Merger with Apple REIT Ten, Inc.

9 Months Ended

Sep. 30, 2016

Disclosure Text Block Supplement [Abstract]

Mergers, Acquisitions and Dispositions Disclosures [Text Block]

2.  Merger with Apple REIT Ten, Inc.

Effective September 1, 2016, the Company completed its previously announced merger with Apple REIT Ten, Inc. (“Apple Ten”) (the “merger”), which merger and related transaction proposals were approved by each company’s respective shareholders, as applicable, on August 31, 2016.  Pursuant to the Agreement and Plan of Merger entered into on April 13, 2016, as amended on July 13, 2016 (the “Merger Agreement”), Apple Ten merged with and into 34 Consolidated, Inc., a wholly-owned subsidiary of the Company (“Acquisition Sub”), at which time the separate corporate existence of Apple Ten ceased and Acquisition Sub became the surviving corporation in the merger.  Acquisition Sub was formed solely for the purpose of engaging in the merger and had not conducted any prior activities.  Immediately following the effective time of the merger, the name of Acquisition Sub was changed to Apple REIT Ten, Inc.  As a result of the merger, the Company acquired the business of Apple Ten, a real estate investment trust, which immediately prior to the effective time of the merger, owned 56 hotels located in 17 states with an aggregate of 7,209 rooms.

Upon completion of the merger, each issued and outstanding unit of Apple Ten (consisting of a common share and related Series A preferred share) (each, an “Apple Ten unit”) was converted into the right to receive (i) 0.522 (the “unit exchange ratio”) common shares of the Company, with cash in lieu of fractional shares, and (ii) $1.00 in cash, and each issued and outstanding Series B convertible preferred share of Apple Ten was converted into the right to receive (i) a number of common shares of the Company equal to 12.11423 multiplied by the unit exchange ratio, with cash in lieu of fractional shares, and (ii) an amount in cash equal to 12.11423 multiplied by $1.00, resulting in the issuance of a total of approximately 48.7 million common shares of the Company and a total payment of approximately $93.6 million in cash, including $0.2 million for fractional shares, to Apple Ten shareholders.  The cash payment was funded through borrowings on the Company’s revolving credit facility.  The Company’s common shares totaling 174.7 million prior to the merger remained outstanding following the merger, resulting in approximately 223.4 million common shares outstanding upon completion of the merger.  Also, as a result of the merger, the Company, through its wholly-owned subsidiary, assumed all of Apple Ten’s assets and liabilities at closing.  

The Company has accounted for the merger in accordance with the Accounting Standards Codification (“ASC”) 805, Business Combinations.  The Company is considered the acquirer for financial reporting purposes, which requires, among other things, that the assets acquired and liabilities assumed from Apple Ten be recognized at their acquisition date fair values.  For purpose of accounting for the transaction, the aggregate value of the merger consideration paid to Apple Ten shareholders was estimated to be approximately $1.0 billion, and is comprised of approximately $956.1 million for the issuance of approximately 48.7 million common shares of the Company valued at $19.62 per share, which was the closing price of the Company’s common shares on August 31, 2016 (the date that the merger was approved), and $93.6 million in cash.

As more fully described in Note 5, effective September 1, 2016, upon completion of the merger, the Company assumed approximately $145.7 million in mortgage debt, prior to any fair value adjustments, secured by nine properties.  The Company also assumed the outstanding balance on Apple Ten’s credit facility totaling $111.1 million, which was terminated and repaid in full on September 1, 2016 with borrowings on the Company’s revolving credit facility.

All costs related to the merger are being expensed in the period they are incurred and are included in transaction costs in the Company’s consolidated statements of operations.  In connection with the merger, the Company has incurred approximately $37.6 million in merger costs (including approximately $33.8 million of costs incurred to defend and reflect the proposed settlement (which remains subject to court approval) of the ongoing lawsuit related to the merger discussed in Note 10) for the nine months ended September 30, 2016.

In connection with the issuance of approximately 48.7 million common shares to effect the merger, the Company incurred approximately $1.2 million in issuance costs including legal, accounting and reporting services.  These costs were recorded by the Company as a reduction of shareholders’ equity.

As contemplated in the Merger Agreement, in connection with the completion of the merger, the advisory and related party arrangements with respect to Apple Ten and its advisors, as described in more detail in Note 7, were terminated.

