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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

FOR THE TRANSITION PERIOD FROM                TO               

 

Commission File Number 000-53603

 

Apple REIT Nine, Inc.

 (Exact name of registrant as specified in its charter)

 

Virginia

 

26-1379210

(State or other jurisdiction

 

(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  o   No  o

 

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  o

 

Accelerated filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  x

(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  o  No  x

 

Number of registrant’s common shares outstanding as of November 1, 2009: 86,760,954

 

 

 



Table of Contents

 

APPLE REIT NINE, 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 - Three and nine months ended September 30, 2009 and 2008

4

 

 

 

 

Consolidated Statements of Cash Flows – 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

18

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

30

 

 

 

Item 4.

Controls and Procedures

30

 

 

 

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

31

 

 

 

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

33

 

 

 

Signatures

 

34

 

This Form 10-Q includes references to certain trademarks or service marks.  The Hampton Inn®, Hampton Inn and Suites®, Homewood Suites® by Hilton, Embassy Suites Hotels® and Hilton Garden Inn® trademarks are the property of Hilton Worldwide or one or more of its affiliates.  The Courtyard® by Marriott, Fairfield Inn® by Marriott, Fairfield Inn and Suites® by Marriott, TownePlace Suites® by Marriott, SpringHill Suites® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates.  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



Table of Contents

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

Apple REIT Nine, Inc.

Consolidated Balance Sheets

(in thousands, except share data)

 

 

 

September 30,

 

December 31,

 

 

 

2009

 

2008

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Investment in real estate, net of accumulated depreciation of $12,055 and $2,277, respectively

 

$

686,620

 

$

346,423

 

Cash and cash equivalents

 

114,934

 

75,193

 

Due from third party managers, net

 

3,203

 

1,775

 

Other assets, net

 

17,557

 

8,228

 

Total Assets

 

$

822,314

 

$

431,619

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Notes payable

 

$

58,998

 

$

38,647

 

Accounts payable and accrued expenses

 

6,414

 

3,232

 

Total Liabilities

 

65,412

 

41,879

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preferred stock, authorized 30,000,000 shares; none issued and outstanding

 

 

 

Series A preferred stock, no par value, authorized 400,000,000 shares; issued and outstanding 80,754,695 and 41,013,517 shares, respectively

 

 

 

Series B convertible preferred stock, no par value, authorized 480,000 shares; issued and outstanding 480,000 shares, respectively

 

48

 

48

 

Common stock, no par value, authorized 400,000,000 shares; issued and outstanding 80,754,695 and 41,013,517 shares, respectively

 

793,395

 

400,569

 

Distributions greater than net income

 

(36,541

)

(10,877

)

Total Shareholders’ Equity

 

756,902

 

389,740

 

 

 

 

 

 

 

Total Liabilities and Shareholders’ Equity

 

$

822,314

 

$

431,619

 

 

See accompanying notes to consolidated financial statements.

 

The Company was initially capitalized on November 9, 2007 and commenced operations on July 31, 2008.

 

3



Table of Contents

 

Apple REIT Nine, Inc.

Consolidated Statements of Operations

(Unaudited)

(in thousands, except per share data)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Room revenue

 

$

20,420

 

$

609

 

$

56,252

 

$

609

 

Other revenue

 

2,242

 

110

 

6,601

 

110

 

Total hotel revenue

 

22,662

 

719

 

62,853

 

719

 

Rental revenue

 

5,439

 

 

10,515

 

 

Total revenue

 

28,101

 

719

 

73,368

 

719

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expense

 

6,385

 

250

 

16,751

 

250

 

Hotel administrative expense

 

1,920

 

68

 

4,947

 

68

 

Sales and marketing

 

2,063

 

80

 

5,611

 

80

 

Utilities

 

1,283

 

47

 

3,096

 

47

 

Repair and maintenance

 

1,043

 

39

 

2,837

 

39

 

Franchise fees

 

894

 

30

 

2,586

 

30

 

Management fees

 

668

 

16

 

2,004

 

16

 

Taxes, insurance and other

 

1,498

 

20

 

4,529

 

20

 

General and administrative

 

937

 

394

 

2,835

 

505

 

Acquisition related costs

 

2,405

 

 

4,868

 

 

Depreciation expense

 

4,004

 

267

 

9,778

 

267

 

Total expenses

 

23,100

 

1,211

 

59,842

 

1,322

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

5,001

 

(492

)

13,526

 

(603

)

 

 

 

 

 

 

 

 

 

 

Interest income (expense), net

 

(302

)

1,480

 

(930

)

1,865

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

4,699

 

$

988

 

$

12,596

 

$

1,262

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted net income per common share

 

$

0.06

 

$

0.04

 

$

0.21

 

$

0.13

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic and diluted

 

72,310

 

22,580

 

58,826

 

9,705

 

 

 

 

 

 

 

 

 

 

 

Distributions declared and paid per common share

 

$

0.22

 

$

0.22

 

$

0.66

 

$

0.29

 

 

See accompanying notes to consolidated financial statements.

