
Alexandria (1) | | VA | | SpringHill Suites | | Marriott | | 3/28/2011 | | | 155 | | | | 24,863 | |
Dallas | | TX | | Hilton | | Hilton | | 5/17/2011 | | | 224 | | | | 42,000 | |
Santa Ana | | CA | | Courtyard | | Dimension | | 5/23/2011 | | | 155 | | | | 24,800 | |
Lafayette | | LA | | SpringHill Suites | | LBA | | 6/23/2011 | | | 103 | | | | 10,232 | |
Tucson | | AZ | | TownePlace Suites | | Western | | 10/6/2011 | | | 124 | | | | 15,852 | |
El Paso | | TX | | Hilton Garden Inn | | Western | | 12/19/2011 | | | 145 | | | | 19,974 | |
Nashville | | TN | | Home2 Suites | | Vista | | 5/31/2012 | | | 119 | | | | 16,660 | |
Total | | | | | | | | | | | 11,371 | | | $ | 1,546,839 | |
(1) Hotel construction was completed by the Company and the hotel opened for business on March 28, 2011. The gross purchase price includes the acquisition of land during 2009 and construction costs. |
Development Project
In July 2012, the Company acquired approximately one acre of land in downtown Richmond, Virginia for a purchase price totaling $3.0 million, for the development of adjoining Courtyard and Residence Inn hotels. In May 2013, the Company entered into a construction contract with a third party and began construction of the hotels during the second quarter of 2013, which is expected to be completed within eighteen months to two years. Upon completion, the Courtyard and Residence Inn are expected to contain approximately 135 and 75 guest rooms, respectively, and are planned to be managed by White. The Company expects to spend a total of approximately $35 million to develop the hotels and has incurred approximately $5.3 million in development costs as of September 30, 2013.
Results of Operations
As of September 30, 2013, the Company owned 89 hotels with 11,371 rooms (including one newly constructed hotel acquired on May 31, 2012, the same day the hotel opened for business). No other hotels have been purchased since the beginning of January 1, 2012.
Hotel performance is impacted by many factors, including the economic conditions in the United States as well as each locality. Although hampered by government spending uncertainty, economic indicators in the United States have shown evidence of a sustainable recovery, which continues to overall positively impact the lodging industry. As a result, the Company’s revenue and operating income improved during the first nine months of 2013 as compared to the same period of 2012 and the Company expects continued improvement in revenue and operating income in 2013 as compared to 2012 and into 2014. 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 revenue consisting of room and other related revenue. For the three months ended September 30, 2013 and 2012, the Company had hotel revenue of $100.2 million and $93.7 million, respectively. For the nine months ended September 30, 2013 and 2012, the Company had hotel revenue of $297.2 million and $278.9 million, respectively. This revenue reflects hotel operations for the 89 hotels owned as of September 30, 2013 for their respective periods of ownership by the Company. For the three months ended September 30, 2013 and 2012, the hotels achieved combined average occupancy of 77% and 74%, ADR of $115 and $111 and RevPAR of $88 and $82. For the nine months ended September 30, 2013 and 2012, the hotels achieved combined average occupancy of 76% and 73%, ADR of $115 and $112 and RevPAR of $87 and $82. ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.
During the third quarter and first nine months of 2013, the Company experienced an increase in demand as demonstrated by the improvement in average occupancy for its comparable hotels of 4% during these periods in 2013 as compared to the same period of 2012. In addition, also signifying a progressing economy, the Company experienced an increase in ADR of 4% for comparable hotels during the third quarter and 3% during the first nine months of 2013 as compared to the same periods in the prior year. Although certain markets have been negatively impacted by reduced government spending, with overall continued demand and room rate improvement, the Company and industry are forecasting a mid-single digit percentage increase in revenue for 2013 as compared to 2012 for comparable hotels with the trend expected to continue in 2014. The Company’s hotels continue to be leaders in their respective markets. The Company’s average Market Yield for the first nine months of 2013 and 2012 was 123 and 121, respectively. The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation or open less than two years) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world. The Company will continue to pursue market opportunities to improve revenue.
