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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 


x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2012

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______

Commission File Number 000-52585

Apple REIT Seven, Inc.
(Exact name of registrant as specified in its charter)
 
Virginia 20-2879175
(State or other jurisdiction    (IRS Employer
of incorporation or organization) Identification No.)
   
814 East Main Street
Richmond, Virginia
23219
(Address of principal executive offices) (Zip Code)
   
(804) 344-8121
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x   No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer   ¨
 
Accelerated filer   ¨
 
Non-accelerated filer x  
 
Smaller reporting company   ¨
       
(Do not check if a smaller
reporting company)
   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Number of registrant’s common shares outstanding as of May 1, 2012: 90,718,556

 
 


APPLE REIT SEVEN, INC.
FORM 10-Q
 
 
Page Number
PART I.  FINANCIAL INFORMATION
 
   
 
Item 1.
 
       
 
 
3
 
     
 
 
4
       
 
 
5
       
 
 
6
       
 
Item 2.
   11
       
 
Item 3.
   20
       
 
Item 4.
   20
       
PART II.  OTHER INFORMATION
 
       
 
Item 1.
21
       
 
Item 2.
22
       
 
Item 6.
23
       
 
24
 
This Form 10-Q includes references to certain trademarks or service marks.  The SpringHill Suites® by Marriott, TownePlace Suites® by Marriott, Fairfield Inn® by Marriott, Courtyard® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates.  The Homewood Suites® by Hilton, Hilton Garden Inn®, Hampton Inn® and Hampton Inn & Suites® trademarks are the property of Hilton Worldwide or one or more of its affiliates.  For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.

 
2

 
PART I.          FINANCIAL INFORMATION
 
Item 1.  Financial Statements
 
Apple REIT Seven, Inc.
Consolidated Balance Sheets
(In thousands, except share data)
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(unaudited)
       
Assets
           
Investment in real estate, net of accumulated depreciation
    of $156,822 and $148,257, respectively
  $ 839,501     $ 846,377  
Restricted cash-furniture, fixtures and other escrows
    7,252       7,141  
Due from third party managers, net
    11,100       6,426  
Other assets, net
    5,547       5,197  
  Total Assets
  $ 863,400     $ 865,141  
                 
Liabilities
               
Credit facility
  $ 76,600     $ 64,700  
Mortgage debt
    109,233       110,147  
Accounts payable and accrued expenses
    12,365       12,314  
  Total Liabilities
    198,198       187,161  
                 
Shareholders' Equity
               
Preferred stock, authorized 15,000,000 shares; none issued
    and outstanding
    0       0  
Series A preferred stock, no par value, authorized 200,000,000
    shares; issued and outstanding 91,036,660 and
    91,109,651 shares, respectively
    0       0  
Series B convertible preferred stock, no par value, authorized
    240,000 shares; issued and outstanding 240,000
    shares, respectively
    24       24  
Common stock, no par value, authorized 200,000,000 shares;
     issued and outstanding 91,036,660 and 91,109,651
    shares, respectively
    899,752       900,555  
Distributions greater than net income
    (234,574 )     (222,599 )
  Total Shareholders' Equity
    665,202       677,980  
                 
  Total Liabilities and Shareholders' Equity
  $ 863,400     $ 865,141  
 
See notes to consolidated financial statements.
 
 
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Apple REIT Seven, Inc.
Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)
 
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
             
Revenues:
           
Room revenue
  $ 47,397     $ 44,705  
Other revenue
    5,102       4,738  
Total revenue
    52,499       49,443  
                 
Expenses:
               
Operating expense
    13,952       13,635  
Hotel administrative expense
    3,936       3,879  
Sales and marketing
    4,101       3,802  
Utilities
    2,070       2,117  
Repair and maintenance
    2,362       2,251  
Franchise fees
    2,199       2,060  
Management fees
    1,776       1,650  
Taxes, insurance and other
    3,174       3,094  
General and administrative
    2,118       1,119  
Depreciation expense
    8,565       8,366  
Total expenses
    44,253       41,973  
                 
Operating income
    8,246       7,470  
                 
Interest expense, net
    2,716       2,281  
                 
Net income
  $ 5,530     $ 5,189  
                 
Basic and diluted net income per common share
  $ 0.06     $ 0.06  
                 
Weighted average common shares outstanding
       - basic and diluted
    90,959       91,764  
 
See notes to consolidated financial statements.
 
 
4

 
Apple REIT Seven, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
 
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net income
  $ 5,530     $ 5,189  
Adjustments to reconcile net income to cash provided by
    operating activities:
               
Depreciation     8,565       8,366  
Amortization of deferred financing costs, fair value
    adjustments and other non-cash expenses, net
    52       45  
Changes in operating assets and liabilities:
               
Increase in due from third party managers, net     (4,674 )     (4,535 )
Increase in other assets     (31 )     (462 )
Increase in accounts payable and accrued expenses     781       5  
Net cash provided by operating activities     10,223       8,608  
                 
Cash flows from investing activities:
               
  Capital improvements     (2,420 )     (1,843 )
  Net decrease (increase) in cash restricted for property improvements     (631 )     349  
Net cash used in investing activities     (3,051 )     (1,494 )
                 
Cash flows from financing activities:
               
  Payments of mortgage debt     (764 )     (684 )
  Proceeds from mortgage debt     0       10,500  
  Net proceeds from credit facility     11,900       2,700  
  Deferred financing costs     0       (133 )
  Redemptions of Units     (4,988 )     (7,999 )
  Net proceeds related to issuance of Units     4,185       6,160  
  Distributions paid to common shareholders     (17,505 )     (17,658 )
Net cash used in financing activities     (7,172 )     (7,114 )
                 
Net change in cash and cash equivalents
    0       0  
                 
Cash and cash equivalents, beginning of period
    0       0  
                 
Cash and cash equivalents, end of period
  $ 0     $ 0  
 
See notes to consolidated financial statements.
 
