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** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(****Mark One)**

 

| **x**                                                            | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                             |                                                                                                     |
| **For the quarterly period ended September 30,  2009** |
|                                                             |                                                                                                     |
| **or**                                                           |
|                                                             |                                                                                                     |
| **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 ofregistrant as specified in its charter)

 

| **VIRGINIA**                                                    | ** ** | **20-2879175**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

| **814 EAST MAIN STREET, RICHMOND,  VIRGINIA** | ** ** | **23219**  |
|-----------------------------------------------|------------|------------|
| (Address of principal  executive offices)     |       | (Zip Code) |

 

**(804) 344-8121**

(Registrant’stelephone number, including area code)

 

 

(Former name,former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  x Yes o No

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).  o Yes o No

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See the definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act.

 

| Large accelerated filer o                                |   | Accelerated filer o              |
|-------------------------------------------------------------------------|--------|--------------------------------------------|
|                                                                    |   |                                       |
| Non-accelerated filer x                                       |   | Smaller reporting company o |
| (Do not check if a smaller  reporting company) |   |                                       |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act)  oYes  x No

 

As of November 1, 2009 there were 93,146,763outstanding shares of common stock, no par value, of the registrant.

 

 

 

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**APPLEREIT SEVEN, INC.****FORM 10-Q**

**INDEX**

 
| ** **                        | **Page  Number** |
|-----------------------------------|------------------|
| **PART I. FINANCIAL INFORMATION** | ** **       |
| ** **                        | ** **       |
|                              | Item 1.          | Financial Statements (Unaudited) |   |
|                              |             |   |   |
|                              |             | Consolidated Balance Sheets - September 30, 2009 and  December 31, 2008 | 3 |
|                              |             |   |   |
|                              |             | Consolidated  Statements of Operations — For the three and nine months ended September 30,  2009 and 2008 | 4 |
|                              |             |   |   |
|                              |             | Consolidated  Statements of Cash Flows — For the nine months ended September 30, 2009 and  2008 | 5 |
|                              |             |   |   |
|                              |             | Notes to Consolidated Financial Statements | 6 |
|                              |             |   |   |
|                              | Item  2.         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 10 |
|                              |             |   |   |
|                              | Item 3.          | Quantitative  and Qualitative Disclosures About Market Risk | 19 |
|                              |             |   |   |
|                              | Item 4.          | Controls  and Procedures | 19 |
|                              |             |   |   |
| **PART II. OTHER  INFORMATION**   |
| ** **                        |
|                              | Item 1.          | Legal Proceedings (not applicable) |   |
|                              |             |   |   |
|                              | Item 1A.         | Risk Factors (not applicable) |   |
|                              |             |   |   |
|                              | Item 2.          | Unregistered  Sales of Equity Securities and Use of Proceeds | 20 |
|                              |             |   |   |
|                              | Item 3.          | Defaults Upon Senior Securities (not applicable) |   |
|                              |             |   |   |
|                              | Item 4.          | Submission of Matters to a Vote of Security Holders  (not applicable) |   |
|                              |             |   |   |
|                              | Item 5.          | Other Information (not applicable) |   |
|                              |             |   |   |
|                              | Item 6.          | Exhibits | 21 |
|                              |             |   |   |
| Signatures                        | 22               |

 

This Form 10-Q includes references to certaintrademarks or service marks.  TheSpringHill 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 itsaffiliates.  The Homewood Suites® byHilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites®trademarks are the property of Hilton Worldwide (formerly Hilton HotelsCorporation) or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol hasbeen omitted but will be deemed to be included wherever the above referencedterms are used.

 

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**Apple REIT Seven, Inc.**

**Consolidated Balance Sheets**

**(Unaudited)**

**(In thousands, except share data)**

** **
| ** **                                                                                                                                      | ** ** | **September  30,** | ** ** | **December  31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                                      | ** ** | **2009**           | ** ** | **2008**          | ** ** |
| **ASSETS**                                                                                                                                      |       |               |       |              |       |
| Investment in  real estate, net of accumulated depreciation of $72,609 and $48,497, respectively                                                |       | $                  | 908,268    |              | $          | 920,688 |   |
| Cash and cash  equivalents                                                                                                                      |       | —             |       | 20,609            |       |
| Restricted  cash-furniture, fixtures and other escrows                                                                                          |       | 9,127              |       | 9,421             |       |
| Due from third party  managers                                                                                                                  |       | 8,346              |       | 6,548             |       |
| Other assets, net                                                                                                                               |       | 6,793              |       | 10,578            |       |
|                                                                                                                                            |       |               |       |              |       |
| **TOTAL  ASSETS**                                                                                                                               |       | $                  | 932,534    |              | $          | 967,844 |   |
|                                                                                                                                            |       |               |       |              |       |
| **LIABILITIES**                                                                                                                                 |       |               |       |              |       |
| Notes payable                                                                                                                                   |       | $                  | 109,315    |              | $          | 109,275 |   |
| Accounts payable and  accrued expenses                                                                                                          |       | 14,096             |       | 12,816            |       |
|                                                                                                                                            |       |               |       |              |       |
| **TOTAL  LIABILITIES**                                                                                                                          |       | 123,411            |       | 122,091           |       |
|                                                                                                                                            |       |               |       |              |       |
| **SHAREHOLDERS’  EQUITY**                                                                                                                  |       |               |       |              |       |
| Preferred stock,  authorized 15,000,000 shares; none issued and outstanding                                                                     |       | —             |       | —            |       |
| Series A  preferred shares, no par value, authorized 200,000,000 shares; issued and  outstanding 93,640,850 and 93,530,188 shares, respectively |       | —             |       | —            |       |
| 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 93,640,850  and 93,530,188 shares, respectively              |       | 927,554            |       | 925,248           |       |
| Distributions greater than  net income                                                                                                          |       | (118,455           | )          | (79,519           | )          |
|                                                                                                                                            |       |               |       |              |       |
| **TOTAL  SHAREHOLDERS’ EQUITY**                                                                                                            |       | 809,123            |       | 845,753           |       |
|                                                                                                                                            |       |               |       |              |       |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                            |       | $                  | 932,534    |              | $          | 967,844 |   |

 

**Seenotes to consolidated financial statements.**

 