Expenses
Hotel operating expenses relate to the 89 hotels owned as of September 30, 2013 for their respective periods owned and consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the three months ended September 30, 2013 and 2012, hotel operating expenses totaled $57.2 million or 57% of total revenue and $53.1 million or 57% of total revenue. For the nine months ended September 30, 2013 and 2012, hotel operating expenses totaled $166.4 million or 56% of total revenue and $155.7 million or 56% of total revenue. Overall hotel operational expenses for the first nine months of 2013 reflect the impact of increases in revenues and occupancy at most of the Company’s hotels, and the Company’s efforts to control costs. Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utility costs by continually monitoring and sharing utilization data across its hotels and management companies. The Company has experienced an increase in labor benefit costs compared to the prior year, which are likely to continue to grow at increased rates due to new government regulations surrounding healthcare. Although operating expenses will increase as revenue increases, the Company will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
Property taxes, insurance, and other expense for the three months ended September 30, 2013 and 2012 totaled $4.8 million or 5% of total revenue and $5.2 million or 6% of total revenue. For the nine months ended September 30, 2013 and 2012, property taxes, insurance, and other expense totaled $15.6 million or 5% of total revenue and $15.1 million or 5% of total revenue. For comparable hotels, real estate taxes during the nine months ended September 30, 2013 increased due to higher taxes for certain properties due to the reassessment of property values by localities resulting from the improved economy, partially offset by a decrease in 2013 due to successful appeals of tax assessments at certain locations. Also, for comparable hotels, 2013 insurance rates increased modestly.
General and administrative expense for the three months ended September 30, 2013 and 2012 was $1.8 million and $2.1 million. For the nine months ended September 30, 2013 and 2012, general and administrative expenses were $5.8 million and $6.4 million. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expenses. During the nine months ended September 30, 2013 and 2012, the Company incurred approximately $0.5 million and $1.3 million, respectively in legal costs related to the legal matters discussed herein and continued costs related to responding to requests from the staff of the SEC. The SEC staff has been conducting a non-public investigation, which is focused principally on the adequacy of certain disclosures in the Company’s filings with the SEC beginning in 2008, as well as the Company’s review of certain transactions involving the Company and the other Apple REIT Entities. The Company intends to continue to cooperate with the SEC staff, and it is engaging in a dialogue with the SEC staff concerning these issues and the roles of certain officers. The Company does not believe the issues raised by the
SEC staff affect the material accuracy of the Company's consolidated financial statements. At this time, the Company cannot predict the outcome of this investigation as to the Company or any of its officers, nor can it predict the timing associated with any such conclusion or resolution. As discussed below under Related Parties, the Company shares legal counsel with the other Apple REIT Entities. Total costs for these legal matters for all of the Apple REIT Entities were approximately $2.2 million and $5.7 million during the nine months ended September 30, 2013 and 2012. The Company anticipates it will continue to incur costs associated with these matters.
Merger transaction costs for the three months ended September 30, 2013 and 2012 totaled $1.9 million and $0, and for the nine months ended September 30, 2013 and 2012, were $2.0 million and $0.6 million. Costs incurred during the three and nine months ended September 30, 2013 were in connection with the Merger Agreement discussed herein. The Company will continue to incur these costs until the mergers are completed or the Merger Agreement is terminated. Costs incurred during the nine months ended September 30, 2012 were associated with the Company’s evaluation of a prior potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc. (the “other Apple REITs”). In May 2012, it was determined by the Board of Directors of the Company and the Board of Directors of each of the other Apple REITs not to move forward with the prior potential consolidation transaction at that time.
Acquisition related costs for the three months ended September 30, 2013 and 2012 were $0 and $3,000, and $0.1 million and $0.5 million for the nine months ended September 30, 2013 and 2012. During the second quarter of 2013, the Company purchased two land parcels which had previously been leased from a third party. The Company did not complete any hotel acquisitions during 2013 and completed only one hotel acquisition during 2012, resulting in a significant decline in these costs from prior years.
Depreciation expense for the three months ended September 30, 2013 and 2012 was $13.7 million and $13.3 million, and $40.9 million and $39.3 million for the nine months ended September 30, 2013 and 2012. Depreciation expense primarily represents expense of the Company’s 89 hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment) for their respective periods owned. The increase was due to the increase in the number of properties owned and renovations completed throughout 2013 and 2012.
Interest expense for the three months ended September 30, 2013 and 2012 was $2.4 million and $1.9 million, respectively and is net of approximately $46,000 and $0.2 million of interest capitalized associated with renovation and construction projects. Interest expense for the nine months ended September 30, 2013 and 2012 was $7.1 million and $5.2 million, respectively and is net of approximately $0.2 million and $0.5 million of interest capitalized associated with renovation and construction projects. Interest expense primarily arose from debt assumed with the acquisition of 14 of the Company’s hotels, the origination of three mortgage loans during the third quarter 2012, borrowings on the Company’s $50 million revolving line of credit beginning in January 2013 and borrowings on the Company’s $30 million non-revolving line of credit in May 2012 that was extinguished and paid off during the third quarter of 2012. During both the three months ended September 30, 2013 and 2012, the Company also recognized $0.1 million in interest income, and $0.4 million and $0.5 million for the nine months ended September 30, 2013 and 2012, primarily representing interest on excess cash invested in short-term money market instruments and one mortgage note acquired during 2010.