 

The Company was initially capitalized on November 9, 2007 and commenced operations on July 31, 2008.

 

4



Table of Contents

 

Apple REIT Nine, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

12,596

 

$

1,262

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation

 

9,778

 

267

 

Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net

 

179

 

26

 

Straight-line rental income

 

(3,043

)

 

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in funds due from third party managers, net

 

(1,186

)

(263

)

Increase in other assets, net

 

(1,602

)

(57

)

Increase in accounts payable and accrued expenses

 

3,278

 

35

 

Net cash provided by operating activities

 

20,000

 

1,270

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

Cash paid for acquisitions

 

(325,393

)

(60,819

)

Deposits and other disbursements for potential acquisitions, net

 

232

 

(3,287

)

Capital improvements

 

(4,951

)

 

Increase in capital improvement reserves

 

(539

)

 

Investment in other assets

 

(3,240

)

 

Net cash used in investing activities

 

(333,891

)

(64,106

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net proceeds related to issuance of common shares

 

393,972

 

264,678

 

Redeemptions of common stock

 

(1,254

)

 

Distributions paid to common shareholders

 

(38,260

)

(5,681

)

Payments of notes payable

 

(526

)

 

Deferred financing costs

 

(300

)

 

Payoff of the line of credit, net of borrowings

 

 

(151

)

Net cash provided by financing activities

 

353,632

 

258,846

 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

39,741

 

196,010

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

75,193

 

20

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

114,934

 

$

196,030

 

 

 

 

 

 

 

Non-cash transactions:

 

 

 

 

 

Notes payable assumed in acquisitions

 

$

19,284

 

$

 

 

See accompanying notes to consolidated financial statements.

 

The Company was initially capitalized on November 9, 2007 and commenced operations on July 31, 2008.

 

5



Table of Contents

 

Apple REIT Nine, 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 financials should be read in conjunction with the Company’s audited consolidated financial statements included in its 2008 Annual Report on Form 10-K.  Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2009.

 

2.  General Information and Summary of Significant Accounting Policies

 

Organization

 

Apple REIT Nine, Inc. together with its wholly owned subsidiaries (the “Company”) is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes.  The Company was formed to invest in hotels, residential apartment communities and other income-producing real estate in selected metropolitan areas in the United States.  Initial capitalization occurred on November 9, 2007, when 10 Units, each Unit consisting of one common share and one Series A preferred share, were purchased by Apple Nine Advisors, Inc. (“A9A”) and 480,000 Series B convertible preferred shares were purchased by Glade M. Knight, the Company’s Chairman and Chief Executive Officer.  The Company began operations on July 31, 2008 when it purchased its first hotel.  The Company’s fiscal year end is December 31.  The Company has no foreign operations or assets and its operating structure includes two segments, hotels and a ground lease.  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 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.

 

Offering Costs

 

The Company is raising capital through a best-efforts offering of its Units by David Lerner Associates, Inc., the managing underwriter, which receives a selling commission and a marketing expense allowance based on proceeds of the shares sold.  Additionally, the Company has incurred other offering costs including legal, accounting and reporting services.  These offering costs are recorded by the Company as a reduction of shareholders’ equity.  Prior to the commencement of the Company’s offering, these costs were deferred and recorded as prepaid expense.  As of September 30, 2009, the Company had sold 80.9 million Units for gross proceeds of $884.9 million and proceeds net of offering costs of $794.6 million.  The Company will offer Units until April 25, 2010, unless the offering is extended, or terminated if all of the Units are sold before then.

 

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Table of Contents

 

Rental Income

 

On April 7, 2009, the Company entered into a ground lease with a subsidiary of Chesapeake Energy Corporation, the largest independent producer of natural gas in the United States and guarantor of the lease.  The lease has an initial term of 40 years with five renewal options of five years each, exercisable by the tenant.  Rental payments are fixed and have determinable rent increases during the initial lease term and reset to market during the first year of the renewal period.  Rental payments are required to be made monthly in advance.  Under the lease, the tenant is responsible for all operating costs associated with the land including, maintenance, insurance, property taxes, environmental, zoning, permitting, etc. and the tenant is required to maintain the land in good condition.  The lease is classified as an operating lease and rental income is recognized on a straight line basis over the initial term of the lease.  Rental income includes $1.6 million and $3.0 million of adjustments necessary to record rent on the straight line basis for the three and nine months ended September 30, 2009, respectively.  Straight line rental receivable is included in other assets, net in the Company’s consolidated balance sheet and totaled $3.0 million as of September 30, 2009.

 

Earnings Per Common Share

 

Basic earnings per common share is computed as net income divided by the weighted average number of common 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 shares with a dilutive effect for the three and nine months ended September 30, 2009 or 2008.  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 converted to common shares.