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**AppleREIT Seven, Inc.**

**Consolidated Statements of Operations**

**(Unaudited)**

**(Inthousands, except per share data)**

 
| ** **                                                     | ** ** | **Three  months**       | ** ** | **Three  months**       | ** ** | **Nine  months**        | ** ** | **Nine  months**        | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                     | ** ** | **ended**               | ** ** | **ended**               | ** ** | **ended**               | ** ** | **ended**               | ** ** |
| ** **                                                     | ** ** | **September  30, 2009** | ** ** | **September  30, 2008** | ** ** | **September  30, 2009** | ** ** | **September  30, 2008** | ** ** |
| ** **                                                     | ** ** | ** **              | ** ** | ** **              | ** ** | ** **              | ** ** | ** **              | ** ** |
| Revenues:                                                      | ** ** | ** **              | ** ** | ** **              | ** ** | ** **              | ** ** | ** **              | ** ** |
| Room revenue                                                   |       | $                       | 45,225     |                    | $          | 52,552                  |       | $                       | 134,796    |   | $ | 151,031 |   |
| Other revenue                                                  |       | 4,198                   |       | 4,696                   |       | 12,768                  |       | 13,852                  |       |
| Total revenue                                                  |       | 49,423                  |       | 57,248                  |       | 147,564                 |       | 164,883                 |       |
|                                                           |       |                    |       |                    |       |                    |       |                    |       |
| Expenses:                                                      |       |                    |       |                    |       |                    |       |                    |       |
| Operating expense                                              |       | 13,098                  |       | 14,805                  |       | 38,781                  |       | 42,728                  |       |
| Hotel administrative  expense                                  |       | 3,839                   |       | 4,240                   |       | 11,854                  |       | 13,323                  |       |
| Sales and marketing                                            |       | 3,844                   |       | 4,228                   |       | 11,589                  |       | 12,433                  |       |
| Utilities                                                      |       | 2,528                   |       | 2,735                   |       | 6,808                   |       | 6,939                   |       |
| Repair and maintenance                                         |       | 2,223                   |       | 2,592                   |       | 6,699                   |       | 7,291                   |       |
| Franchise fees                                                 |       | 2,063                   |       | 2,201                   |       | 6,036                   |       | 6,421                   |       |
| Management fees                                                |       | 1,526                   |       | 1,927                   |       | 4,752                   |       | 5,765                   |       |
| Taxes, insurance and  other                                    |       | 3,150                   |       | 3,898                   |       | 10,532                  |       | 10,341                  |       |
| General and administrative                                     |       | 1,030                   |       | 1,323                   |       | 3,369                   |       | 4,381                   |       |
| Depreciation expense                                           |       | 8,176                   |       | 7,313                   |       | 24,111                  |       | 20,809                  |       |
| Total expenses                                                 |       | 41,477                  |       | 45,262                  |       | 124,531                 |       | 130,431                 |       |
|                                                           |       |                    |       |                    |       |                    |       |                    |       |
| Operating income                                               |       | 7,946                   |       | 11,986                  |       | 23,033                  |       | 34,452                  |       |
|                                                           |       |                    |       |                    |       |                    |       |                    |       |
| Interest expense, net                                          |       | (1,696                  | )          | (1,250                  | )          | (4,564                  | )          | (2,588                  | )          |
|                                                           |       |                    |       |                    |       |                    |       |                    |       |
| Net income                                                     |       | $                       | 6,250      |                    | $          | 10,736                  |       | $                       | 18,469     |   | $ | 31,864 |   |
|                                                           |       |                    |       |                    |       |                    |       |                    |       |
| Basic and  diluted net income per common share                 |       | $                       | 0.07       |                    | $          | 0.12                    |       | $                       | 0.20       |   | $ | 0.34 |   |
|                                                           |       |                    |       |                    |       |                    |       |                    |       |
| Weighted average  common shares outstanding; basic and diluted |       | 93,486                  |       | 92,865                  |       | 93,500                  |       | 92,428                  |       |
|                                                           |       |                    |       |                    |       |                    |       |                    |       |
| Distributions  declared and paid per common share              |       | $                       | 0.19       |                    | $          | 0.22                    |       | $                       | 0.61       |   | $ | 0.66 |   |

 

**Seenotes to consolidated financial statements.**

 

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**Apple REIT Seven, Inc.**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**

**(In thousands)**

 
| ** **                                                                     | ** ** | **Nine  months**        | ** ** | **Nine  months**        | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                     | ** ** | **ended**               | ** ** | **ended**               | ** ** |
| ** **                                                                     | ** ** | **September  30, 2009** | ** ** | **September  30, 2008** | ** ** |
| Cash flow from  operating activities:                                          |       |                    |       |                    |       |
| Net income                                                                     |       | $                       | 18,469     |                    | $          | 31,864 |   |
| Adjustments to  reconcile net income to cash provided by operating activities: |       |                    |       |                    |       |
| Depreciation of real  estate owned                                             |       | 24,111                  |       | 20,809                  |       |
| Amortization of  deferred financing costs and fair value adjustments           |       | (289                    | )          | (219                    | )          |
| Changes in operating  assets and liabilities:                                  |       |                    |       |                    |       |
| Increase in funds due  from third party managers                               |       | (1,798                  | )          | (3,887                  | )          |
| Decrease (increase) in  other assets                                           |       | 440                     |       | (91                     | )          |
| Increase in accounts  payable and accrued expenses                             |       | 2,168                   |       | 2,773                   |       |
| Net cash provided by  operating activities                                     |       | 43,101                  |       | 51,249                  |       |
|                                                                           |       |                    |       |                    |       |
| Cash flow used in  investing activities:                                       |       |                    |       |                    |       |
| Capital improvements                                                           |       | (12,583                 | )          | (17,849                 | )          |
| Net decrease in cash  restricted for property improvements                     |       | 287                     |       | 552                     |       |
| Cash paid for the  acquistion of hotel properties                              |       | —                  |       | (102,991                | )          |
| Deposits and other  disbursements for potential acquistion of hotel properties |       | —                  |       | (126                    | )          |
| Redemption of ownership  interest in non-hotel assets                          |       | 3,240                   |       | —                  |       |
| Net cash used in  investing activities                                         |       | (9,056                  | )          | (120,414                | )          |
|                                                                           |       |                    |       |                    |       |
| Cash flow used in  financing activities:                                       |       |                    |       |                    |       |
| Net proceeds from line  of credit                                              |       | 2,270                   |       | —                  |       |
| Payment of mortgage  notes payable                                             |       | (1,782                  | )          | (1,613                  | )          |
| Payment of financing  costs related to borrowings                              |       | (43                     | )          | (301                    | )          |
| Redemptions of common  stock                                                   |       | (17,521                 | )          | (4,933                  | )          |
| Net proceeds related to  issuance of common stock                              |       | 19,827                  |       | 20,848                  |       |
| Cash distributions paid  to common shareholders                                |       | (57,405                 | )          | (60,940                 | )          |
| Net cash used in  financing activities                                         |       | (54,654                 | )          | (46,939                 | )          |
|                                                                           |       |                    |       |                    |       |
| Decrease in cash and  cash equivalents                                         |       | (20,609                 | )          | (116,104                | )          |
|                                                                           |       |                    |       |                    |       |
| Cash and cash  equivalents, beginning of period                                |       | 20,609                  |       | 142,437                 |       |
| Cash and cash  equivalents, end of period                                      |       | $                       | —     |                    | $          | 26,333 |   |
|                                                                           |       |                    |       |                    |       |
| Non-cash transactions:                                                         |       |                    |       |                    |       |
| Notes payable assumed  in acquisitions                                         |       | $                       | —     |                    | $          | 27,334 |   |

 

**Seenotes to consolidated financial statements.**

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

** **

**Note 1**

 

**Basis of Presentation**

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith the instructions for Form 10-Q and Article 10 of RegulationS-X.  Accordingly, they do not includeall of the information required by accounting principles generally accepted inthe United States.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.  These unaudited financial statements shouldbe read in conjunction with the Company’s audited financial statements includedin its 2008 Annual Report on Form 10-K. Operating results for the three and nine month periods endedSeptember 30, 2009 are not necessarily indicative of the results that maybe expected for the twelve month period ending December 31, 2009.

 

**General Information and Summary of SignificantAccounting Policies**

 

Organization

 

Apple REIT Seven, Inc. (the “Company”) is aVirginia corporation formed to invest in hotels and other selected real estatein select metropolitan areas in the United States.  The Company has elected to be treated as areal estate investment trust (“REIT”) for federal income tax purposes.  Initial capitalization occurred onMay 26, 2005 and operations began on April 27, 2006 when the Companyacquired its first hotel.  The Companyconcluded its best-efforts offering of Units (each Unit consists of one commonshare and one Series A preferred share) in July 2007.  The Company has no foreign operations orassets and its operations include only one segment. The consolidated financialstatements include the accounts of the Company and its subsidiaries. Allintercompany transactions and balances have been eliminated upon consolidation.

 

Earnings per Common Share

 

Basic earnings per common share is computed based uponthe weighted average number of shares outstanding during the period. Dilutedearnings per share is calculated after giving effect to all potential commonshares that were dilutive and outstanding for the period.  There were no potential common shares with adilutive effect for the nine months ended September 30, 2009 and 2008. Asa result, basic and dilutive outstanding shares were the same.  Series B convertible preferred sharesare not included in earnings per common share until such time the Series Bconvertible preferred shares are converted to common shares.

 

Use of Estimates

 

The preparation of the financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the amounts reported in theconsolidated financial statements and accompanying notes. Actual results coulddiffer from those estimates.

 

Recent Accounting Pronouncements

 

Accounting StandardsCodification

 

In June 2009, the Financial Accounting StandardsBoard (“FASB”) issued a pronouncement establishing the FASB AccountingStandards CodificationTM as the source of authoritative accounting principlesrecognized by the FASB to be applied in the preparation of financial statementsin conformity with United States generally accepted accounting principles(“GAAP”).  The standard explicitlyrecognizes rules and interpretive releases of the Securities ExchangeCommission (“SEC”) under federal securities laws as authoritative GAAP for SECregistrants. This standard is effective for financial statements issued forinterim 

 

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and annual periods ending after September 15,2009. The adoption of this standard did not have a material impact on theCompany’s consolidated financial statements.