 
5

 
Apple REIT Seven, Inc.
Notes to Consolidated Financial Statements

1.  Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not include all of the information required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its 2011 Annual Report on Form 10-K. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2012.

2.  General Information and Summary of Significant Accounting Policies

    Organization

Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”), is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes.  The Company was formed to invest in income-producing real estate in the United States. Initial capitalization occurred on May 26, 2005 and operations began on April 27, 2006 when the Company acquired its first hotel. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007. The Company’s fiscal year end is December 31. As of March 31, 2012, the Company owned 51 hotels. The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated.

    Significant Accounting Policies

    Use of Estimates

The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

    Earnings per Common Share 

Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the period. Diluted earnings per share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period. There were no potential common shares with a dilutive effect for the three months ended March 31, 2012 or 2011. As a result, basic and dilutive outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares.
 
 
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3.  Credit Facility
 
The Company has an unsecured revolving credit facility, originated in October 2010 that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. The syndicated credit facility provides for a maximum aggregate commitment by the lenders, three commercial banks, of $85 million, and has a scheduled maturity in October 2012. The applicable interest rate under the unsecured revolving credit facility is, at the Company’s option, equal to a) LIBOR (the London Interbank Offered Rate for a one-month term) plus 3.5%, subject to a minimum LIBOR interest rate floor of 1.5%, or b) the banks’ commercial prime rate plus 3.5%. The applicable LIBOR rate was approximately 0.241% at March 31, 2012.  Payments of interest only are due monthly under the terms of the credit agreement; the Company may make voluntary prepayments in whole or in part, at any time. The Company is required to pay a quarterly fee at an annual rate of 0.5% on the average unused balance of the credit facility.  The balance outstanding under the credit facility on March 31, 2012 and December 31, 2011 was $76.6 million and $64.7 million, both at an annual interest rate of 5.0%. The credit facility contains representations, financial and other covenants typical for this type of commercial credit facility.  The Company was in compliance with each of these covenants at March 31, 2012.

4.  Fair Value of Financial Instruments

The Company estimates the fair value of its debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit terms and credit characteristics which are Level 3 inputs.  Market rates take into consideration general market conditions and maturity.  As of March 31, 2012, the carrying value and estimated fair value of the Company’s debt was approximately $185.8 million and $188.6 million. As of December 31, 2011, the carrying value and estimated fair value of the Company’s debt was $174.8 million and $175.6 million. The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.

5.  Related Parties

The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be at arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the three months ended March 31, 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships.  However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.

The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to provide brokerage services for the acquisition and disposition of the Company’s real estate assets. ASRG is wholly owned by the Company’s Chairman and Chief Executive Officer, Glade M. Knight. In accordance with the contract, ASRG is paid a fee of 2% of the gross purchase price of any acquisitions or gross sale price of any dispositions of real estate investments, subject to certain conditions plus certain reimbursable costs. As of March 31, 2012, payments to ASRG for services under the terms of this contract totaled approximately $18.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees were incurred during the three months ended March 31, 2012 and 2011 under this contract.

The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“A7A”) to provide management services to the Company.  A7A provides these management services through an affiliate called Apple Fund management LLC (“AFM”), which is a subsidiary of Apple REIT Six, Inc.  An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $0.4 million and $0.3 million for the three months ended March 31, 2012 and 2011.

In addition to the fees payable to A7A, the Company reimbursed A7A or paid directly to AFM on behalf of A7A approximately $0.4 million for both the three months ended March 31, 2012 and 2011. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A7A.
 
 
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AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight).  As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (collectively the “Apple REIT Entities”).  Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.

The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors.  The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities.  In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each Company’s level of business activity and the extent to which each Company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day to day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.

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

Included in other assets, net on the Company’s consolidated balance sheet, is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment in Apple Air was approximately $1.9 million at both March 31, 2012 and December 31, 2011. The Company has recorded its share of income or losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the three months ended March 31, 2012 and 2011, the Company recorded a loss of approximately $42,000 and $53,000 as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.

The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting and auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, the services received by the Company are shared as applicable across the Apple REIT Entities. The professionals cannot always specifically identify their fees for one company therefore management allocates these costs across the companies that benefit from the services.
 
 
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6.  Shareholders’ Equity

Unit Redemption Program

The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. Since inception of the program through March 31, 2012, the Company has redeemed approximately 10.3 million Units representing $111.4 million, including 0.5 million Units in the amount of $5.0 million and 0.7 million Units in the amount of $8.0 million redeemed during the three months ended March 31, 2012 and 2011.  As contemplated in the program, beginning with the January 2011 redemption, the scheduled redemption date for the first quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and the first quarter of 2012:

Redemption Date
 
Requested Unit Redemptions
   
Units Redeemed
   
Redemption Requests Not Redeemed
 
                   
January 2011
    1,137,969       728,135       409,834  
April 2011
    1,303,574       728,883       574,691  
July 2011
    5,644,778       732,160       4,912,618  
October 2011
    11,332,625       727,980       10,604,645  
January 2012
    12,885,635       455,093       12,430,542  
 
As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.