Discontinued Operations
On April 27, 2012, the Company completed the sale of its 406 acres of land and land improvements located on 110 sites in the Ft. Worth, Texas area (the “110 parcels”) and the assignment of the lease for a total sale price of $198.4 million. The 110 parcels were acquired in April 2009 for a total purchase price of $147.3 million and were leased to a subsidiary of Chesapeake Energy Corporation (“Chesapeake”) under a long term lease for the production of natural gas. At closing, the Company received approximately $138.4 million in cash proceeds and issued a note receivable totaling $60.0 million to the purchaser (the “note”). The note, which approximated fair market value, is secured by a junior lien on the land and land improvements owned by the purchaser. The stated interest rate on the note is 10.5%. The note requires interest only payments for the first three years of the note. After the first three years, interest is accrued and payments will only be received once the purchaser extinguishes its senior loan with a third party. Once the senior loan is repaid, the Company will receive all payments from the existing lease until fully repaid or the note reaches maturity which is April 2049. Although the purchaser is not affiliated with the Company, a partner of the purchaser is also a member of the Board of Directors of Apple REIT Ten, Inc. In conjunction with the sale, the Company incurred a brokerage commission to Apple Suites Realty Group, Inc. (“ASRG”) totaling approximately $4.0 million, representing 2% of the gross sales price. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60.0 million note. The $4.0 million commission has been recorded as a reduction to the deferred gain on sale as described below.
The total gain on sale was approximately $33.3 million (total sale price of $198.4 million less carrying value totaling $160.5 million, ASRG fee totaling $4.0 million, closing costs totaling $0.3 million and related franchise taxes totaling $0.3 million). In accordance with the Accounting Standards Codification on real estate sales, the sales transaction is being
accounted for under the cost recovery method, therefore the gain on sale and interest earned on the note will be deferred until cash payments by the purchaser, including principal and interest on the note due to the Company and the payment of the $138.4 million at closing exceed the Company’s cost basis of the 110 parcels sold. The note receivable is included in the Company’s consolidated balance sheets, net of the total deferred gain. As of September 30, 2013, the note receivable, net was $17.7 million, including $60.0 million note receivable offset by $33.3 million deferred gain and $9.0 million deferred interest earned. As of December 31, 2012, the note receivable, net was $22.4 million, including $60.0 million note receivable offset by $33.4 million deferred gain and $4.3 million deferred interest earned. The 110 parcels was a separate reportable segment and the results of operations for these properties have been classified in the consolidated statements of operations in the line item income from discontinued operations.
The following table sets forth the components of income from discontinued operations for the three and nine months ended September 30, 2012 (in thousands):
| | Three Months | | | Nine Months | |
| | Ended | | | Ended | |
| | September 30, 2012 | | | September 30, 2012 | |
Rental revenue | | $ | 0 | | | $ | 6,826 | |
Operating expenses | | | 0 | | | | 34 | |
Depreciation expense | | | 0 | | | | 0 | |
Income from discontinued operations | | $ | 0 | | | $ | 6,792 | |
Prior to the sale, the lease was classified as an operating lease and rental income was recognized on a straight-line basis over the initial term of the lease. Rental revenue includes approximately $2.0 million of adjustments to record rent on the straight-line basis for the nine months ended September 30, 2012.
Related Parties
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 if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the nine months ended September 30, 2013 (other than the transactions related to the completion of Apple REIT Six, Inc.’s merger with a third party and the Merger Agreement and related transactions discussed below). The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.
The term the “Apple REIT Entities” means Apple REIT Six, Inc. (“Apple Six”), Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”), Apple REIT Nine, Inc. (“Apple Nine”) and Apple REIT Ten, Inc. (“Apple Ten”). The term the “Advisors” means Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc. (“A9A”), Apple Ten Advisors, Inc., Apple Suites Realty Group, Inc. (“ASRG”) and Apple Six Realty Group, Inc. The Advisors are wholly owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple Seven, Apple Eight and Apple Ten. Members of the Company’s Board of Directors are also on the Board of Directors of Apple Seven and Apple Eight.
On May 14, 2013, Apple Six merged with and into an entity that is not affiliated with the Apple REIT Entities or the Advisors. Pursuant to the terms and conditions of the merger agreement, dated as of November 29, 2012, upon completion of the merger, the separate corporate existence of Apple Six ceased (the “A6 Merger”). Prior to the A6 Merger, Glade M. Knight was Chairman and Chief Executive Office of Apple Six and members of the Company’s Board of Directors were also on the Board of Directors of Apple Six.