 

Noncontrolling Interests

 

In June 2009, the FASB issued a pronouncementwhich amends its guidance surrounding a company’s analysis to determine whetherany of its variable interests constitute controlling financial interests in avariable interest entity.  This analysisidentifies the primary beneficiary of a variable interest entity as theenterprise that has both of the following characteristics:  (a) the power to direct the activitiesof a variable interest entity that most significantly impact the entity’seconomic performance, and (b) the obligation to absorb losses of theentity that could potentially be significant to the variable interest entity orthe right to receive benefits from the entity that could potentially besignificant to the variable interest entity. Additionally, an enterprise is required to assess whether it has animplicit financial responsibility to ensure that a variable interest entityoperates as designed when determining whether it has the power to direct theactivities of the variable interest entity that most significantly impact theentity’s economic performance. The new pronouncement also requires ongoingassessments of whether an enterprise is the primary beneficiary of a variableinterest entity and enhanced disclosure about an enterprise’s involvement witha variable interest entity.  Thispronouncement will be applied prospectively and will be effective for interimand annual reporting periods beginning after November 15, 2009.  The adoption of this standard is notanticipated to have a material impact on the Company’s consolidated financialstatements.

 

Subsequent Events

 

 In May 2009, the FASB issued apronouncement which sets forth general standards of accounting for and disclosureof events that occur after the balance sheet date but before financialstatements are issued or available to be issued.  Although there is new terminology, thispronouncement is based on the same principles as those that currently exist inthe auditing standards.  Thispronouncement, which includes a required disclosure of the date through whichan entity has evaluated subsequent events, was effective for the Companybeginning June 30, 2009.  Theadoption of this standard did not have a material impact on the Company’sconsolidated financial statements.

 

Assets Acquired or Liabilities Assumed in a BusinessCombination

 

In April 2009, the FASB issued a pronouncementwhich amends its guidance for all assets acquired and all liabilities assumedin a business combination that arise from contingencies.  This pronouncement states that the acquirerwill recognize such an asset or liability if the acquisition-date fair value ofthat asset or liability can be determined during the measurement period.  If it cannot be determined during themeasurement period, then the asset or liability should be recognized as of theacquisition date if the following criteria are met: (1) informationavailable before the end of the measurement period indicates that it is probablethat an asset existed or that a liability had been incurred at the acquisitiondate, and (2) the amount of the asset or liability can be reasonablyestimated.  This pronouncement wasadopted by the Company in the first quarter of 2009. The adoption of thisstandard did not have a material impact on the Company’s consolidated financialstatements.

 

Interim Disclosures about Fair Value of FinancialInstruments

 

In April 2009, the FASB issued a pronouncementwhich requires fair value disclosures for financial instruments that are notreflected in the condensed consolidated balance sheets at fair value. Prior tothe issuance of this pronouncement, the fair values of those assets andliabilities were disclosed only once each year. With the issuance of this pronouncement, this information will berequired to be disclosed on a quarterly basis, providing quantitative andqualitative information about fair value estimates for all financialinstruments not measured in the condensed consolidated balance sheets at fairvalue.  This pronouncement was adopted bythe Company in the second quarter of 2009 and did not have a material impact onthe Company’s consolidated financial statements.

 

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**Note2**

 

**Other Assets**

 

The Company has a partial ownership interest in AppleAir Holding, LLC (“Apple Air”).  A 50%interest was originally purchased by the Company in 2007 to allow the Companyaccess to two corporate Lear jets for asset management, hotel acquisition andhotel renovation purposes.  InJanuary 2009, the Company’s ownership interest in Apple Air was reducedfrom 50% to 26%, through the redemption of a 24% ownership interest by AppleAir.  The Company received approximately$3.2 million for the ownership interest redeemed, which approximated theCompany’s carrying value of the 24% ownership interest at the date ofredemption.  No gain or loss from theredemption was recognized by the Company. The Company’s ownership interest in Apple Air (approximately $3.0million at September 30, 2009) is included in other assets, net on theCompany’s consolidated balance sheet. The other members of Apple Air are Apple REIT Six, Inc., Apple REITEight, Inc. and Apple REIT Nine, Inc. The Company records its share of income or loss of the entity under theequity method of accounting, adjusting its investment accordingly.  For the nine months ending September 30,2009 and 2008, the Company recorded a loss of approximately $338 thousand and$716 thousand, respectively, as its share of the net loss of Apple Air.

 

**Note 3**

 

**Related Parties**

 

The Company has, and is expected to continue to engagein, significant transactions with related parties.  These transactions cannot be construed to beat arm’s length, and the results of the Company’s operations may be differentthan if conducted with non-related parties.

 

The Company is party to an advisory agreement withApple Seven Advisors, Inc. (“A7A”), pursuant to which A7A provides managementservices to the Company. An annual fee ranging from .1% to .25% of total equityproceeds received by the Company, in addition to certain reimbursable expenses,are payable for these services.  A7Autilizes Apple REIT Six, Inc. to provide these services.  The total fees incurred under the agreementwith A7A during each of the nine month periods ended September 30, 2009 and2008 were approximately $2.1 million and $2.6 million, respectively.  These fees are recorded in general andadministrative expense in the Company’s Consolidated Statements of Operations.

 

A7A is 100% owned by Glade M. Knight, Chairman andChief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple REITSix, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc.  Members of the Company’s Board of Directorsare also on the boards of Apple REIT Six, Inc., Apple REIT Eight, Inc. andApple REIT Nine, Inc.

 

**Note 4**

 

**Line of Credit Facility**

 

On April 2, 2009, the Company entered into anunsecured line of credit facility, to be utilized for working capital, hotelrenovations, or other general corporate funding purposes including the paymentof distributions.  The credit facilityprovides for a maximum aggregate commitment by the lender, a commercial bank,of $30 million, and has a scheduled maturity in April 2011.  The applicable interest rate under the lineof credit is equal to LIBOR (the London Interbank Offered Rate for a one-monthterm, which was approximately 0.50% at April 2, 2009) plus 1.75%, subjectto a minimum interest rate floor on the line of credit of 3.15%.  Payments of interest only are due monthlyunder the terms of the credit agreement, and any amount borrowed by the Companymay be repaid before maturity with no penalty. The balance outstanding under the line of credit facility onSeptember 30, 2009 was $2.27 million, at an annual interest rate of 3.15%.

 

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**Note5**

 

**Shareholders’Equity**

** **

The Company has a Unit Redemption Program to providelimited interim liquidity to its shareholders who have held their Units for atleast one year.  Shareholders may requestredemption of Units for a purchase price equal to 92% of the price paid perUnit if the Units have been owned for less than three years, or 100% of theprice paid per Unit if the Units have been owned more than three years.  The maximum number of Units that may be redeemedin any 12-month period will be three percent of the weighted average number ofUnits outstanding during the 12-month period. The Company reserves the right to change the purchase price ofredemptions, reject any request for redemption, or otherwise amend the termsof, suspend, or terminate the Unit Redemption Program.  During the nine months ended September 30,2009, the Company redeemed approximately 1.7 million Units for approximately$17.5 million under the program.  Duringthe nine months ended September 30, 2008, the Company redeemed approximately483 thousand Units in the amount of $4.9 million under the program.

 

In 2007, the Company instituted a DividendReinvestment Plan for its shareholders. The plan provides a convenient and costeffective way to increase shareholder investment in the Company by reinvestingdividends to purchase additional Units of the Company. The uses of the proceedsfrom this plan may include purchasing Units under the Company’s Unit RedemptionProgram, enhancing properties, satisfying financing obligations and otherexpenses, increasing working capital, funding various corporate operations, andacquiring hotels. During the nine months ended September 30, 2009,approximately 1.8 million Units, representing $19.7 million in proceeds to theCompany, were issued under the plan. During the nine months ended September 30, 2008, approximately 1.9million Units, representing $20.8 million in proceeds to the Company, wereissued under the plan.