Dividend Reinvestment Plan

In July 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of the proceeds from this plan may include purchasing Units under the Company’s Unit Redemption Program, enhancing properties, satisfying financing obligations and other expenses, increasing working capital, funding various corporate operations, and acquiring hotels. The Company has registered 15 million Units for potential issuance under the plan. During the three months ended March 31, 2012 and 2011, approximately 0.4 million Units, representing $4.2 million and 0.6 million Units, representing $6.2 million in proceeds to the Company, were issued under the plan.  Since inception of the plan through March 31, 2012, approximately 10.2 million Units, representing $112.7 million in proceeds to the Company, were issued under the plan.

Distributions

The Company’s annual distribution rate as of March 31, 2012 was $0.77 per common share, payable monthly. For the three months ended March 31, 2012 and 2011, the Company made distributions of $0.193 per common share for a total of $17.5 million and $17.7 million.

7.  Legal Proceedings

 The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.
 
 
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On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation.  The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012.  The parties agreed to a schedule for answering or otherwise responding to the complaint and that briefing on any motion to dismiss the complaint will be concluded by June 18, 2012.  The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. class action lawsuit but was later dismissed from that action in October 2011.
 
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc and David Lerner.  The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933.  The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida.  The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
 
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc.  The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws.  On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
 
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation.  The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint.  As noted above, the briefing for any motion to dismiss is expected to be concluded by June 18, 2012.
 
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
 
8.  Subsequent Events

In April 2012, the Company declared and paid approximately $5.8 million, or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.4 million or 123,000 Units were reinvested under the Company’s Dividend Reinvestment Plan.

In April 2012, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 441,000 Units in the amount of $4.8 million.  As contemplated in the program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors.  This redemption was approximately 4% of the total 12.6 million requested Units to be redeemed, with approximately 12.1 million requested Units not redeemed.
 
 
10

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

Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes.  Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles; the outcome of current and future litigation, regulatory proceedings or inquiries; and competition within the hotel industry. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved. In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code. Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission. Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.

Overview

Apple REIT Seven, Inc., together with its wholly owned subsidiaries (the “Company”), was formed to invest in income-producing real estate in the United States.  The Company was  initially capitalized on May 26, 2005, with its first investor closing on March 15, 2006. The Company completed its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in July 2007.  The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes.  As of March 31, 2012, the Company owned 51 hotels within different markets in the United States.  The Company’s first hotel was acquired on April 27, 2006 and the last hotel was purchased in September 2008.

Hotel Operations

Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned.  Beginning in 2011 and continuing through the first quarter of 2012, the hotel industry and Company’s revenues and operating income have shown improvement from the significant decline in the industry during 2008 through 2010.  Although there is no way to predict future general economic conditions, the Company anticipates mid-single digit revenue percentage increases for 2012 as compared to 2011.  In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”), revenue per available room (“RevPAR”) and market yield which compares an individual hotel’s results to others in its local market, and expenses, such as hotel operating expenses, general and administrative and other expenses described below.
 
 
11


The following is a summary of the Company’s results:

   
Three Months Ended March 31,
 
(in thousands except statistical data)
 
2012
   
Percent of Revenue
   
2011
   
Percent of Revenue
   
Percent Change
 
Total revenue
  $ 52,499       100 %   $ 49,443       100 %     6 %
Hotel operating expenses
    30,396       58 %     29,394       59 %     3 %
Taxes, insurance and other expense
    3,174       6 %     3,094       6 %     3 %
General and administrative expense
    2,118       4 %     1,119       2 %     89 %
Depreciation
    8,565               8,366               2 %
Interest expense, net
    2,716               2,281               19 %
                                         
Number of hotels
    51               51               -  
Average Market Yield (1)
    127               125               2 %
ADR
  $ 114             $ 111               3 %
Occupancy
    71 %             70 %             1 %
RevPAR
  $ 81             $ 77               5 %
Total rooms sold (2)
    412,294               400,164               3 %
Total rooms available (3)
    581,504               575,592               1 %
 
(1) Calculated from data provided by Smith Travel Research, Inc. ®  Excludes hotels under renovation during the applicable periods.
(2) Represents the number of room nights sold during the period.
           
(3) Represents the number of rooms owned by the Company multiplied by the number of nights in the period.
 
Legal Proceedings

The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.

On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation.  The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012.  The parties agreed to a schedule for answering or otherwise responding to the complaint and that briefing on any motion to dismiss the complaint will be concluded by June 18, 2012.  The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. class action lawsuit but was later dismissed from that action in October 2011.
 
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc and David Lerner.  The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933.  The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida.  The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
 
 
12

 
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc.  The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws.  On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
 
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation.  The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint.  As noted above, the briefing for any motion to dismiss is expected to be concluded by June 18, 2012.
 
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
 
Hotels Owned

The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 51 hotels the Company owned at March 31, 2012.  All dollar amounts are in thousands.
 