As more fully described below, the Company is in the process of finalizing its valuation of the acquired assets and liabilities for the merger, which is expected to be finalized during 2016.  Accordingly, the purchase price allocation adjustments are preliminary and final estimates of fair value may be significantly different from these preliminary estimates.  The following table summarizes the Company’s preliminary purchase price allocation for the merger, which represents its best estimate of the fair values of the assets acquired and liabilities assumed on September 1, 2016, the effective date of the merger (in thousands):

	Purchase Price Allocation
Assets:
Land	$	151,200
Building and improvements		1,065,859
Furniture, fixtures and equipment		75,445
Franchise fees		2,917
Investment in real estate		1,295,421
Restricted cash, due from third party managers and other assets		33,579
Total assets		1,329,000
Liabilities:
Credit facility		111,100
Mortgage debt		151,885
Accounts payable and other liabilities		16,339
Total liabilities		279,324
Fair value estimate of net assets acquired (total consideration paid)	$	1,049,676

The preliminary allocation of the purchase price requires a significant amount of judgment and was based upon valuations and other analyses described below that are currently being finalized.  The Company has engaged a valuation firm to assist in the analysis.  The methodologies and significant inputs and assumptions used in deriving estimates of fair value vary and are based on the nature of the tangible or intangible asset acquired or liability assumed.  The fair value of land, building and improvements, furniture, fixtures and equipment, and identifiable intangible assets was developed based on the cost approach, market approach or income approach depending on available information and compared to a secondary approach when possible.  The fair value of debt was estimated based on contractual future cash flows discounted using borrowing spreads and market interest rates that would be available to the Company as of the acquisition date for the issuance of debt with similar terms and remaining maturities.  Significant inputs and assumptions associated with these approaches included estimates of future operating cash flows and discount rates based on an evaluation of both observable market data (categorized as Level 2 inputs under the fair value hierarchy) and unobservable inputs that reflect the Company’s own internal assumptions and calculations (categorized as Level 3 inputs under the fair value hierarchy).  No goodwill was recorded in connection with the merger.

In connection with the merger, the Company acquired four properties with three existing ground leases, with remaining terms of approximately 26, 46 and 84 years, excluding any option periods to extend the initial lease term.  The Company has the option to extend the term of the lease with 26 years remaining beyond its initial term up to four times for 30 years each renewal period.  There are no renewal options on the other leases.  The three leases assumed were valued at below market rates and as a result the Company recorded intangible assets totaling approximately $10.0 million, which are included in other assets, net in the Company’s consolidated balance sheets.  The value of each lease intangible is amortized over the term of the respective lease and the amortization is included in ground lease expense in the Company’s consolidated statements of operations.  The ground leases are classified as operating leases, and rental expense is recognized on a straight-line basis over the remaining term of the respective lease.

The aggregate amounts of the estimated minimum lease payments pertaining to all of the ground leases assumed in the merger, for the five years subsequent to September 30, 2016 and thereafter are as follows (in thousands):

2016 (October - December)	$	82
2017		409
2018		435
2019		440
2020		440
Thereafter		60,099
Total	$	61,905

The following unaudited pro forma information for the three and nine month periods ended September 30, 2016 and 2015, is presented as if the merger, effective September 1, 2016, had occurred on January 1, 2015, and is based on assumptions and estimates considered appropriate by the Company.  The pro forma information is provided for illustrative purposes only and does not necessarily reflect what the operating results would have been had the merger been completed on January 1, 2015, nor is it necessarily indicative of future operating results.  The pro forma information does not give effect to any cost synergies or other operating efficiencies that could result from the merger.  Amounts are in thousands except per share data.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Total revenue	$	325,924	$	309,835	$	949,760	$	885,015
Net income	$	59,981	$	61,057	$	177,183	$	173,419
Basic and diluted net income per common share	$	0.27	$	0.27	$	0.79	$	0.75
Weighted average common shares outstanding - basic and diluted		223,403		223,799		223,399		230,977

For purposes of calculating these pro forma amounts, merger transaction costs totaling approximately $36.4 million and $37.6 million for the three and nine months ended September 30, 2016, included in the Company’s consolidated statements of operations, were excluded from the pro forma amounts since these costs are attributable to the merger and related transactions and do not have an ongoing impact to the statements of operations.