 

**Note 6**

 

**Fair Value of Financial Instruments**

 

The Company estimates the fair value of its fixed ratedebt and the credit spreads over variable market rates on its variable ratedebt by discounting the future cash flows of each instrument at estimatedmarket rates or credit spreads consistent with the maturity of the debtobligation with similar credit policies. Credit spreads take into considerationgeneral market conditions and maturity. As of September 30, 2009, thecarrying value and estimated fair value of the Company’s debt outstanding was$109.3 million and $113.2 million, respectively.  As of December 31, 2008, the carryingvalue and estimated fair value of the Company’s fixed rate mortgageindebtedness was $109.3 million and $116.3 million, respectively.  The carrying value of the Company’s otherfinancial instruments approximates fair value due to the short-term nature ofthese financial instruments.

 

**Note 7**

 

**Subsequent Events**

 

The Company has evaluated subsequent events throughNovember 4, 2009, the date these financial statements were filed with theSecurities and Exchange Commission.

 

On October 15, 2009,the Company paid $0.064167 per common share, totaling $6.0 million, in adividend distribution to its common shareholders.  Under the Company’s Dividend ReinvestmentPlan, $2.1 million were reinvested, resulting in the issuance of 187,517 Units.

 

In October 2009, the Company redeemed 681,604Units for approximately $7.3 million under its Unit Redemption Program.

 

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**Item 2.    Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

This quarterly report contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended.  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-lookingstatements.  Such factors include, but are not limited to, the ability ofthe Company to implement its acquisition strategy and operating strategy; theCompany’s ability to manage planned growth; changes in economic cyclesincluding the current economic recession throughout the United States, andcompetition within the hotel industry.  Although the Company believes thatthe assumptions underlying the forward-looking statements contained herein arereasonable, any of the assumptions could be inaccurate, and therefore there canbe no assurance that such statements included in the quarterly report willprove to be accurate.  In light of the significant uncertainties inherentin the forward-looking statements included herein, the inclusion of suchinformation should not be regarded as a representation by the Company or anyother person that the results or conditions described in such statements or theobjectives and plans of the Company will be achieved.  In addition, theCompany’s qualification as a real estate investment trust involves theapplication of highly technical and complex provisions of the Internal RevenueCode.  Readers should carefully review the Company’s financial statementsand the notes thereto, as well as the risk factors described in the Company’sfilings with the Securities and Exchange Commission.

 

**Overview**

** **

The Company is a Virginia corporation formed to investin hotels and other selected real estate in select metropolitan areas in theUnited States.  The Company was initiallycapitalized on May 26, 2005, with its first investor closing on March 15, 2006.The best-efforts offering was completed in July 2007.  The Company owned 51 hotels as of September30, 2009, located within different markets in the United States. The Company istreated as a Real Estate Investment Trust (“REIT”) for federal income taxpurposes. The Company’s first hotel was acquired on April 27, 2006. Anadditional 17 hotels were purchased during 2006, 26 hotels were purchasedduring 2007, and seven hotels were purchased during 2008. Accordingly, theresults of operations include only the results of operations of the hotels forthe period owned.   Although hotelperformance can be influenced by many factors including local competition,local and general economic conditions in the United States and the performanceof individual managers assigned to each hotel, performance of the hotels ascompared to other hotels within their respective local market, in general, hasmet the Company’s expectations for the period owned.  With the significant economic downturn in theUnited States, the results of the overall industry as well as the Company havedeclined, and did not meet expectations in the first nine months of 2009.  Although there is no way to predict generaleconomic conditions, the Company anticipates revenue and income declines ascompared to the same period in 2008 throughout the remainder of 2009 and into2010.  The Company is working with itsmanagement companies to reduce costs to offset revenue declines as much aspossible.  In evaluating financial conditionand operating performance, the most important matters on which the Companyfocuses are revenue measurements, such as average occupancy, average daily rate(“ADR”), revenue per available room (“RevPAR”) and market yield which comparesan individual hotel’s results to others in its local market, and expenses, suchas hotel operating expenses, general and administrative and other expensesdescribed below.  The following is asummary of the Company’s results (in thousands, except statistical data):

 

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| ** **                              | ** ** | **Three  months ended September 30,** | ** ** | **Nine  months ended September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                   | ** ** | **% of  Revenue**                         | ** ** | **2008** | ** ** | **% of  Revenue** | ** ** | **Percent  change** | ** ** | **2009** | ** ** | **% of  Revenue** | ** ** | **2008** | ** ** | **% of  Revenue** | ** ** | **Percent  change** | ** ** |
| **Total  hotel revenue**                |       | $                                          | 49,423     |                                      | 100        | % | $ | 57,248 |   | 100 | % | -14 | % | $ | 147,564 |   | 100 | % | $ | 164,883 |   | 100 | % | -11 | % |
| **Hotel  operating expenses**           |       | 29,121                                     |       | 59                                        | %          | 32,728 |   | 57 | % | -11 | % | 86,519 |   | 59 | % | 94,900 |   | 58 | % | -9 | % |
| **Taxes,  insurance and other expense** |       | 3,150                                      |       | 6                                         | %          | 3,898 |   | 7 | % | -19 | % | 10,532 |   | 7 | % | 10,341 |   | 6 | % | 2 | % |
| **General  and administrative expense** |       | 1,030                                      |       | 2                                         | %          | 1,323 |   | 2 | % | -22 | % | 3,369 |   | 2 | % | 4,381 |   | 3 | % | -23 | % |
| **Depreciation**                        |       | 8,176                                      |       |                                      |       | 7,313 |   |   |   | 12 | % | 24,111 |   |   |   | 20,809 |   |   |   | 16 | % |
| **Interest  expense, net**              |       | 1,696                                      |       |                                      |       | 1,250 |   |   |   | 36 | % | 4,564 |   |   |   | 2,588 |   |   |   | 76 | % |
| ** **                              |       |                                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Average  Market Yield (1)**           |       | 123                                        |       |                                      |       | 116 |   |   |   | 6 | % | 123 |   |   |   | 116 |   |   |   | 6 | % |
| **Number  of hotels**                   |       | 51                                         |       |                                      |       | 51 |   |   |   | — |   | 51 |   |   |   | 51 |   |   |   | — |   |
| **Average  Daily Rate (ADR)**           |       | $                                          | 109        |                                      |       |   | $ | 121 |   |   |   | -10 | % | $ | 112 |   |   |   | $ | 121 |   |   |   | -7 | % |
| **Occupancy**                           |       | 70                                         | %          |                                      |       | 75 | % |   |   | -7 | % | 68 | % |   |   | 74 | % |   |   | -8 | % |
| **RevPAR**                              |       | $                                          | 77         |                                      |       |   | $ | 91 |   |   |   | -15 | % | $ | 77 |   |   |   | $ | 90 |   |   |   | -14 | % |

 

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**(1) Calculatedfrom data provided by Smith Travel Research, Inc. ®.**

 

**Hotels Owned**

 

The following table summarizes the location, brand,manager, date acquired, number of rooms and gross purchase price for each ofthe 51 hotels the Company owned at September 30, 2009 (all dollar amountsare in thousands):