 

Recent Accounting Pronouncements

 

Accounting Standards Codification

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued a pronouncement establishing the FASB Accounting Standards Codification™ as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with United States generally accepted accounting principles (“GAAP”).  The standard explicitly recognizes rules and interpretive releases of the Securities Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. This standard is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

Noncontrolling Interests

 

In June 2009, the FASB issued a pronouncement which amends its guidance surrounding a company’s analysis to determine whether any of its variable interests constitute controlling financial interests in a variable interest entity.  This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics:  (a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.  Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity’s economic performance. The new pronouncement also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and enhanced disclosure about an enterprise’s involvement with a variable interest entity.  This pronouncement will be applied prospectively and will be effective for interim and annual reporting periods beginning after November 15, 2009.  The adoption of this standard is not anticipated to have a material impact on the Company’s consolidated financial statements.

 

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Table of Contents

 

Subsequent Events

 

In May 2009, the FASB issued a pronouncement which sets forth general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued.  Although there is new terminology, this pronouncement is based on the same principles as those that currently exist in the auditing standards.  This pronouncement, which includes a required disclosure 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 a material impact on the Company’s consolidated financial statements.

 

Assets Acquired or Liabilities Assumed in a Business Combination

 

In April 2009, the FASB issued a pronouncement which amends its guidance for all assets acquired and all liabilities assumed in a business combination that arise from contingencies.  This pronouncement states that the acquirer will recognize such an asset or liability if the acquisition-date fair value of that asset or liability can be determined during the measurement period.  If it cannot be determined during the measurement period, then the asset or liability should be recognized as of the acquisition date if the following criteria are met: (1) information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date, and (2) the amount of the asset or liability can be reasonably estimated.  This pronouncement was adopted by the Company in the first quarter of 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

Interim Disclosures about Fair Value of Financial Instruments

 

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

 

Business Combinations

 

In December 2007, the FASB issued a pronouncement which amends its guidance for business combinations by requiring an acquirer to recognize the assets of existing businesses acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions.  This method replaces the cost-allocation process, which required the cost of an acquisition of an existing business to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values.  A significant change included in the new pronouncement is the requirement that costs incurred to effect an acquisition of an existing business, must be accounted for separately as expenses.  Such costs include title, legal, accounting and other related costs, as well as commissions including the commission paid to Apple Suites Realty Group, Inc. (“ASRG”), a related party 100% owned by Glade M. Knight, Chairman and CEO of the Company.  This pronouncement was effective January 1, 2009.  For acquisitions of existing businesses prior to January 1, 2009, these costs were capitalized as part of the cost of the acquisition.  During the nine months ended September 30, 2009, the Company expensed $4.9 million in acquisition related costs.  Included in this amount is $293,000 in transaction costs related to potential acquisitions as of December 31, 2008.  These costs were incurred during 2008 and recorded as deferred acquisition costs and included in other assets, net in the Company’s consolidated balance sheet as of December 31, 2008.  In accordance with this pronouncement, these costs were expensed on January 1, 2009.  The adoption of this standard has had a material impact on the Company’s financial position and results of operations and will continue to have a material impact on the Company’s consolidated financial statements as it acquires other operating businesses.

 

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Table of Contents

 

3.  Real Estate Investments

 

Hotel Acquisitions

 

The Company acquired 12 hotels during the first nine months of 2009.  The Company also acquired land for the construction of a SpringHill Suites Hotel.  The following table sets forth the location, brand, manager, gross purchase price, number of hotel rooms and date of purchase by the Company for each property.   All dollar amounts are in thousands.

 

Location

 

Brand

 

Manager

 

Gross Purchase
Price

 

Rooms

 

Date of
Purchase

 

 

 

 

 

 

 

 

 

 

 

 

 

Round Rock, TX

 

Hampton Inn

 

Vista

 

$

11,500

 

93

 

3/6/2009

 

Panama City, FL

 

Hampton Inn & Suites

 

LBA

 

11,600

 

95

 

3/12/2009

 

Alexandria, VA

 

SpringHill Suites

 

Marriott

 

5,100

 

 

3/31/2009

(a)

Austin, TX

 

Homewood Suites

 

Vista

 

17,700

 

97

 

4/14/2009

 

Austin, TX

 

Hampton Inn

 

Vista

 

18,000

 

124

 

4/14/2009

 

Dothan, AL

 

Hilton Garden Inn

 

LBA

 

11,601

 

104

 

6/1/2009

 

Troy, AL

 

Courtyard

 

LBA

 

8,696

 

90

 

6/18/2009

(b)

Orlando, FL

 

Fairfield Inn & Suites

 

Marriott

 

25,800

 

200

 

7/1/2009

 

Orlando, FL

 

SpringHill Suites

 

Marriott

 

29,000

 

200

 

7/1/2009

 

Clovis, CA

 

Hampton Inn & Suites

 

Dimension

 

11,150

 

86

 

7/31/2009

 

Rochester, MN

 

Hampton Inn & Suites

 

White

 

14,136

 

124

 

8/3/2009

 

Johnson City, TN

 

Courtyard

 

LBA

 

9,880

 

90

 

9/25/2009

 

Baton Rouge, LA

 

SpringHill Suites

 

Dimension

 

15,100

 

119

 

9/25/2009

 

Total

 

 

 

 

 

$

189,263

 

1,422

 

 

 

 


(a)          The Company acquired the land for the construction of a SpringHill Suites hotel, which is expected to be completed over the next 18 months.  Upon completion, the hotel will contain approximately 152 guest rooms and is expected to be managed by Marriott.