ASRG Agreement
The Company has a contract with ASRG, to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of September 30, 2013, payments to ASRG for fees under the terms of this contract related to the acquisition of assets have totaled approximately $33.6 million since inception. Of this amount, the Company incurred approximately $0.1 million and $0.4 million during the nine months ended September 30, 2013 and 2012. During the second quarter of 2013, the Company paid fees to ASRG for the purchase of two land parcels located at the Residence Inn hotels in Manassas, Virginia and San Bernardino, California, both which had previously been leased from a third party. In addition, the Company incurred a brokerage commission to ASRG totaling approximately $4.0 million related to the sale of the
Company’s 110 parcels in April 2012, which has been recorded as a reduction to the deferred gain on sale. Of this amount, approximately $2.8 million was paid to ASRG during the second quarter of 2012 and the remaining $1.2 million will be paid upon repayment of the $60 million note.
A9A Agreement
The Company is party to an advisory agreement with A9A, pursuant to which A9A provides management services to the Company. A9A provides these management services through Apple Fund Management, LLC (“AFM”), which immediately after the A6 Merger became a wholly-owned subsidiary of A9A. This transaction between A9A and Apple Six was made with no cash consideration exchanged between the entities. Prior to May 14, 2013, AFM was a wholly-owned subsidiary of Apple Six. An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses as described below, are payable to A9A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $2.1 million and $2.2 million for the nine months ended September 30, 2013 and 2012.
Apple REIT Entities and Advisors Cost Sharing Structure
In addition to the fees payable to ASRG or A9A, the Company reimbursed to ASRG or A9A, or paid directly to AFM on behalf of ASRG or A9A, approximately $1.6 million for both the nine months ended September 30, 2013 and 2012. The expenses reimbursed were approximately $0 and $0.1 million, respectively, for costs reimbursed under the contract with ASRG and approximately $1.6 million and $1.5 million, respectively, for costs reimbursed under the contract with A9A. The costs are included in general and administrative expenses and are for the Company’s allocated share of the staffing and related costs provided by AFM at the direction of A9A.
AFM is an affiliate of each of the Advisors. Each of the Advisors provides management services through the use of AFM to, respectively, Apple Six (prior to the A6 Merger), Apple Seven, Apple Eight, Apple Nine and Apple Ten. In connection with the A6 Merger, effective May 14, 2013, the entire membership interest of Apple Six in AFM was transferred and assigned to A9A, which then became the sole member of AFM. As part of the assignment, A9A and the other Advisors agreed to indemnify the buyer of Apple Six for liabilities related to AFM. The assignment of AFM’s interest to A9A had no impact on the Company’s advisory agreement with A9A or the process of allocating costs from AFM to the Apple REIT Entities or Advisors as described below, except Apple Six and its advisors, Apple Six Advisors, Inc. and Apple Six Realty Group, Inc. (collectively “A6 Advisors”), no longer participate in the cost sharing arrangement, thereby increasing the remaining companies’ share of the allocated costs.
Also, in connection with the A6 Merger, on May 13, 2013, the Company acquired from Apple Six the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and assumed the Fort Worth, Texas office lease agreement for approximately $4.5 million, which approximated fair value at the time of acquisition based on third party market comparisons. As part of the purchase, the Company agreed to release Apple Six from any liabilities related to the Headquarters or office lease. As described below, any costs associated with the Headquarters and office lease, including office rent, utilities, office supplies, etc. (“Office Related Costs”) will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors.
Prior to the A6 Merger, amounts reimbursed to AFM included both compensation for personnel and Office Related Costs used by the companies. As discussed above, as a result of the A6 Merger, beginning on May 14, 2013, Office Related Costs are now allocated from the Company to the other Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors. Each of these companies has agreed to reimburse the Company for its share of these costs. From the period May 14, 2013 through September 30, 2013, the Company received reimbursement of its costs totaling approximately $0.4 million from the participating entities. The Company’s net allocated Office Related Costs were approximately $0.1 million and is included in general and administrative costs in the Company’s consolidated statements of operations.
All of the Office Related Costs and costs of AFM are allocated among the Apple REIT Entities and the Advisors, excluding Apple Six and A6 Advisors after the A6 Merger. The allocation of costs is reviewed at least annually by the Compensation Committees of the Apple REIT Entities. In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each company’s level of business activity and the extent to which each company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described above allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Since the employees of AFM perform services for the Apple REIT Entities and
Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.
As part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) are reimbursed or collected and are not significant in amount.
The Company has incurred legal fees associated with the Legal Proceedings and Related Matters discussed herein. The Company also incurs other professional fees such as accounting, auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable across the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services. The total costs for the Legal Proceedings and Related Matters discussed herein for all of the Apple REIT Entities (excluding Apple Six after the A6 Merger) was approximately $2.2 million for the nine months ended September 30, 2013, of which approximately $0.5 million was allocated to the Company. Total costs for the nine months ended September 30, 2012 for all of the Apple REIT Entities was approximately $5.7 million, of which approximately $1.3 million was allocated to the Company.