 
| **City**        | ** ** | **State** | ** ** | **Brand**         | ** ** | **Manager**  | ** ** | **Date  Acquired** | ** ** | **Rooms** | ** ** | **Gross  Purchase  Price** | ** ** |
|-----------------|------------|-----------|------------|-------------------|------------|--------------|------------|--------------------|------------|-----------|------------|----------------------------|------------|
| Montgomery      |       | AL        |       | Homewood Suites   |       | LBA          |       | 8/17/2006          |       | 91        |       | $                          | 10,660     |   |
| Montgomery      |       | AL        |       | Hilton Garden Inn |       | LBA          |       | 8/17/2006          |       | 97        |       | 10,385                     |       |
| Troy            |       | AL        |       | Hampton Inn       |       | LBA          |       | 8/17/2006          |       | 82        |       | 6,130                      |       |
| Auburn          |       | AL        |       | Hilton Garden Inn |       | LBA          |       | 8/17/2006          |       | 101       |       | 10,185                     |       |
| Huntsville      |       | AL        |       | Hilton Garden Inn |       | LBA          |       | 8/17/2006          |       | 101       |       | 10,285                     |       |
| Huntsville      |       | AL        |       | Homewood Suites   |       | LBA          |       | 10/27/2006         |       | 107       |       | 11,606                     |       |
| Prattville      |       | AL        |       | Courtyard         |       | LBA          |       | 4/24/2007          |       | 84        |       | 9,304                      |       |
| Dothan          |       | AL        |       | Fairfield Inn     |       | LBA          |       | 5/16/2007          |       | 63        |       | 4,584                      |       |
| Trussville      |       | AL        |       | Courtyard         |       | LBA          |       | 10/4/2007          |       | 84        |       | 9,510                      |       |
| Huntsville      |       | AL        |       | TownePlace Suites |       | LBA          |       | 12/10/2007         |       | 86        |       | 8,927                      |       |
| Dothan          |       | AL        |       | Residence Inn     |       | LBA          |       | 4/16/2008          |       | 84        |       | 9,669                      |       |
| Tucson          |       | AZ        |       | Residence Inn     |       | Western      |       | 1/17/2008          |       | 124       |       | 16,640                     |       |
| San Diego       |       | CA        |       | Hilton Garden Inn |       | Inn Ventures |       | 5/9/2006           |       | 200       |       | 34,500                     |       |
| Rancho Bernardo |       | CA        |       | Courtyard         |       | Dimension    |       | 12/12/2006         |       | 210       |       | 36,000                     |       |
| Agoura Hills    |       | CA        |       | Homewood Suites   |       | Dimension    |       | 5/8/2007           |       | 125       |       | 25,250                     |       |
| San Diego       |       | CA        |       | Residence Inn     |       | Dimension    |       | 6/13/2007          |       | 121       |       | 32,500                     |       |
| San Diego       |       | CA        |       | Hampton Inn       |       | Dimension    |       | 7/19/2007          |       | 177       |       | 42,000                     |       |
| Highlands Ranch |       | CO        |       | Residence Inn     |       | Dimension    |       | 2/22/2007          |       | 117       |       | 19,000                     |       |
| Highlands Ranch |       | CO        |       | Hilton Garden Inn |       | Dimension    |       | 3/9/2007           |       | 128       |       | 20,500                     |       |
| Sarasota        |       | FL        |       | Homewood Suites   |       | Hilton       |       | 9/15/2006          |       | 100       |       | 13,800                     |       |
| Miami           |       | FL        |       | Homewood Suites   |       | Dimension    |       | 2/21/2007          |       | 159       |       | 24,300                     |       |
| Tallahassee     |       | FL        |       | Fairfield Inn     |       | LBA          |       | 4/24/2007          |       | 79        |       | 6,647                      |       |
|                 |            |           |            |                   |            |              |            |                    |            |           |            |                            |            |  |

 

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| Lakeland    |   | FL     |   | Courtyard         |   | LBA          |   | 4/24/2007  |   | 78    |   | 9,805  |    |
|-------------|--------|--------|--------|-------------------|--------|--------------|--------|------------|--------|-------|--------|--------|---------|
| Miami       |   | FL     |   | Courtyard         |   | Dimension    |   | 9/5/2008   |   | 118   |   | 15,000 |    |
| Columbus    |   | GA     |   | Fairfield Inn     |   | LBA          |   | 4/24/2007  |   | 79    |   | 7,333  |    |
| Macon       |   | GA     |   | Hilton Garden Inn |   | LBA          |   | 6/28/2007  |   | 101   |   | 10,660 |    |
| Columbus    |   | GA     |   | SpringHill Suites |   | LBA          |   | 3/6/2008   |   | 85    |   | 9,675  |    |
| Columbus    |   | GA     |   | TownePlace Suites |   | LBA          |   | 5/22/2008  |   | 86    |   | 8,428  |    |
| Boise       |   | ID     |   | SpringHill Suites |   | Inn Ventures |   | 9/14/2007  |   | 230   |   | 21,000 |    |
| New Orleans |   | LA     |   | Homewood Suites   |   | Dimension    |   | 12/15/2006 |   | 166   |   | 43,000 |    |
| Hattiesburg |   | MS     |   | Courtyard         |   | LBA          |   | 10/5/2006  |   | 84    |   | 9,455  |    |
| Tupelo      |   | MS     |   | Hampton Inn       |   | LBA          |   | 1/23/2007  |   | 96    |   | 5,245  |    |
| Omaha       |   | NE     |   | Courtyard         |   | Marriott     |   | 11/4/2006  |   | 181   |   | 23,100 |    |
| Cranford    |   | NJ     |   | Homewood Suites   |   | Dimension    |   | 3/7/2007   |   | 108   |   | 13,500 |    |
| Mahwah      |   | NJ     |   | Homewood Suites   |   | Dimension    |   | 3/7/2007   |   | 110   |   | 19,500 |    |
| Ronkonkoma  |   | NY     |   | Hilton Garden Inn |   | White        |   | 12/15/2006 |   | 164   |   | 27,000 |    |
| Cincinnati  |   | OH     |   | Homewood Suites   |   | White        |   | 12/1/2006  |   | 76    |   | 7,100  |    |
| Memphis     |   | TN     |   | Homewood Suites   |   | Hilton       |   | 5/15/2007  |   | 140   |   | 11,100 |    |
| Houston     |   | TX     |   | Residence Inn     |   | Western      |   | 4/27/2006  |   | 129   |   | 13,600 |    |
| Brownsville |   | TX     |   | Courtyard         |   | Western      |   | 6/19/2006  |   | 90    |   | 8,550  |    |
| Stafford    |   | TX     |   | Homewood Suites   |   | Western      |   | 8/15/2006  |   | 78    |   | 7,800  |    |
| San Antonio |   | TX     |   | TownePlace Suites |   | Western      |   | 6/29/2007  |   | 106   |   | 11,925 |    |
| Addison     |   | TX     |   | SpringHill Suites |   | Marriott     |   | 8/10/2007  |   | 159   |   | 12,500 |    |
| San Antonio |   | TX     |   | TownePlace Suites |   | Western      |   | 9/27/2007  |   | 123   |   | 13,838 |    |
| El Paso     |   | TX     |   | Homewood Suites   |   | Western      |   | 4/23/2008  |   | 114   |   | 15,390 |    |
| Provo       |   | UT     |   | Residence Inn     |   | Dimension    |   | 6/13/2007  |   | 114   |   | 11,250 |    |
| Alexandria  |   | VA     |   | Courtyard         |   | Marriott     |   | 7/13/2007  |   | 176   |   | 36,997 |    |
| Richmond    |   | VA     |   | Marriott          |   | White        |   | 1/25/2008  |   | 410   |   | 53,300 |    |
| Seattle     |   | WA     |   | Residence Inn     |   | Inn Ventures |   | 9/1/2006   |   | 234   |   | 56,173 |    |
| Vancouver   |   | WA     |   | SpringHill Suites |   | Inn Ventures |   | 6/1/2007   |   | 119   |   | 15,988 |    |
| Kirkland    |   | WA     |   | Courtyard         |   | Inn Ventures |   | 10/23/2007 |   | 150   |   | 31,000 |    |
|        |   |   |   |              |   |         |   | Total      |   | 6,424 |   | $      | 901,594 |   |
|             |        |        |        |                   |        |              |        |            |        |       |        |        |         |  |

 

With the exception of assumed mortgage loans oncertain hotel properties, substantially all of the purchase price of the hotelswas funded by proceeds from the Company’s best-efforts offering of Units,completed in July 2007.  The Companyalso used the proceeds of its offering to pay 2% of the gross purchase pricefor these hotels, which was approximately $18.0 million, as a brokeragecommission to Apple Suites Realty Group, Inc. (“ASRG”), wholly-owned byGlade M. Knight, the Company’s Chairman and Chief Executive Officer.  The Company leased all of its hotels towholly-owned taxable REIT subsidiaries under master hotel leaseagreements.  No hotels have beenpurchased since September 2008, and there are no outstanding purchasecontracts for additional hotels as of September 30, 2009.