(b)         Purchase contract includes a provision for an additional $750,000 to be paid to the Seller if certain earnings targets are met over the 15 months subsequent to acquisition.

 

The purchase price for these properties, net of debt assumed, was funded primarily by the Company’s ongoing best-efforts offering of Units.  The Company assumed approximately $19.3 million of debt during the first nine months of 2009, associated with three of its hotel acquisitions.  The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary (or a subsidiary thereof) under master hotel lease agreements.  The Company also used the proceeds of its ongoing best-efforts offering to pay approximately $3.8 million, representing 2% of the gross purchase price for these properties, as a brokerage commission to ASRG and to pay approximately $970,000 in other acquisition related costs, including title, legal and other related costs.  The aforementioned costs associated with acquiring existing businesses have been expensed and are included in acquisition related costs in the Company’s consolidated statements of operations for the nine months ended September 30, 2009.

 

No goodwill was recorded in connection with any of the acquisitions.

 

As of September 30, 2009, the Company owned 33 hotels, located in 14 states with an aggregate of 3,900 rooms and consisted of the following:  seven Hilton Garden Inn hotels, three Homewood Suites hotels, 11 Hampton Inn hotels, five Courtyard hotels, three Residence Inn hotels, two SpringHill Suites hotels and two Fairfield Inn hotels.

 

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Table of Contents

 

Land Acquisition

 

On April 7, 2009, the Company completed the preliminary closing with a subsidiary of Chesapeake Energy Corporation under the terms of the purchase and sale contract dated January 21, 2009, as amended, for the purchase of approximately 417 acres of land located on 113 sites in the Ft. Worth, Texas area.  The purchase price for the land was approximately $147 million.  The preliminary closing provides equitable title to the Company.  The recorded fee simple title will be completed and conveyed to the Company by the final closing date, which is the earlier of November 30, 2009 or the completion of platting each of the 113 sites with the relevant governmental localities.  Each of the 113 individual sites is between approximately two and eleven acres in size.  Simultaneous with the preliminary closing, the Company entered into a ground lease for this land (the “Lease”).  The Lease is with a subsidiary of Chesapeake Energy Corporation, Chesapeake Operating, Inc. (the “Tenant”).    Chesapeake Energy Corporation is a guarantor of the Lease.  The Lease has an initial term of 40 years with five renewal options of five years each, and annual rent ranging from approximately $15.5 million to $27.4 million with the average annual rent over the initial term being $21.8 million. Payments under the Lease are required to be made monthly in advance.  Currently, the Tenant is using approximately 70% of the sites for natural gas production and anticipates using the remaining land for natural gas production. Under the Lease, the Tenant is responsible for all operating costs associated with the land including, maintenance, insurance, property taxes, environmental, zoning, permitting, etc. and the Tenant is required to maintain the land in good condition.  During the term of the Lease, the Tenant has the option to purchase up to 30 sites (no more than 10 producing natural gas) for $1.4 million per site in years 1-5 of the Lease and $1.9 million for the remainder of the Lease.  For any sites purchased, the annual rent will be reduced proportionately to the remaining sites.

 

Chesapeake Energy Corporation is a publicly held company that is traded on the New York Stock Exchange.  Chesapeake Energy Corporation is the largest independent producer of natural gas in the United States with interests in over 43,000 producing, natural gas and oil wells.

 

The purchase price for the 417 acres of land was funded primarily by the Company’s ongoing best-efforts offering of Units.  The Company also used the proceeds of its ongoing best-efforts offering to pay approximately $2.9 million; representing 2% of the gross purchase price, as a brokerage commission to ASRG.  The Company capitalized the commission as well as other closing costs of $1.1 million as part of the acquisition cost of the land.  The Company has preliminarily recorded the purchase price and associated costs to land on the Company’s consolidated balance sheets.  The Company is in the process of obtaining an independent valuation of each site and the Lease and will finalize its purchase price allocation upon completion of these valuations.

 

Total Real Estate Investments

 

At September 30, 2009, the Company’s investment in real estate consisted of the following (in thousands):

 

Land

 

$

214,126

 

Building and Improvements

 

448,039

 

Furniture, Fixtures and Equipment

 

36,510

 

 

 

698,675

 

Less Accumulated Depreciation

 

(12,055

)

Investment in real estate, net

 

$

686,620

 

 

As of September 30, 2009, the Company had outstanding contracts for the potential purchase of eight additional hotels for a total purchase price of $162.3 million.  All of these hotels are under construction and are expected to be completed over the next 12 to 18 months.  Although the Company is working towards acquiring these hotels, there are many conditions to closing that have not yet been satisfied and there can be no assurance that closings will occur under the outstanding purchase contracts.  The following table summarizes the location, brand, number of rooms, refundable (if the seller does not meet its obligations

 

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under the contract) contract deposits paid, and gross purchase price for each of the contracts.  All dollar amounts are in thousands.