Location
 
State
 
Brand
 
Manager
 
Date of Purchase
 
Rooms
   
Gross Purchase Price
 
Auburn
 
AL
 
Hilton Garden Inn
 
LBA
 
8/17/06
    101     $ 10,185  
Dothan
 
AL
 
Fairfield Inn
 
LBA
 
5/16/07
    63       4,584  
Dothan
 
AL
 
Residence Inn
 
LBA
 
4/16/08
    84       9,669  
Huntsville
 
AL
 
Hilton Garden Inn
 
LBA
 
8/17/06
    101       10,285  
Huntsville
 
AL
 
Homewood Suites
 
LBA
 
10/27/06
    107       11,606  
Huntsville
 
AL
 
TownePlace Suites
 
LBA
 
12/10/07
    86       8,927  
Montgomery
 
AL
 
Hilton Garden Inn
 
LBA
 
8/17/06
    97       10,385  
Montgomery
 
AL
 
Homewood Suites
 
LBA
 
8/17/06
    91       10,660  
Prattville
 
AL
 
Courtyard
 
LBA
 
4/24/07
    84       9,304  
Troy
 
AL
 
Hampton Inn
 
LBA
 
8/17/06
    82       6,130  
Trussville
 
AL
 
Courtyard
 
LBA
 
10/4/07
    84       9,510  
Tucson
 
AZ
 
Residence Inn
 
Western
 
1/17/08
    124       16,640  
Agoura Hills
 
CA
 
Homewood Suites
 
Dimension
 
5/8/07
    125       25,250  
Rancho Bernardo
 
CA
 
Courtyard
 
Dimension
 
12/12/06
    210       36,000  
San Diego
 
CA
 
Hampton Inn
 
Dimension
 
7/19/07
    177       42,000  
San Diego
 
CA
 
Hilton Garden Inn
 
Inn Ventures
 
5/9/06
    200       34,500  
San Diego
 
CA
 
Residence Inn
 
Dimension
 
6/13/07
    121       32,500  
Highlands Ranch
 
CO
 
Hilton Garden Inn
 
Dimension
 
3/9/07
    128       20,500  
Highlands Ranch
 
CO
 
Residence Inn
 
Dimension
 
2/22/07
    117       19,000  
Lakeland
 
FL
 
Courtyard
 
LBA
 
4/24/07
    78       9,805  
Miami
 
FL
 
Courtyard
 
Dimension
 
9/5/08
    118       15,000  
Miami
 
FL
 
Homewood Suites
 
Dimension
 
2/21/07
    159       24,300  
 
 
13

 
Sarasota
 
FL
 
Homewood Suites
 
Hilton
 
9/15/06
    100       13,800  
Tallahassee
 
FL
 
Fairfield Inn
 
LBA
 
4/24/07
    79       6,647  
Columbus
 
GA
 
Fairfield Inn
 
LBA
 
4/24/07
    79       7,333  
Columbus
 
GA
 
SpringHill Suites
 
LBA
 
3/6/08
    85       9,675  
Columbus
 
GA
 
TownePlace Suites
 
LBA
 
5/22/08
    86       8,428  
Macon
 
GA
 
Hilton Garden Inn
 
LBA
 
6/28/07
    101       10,660  
Boise
 
ID
 
SpringHill Suites
 
Inn Ventures
 
9/14/07
    230       21,000  
New Orleans
 
LA
 
Homewood Suites
 
Dimension
 
12/15/06
    166       43,000  
Hattiesburg
 
MS
 
Courtyard
 
LBA
 
10/5/06
    84       9,455  
Tupelo
 
MS
 
Hampton Inn
 
LBA
 
1/23/07
    96       5,245  
Omaha
 
NE
 
Courtyard
 
Marriott
 
11/4/06
    181       23,100  
Cranford
 
NJ
 
Homewood Suites
 
Dimension
 
3/7/07
    108       13,500  
Mahwah
 
NJ
 
Homewood Suites
 
Dimension
 
3/7/07
    110       19,500  
Ronkonkoma
 
NY
 
Hilton Garden Inn
 
White
 
12/15/06
    164       27,000  
Cincinnati
 
OH
 
Homewood Suites
 
White
 
12/1/06
    76       7,100  
Memphis
 
TN
 
Homewood Suites
 
Hilton
 
5/15/07
    140       11,100  
Addison
 
TX
 
SpringHill Suites
 
Marriott
 
8/10/07
    159       12,500  
Brownsville
 
TX
 
Courtyard
 
Western
 
6/19/06
    90       8,550  
El Paso
 
TX
 
Homewood Suites
 
Western
 
4/23/08
    114       15,390  
Houston
 
TX
 
Residence Inn
 
Western
 
4/27/06
    129       13,600  
San Antonio
 
TX
 
TownePlace Suites
 
Western
 
6/29/07
    106       11,925  
San Antonio
 
TX
 
TownePlace Suites
 
Western
 
9/27/07
    123       13,838  
Stafford
 
TX
 
Homewood Suites
 
Western
 
8/15/06
    78       7,800  
Provo
 
UT
 
Residence Inn
 
Dimension
 
6/13/07
    114       11,250  
Alexandria
 
VA
 
Courtyard
 
Marriott
 
7/13/07
    178       36,997  
Richmond
 
VA
 
Marriott
 
White
 
1/25/08
    410       53,300  
Kirkland
 
WA
 
Courtyard
 
Inn Ventures
 
10/23/07
    150       31,000  
Seattle
 
WA
 
Residence Inn
 
Inn Ventures
 
9/1/06
    234       56,173  
Vancouver
 
WA
 
SpringHill Suites
 
Inn Ventures
 
6/1/07
    119       15,988  
                      6,426     $ 901,594  
 
 Results of Operations

As of March 31, 2012, the Company owned 51 hotels with 6,426 rooms. The Company’s portfolio of hotels owned is unchanged since 2008. Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. During the period from the second half of 2008 through 2010, the overall weakness in the U.S. economy had a considerable negative impact on both consumer and business travel. As a result, hotel revenue in most markets in the United States declined from levels of 2007 and the first half of 2008. However, economic conditions have shown evidence of improvement in 2011 and the first quarter of 2012. Although the Company expects continued improvements in 2012, it is not anticipated that revenue and operating income will reach pre-recession levels. The Company’s hotels in general have shown results consistent with industry and brand averages for the period of ownership.