 

**Results of Operations**

 

As of September 30, 2009, the Company owned 51hotels with 6,424 rooms.  The Company’sportfolio of hotels owned is unchanged from September 30, 2008.  Of the Company’s 51 hotels, seven werepurchased during the first nine months of 2008, representing a total of 1,012rooms at time of purchase.  Hotelperformance is impacted by many factors including economic conditions in theUnited States, as well as each locality. Due to a general decline in economic conditions throughout the UnitedStates, the financial results of the Company’s hotels did not meet expectationsduring the first nine months of 2009.  Itis anticipated the properties’ performance will continue to be below comparableoperating periods of 2008 until general economic conditions improve.  The Company will continue to aggressivelypursue market opportunities to improve revenue and aggressively pursue costcontrols to improve results during and after the economic downturn.

 

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Although it is notpossible to predict when economic conditions will improve or their impact onthe hotel industry, many industry analysts forecast 15-20% declines in RevPARin 2009 compared to 2008 rates. Additionally, many analysts forecast 0 - 5% RevPAR declines in 2010 (ascompared to 2009).  While reflecting theimpact of declining economic activity, the Company’s hotel performance ascompared to other hotels within each individual market has generally metexpectations for the period held.

 

Revenues

 

TheCompany’s principal source of revenue is hotel room revenue and other relatedrevenue.  Hotel operations included inthe consolidated statement of operations are for the Company’s hotels acquiredthrough September 30, 2009, for the respective period of ownership foreach property.  The Company owned 51hotels as of September 30, 2009 and September 30, 2008.  Of these 51 hotels, seven were purchasedduring the first nine months of 2008. For the three months ended September 30, 2009 and 2008, the Companyhad total revenue of $49.4 and $57.2 million, respectively, with averageoccupancy of 70% and 75%, ADR of $109 and $121, and RevPAR of $77 and $91.  For the nine months ended September 30,2009 and 2008, the Company had total revenue of $147.6 and $164.9 million,respectively, with average occupancy of 68% and 74%, ADR of $112 and $121, andRevPAR of $77 and $90.  ADR is calculatedas room revenue divided by the number of rooms sold, and RevPAR is calculatedas occupancy multiplied by ADR.  Theserates are comparable with industry and brand averages, given the Company’sportfolio of hotels and the markets where the Company’s hotels arelocated.  However, as demand hasdeclined, and general economic conditions have weakened throughout the UnitedStates, the Company’s revenue at most individual hotels has experienceddeclines compared to prior year results. The Company expects this trend to continue for the remainder of2009.  As a result, the Company does notanticipate improvement in occupancy levels, ADR and RevPAR for the next severalquarters, versus comparable prior periods. Although the Company has experienced declines in RevPAR, the Companycontinues to focus on improving market share and continues to be a leader inits local markets.  The Company’s MarketYield for the first nine months of 2009 was 123, an increase of 6% over thefirst nine months of 2008.  The MarketYield is a measure of each hotel’s RevPAR compared to the average in its localmarket.

 

Expenses

 

Expensesfor the three and nine months periods ended September 30, 2009 and 2008represent the expenses related to the 51 hotels acquired throughSeptember 30, 2009 for their respective periods owned.  For the three month periods endedSeptember 30, 2009 and 2008, hotel direct expenses totaled $29.1 and $32.7million, or 59% and 57% of total revenue, respectively.  For the nine month periods endedSeptember 30, 2009 and 2008, hotel direct expenses totaled $86.5 and $94.9million, or 59% and 58% of total revenue, respectively, for each period.  Hotel direct expenses consist of operatingexpense, hotel administrative expense, sales and marketing expense, utilities expense,repair and maintenance expense, franchise fees and management fees.

 

Resultsfor the three and nine months periods ended September 30, 2009 reflect theimpact of declining revenues at most of the Company’s hotels, and the Company’sefforts to control costs in such an economic environment.  However, certain operating costs such asmanagement costs, certain utility costs and minimum supply and maintenancecosts are relatively fixed in nature, and cannot be curtailed or eliminated.  The Company has been successful in reducingcertain labor costs, food and supply costs and utility costs by continuallymonitoring and sharing utilization data across its hotels and managementcompanies.  With the weakened economicconditions, the Company has and will continue to work with its managementcompanies to reduce costs as aggressively as possible, however it is notanticipated these reductions will offset revenue declines.

 

Taxes,insurance, and other expense for the three months ended September 30, 2009and 2008 were $3.2 and $3.9 million, or 6% and 7% of total revenue for theapplicable period.  For the nine monthperiods ended September 30, 2009 and 2008, taxes, insurance, and otherexpense totaled $10.5 and $10.3 million, or 7% and 6% of total revenue for theapplicable period.  Increases in these expensesfor the comparable nine month periods ending September 30, 2009 and 2008reflect higher real estate and personal property tax assessments at selectedhotels, including some of the Company’s hotels that were newly constructedduring 2007 and 2008.  For the comparablethree month periods ended September 30, 2009 and 2008, the decrease in 

 

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expenses reflectssuccessful appeals of real estate assessments at certain hotel locations.

 

Generaland administrative expense for the three months ended September 30, 2009and 2008 were $1.0 and $1.3 million, representing 2% of total revenue for eachperiod, respectively.  For the nine monthperiods ended September 30, 2009 and 2008, general and administrativeexpenses were $3.4 and $4.4 million, representing 2% and 3% of total revenuefor the applicable period.  The Companyanticipates general and administrative costs to be slightly less than 2008 forthe remainder of the year as it has reduced its interest in Apple Air Holding,LLC and has reduced certain other administrative costs.

 

Depreciationexpense for the three months ended September 30, 2009 and 2008 was $8.2 millionand $7.3 million.  For the nine monthperiods ended September 30, 2009 and 2008, depreciation expense totaled$24.1 million and $20.8 million.  Theseamounts represent depreciation expense of the Company’s hotel buildings andrelated improvements, and associated furniture, fixtures and equipment, for therespective periods owned.

 

Interestexpense during the nine months ended September 30, 2009 and 2008 totaled$4.7 and $4.3 million, respectively.  Forthe three months ended September 30, 2009 and 2008, the Company incurredinterest expense of $1.7 and $1.6 million. Interest expense primarily represents interest incurred on mortgageloans assumed on acquired hotels.  As ofSeptember 30, 2009, mortgage loans were outstanding on ten of theCompany’s hotel properties, totaling $107.0 million.  Interest expense in 2009 and 2008 is net ofcapitalized interest, of approximately $0.4 million for the nine month periodended September 30, 2009, and approximately $0.7 million for the ninemonth period ended September 30, 2008, associated with hotelrenovations.  For the nine month periodsended September 30, 2009 and 2008, the Company recognized interest incomeof $0.1 million and $1.7 million, respectively. For the three months ended September 30, 2008, the Companyrecognized interest income of $0.3 million; interest income recognized in thethree months ended September 30, 2009 was not material.  Interest income represents earnings on excesscash invested in short term money market instruments.  The Company’s average balances of investedcash have decreased since December 31, 2007 due to the completion of sevenhotel acquisitions during 2008, and due to funding of significant renovationactivity in both 2008 and 2009.  Inaddition, average interest rates earned on invested cash balances have, ingeneral, declined during 2008 and 2009.

 

**Liquidityand Capital Resources**

 

The Company’s operatingcash flow from the properties owned and line of credit facility are theCompany’s principal sources of liquidity. In addition, the Company may borrow additional funds, subject tolimitations set forth in its bylaws.  TheCompany anticipates that cash flow and credit availability will be adequate tocover its operating expenses and to permit the Company to meet its anticipatedliquidity requirements, including distributions to shareholders, capitalexpenditures and debt service.

 

OnApril 2, 2009, the Company entered into an unsecured line of creditfacility, to be utilized for working capital, hotel renovations, or other generalcorporate funding purposes including the payment of distributions.  The credit facility provides for a maximumaggregate commitment by the lender, a commercial bank, of $30 million, and hasa scheduled maturity in April 2011. The applicable interest rate under the line of credit is equal to LIBOR(the London Interbank Offered Rate for a one-month term, which wasapproximately 0.25% at September 30, 2009) plus 1.75%, subject to aminimum interest rate floor on the line of credit of 3.15%.  Payments of interest only are due monthlyunder the terms of the credit agreement, and any amount borrowed by the Companymay be repaid before maturity with no penalty. The balance outstanding under the line of credit facility onSeptember 30, 2009 was $2.27 million, at an effective interest rate of3.15%.