 

Location

 

Brand

 

Rooms

 

Deposits
Paid

 

Gross Purchase
Price

 

Hillsboro, OR

 

Embassy Suites

 

165

 

$

100

 

$

32,500

(a)

Hillsboro, OR

 

Hampton Inn & Suites

 

106

 

100

 

14,500

(a)

Clovis, CA

 

Homewood Suites

 

83

 

55

 

12,435

(a)

Albany, GA

 

Fairfield Inn & Suites

 

87

 

5

 

7,920

(a)/(b)

Panama City, FL

 

TownePlace Suites

 

103

 

5

 

10,640

(a)/(b)

Houston, TX

 

Marriott

 

206

 

200

 

51,000

(a)/(b)

Holly Springs, NC

 

Hampton Inn

 

124

 

100

 

14,880

(a)

Ft. Worth, TX

 

TownePlace Suites

 

140

 

100

 

18,460

(a)/(b)

 

 

 

 

1,014

 

$

665

 

$

162,335

 

 


(a)          The hotels are currently under construction. The table shows the expected number of rooms upon hotel completion and the expected franchise.

(b)         If the seller meets all of the conditions to closing, the Company is obligated to specifically perform under the contract.  As the properties are under construction, at this time, the seller has not met all of the conditions to closing.

 

As there can be no assurance that all conditions to closing will be satisfied, the Company includes deposits paid under contracts in other assets, net in the Company’s consolidated balance sheets, and in deposits and other disbursements for potential acquisitions in the Company’s consolidated statements of cash flows.

 

4.  Notes Payable

 

During the first nine months of 2009, the Company assumed approximately $19.3 million of debt secured by first mortgage notes on three of its hotel properties (Round Rock, Texas Hampton Inn, Austin, Texas Homewood Suites and Austin, Texas Hampton Inn).  During 2008, the Company assumed approximately $34.5 million of debt secured by first mortgage notes on three of its hotel properties.  In addition, the Company assumed a non-mortgage note payable of $3.8 million in connection with the Lewisville, Texas Hilton Garden Inn hotel.  The following table summarizes the hotel location, interest rate, maturity date and the principal amount assumed associated with each note payable outstanding as of September 30, 2009. All dollar amounts are in thousands.

 

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Location

 

Brand

 

Interest
Rate (1)

 

Maturity
Date

 

Principal
Assumed

 

Outstanding
balance as of
September 30,
2009

 

 

 

 

 

 

 

 

 

 

 

 

 

Lewisville, TX

 

Hilton Garden Inn

 

0.00

%

12/31/2016

 

$

3,750

 

$

3,750

 

Duncanville, TX

 

Hilton Garden Inn

 

5.88

%

5/11/2017

 

13,966

 

13,801

 

Allen, TX

 

Hilton Garden Inn

 

5.37

%

10/11/2015

 

10,787

 

10,630

 

Bristol, VA

 

Courtyard

 

6.59

%

8/1/2016

 

9,767

 

9,670

 

Round Rock, TX

 

Hampton Inn

 

5.95

%

5/1/2016

 

4,175

 

4,132

 

Austin, TX

 

Homewood Suites

 

5.99

%

3/1/2016

 

7,556

 

7,490

 

Austin, TX

 

Hampton Inn

 

5.95

%

3/1/2016

 

7,553

 

7,487

 

 

 

 

 

 

 

 

 

$

 57,554

 

$

56,960

 

 


(1)                   At acquisition, the Company adjusted the interest rates on these loans to market rates and is amortizing the adjustments to interest expense over the life of the loan.

 

The Company estimates the fair value of its fixed rate debt and the credit spreads over variable market rates on its variable rate debt by discounting the future cash flows of each instrument at estimated market rates or credit spreads consistent with the maturity of the debt obligation with similar credit policies.  Credit spreads take into consideration general market conditions and maturity.  As of September 30, 2009, the carrying value and estimated fair value of the Company’s debt was $59.0 million and $58.2 million.  As of December 31, 2008, the carrying value and estimated fair value of the Company’s debt was $38.6 million and $40.4 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 significant transactions with related parties.  These transactions cannot be construed to be at arm’s length and the results of the Company’s operations may be different than if conducted with non-related parties.

 

The Company has a contract with ASRG, to acquire and dispose of real estate assets for the Company.  A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services.  As of September 30, 2009, payments to ASRG for services under the terms of this contract have totaled approximately $13.6 million since inception.

 

The Company is party to an advisory agreement with A9A to provide management services to the Company and its assets. An annual fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services.  A9A has entered into an agreement with Apple REIT Six, Inc. (“AR6”) to provide certain management services to the Company.  The Company will reimburse A9A for the cost of the services provided by AR6.  A9A will in turn reimburse AR6.  Total advisory fees and reimbursable expenses incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1,490,000 and $271,000 for the nine months ended September 30, 2009 and 2008, respectively.

 

ASRG and A9A are 100% owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company.

 

Mr. Knight is also Chairman and Chief Executive Officer of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc., other REITS.  Members of the Company’s Board of Directors are also on the Board of Directors of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc.