Revenues

The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue. For the three months ended March 31, 2012 and 2011, the Company had total revenue of $52.5 million and $49.4 million, respectively.  For the three months ended March 31, 2012 and 2011, the hotels achieved average occupancy of 71% and 70%, ADR of $114 and $111, and RevPAR of $81 and $77.  ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.
 
 
14


Since the beginning of 2010 and continuing into 2012, the Company has experienced an increase in demand, as demonstrated by the improvement in average occupancy.  In addition, also signifying a stabilizing economy, the Company experienced an increase in ADR of 3% during the first quarter of 2012 as compared to the first quarter of 2011.  With continued demand and room rate improvement, the Company and industry are forecasting a mid single digit percentage increase in revenue for 2012 as compared to 2011.  While reflecting the impact of post-recessionary levels of single-digit growth in national economic activity, the Company’s hotels also continue to be leaders in their respective markets.  The Company’s average Market Yield for the first three months of 2012 and 2011 was 127 and 125, respectively.  The Market Yield is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average (the index excludes hotels under renovation) and is provided by Smith Travel Research, Inc.®, an independent company that tracks historical hotel performance in most markets throughout the world.  The Company will continue to pursue market opportunities to improve revenue.

Expenses

Hotel operating expenses consist of direct room expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees.  For the three months ended March 31, 2012 and 2011, hotel operating expenses totaled $30.4 million and $29.4 million, or 58% and 59% of total revenue, respectively.  Results for the three month period ended March 31, 2012 reflect the impact of modest increases in revenues and occupancy at most of the Company’s hotels, and the Company’s efforts to control costs.  Certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature. The Company has been successful in reducing, relative to revenue increases, certain labor costs, hotel supply costs, maintenance costs and utilities by continually monitoring and sharing utilization data across its hotels and management companies. Although operating expenses will increase as occupancy and revenue increases, the Company has and will continue to work with its management companies to reduce costs as a percentage of revenue as aggressively as possible while maintaining quality and service levels at each property.
 
Taxes, insurance and other expense for the three months ended March 31, 2012 and 2011 was $3.2 million and $3.1 million, or 6% of total revenue for each respective period. Taxes have increased due to the reassessment of property values by localities resulting from the improved economy.   Also, insurance rates have increased due to property and casualty carriers’ losses world-wide in the past year.

General and administrative expense for the three months ended March 31, 2012 and 2011 was $2.1 million and $1.1 million, or 4% and 2% of total revenue.  The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expenses.  During the three months ended March 31, 2012 and 2011, the Company incurred approximately $0.5 million and $0.1 million, respectively, in legal costs, an increase over prior year due to the legal matters discussed herein and continued costs related to responding to Securities and Exchange Commission inquiries.  The Company anticipates it will continue to incur significant legal costs for at least the remainder of 2012.  Also, during the fourth quarter of 2011, the Company began to incur costs associated with its evaluation of a potential consolidation transaction with Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc.  Total costs incurred during the three months ended March 31, 2012 were approximately $0.5 million.  The Company will continue to incur these costs during 2012 if a transaction is pursued.

Depreciation expense for the three months ended March 31, 2012 and 2011 was $8.6 million and $8.4 million. Depreciation expense represents the expense of the Company’s hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment), for the respective periods owned.

Interest expense, net for the three months ended March 31, 2012 and 2011 was $2.7 million and $2.3 million. Interest expense primarily arose from mortgage debt outstanding on 11 of the Company’s hotel properties, in addition to interest on borrowings under the Company’s unsecured credit facility during those periods.  As of March 31, 2012, the Company had debt outstanding of $185.8 million compared to $160.4 million at March 31, 2011.  Interest expense increased from 2011 due to the debt increase to fund working capital needs, while maintaining a relatively stable distribution rate to Unit holders during a low-growth economic period.
 
 
15


Related Party Transactions

The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be at arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to these contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the three months ended March 31, 2012. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships.  However, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.

The Company has a contract with Apple Suites Realty Group, Inc. (“ASRG”) to provide brokerage services for the acquisition and disposition of the Company’s real estate assets. ASRG is wholly owned by the Company’s Chairman and Chief Executive Officer, Glade M. Knight. In accordance with the contract, ASRG is paid a fee of 2% of the gross purchase price of any acquisitions or gross sale price of any dispositions of real estate investments, subject to certain conditions plus certain reimbursable costs. As of March 31, 2012, payments to ASRG for services under the terms of this contract totaled approximately $18.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No fees were incurred during the three months ended March 31, 2012 and 2011 under this contract.