Apple Air Holding, LLC (“Apple Air”) Membership Interest
Included in other assets, net on the Company’s consolidated balance sheet is a 24% equity investment in Apple Air. The other current members of Apple Air are Apple Seven, Apple Eight and Apple Ten. In connection with the A6 Merger, on May 13, 2013, Apple Ten acquired its membership interest in Apple Air from Apple Six. Through its equity investment, the Company has access to Apple Air’s aircraft for acquisition, asset management and renovation purposes. The Company’s equity investment was approximately $1.7 million and $1.9 million as of September 30, 2013 and December 31, 2012. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the nine months ended September 30, 2013 and 2012, the Company recorded a loss of approximately $181,000 and $145,000 respectively, as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.
Merger Agreement and Related Transactions
Concurrently with the execution of the Merger Agreement (as discussed in note 2), on August 7, 2013, the following agreements were entered into by the Company:
· Apple Seven, Apple Eight and Apple Nine entered into a termination agreement, as amended (the “Termination Agreement”) with Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., A9A and ASRG, effective immediately before the completion of the mergers. Pursuant to the Termination Agreement, the existing advisory agreements and property acquisition/disposition agreements with respect to Apple Seven, Apple Eight and Apple Nine will be terminated. The Termination Agreement does not provide for any separate payments to be made in connection with the termination of the existing advisory agreements and property acquisition/disposition agreements. As a result, if the mergers are completed, Apple Seven, Apple Eight and Apple Nine will no longer pay the various fees currently paid to its respective advisors.
· Apple Nine entered into a subcontract agreement, as amended (the “Subcontract Agreement”) with Apple Ten Advisors, Inc. (“A10A”). Pursuant to the Subcontract Agreement, A10A will subcontract its obligations under the advisory agreement between A10A and Apple Ten to Apple Nine. The Subcontract Agreement provides that, from and after the completion of the mergers, Apple Nine will provide to Apple Ten the advisory services contemplated under the A10A advisory agreement and will receive the fees and expenses payable under the A10A advisory agreement from Apple Ten.
· Apple Nine entered into an assignment and transfer agreement, as amended (the “Transfer Agreement”) with A9A and AFM. Pursuant to the Transfer Agreement, Apple Nine will acquire all of the membership interests in AFM from A9A effective immediately following the completion of the mergers. The Transfer Agreement provides that Apple Nine will assume all of the obligations of the predecessor owners of AFM under prior transfer agreements involving the transfer of the membership interests in AFM (including Apple Hospitality Two, Inc., Apple Hospitality Five, Inc., Apple Six and A9A) and relieve the predecessor owners and the other advisory companies of any liability with respect to AFM.
Liquidity and Capital Resources
Capital Resources
In November 2012, the Company entered into a $50 million credit facility with a commercial bank that is utilized for working capital, hotel renovations and development, and other general corporate funding purposes, including the payment of redemptions and distributions. The credit facility may be increased to $100 million, subject to certain conditions. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part at any time. The credit facility matures in November 2014; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to November 2015. Interest payments are due monthly and the interest rate, subject to certain exceptions, is equal to the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 2.75%, depending upon the Company’s leverage ratio, as calculated under the terms of the credit agreement. The Company is also required to pay an unused facility fee of 0.30% or 0.40% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during the quarter. As of September 30, 2013, the credit facility had an outstanding principal balance of $22.0 million and an annual interest rate of approximately 2.43%. As of December 31, 2012, there were no borrowings outstanding under the credit facility.
The credit agreement requires the Company to maintain a specific pool of Unencumbered Borrowing Base Properties (must be a minimum of ten properties and must satisfy conditions as defined in the credit agreement). The obligations of the lender to make any advances under the credit facility are subject to certain conditions, including that the outstanding borrowings do not exceed the Borrowing Base Availability. The credit facility contains customary affirmative covenants, negative covenants and events of default. In addition, the credit facility contains the following quarterly financial covenants (capitalized terms are defined in the credit agreement):
· | A maximum Consolidated Total Indebtedness limit of 45% of the aggregate Real Estate Values for all Eligible Real Estate that is or qualifies as an Unencumbered Borrowing Base Property; |
· | A maximum Consolidated Total Indebtedness limit of 50% of the Consolidated Total Asset Value; |
· | A minimum Adjusted Consolidated EBITDA to Consolidated Fixed Charges covenant of 1.75 to 1.00 for the total of the four trailing quarterly periods; |
· | A minimum Consolidated Tangible Net Worth of $1.0 billion; |
· | A maximum Consolidated Secured Debt limit of 40% of Consolidated Total Asset Value; |
· | A minimum Adjusted NOI for all Eligible Real Estate that is or qualifies as an Unencumbered Borrowing Base Property to Implied Debt Service covenant of 2.25 to 1.00; |
· | A maximum Consolidated Secured Recourse Indebtedness of $10 million; and |
· | Restricted Payments (including Distributions and Unit Redemptions), net of proceeds from the Company’s Dividend Reinvestment Plan, cannot exceed $152 million in any cumulative 12 month period and Distributions cannot exceed $0.83025 per share for any calendar year, unless such Restricted Payments are less than the Company’s Funds From Operations for any cumulative four calendar quarters. |
The Company was in compliance with each of these covenants at September 30, 2013.