 

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6.  Shareholder’s Equity

 

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 for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any given year will be three 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.  During the nine months ended September 30, 2009, the Company redeemed approximately 120,000 Units in the amount of $1.3 million under the program.

 

7.  Series B Convertible Preferred Stock

 

The Company has issued 480,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $48,000.  The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.

 

There are no dividends payable on the Series B convertible preferred shares.  Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.

 

Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares.  However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares distribution rights.  The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below.  In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.

 

Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:

 

(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;

 

(2) the termination or expiration without renewal of the advisory agreement with A9A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or

 

(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.

 

Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into a number of common shares based upon the gross proceeds raised through the date of conversion in the Company’s $2 billion offering according to the following table:

 

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Gross Proceeds Raised from Sales of
Units through Date of Conversion

 

Number of Common Shares
through Conversion of
One Series B Convertible Preferred
Share

 

$800 million

 

 9.70287

 

$900 million

 

10.90855

 

$    1  billion

 

12.11423

 

$ 1.1  billion

 

13.31991

 

$ 1.2  billion

 

14.52559

 

$ 1.3  billion

 

15.73128

 

$ 1.4  billion

 

16.93696

 

$ 1.5  billion

 

18.14264

 

$ 1.6  billion

 

19.34832

 

$ 1.7  billion

 

20.55400

 

$ 1.8  billion

 

21.75968

 

$ 1.9  billion

 

22.96537

 

$    2  billion

 

24.17104

 

 

In the event that after raising gross proceeds of $2 billion, the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/100 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest 100 million.

 

No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests.

 

Expense related to the issuance of 480,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B shares can be reasonably estimated and the event triggering the conversion of the Series B shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B shares can be converted and the amounts paid for the Series B shares. Although the fair market value cannot be determined at this time, expense if the maximum offering is achieved could range from $0 to in excess of $127 million (assumes $11 per unit fair market value).  Based on equity raised through September 30, 2009, if a triggering event had occurred, expense would have ranged from $0 to $51.2 million (assumes $11 per unit fair market value) and approximately 4.7 million common shares would have been issued.

 

8.  Other Assets

 

In January 2009, the Company purchased a 24% ownership interest in Apple Air Holding, LLC (“Apple Air”), for $3.2 million in cash. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly.  The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc.  The interest was purchased to allow the Company access to two Lear jets for asset management and renovation purposes. The investment is included in other assets, net in the Company’s consolidated balance sheet.

 

9.  Segment Reporting

 

The Company has two reportable segments:  hotel investments and land leased under a long-term triple-net lease.  The Company owns extended-stay and limited service hotel properties throughout the United States that generate rental and other property related income.  The Company separately evaluates the performance of each of its hotel properties.  However, because each of the hotels has similar economic characteristics, facilities, and services, and each hotel is not individually significant, the properties have

 

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been aggregated into a single operating segment.  During the second quarter of 2009, the Company closed on the acquisition of 417 acres of land located on 113 sites in the Ft. Worth area and simultaneously entered into a long-term ground lease with a tenant that will use the land for natural gas production.  Prior to this acquisition, the Company’s only reportable segment was hotel investments.  The Company does not allocate corporate-level accounts to its operating segments, including corporate general and administrative expenses, non-operating interest income and interest expense.  The following table summarizes the results of operations and assets for each segment for the three and nine months ending September 30, 2009.  Dollar amounts are in thousands.

 

 

 

For the three months ended September 30, 2009

 

 

 

Hotels

 

Ground Lease

 

Corporate

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

22,662

 

$

5,439

 

$

 

$

28,101

 

Operating expenses

 

15,728

 

26

 

 

15,754

 

Acquisition related costs

 

2,405

 

 

 

2,405

 

Depreciation expense

 

4,004

 

 

 

4,004

 

General and administrative

 

 

 

937

 

937

 

Operating income

 

525

 

5,413

 

(937

)

5,001

 

Interest income

 

 

 

248

 

248

 

Interest expense

 

(550

)

 

 

(550

)

Net income/(loss)

 

$

(25

)

$

5,413

 

$

(689

)

$

4,699

 

 

 

 

For the nine months ended September 30, 2009

 

 

 

Hotels

 

Ground Lease

 

Corporate

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

62,853

 

$

10,515

 

$

 

$

73,368

 

Operating expenses

 

42,308

 

53

 

 

42,361

 

Acquisition related costs

 

4,868

 

 

 

4,868

 

Depreciation expense

 

9,778

 

 

 

9,778

 

General and administrative

 

 

 

2,835

 

2,835

 

Operating income

 

5,899

 

10,462

 

(2,835

)

13,526

 

Interest income

 

 

 

836

 

836

 

Interest expense

 

(1,766

)

 

 

(1,766

)

Net income/(loss)

 

$

4,133

 

$

10,462

 

$

(1,999

)

$

12,596

 

 

 

 

 

 

 

 

 

 

 

Total assets as of September 30, 2009

 

$

548,524

 

$

154,309

 

$

119,481

 

$

822,314

 

 

10.  Significant Tenant

 

Chesapeake Energy Corporation leases properties with carrying values that represent nearly 20% of the Company’s total assets, at cost, as of September 30, 2009.  The following table presents summary financial information for Chesapeake Energy Corporation as of September 30, 2009 and December 31, 2008, and for the three months and nine months ended September 30, 2009 and 2008, as reported in its September 30, 2009 Earnings Release on Form 8-K furnished with the Securities and Exchange Commission (the “SEC”).