The Company is party to an advisory agreement with Apple Seven Advisors, Inc. (“A7A”) to provide management services to the Company.  A7A provides these management services through an affiliate called Apple Fund management LLC (“AFM”), which is a subsidiary of Apple REIT Six, Inc.  An annual advisory fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable to A7A for these management services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $0.4 million and $0.3 million for the three months ended March 31, 2012 and 2011.

In addition to the fees payable to A7A, the Company reimbursed A7A or paid directly to AFM on behalf of A7A approximately $0.4 million for both the three months ended March 31, 2012 and 2011. The costs are included in general and administrative expenses and are for the Company’s proportionate share of the staffing and related costs provided by AFM at the direction of A7A.

AFM is an affiliate of Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., ASRG and Apple Six Realty Group, Inc., (collectively the “Advisors” which are wholly owned by Glade M. Knight).  As such, the Advisors provide management services through the use of AFM to, respectively, Apple REIT Six, Inc., Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. (collectively the “Apple REIT Entities”).  Although there is a potential conflict on time allocation of employees due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement described more fully below allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to AFM include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) used by the companies. Since the employees of AFM perform services for the Apple REIT Entities and Advisors at the direction of the Advisors, individuals, including executive officers, receive their compensation at the direction of the Advisors and may receive consideration directly from the Advisors.

The Advisors and Apple REIT Entities allocate all of the costs of AFM among the Apple REIT Entities and the Advisors.  The allocation of costs from AFM is reviewed at least annually by the Compensation Committees of the Apple REIT Entities.  In making the allocation, management of each of the entities and their Compensation Committee consider all relevant facts related to each Company’s level of business activity and the extent to which each Company requires the services of particular personnel of AFM. Such payments are based on the actual costs of the services and are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to the Company. As part of this arrangement, the day to day transactions may result in amounts due to or from the Apple REIT Entities. To efficiently manage cash disbursements, an individual Apple REIT Entity may make payments for any or all of the related companies. The amounts due to or from the related Apple REIT Entity are reimbursed or collected and are not significant in amount.
 
 
16


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

Included in other assets, net on the Company’s consolidated balance sheet, is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment in Apple Air was approximately $1.9 million at both March 31, 2012 and December 31, 2011. The Company has recorded its share of income or losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the three months ended March 31, 2012 and 2011, the Company recorded a loss of approximately $42,000 and $53,000 as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations.

The Company has incurred legal fees associated with the Legal Proceedings discussed herein. The Company also incurs other professional fees such as accounting and auditing and reporting. These fees are included in general and administrative expense in the Company’s consolidated statements of operations. To be cost effective, the services received by the Company are shared as applicable across the Apple REIT Entities. The professionals cannot always specifically identify their fees for one company therefore management allocates these costs across the companies that benefit from the services.

Liquidity and Capital Resources

The Company has an unsecured revolving credit facility, originated in October 2010 that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions.  The syndicated credit facility provides for a maximum aggregate commitment by the lenders, three commercial banks, of $85 million, and has a scheduled maturity in October 2012. The applicable interest rate under the unsecured revolving credit facility is, at the Company’s option, equal to a) LIBOR (the London Interbank Offered Rate for a one-month term) plus 3.5%, subject to a minimum LIBOR interest rate floor of 1.5%, or b) the banks’ commercial prime rate plus 3.5%. With the availability of the Company’s credit facility, the Company generally maintains little cash on hand, accessing the credit facility as necessary. As a result, unrestricted cash on hand was $0 at March 31, 2012.  The outstanding balance on the credit facility was $76.6 million at March 31, 2012 and its annual interest rate was 5.0%.  The loan contains the following quarterly financial covenants (capitalized terms are defined in the loan agreements):
 
· 
Tangible Net Worth must exceed $325 million;
   
· 
Total Debt to Asset Value must not exceed 40%;
   
· 
Cumulative 12 month Distributions and Redemptions, net of proceeds from the Company’s Dividend Reinvestment Program, does not exceed $84 million, and quarterly Distributions will not exceed $0.193 per share, unless such cumulative Net Distributions are less than total Funds From Operations for the period;
   
· 
Loan balance must not exceed 25% of the Unencumbered Asset Value;
   
· 
Ratio of Net Operating Income, for the Company’s unencumbered properties compared to an Implied Debt Service for the properties must exceed four; and
   
· 
Ratio of net income before depreciation and interest expense to total Fixed Charges, on a cumulative 12 month basis, must exceed two.
 
 
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The Company was in compliance with each of these covenants at March 31, 2012.

The Company anticipates that cash flow from operations, its current revolving credit facility and other available credit (including refinancing its existing credit facility) will be adequate to meet its anticipated liquidity requirements, including required distributions to shareholders (the Company is not required to make distributions at its current rate for REIT purposes), planned Unit redemptions, capital expenditures and debt service.  The Company intends to maintain a relatively stable distribution rate instead of raising and lowering the distribution rate with varying economic cycles.  The Company will attempt if necessary to utilize additional financing to achieve this objective. Although the Company has relatively low levels of debt, there can be no assurances it will be successful with this strategy and may need to reduce its distribution to required levels. If the Company is unsuccessful in the extension of debt maturing in future periods, or if it were to default on its debt, it may be unable to make distributions or redemptions.