Capital Uses
The Company’s principal sources of liquidity are the operating cash flow generated from the Company’s properties, interest received on the Company’s note receivables and its $50 million revolving credit facility. The Company anticipates that cash flow from operations, interest received from notes receivables and availability under its revolving credit facility will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements (including its development project discussed herein), required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), and planned Unit redemptions.
As a result of the sale of its 110 parcels, the Board of Directors approved a special distribution of $0.75 per Unit, totaling $136.1 million on May 17, 2012 to shareholders of record on May 11, 2012 (the “Special Distribution”). As a result of the sale and Special Distribution, the Company’s Board of Directors changed the annualized distribution rate from $0.88 per Unit to $0.83 per Unit beginning with the June 2012 distribution, and in August 2012, the Board of Directors increased the annualized distribution rate from $0.83 per Unit to $0.83025 per Unit. Additionally, the offering price per Unit under the Company’s Dividend Reinvestment Plan was adjusted by the amount of the Special Distribution (from $11.00 to $10.25), and the purchase price per Unit under the Company’s Unit Redemption Program was adjusted by the amount of the Special Distribution (from $11.00 to $10.25 for the maximum purchase price, based on the original purchase price and length of time such Units have been held by the shareholder).
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions during the first nine months of 2013 totaled approximately $113.6 million and were paid at a monthly rate of $0.0691875 per common share. For the same period the Company’s net cash generated from operations was approximately $98.0 million. This shortfall includes a return of capital and was funded primarily by borrowings on the credit facility and cash on hand.
The Company’s objective in setting an annualized distribution rate is to project a rate that will provide consistency over the life of the Company taking into account acquisitions, dispositions, capital improvements, ramp up of new properties, completion of planned development projects and varying economic cycles. To meet this objective, the Company may require the use of debt and offering proceeds, in addition to cash from operations. Since a portion of distributions has been funded with borrowed funds, the Company’s ability to maintain its current intended rate of distribution will be primarily based on the ability of the Company’s properties to generate cash from operations at this level, as well as the Company’s ability to utilize currently available financing, or the Company’s ability to obtain additional financing. Since there can be no assurance of the Company’s ability to obtain additional financing or that properties owned by the Company will provide income at this level, there can be no assurance as to the classification or duration of distributions at the current rate. 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 July 2009, 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. Since the inception of the program through April 2012, shareholders were permitted to request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. In May 2012, as a result of the Special Distribution, the purchase price per Unit under the Company’s Unit Redemption Program was adjusted by the amount of the Special Distribution (from $11.00 to $10.25 for the maximum purchase price, based on the original purchase price and length of time such Units have been held by the shareholder). The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. 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. On June 27, 2013, the Company announced the suspension of its Unit Redemption Program as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the program until the Merger Agreement is terminated or the mergers are completed.
Since inception of the program through September 30, 2013, the Company has redeemed approximately 11.7 million Units representing $121.2 million, including 2.0 million Units in the amount of $20.0 million and 4.0 million Units in the amount of $42.0 million redeemed during the nine months ended September 30, 2013 and 2012, respectively. Since July 2011, the total redemption requests have exceeded the authorized amount of redemptions and, as a result, the Board of Directors has limited the amount of redemptions as deemed prudent. Therefore, as contemplated in the program, beginning with the July 2011 redemption, the scheduled redemption date for the third quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to July 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2012 and the first nine months of 2013:
Redemption Date | | Total Requested Unit Redemptions at Redemption Date | | | Units Redeemed | | | Total Redemption Requests Not Redeemed at Redemption Date | |
| | | | | | | | | |
First Quarter 2012 | | | 10,689,219 | | | | 1,507,187 | | | | 9,182,032 | |
Second Quarter 2012 | | | 11,229,890 | | | | 1,509,922 | | | | 9,719,968 | |
Third Quarter 2012 | | | 10,730,084 | | | | 1,004,365 | | | | 9,725,719 | |
Fourth Quarter 2012 | | | 11,155,269 | | | | 1,003,267 | | | | 10,152,002 | |
First Quarter 2013 | | | 12,135,251 | | | | 990,324 | | | | 11,144,927 | |
Second Quarter 2013 | | | 13,039,019 | | | | 988,095 | | | | 12,050,924 | |
In December 2010, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a 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. As a result of the Special Distribution, beginning in May 2012, the offering price per Unit under the Company’s Dividend Reinvestment Plan was adjusted by the amount of the Special Distribution (from $11.00 to $10.25). The Company has registered 20.0 million Units for potential issuance under the plan.