 

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Chesapeake Energy Corporation

Selected Financial Data

(In millions)

 

Consolidated Balance Sheet Data:

 

 

 

September 30,
2009

 

December 31,
2008

 

 

 

 

 

 

 

Current assets

 

$

2,508

 

$

4,292

 

Noncurrent assets

 

27,211

 

34,301

 

Current liabilities

 

2,514

 

3,621

 

Noncurrent liabilities

 

14,376

 

17,955

 

Total equity

 

12,829

 

17,017

 

 

Consolidated Statements of Income Data:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Total revenues

 

$

1,811

 

$

7,491

 

$

5,480

 

$

8,648

 

Total operating costs

 

1,414

 

2,013

 

13,712

 

5,806

 

Operating income (loss)

 

397

 

5,478

 

(8,232

)

2,842

 

Net income (loss)

 

192

 

3,322

 

(5,306

)

1,600

 

 

Consolidated Statements of Cash Flows Data:

 

 

 

Nine Months Ended

 

 

 

 

 

 

 

September 30,

 

 

 

 

 

 

 

2009

 

2008

 

 

 

 

 

Cash provided by operating activities

 

$

3,131

 

$

4,387

 

 

 

 

 

Cash used in investing activities

 

(3,654

)

(8,283

)

 

 

 

 

Cash (used in) provided by financing activities

 

(706

)

5,859

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

(1,229

)

1,963

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

1,749

 

1

 

 

 

 

 

Cash and cash equivalents, end of period

 

520

 

1,964

 

 

 

 

 

 

The summary financial information of Chesapeake Energy Corporation is presented to comply with applicable accounting regulations of the SEC.  References in these financials statements to the financial statements furnished with the SEC for Chesapeake Energy Corporation are included as textual references only, and the information in Chesapeake Energy Corporation’s filing is not incorporated by reference into these financial statements.

 

11.  Pro Forma Information (unaudited)

 

The following unaudited pro forma information for the three and nine months ended September 30, 2009 and 2008 is presented as if the acquisitions of the Company’s hotels acquired after December 31, 2007 had occurred on the latter of January 1, 2008 or the opening date of the hotel. The pro forma information does not purport to represent what the Company’s results of operations would actually have been if such transactions, in fact, had occurred on these applicable dates, nor does it purport to represent the results of operations for future periods. Amounts are in thousands, except per share data.

 

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Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

28,101

 

$

20,832

 

$

76,177

 

$

61,028

 

Net income

 

4,699

 

3,339

 

14,554

 

9,564

 

Net income per share - basic and diluted

 

$

0.06

 

$

0.10

 

$

0.25

 

$

0.31

 

 

The pro forma information reflects adjustments for actual revenues and expenses of the 33 hotels acquired during 2008 and 2009 for the respective period owned prior to acquisition by the Company.  Net income has been adjusted as follows: (1) interest income and expense have been adjusted to reflect the reduction in cash and cash equivalents required to fund the acquisitions; (2) interest expense related to prior owners’ debt which was not assumed has been eliminated; (3) depreciation has been adjusted based on the Company’s basis in the hotels; and (4) transaction costs have been adjusted for the acquisition of existing businesses that occurred on or after January 1, 2009.

 

12.  Subsequent Events

 

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

 

In October 2009, the Company declared and paid approximately $5.9 million in dividend distributions to its common shareholders, or $0.073334 per outstanding common share.

 

During October 2009, the Company closed on the issuance of 6.1 million Units through its ongoing best-efforts offering, representing gross proceeds to the Company of $67.5 million and proceeds net of selling and marketing costs of $60.8 million.

 

In October 2009, the Company redeemed 132,000 Units in the amount of $1.35 million under its Unit Redemption Program.

 

On October 14, 2009, the Company entered into a ground lease for approximately one acre of land located in downtown Richmond, Virginia.  The lease terminates on December 31, 2098, subject to the Company’s right to exercise two renewal periods of ten years each.  The Company intends to use the land to build two nationally recognized brand hotels.  Under the terms of the lease the Company has a six month “Study Period” to determine the viability of the hotels.  The Company can terminate the lease for any reason during the Study Period, which ends on April 14, 2010. After the Study Period, the lease continues to be subject to various conditions, including but not limited to obtaining various permits, licenses, zoning variances and franchise approvals.  If any of these conditions are not met the Company has the right to terminate the lease at any time.  Rent payments are not required until the Company decides to begin construction on the hotels.  Annual rent under the lease is $300,000 with adjustments throughout the lease term based on the Consumer Price Index.  As there are many conditions to beginning construction on the hotels, there are no assurances that the Company will construct the hotels or continue the lease.