To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income.  The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company, taking into account acquisitions, capital improvements, ramp-up of new properties and varying economic cycles. Distributions during the first three months of 2012 totaled $17.5 million and were paid monthly at a rate of $0.064167 per common share.  For the same period, the Company’s cash generated from operations was approximately $10.2 million. This shortfall includes a return of capital and was funded primarily by increases in the Company’s borrowings under its credit facility.  Since a portion of distributions has been funded with borrowed funds, the Company’s ability to maintain its current intended rate of distribution will be primarily based on the ability of the Company’s properties to generate cash from operations at this level, the Company’s ability to utilize currently available financing, or the Company’s ability to obtain additional financing. Since there can be no assurance of the Company’s ability to obtain additional financing or that properties owned by the Company will provide income at this level, there can be no assurance as to the classification or duration of distributions at the current rate.  Additionally, the Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make additional adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company.
 
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and under certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. The Company expects that this amount will be adequate to fund required repair, replacement, and refurbishments and to maintain the Company’s hotels in a competitive condition. Also, as of March 31, 2012, the Company held $6.1 million in reserve for capital expenditures.  For the first three months of 2012, the Company spent approximately $2.4 million on capital expenditures and anticipates spending an additional $8 to $10 million for the remainder of the year.  The Company currently does not have any existing or planned projects for new development.

The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. Since inception of the program through March 31, 2012, the Company has redeemed approximately 10.3 million Units representing $111.4 million, including 0.5 million Units in the amount of $5.0 million and 0.7 million Units in the amount of $8.0 million redeemed during the three months ended March 31, 2012 and 2011.  As contemplated in the program, beginning with the January 2011 redemption, the scheduled redemption date for the first quarter of 2011, the Company redeemed Units on a pro-rata basis. Prior to 2011, the Company redeemed 100% of redemption requests. The following is a summary of the Unit redemptions during 2011 and the first quarter of 2012:
 
Redemption Date
 
Requested Unit Redemptions
   
Units Redeemed
   
Redemption Requests Not Redeemed
 
                   
January 2011
    1,137,969       728,135       409,834  
April 2011
    1,303,574       728,883       574,691  
July 2011
    5,644,778       732,160       4,912,618  
October 2011
    11,332,625       727,980       10,604,645  
January 2012
    12,885,635       455,093       12,430,542  
 
 
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As noted in the table above, beginning with the January 2011 redemption, the total redemption requests exceeded the authorized amount of redemptions and, as a result the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.  Currently, the Company plans to redeem under its Redemption Program approximately 2% of weighted average Units during 2012.

In July 2007, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of the proceeds from this plan may include purchasing Units under the Company’s Unit Redemption Program, enhancing properties, satisfying financing obligations and other expenses, increasing working capital, funding various corporate operations, and acquiring hotels. The Company has registered 15 million Units for potential issuance under the plan. During the three months ended March 31, 2012 and 2011, approximately 0.4 million Units, representing $4.2 million and 0.6 million Units, representing $6.2 million in proceeds to the Company, were issued under the plan.  Since inception of the plan through March 31, 2012, approximately 10.2 million Units, representing $112.7 million in proceeds to the Company, were issued under the plan.

Impact of Inflation

Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation.  Competitive pressures may, however, limit the operators’ ability to raise room rates.  Currently the Company is not experiencing any material impact from inflation.
 
Business Interruption

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

Seasonality

The hotel industry historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or, if necessary, any available other financing sources to make distributions.

Subsequent Events

In April 2012, the Company declared and paid approximately $5.8 million, or $0.064167 per outstanding common share, in distributions to its common shareholders, of which approximately $1.4 million or 123,000 Units were reinvested under the Company’s Dividend Reinvestment Plan.

In April 2012, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 441,000 Units in the amount of $4.8 million.  As contemplated in the program, the Company redeemed Units on a pro-rata basis, whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors.  This redemption was approximately 4% of the total 12.6 million requested Units to be redeemed, with approximately 12.1 million requested Units not redeemed.
 
 
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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of March 31, 2012, the Company’s financial instruments were not exposed to significant market risk due to foreign currency exchange risk, commodity price risk or equity price risk. The Company will be exposed to interest rate risk due to possible changes in short term interest rates as it invests its cash, or borrows on its credit facility. The Company had an outstanding balance of approximately $76.6 million on its $85 million credit facility at March 31, 2012, and to the extent it utilizes the credit facility, the Company will be exposed to changes in short term interest rates. Based on the outstanding balance at March 31, 2012, every 100 basis point change in interest rates can potentially impact the Company’s annual net income by $766,000, subject to the conditions of the interest rate floor provisions of the credit facility, and with all other factors remaining the same. The Company’s cash balance at March 31, 2012 was $0.

Item 4.  Controls and Procedures
 
Senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report.  Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2012.  There have been no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
 
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PART II.          OTHER INFORMATION

Item 1.  Legal Proceedings

The term the “Apple REIT Companies” means the Company, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.

On December 13, 2011, the United States District Court for the Eastern District of New York ordered that three putative class actions, Kronberg, et al. v. David Lerner Associates, Inc., et al., Kowalski v. Apple REIT Ten, Inc., et al., and Leff v. Apple REIT Ten, Inc., et al., be consolidated and amended the caption of the consolidated matter to be In re Apple REITs Litigation.  The District Court also appointed lead plaintiffs and lead counsel for the consolidated action and ordered lead plaintiffs to file and serve a consolidated complaint by February 17, 2012.  The parties agreed to a schedule for answering or otherwise responding to the complaint and that briefing on any motion to dismiss the complaint will be concluded by June 18, 2012.  The Company was previously named as a party in the Kronberg, et al. v. David Lerner Associates, Inc., et al. class action lawsuit but was later dismissed from that action in October 2011.
 