Since inception of the plan through September 30, 2013, approximately 12.3 million Units, representing $131.0 million in proceeds to the Company, were issued under the plan. During the nine months ended September 30, 2013 and 2012, approximately 2.1 million Units, representing $22.0 million in proceeds to the Company, and 3.6 million Units, representing $38.2 million in proceeds to the Company, were issued under the plan. On June 27, 2013, the Company announced the suspension of its Dividend Reinvestment Plan as it evaluated the potential merger transaction. Under the Merger Agreement, the Company is required to continue the suspension of the plan until the Merger Agreement is terminated or the mergers are completed.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. As of September 30, 2013, the Company held $7.7 million in reserves for capital expenditures. During the first nine months of 2013, the Company spent approximately $8.8 million on capital expenditures for existing hotels and anticipates spending an additional $20 to $25 million through 2014. Additionally, the Company acquired land in Richmond, Virginia for the development of adjoining Courtyard and Residence Inn hotels. In May 2013, the Company entered into a construction contract with a third party and began construction of the hotels during the second quarter of 2013, which is expected to be completed within eighteen months to two years. The Company expects to spend a total of approximately $35 million to develop the hotels and has incurred approximately $5.3 million in development costs as of September 30, 2013, of which approximately $4.2 million was incurred during the first nine months of 2013.
In connection with the A6 Merger, on May 13, 2013, the Company acquired from Apple Six the Apple REIT Entities’ and Advisors’ headquarters in Richmond, Virginia (“Headquarters”) and assumed the Fort Worth, Texas office lease agreement for approximately $4.5 million. As part of the purchase, the Company agreed to release Apple Six from any liabilities related to the Headquarters or office lease. Any costs associated with the Headquarters and office lease, including office rent, utilities, office supplies, etc. will continue to be allocated to the Apple REIT Entities and Advisors, excluding Apple Six and A6 Advisors as described above in Related Parties.
As discussed above in Related Parties, as part of the cost sharing arrangements, the day-to-day transactions may result in amounts due to or from the Apple REIT Entities and Advisors (excluding Apple Six and A6 Advisors after the A6 Merger). To efficiently manage cash disbursements, an individual Apple REIT Entity or Advisor (excluding Apple Six and A6 Advisors after the A6 Merger) may make payments for any or all of the related companies.
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 historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.
Subsequent Events
In October 2013, the Company declared and paid approximately $12.6 million, or $0.0691875 per outstanding common share, in distributions to its common shareholders.
On November 1, 2013, the $60 million note receivable, as discussed above in Discontinued Operations was repaid by the purchaser in full and the purchaser was released from all liability and obligations under the note. In exchange for the early payment and waiver by the purchaser of certain terms of the note, the Company agreed to waive approximately $0.5 million of interest for the month of October 2013. As a result of the repayment of the note, the Company will recognize the deferred gain on sale totaling $33.3 million and deferred interest earned totaling $9.0 million for a total gain of
approximately $42.3 million as of September 30, 2013 in the fourth quarter of 2013. The Company plans to use the proceeds from the repayment of the note to reduce the outstanding balance under its $50 million credit facility and to fund general corporate purposes, including working capital, renovations and hotel development.
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, 2013, the Company’s financial instruments were not exposed to significant market risk due to 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 on its credit facility. Based on the balance of the Company’s credit facility at September 30, 2013 of $22.0 million, every 100 basis points change in interest rates could impact the Company’s annual net income by approximately $0.2 million, all other factors remaining the same. The Company’s cash balance at September 30, 2013 was $0.
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 were effective as of September 30, 2013. 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.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The term the “Apple REIT Entities” means Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation. The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012. The Company was previously named as a party in all three of the above mentioned class action lawsuits.