 

To maintain its REITstatus the Company is required to distribute at least 90% of its ordinaryincome.  Distributions in the first ninemonths of 2009 totaled $57.4 million and were paid monthly at a rate of$0.073334 per common share from January through April 2009, andmonthly at a rate of $0.064167 per common share from May throughSeptember of 2009.  For the samenine month period, the Company’s cash generated from operations wasapproximately $43.1 million.  This shortfall includes a return of capitaland was funded primarily by cash on hand as of January 1, 2009.  The Company intends to continue payingdistributions 

 

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on a monthly basis.  However, since there can be no assurance ofthe ability of the Company’s properties to provide income at this level, therecan be no assurance as to the classification or duration of distributions atthe current monthly rate.  Inconsideration of the weakness in economic conditions throughout the UnitedStates, the Board of Directors monitors the Company’s distribution raterelative to the performance of the hotels on an ongoing basis and may makeadjustments to the distribution rate as determined to be prudent in relation toother cash requirements of the Company. In April 2009, the Board of Directors approved a reduction in theCompany’s annual distribution rate from $0.88 to $0.77 per common share.  The reduction of the dividend was effectivebeginning with the May 15, 2009 distribution.

 

The Company has on-goingcapital commitments to fund its capital improvements. The Company is required,under all of the hotel management agreements, to make available, for therepair, replacement, refurbishing of furniture, fixtures, and equipment, anamount between 2% to 5% of gross revenues of the applicable hotel, providedthat such amount may be used for the Company’s capital expenditures with respectto the applicable hotel. The Company expects that this amount will be adequateto fund required repair, replacement, and refurbishments and to maintain theCompany’s hotels in a competitive condition. As of September 30, 2009, theCompany also held $7.7 million in restricted cash accounts for capitalimprovement purposes as required by certain loan or hotel managementagreements.  The Company substantiallycompleted significant renovations on three hotel properties during the firstnine months of 2009.  An additionalproperty is expected to begin major renovations during 2009.  Total capital expenditures incurred in thefirst nine months of 2009 were approximately $11.7 million.  Additional capital expenditures areanticipated to be in the range of approximately $3 million to $5 million overthe remaining three months of 2009.

 

The Company has a UnitRedemption Program to provide limited interim liquidity to its shareholders whohave held their Units for at least one year. Shareholders may request redemptionof Units for a purchase price equal to 92% of the price paid per Unit if theUnits have been owned for less than three years, or 100% of the price paid perUnit if the Units have been owned more than three years.  The maximum number of Units that may beredeemed in any 12-month period will be three percent of the weighted averagenumber of Units outstanding during the 12-month period.  The Company reserves the right to change thepurchase price of redemptions, reject any request for redemption, or otherwiseamend the terms of, suspend, or terminate the Unit Redemption Program.  During the nine months endedSeptember 30, 2009, the Company redeemed approximately 1.7 million Unitsin the amount of $17.5 million under the program.  During the nine months endedSeptember 30, 2008, the Company redeemed approximately 483 thousand Unitsin the amount of $4.9 million under the program.

 

In 2007, the Companyinstituted a Dividend Reinvestment Plan for its shareholders. The plan providesa convenient and cost effective way to increase shareholder investment in theCompany by reinvesting dividends to purchase additional Units of the Company.The uses of the proceeds from this plan may include purchasing Units under theCompany’s Unit Redemption Program, enhancing properties, satisfying financingobligations and other expenses, increasing working capital, funding variouscorporate operations, and acquiring hotels. During the nine months endedSeptember 30, 2009, approximately 1.8 million Units, representing $19.7million in proceeds to the Company, were issued under the plan.  During the nine months endedSeptember 30, 2008, approximately 1.9 million Units, representing $20.8million in proceeds to the Company, were issued under the plan.

 

**Related Party Transactions**

 

The Company has, and isexpected to continue to engage in, significant transactions with relatedparties.  These transactions cannot beconstrued to be at arm’s length, and the results of the Company’s operationsmay be different than if conducted with non-related parties.

 

The Company is party toan advisory agreement with Apple Seven Advisors, Inc. (“A7A”), pursuant towhich A7A provides management services to the Company. An annual fee rangingfrom .1% to .25% of total equity proceeds received by the Company, in additionto certain reimbursable expenses, are payable for these services.  A7A utilizes Apple REIT Six, Inc. toprovide these services.  The total feesincurred under the agreement with A7A during each of the nine month periodsended September 30, 2009 and 2008 were 

 

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approximately $2.1million and $2.6 million, respectively. These fees are recorded in general and administrative expense in theCompany’s Consolidated Statements of Operations.

 

A7A is 100% owned byGlade M. Knight, Chairman and Chief Executive Officer of the Company.  Mr. Knight is also Chairman and ChiefExecutive Officer of Apple REIT Six, Inc., Apple REIT Eight, Inc. andApple REIT Nine, Inc.  Members ofthe Company’s Board of Directors are also on the boards of Apple REITSix, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc.

 

The Company has a partialownership interest in Apple Air Holding, LLC (“Apple Air”).  A 50% interest was originally purchased bythe Company in 2007 to allow the Company access to two corporate Lear jets forasset management, hotel acquisition and hotel renovation purposes.  In January 2009, the Company’s ownershipinterest in Apple Air was reduced from 50% to 26%, through the redemption of a24% ownership interest by Apple Air.  TheCompany received approximately $3.2 million for the ownership interestredeemed, which approximated the Company’s carrying value of the 24% ownershipinterest at the date of redemption.  Nogain or loss from the redemption was recognized by the Company.  The Company’s ownership interest in Apple Air(approximately $3.0 million at September 30, 2009) is included in otherassets, net on the Company’s consolidated balance sheet.  The other members of Apple Air are Apple REITSix, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc.  The Company records its share of income orloss of the entity under the equity method of accounting, adjusting itsinvestment accordingly.  For the ninemonths ending September 30, 2009 and 2008, the Company recorded a loss ofapproximately $338 thousand and $716 thousand, respectively, as its share ofthe net loss of Apple Air.

 

**SubsequentEvents**

 

OnOctober 15, 2009, the Company paid $0.064167 per common share, totaling$6.0 million, in a dividend distribution to its common shareholders.  Under the Company’s Dividend ReinvestmentPlan, $2.1 million were reinvested, resulting in the issuance of 187,517 Units.

 

In October 2009, theCompany redeemed 681,604 Units for approximately $7.3 million under its UnitRedemption Program.

 

**Impactof Inflation**

 

Operatorsof hotels, in general, possess the ability to adjust room rates daily toreflect the effects of inflation. Competitive pressures may, however, limit the operators’ ability toraise room rates.  Currently the Companyis not experiencing any material impact from inflation.

### ** **

**Business Interruption**

 

Being in the real estate industry, the Company isexposed to natural disasters on both a local and national scale.  Although management believes there isadequate insurance to cover this exposure, there can be no assurance that suchevents will not have a material adverse effect on the Company’s financialposition or results of operations.

 

**Seasonality**

 

The hotel industry is seasonal in nature.  Generally, occupancy rates and hotel revenuesare greater in the second and third quarters than in the first and fourthquarters.  As a result, there may bequarterly fluctuations in results of operations.  The Company may utilize short-term borrowingsin certain periods in order to offset these fluctuations in revenues and tomake distributions to shareholders.

 

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**Recent Accounting Pronouncements**

 

Accounting Standards Codification

 

In June 2009, the Financial AccountingStandards Board (“FASB”) issued a pronouncement establishing the FASB AccountingStandards CodificationTM as the source of authoritative accounting principlesrecognized by the FASB to be applied in the preparation of financial statementsin conformity with United States generally accepted accounting principles(“GAAP”).  The standard explicitlyrecognizes rules and interpretive releases of the Securities ExchangeCommission (“SEC”) under federal securities laws as authoritative GAAP for SECregistrants. This standard is effective for financial statements issued for interimand annual periods ending after September 15, 2009. The adoption of thisstandard did not have a material impact on the Company’s consolidated financialstatements.