On February 17, 2012, lead plaintiffs and lead counsel in the In re Apple REITs Litigation, Civil Action No. 1:11-cv-02919-KAM-JO, filed an amended consolidated complaint in the United States District Court for the Eastern District of New York against the Company, Apple Suites Realty Group, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc., Apple Ten Advisors, Inc., Apple Fund Management, LLC, Apple REIT Six, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc., their directors and certain officers, and David Lerner Associates, Inc and David Lerner.  The consolidated complaint, purportedly brought on behalf of all purchasers of Units in the Company and the other Apple REIT Companies, or those who otherwise acquired these Units that were offered and sold to them by David Lerner Associates, Inc., or its affiliates and on behalf of subclasses of shareholders in New Jersey, New York, Connecticut and Florida, asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933.  The consolidated complaint also asserts claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, negligence, and unjust enrichment, and claims for violation of the securities laws of Connecticut and Florida.  The complaint seeks, among other things, certification of a putative nationwide class and the state subclasses, damages, rescission of share purchases and other costs and expenses.
 
On February 16, 2012, one shareholder of the Company and Apple REIT Six, Inc., filed a putative class action lawsuit captioned Laurie Brody v. David Lerner Associates, Inc., et al., Case No. 1:12-cv-782-ERK-RER, in the United States District Court for the Eastern District of New York against the Company, Apple REIT Six, Inc., Glade M. Knight, Apple Suites Realty Group, Inc., David Lerner Associates, Inc., and certain executives of David Lerner Associates, Inc.  The complaint, purportedly brought on behalf of all purchasers of Units of the Company and Apple REIT Six, Inc., or those who otherwise acquired these Units, asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, unjust enrichment, negligence, breach of written or implied contract (against the David Lerner Associates, Inc. defendants only), and for violation of New Jersey’s state securities laws.  On March 13, 2012, by order of the court, Laurie Brody v. David Lerner Associates, Inc., et al. was consolidated into the In re Apple REITs Litigation.
 
On April 18, 2012, the Company, and the other Apple REIT Companies, served a motion to dismiss the consolidated complaint in the In re Apple REITs Litigation.  The Company and the other Apple REIT Companies accompanied their motion to dismiss the consolidated complaint with a memorandum of law in support of their motion to dismiss the consolidated complaint.  As noted above, the briefing for any motion to dismiss is expected to be concluded by June 18, 2012.
 
The Company believes that any claims against it, its officers and directors and other Apple entities are without merit, and intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.
 
 
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Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

Unit Redemption Program

Effective in April 2007, the Company’s Board of Directors approved a Unit Redemption Program to provide limited interim liquidity to shareholders who have held their Units for at least one year. A shareholder may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any given year is five percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. As noted below, during 2011 and the first quarter of 2012, the total redemption requests exceeded the authorized amount of redemptions and the Board of Directors has and will continue to limit the amount of redemptions as it deems prudent.

Since inception of the program through March 31, 2012, the Company has redeemed approximately 10.3 million Units representing $111.4 million. During the three months ended March 31, 2012, the Company redeemed approximately 0.5 million Units in the amount of $5.0 million. As contemplated in the program, beginning with the January 2011 redemption, the Company redeemed Units on a pro-rata basis with approximately 64%, 56%, 13%, 6% and 4% of the amounts requested redeemed in the first, second, third and fourth quarters of 2011 and the first quarter of 2012, respectively, leaving approximately 12.4 million Units requested but not redeemed as of the last scheduled redemption date in the first quarter of 2012 (January 2012).  Prior to 2011, the Company had redeemed 100% of the redemption requests. The Company has a number of cash sources including cash from operations, dividend reinvestment plan proceeds, borrowings under its credit facilities and asset sales from which it can make distributions. See the Company’s complete consolidated statements of cash flows for the three months ended March 31, 2012 and 2011 included in the Company’s interim financial statements in Item 1 of this Form 10-Q for a further description of the sources and uses of the Company’s cash flows. The following is a summary of redemptions during the first quarter of 2012 (no redemptions occurred in February and March 2012):
 
Issuer Purchases of Equity Securities
 
   
(a)
   
(b)
   
(c)
   
(d)
 
Period
 
Total Number of
Units Purchased
   
Average Price
Paid per Unit
   
Total Number of Units
Purchased as Part
of Publicly Announced
Plans or Programs
   
Maximum Number of Units
that May Yet Be Purchased
Under the Plans or Programs
 
January 2012
    455,093     $ 10.96       455,093         (1)

(1) The maximum number of Units that may be redeemed in any 12 month period is limited to up to five percent (5.0%) of the weighted average number of Units outstanding from the beginning of the 12 month period, subject to the Company’s right to change the number of Units to be redeemed.
 
 
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Item 6.  Exhibits

Exhibit
Number
Description of Documents
   
   
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
   
31.2
   
32.1
   
101
The following materials from Apple REIT Seven, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text (FURNISHED HEREWITH)

 
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
APPLE REIT SEVEN, INC.
   
         
By:
/s/    GLADE M. KNIGHT        
   
Date: May 7, 2012
 
Glade M. Knight,
     
 
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
     
         
By:
/s/    BRYAN PEERY        
   
Date: May 7, 2012
 
Bryan Peery,
     
 
Chief Financial Officer
(Principal Financial and Principal Accounting Officer)
     

 
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