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc. and David Lerner. The consolidated complaint, which was dismissed in April 2013, was purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Entities, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, and alleges that the Apple REIT Entities “misrepresented the investment objectives of the Apple REITs, the dividend payment policy of the Apple REITs, and the value of their Apple REIT investments.” The consolidated complaint asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, as well as claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida. The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
On April 18, 2012, the Company, and the other defendants moved to dismiss the consolidated complaint in the In re Apple REITs Litigation. By Order entered on March 31, 2013 and opinion issued on April 3, 2013, the Court dismissed the consolidated complaint in its entirety with prejudice and without leave to amend. Plaintiffs filed a Notice of Appeal to the Second Circuit Court of Appeals on April 12, 2013, and filed their Brief for Plaintiffs-Appellants on July 26, 2013. Defendants-Appellees filed their Briefs on October 25, 2013. The Company believes that Plaintiffs’ claims against it, its officers and directors and other Apple REIT Entities were properly dismissed by the lower court, and intends to vigorously defend the judgment as entered. In the event some or all of Plaintiffs’ claims are revived as a result of Plaintiffs’ appeal, the Company will, once again, defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
The Company faces many risks, a number of which are described under “Risk Factors” in Part I of its 2012 Annual Report and described below. The risks so described may not be the only risks the Company faces. Additional risks of which the Company is not yet aware, or that currently are not significant, may also impair its operations or financial results. If any of the events or circumstances described in the risk factors contained in the Company’s 2012 Annual Report or described below occurs, the business, financial condition or results of operations of the Company could be negatively impacted. The following updates the disclosures from Item 1A. “Risk Factors” previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, filed with the Securities and Exchange Commission, and should be read in conjunction with those risk factors.
The proposed mergers with Apple REIT Seven, Inc. and Apple REIT Eight, Inc. present certain risks to the Company’s business and operations.
In August 2013, the Company entered into an agreement and plan of merger with Apple REIT Seven, Inc. and Apple REIT Eight, Inc. under which Apple REIT Seven, Inc. and Apple REIT Eight, Inc. would merge into wholly owned subsidiaries of the Company. The mergers are expected to be completed in the fourth quarter of 2013 or the first quarter of 2014, although there can be no assurance of completion by any particular date, if at all. Because the mergers are subject to a number of conditions, including required shareholder and other third party approvals and the receipt of certain consents and waivers from third parties, the exact timing of when the mergers will be completed, if at all, cannot be determined at this time.
Prior to closing, the mergers may present certain risks to the Company’s business and operations, including, among other things, that:
· | management’s attention to day-to-day business may be diverted; |
· | the Company expects to incur significant transaction costs related to the mergers; |
· | if the merger agreement is terminated under certain circumstances, the Company may be required to pay termination fees and reimburse certain expenses; and |
· | the merger agreement prohibits the Company from soliciting competing transactions, and places conditions on its ability to negotiate and accept a superior competing transaction. |
Exhibit Number | Description of Documents |
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2.1 | Agreement and Plan of Merger, dated as of August 7, 2013, as amended, among Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc., Apple Seven Acquisition Sub, Inc. and Apple Eight Acquisition Sub, Inc. (Incorporated by reference to Annex A to the joint proxy statement/prospectus included in the registrant’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
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3.1 | Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008) |
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3.2 | Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008) |
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10.103 | Voting Agreement, dated as of August 7, 2013, as amended, by and among Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Glade M. Knight (Incorporated by reference to Exhibit 10.7 to the registrant’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
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10.104 | Form of Conversion Agreement (Incorporated by reference to Exhibit 99.5 to the registrant’s current report on Form 8-K (SEC File No. 000-53603) filed August 8, 2013) |
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10.105 | Termination Agreement dated as of August 7, 2013, as amended, by and among Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Suites Realty Group, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. (Incorporated by reference to Annex G to the joint proxy statement/prospectus included in the registrant’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
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10.106 | Subcontract Agreement, dated as of August 7, 2013, as amended, between Apple REIT Nine, Inc. and Apple Ten Advisors, Inc. (Incorporated by reference to Annex H to the joint proxy statement/prospectus included in the registrant’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
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10.107 | Assignment and Transfer Agreement, dated as of August 7, 2013, as amended, by and among Apple Fund Management, LLC, Apple Nine Advisors, Inc. and Apple REIT Nine, Inc. (Incorporated by reference to Annex I to the joint proxy statement/prospectus included in the registrant’s registration statement on Form S-4 (SEC File No. 333-191084) originally filed September 11, 2013) |
31.1 | Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH) |
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31.2 | Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH) |
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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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101 | The following materials from Apple REIT Nine, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text and in detail (FILED HEREWITH) |
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 NINE, INC. | | |
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By: | /s/ GLADE M. KNIGHT | | Date: November 6, 2013 |
| Glade M. Knight, | | |
| Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | | |
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By: | /s/ BRYAN PEERY | | Date: November 6, 2013 |
| Bryan Peery, | | |
| Chief Financial Officer (Principal Financial and Principal Accounting Officer) | | |