 

Noncontrolling Interests

 

In June 2009, the FASB issued a pronouncementwhich amends its guidance surrounding a company’s analysis to determine whetherany of its variable interests constitute controlling financial interests in avariable interest entity.  This analysisidentifies the primary beneficiary of a variable interest entity as the enterprisethat has both of the following characteristics: (a) the power to direct the activities of a variable interestentity that most significantly impact the entity’s economic performance, and(b) the obligation to absorb losses of the entity that could potentiallybe significant to the variable interest entity or the right to receive benefitsfrom the entity that could potentially be significant to the variable interestentity.  Additionally, an enterprise isrequired to assess whether it has an implicit financial responsibility toensure that a variable interest entity operates as designed when determiningwhether it has the power to direct the activities of the variable interestentity that most significantly impact the entity’s economic performance. Thenew pronouncement also requires ongoing assessments of whether an enterprise isthe primary beneficiary of a variable interest entity and enhanced disclosureabout an enterprise’s involvement with a variable interest entity.  This pronouncement will be appliedprospectively and will be effective for interim and annual reporting periodsbeginning after November 15, 2009. The adoption of this standard is not anticipated to have a materialimpact on the Company’s consolidated financial statements.

 

Subsequent Events

 

In May 2009, the FASB issued a pronouncementwhich sets forth general standards of accounting for and disclosure of eventsthat occur after the balance sheet date but before financial statements areissued or available to be issued. Although there is new terminology, this pronouncement is based on thesame principles as those that currently exist in the auditing standards.  This pronouncement, which includes a requireddisclosure of the date through which an entity has evaluated subsequent events,was effective for the Company beginning June 30, 2009.  The adoption of this standard did not have amaterial impact on the Company’s consolidated financial statements.

 

Assets Acquired or Liabilities Assumed in a BusinessCombination

 

In April 2009, the FASB issued a pronouncementwhich amends its guidance for all assets acquired and all liabilities assumedin a business combination that arise from contingencies.  This pronouncement states that the acquirerwill recognize such an asset or liability if the acquisition-date fair value ofthat asset or liability can be determined during the measurement period.  If it cannot be determined during themeasurement period, then the asset or liability should be recognized as of theacquisition date if the following criteria are met: (1) informationavailable before the end of the measurement period indicates that it isprobable that an asset existed or that a liability had been incurred at theacquisition date, and (2) the amount of the asset or liability can be reasonablyestimated.  This pronouncement wasadopted by the Company in the first quarter of 2009. The adoption of thisstandard did not have a material impact on the Company’s consolidated financialstatements.

 

Interim Disclosures about Fair Value of FinancialInstruments

 

In April 2009, the FASB issued a pronouncementwhich requires fair value disclosures for financial instruments that are notreflected in the condensed consolidated balance sheets at fair value. Prior tothe issuance of this pronouncement, the fair values of those assets andliabilities were disclosed only once each year. With the issuance of this pronouncement, this information will berequired to be disclosed on a quarterly 

 

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basis, providing quantitative and qualitativeinformation about fair value estimates for all financial instruments notmeasured in the condensed consolidated balance sheets at fair value.  This pronouncement was adopted by the Companyin the second quarter of 2009 and did not have a material impact on theCompany’s consolidated financial statements.

 

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** **

**Item 3.  Quantitative and Qualitative Disclosures About MarketRisk**

 

The Company does not engage in transactions in derivative financialinstruments or derivative commodity instruments. As of September 30, 2009,the Company’s financial instruments were not exposed to significant market riskdue to interest rate risk, foreign currency exchange risk, commodity price riskor equity price risk. The Company can be exposed to changes in short term moneymarket rates paid on balances borrowed under its line of credit facility.  Based on the outstanding balance borrowed onthe Company’s line of credit at September 30, 2009 of $2.27 million, every100 basis point change in interest rates can potentially impact the Company’sannual net income by $22.7 thousand, subject to the conditions of the interestrate floor provisions of the line of credit facility, and with all otherfactors remaining the same.  The Company’scash balance at September 30, 2009 was $0.

 

**Item4.  Controlsand Procedures**

 

Senior management,including the Chief Executive Officer and Chief Financial Officer, evaluatedthe effectiveness of the Company’s disclosure controls and procedures as of theend of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and ChiefFinancial Officer have concluded that the Company’s disclosure controls andprocedures are effective and that there have been no changes in the Company’sinternal control over financial reporting that occurred during the last fiscalquarter that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.  Since that evaluation process was completedthere have been no significant changes in internal controls or in other factorsthat could significantly affect these controls. 

 

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**PART II.                         OTHER INFORMATION**

 

**Item2.        UnregisteredSales of Equity Securities and Use of Proceeds**

 

*Unit Redemption Program*

 

The Company has instituted a Unit Redemption Program to provide itsshareholders who have held their Units for at least one year with the benefitof limited interim liquidity, by presenting for redemption all or any portionof their Units.  If Units are held forthe required one-year period, the Units may be redeemed for a purchase price equalto 92% of the price paid per Unit if the Units have been owned less than threeyears, or 100% of the price paid per Unit if the Units have been owned forthree years or more.  The board ofdirectors reserves the right, in its sole discretion, at any time and from timeto time, to waive the one-year holding period, reject any request forredemption, change the purchase price for redemptions or otherwise amend theterms of, suspend, or terminate the Unit Redemption Program.  The following is a summary of redemptionsduring the third quarter of 2009:

 

**IssuerPurchases of Equity Securities**

 
| ** **     | ** ** | **(a)**                                | ** ** | **(b)**                           | ** ** | **(c)**                                                                                       | ** ** | **(d)**                                                                                | ** ** |
|----------------|------------|----------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| **Period**     | ** ** | **Total  Number  of Units  Purchased** | ** ** | **Average  Price Paid  per Unit** | ** ** | **Total  Number of  Units Purchased as  Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum  Number  of Units that May  Yet Be Purchased  Under the Plans or  Programs** | ** ** |
| July 2009 |       | 602,546                                |       | $                                 | 10.64      |                                                                                          | 2,548,146  |                                                                                   | (1)        |   |
|                |            |                                        |            |                                   |            |                                                                                               |            |                                                                                        |            |  |

 

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(1)  The maximum number of Units thatmay be redeemed in any 12 month period is limited to three percent (3.0%) ofthe weighted average number of Units outstanding from the beginning of the 12month period.

 

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** **

**Item 6.    Exhibits**

** **
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                              |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                                              |
| 3.1                 |       | Amended and Restated Articles of Incorporation of  the Registrant. (Incorporated by reference to Exhibit 3.3 to amendment  no. 3 to the Registrant’s registration statement on Form S-11 (SEC File  No. 333-125546) effective March 3, 2006). |                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                                              |
|                | 3.2        |                                                                                                                                                                                                                                                                   | Bylaws of the Registrant. (Incorporated by reference  to Exhibit 3.2 to the Registrant’s registration statement on  Form S-11 (SEC File No. 333-125546) effective March 3, 2006).                        |
|                |       |                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                                              |
|                | 31.1       |                                                                                                                                                                                                                                                                   | Certification of the Company’s Chief Executive  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (**FILED HEREWITH**).                                                                                 |
|                |       |                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                                              |
|                | 31.2       |                                                                                                                                                                                                                                                                   | Certification of the Company’s Chief Financial  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (**FILED HEREWITH**).                                                                                 |
|                |       |                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                                              |
|                | 32.1       |                                                                                                                                                                                                                                                                   | Certification of the Company’s Chief Executive  Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (**FILED HEREWITH**). |
|                     |            |                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                   |  |  |  |

 

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** **

**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| APPLE REIT SEVEN, INC. |                                                                                    |
|------------------------|-----------------------------------------------------------------------------------------|
|                   |                                                                                    |
| By:                    | /s/    GLADE  M. KNIGHT                                             |   | Date: November 4,  2009 |
|                   | **Glade M. Knight,**                                                                    |   |   |
|                   | **Chairman of the Board and  Chief Executive Officer****(Principal Executive Officer)** |   |   |
|                   |                                                                                    |   |   |
| By:                    | /s/    BRYAN  PEERY                                                 |   | Date: November 4,  2009 |
|                   | **Bryan Peery,**                                                                        |   |   |
|                   | **Chief Financial Officer****(Principal Financial and Principal  Accounting Officer)**  |   |   |

 

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