 

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

 

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.  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, including the current economic recession throughout the United States; and competition within the real estate industry.  Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved.  In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code.  Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission.

 

General

 

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, which has limited operating history, was formed to invest in hotels, residential apartment communities and other income-producing real estate in selected metropolitan areas in the United States.  The Company was initially capitalized November 9, 2007, with its first investor closing on May 14, 2008.  Prior to the Company’s first hotel acquisition on July 31, 2008, the Company had no revenue, exclusive of interest income.  As of September 30, 2009, the Company owned 33 hotels (21 of which were purchased during 2008 and 12 which were acquired during the first nine months of 2009).  Also, in April 2009, the Company purchased 417 acres of land located on 113 sites in the Ft. Worth, Texas area and simultaneously entered into a long-term, triple net lease with one of the nation’s largest producers of natural gas.  Accordingly, the results of operations include only results from the date of ownership of the properties.

 

Hotel Operations

 

Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the hotels within their respective local markets, in general, has met the Company’s expectations for the period owned.  With the significant decline in economic conditions throughout the United States, overall performance of the Company’s hotels have not met expectations.  Although there is no way to predict general economic conditions, many industry analysts believe the hotel industry will continue to see revenue declines as compared to prior year for the next several quarters.  In evaluating financial condition and operating performance, the most important matters on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”) and revenue per available room (“RevPAR”), and expenses, such as hotel operating expenses, general and administrative and property taxes and insurance.

 

Hotels Owned

 

As noted above, the Company commenced operations in July 2008 upon the purchase of its first hotel property.  The following table summarizes the location, brand, manager, gross purchase price, number of hotel rooms and date of purchase for each of the 33 hotels the Company owned as of September 30, 2009.  All dollar amounts are in thousands.

 

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Table of Contents

 

Location

 

Brand

 

Manager

 

Gross Purchase
Price

 

Rooms

 

Date of Purchase

 

Tucson, AZ

 

Hilton Garden Inn

 

Western

 

$

18,375

 

125

 

7/31/2008

 

Santa Clarita, CA

 

Courtyard

 

Dimension

 

22,700

 

140

 

9/24/2008

 

Charlotte, NC

 

Homewood Suites

 

McKibbon

 

5,750

 

112

 

9/24/2008

 

Allen, TX

 

Hampton Inn & Suites

 

Gateway

 

12,500

 

103

 

9/26/2008

 

Twinsburg, OH

 

Hilton Garden Inn

 

Gateway

 

17,792

 

142

 

10/7/2008

 

Lewisville, TX

 

Hilton Garden Inn

 

Gateway

 

28,000

 

165

 

10/16/2008

 

Duncanville, TX

 

Hilton Garden Inn

 

Gateway

 

19,500

 

142

 

10/21/2008

 

Santa Clarita, CA

 

Hampton Inn

 

Dimension

 

17,129

 

128

 

10/29/2008

 

Santa Clarita, CA

 

Residence Inn

 

Dimension

 

16,600

 

90

 

10/29/2008

 

Santa Clarita, CA

 

Fairfield Inn

 

Dimension

 

9,337

 

66

 

10/29/2008

 

Beaumont, TX

 

Residence Inn

 

Western

 

16,900

 

133

 

10/29/2008

 

Pueblo, CO

 

Hampton Inn & Suites

 

Dimension

 

8,025

 

81

 

10/31/2008

 

Allen, TX

 

Hilton Garden Inn

 

Gateway

 

18,500

 

150

 

10/31/2008

 

Bristol, VA

 

Courtyard

 

LBA

 

18,650

 

175

 

11/7/2008

 

Durham, NC

 

Homewood Suites

 

McKibbon

 

19,050

 

122

 

12/4/2008

 

Hattiesburg, MS

 

Residence Inn

 

LBA

 

9,793

 

84

 

12/11/2008

 

Jackson, TN

 

Courtyard

 

Vista

 

15,200

 

94

 

12/16/2008

 

Jackson, TN

 

Hampton Inn & Suites

 

Vista

 

12,600

 

83

 

12/30/2008

 

Pittsburgh, PA

 

Hampton Inn

 

Vista

 

20,458

 

132

 

12/31/2008

 

Fort Lauderdale, FL

 

Hampton Inn

 

Vista

 

19,290

 

109

 

12/31/2008

 

Frisco, TX

 

Hilton Garden Inn

 

Western

 

15,050

 

102

 

12/31/2008

 

Round Rock, TX

 

Hampton Inn

 

Vista

 

11,500

 

93

 

3/6/2009

 

Panama City, FL

 

Hampton Inn & Suites

 

LBA

 

11,600

 

95

 

3/12/2009

 

Austin, TX

 

Homewood Suites

 

Vista

 

17,700

 

97

 

4/14/2009

 

Austin, TX

 

Hampton Inn

 

Vista

 

18,000

 

124

 

4/14/2009

 

Dothan, AL

 

Hilton Garden Inn

 

LBA

 

11,601

 

104

 

6/1/2009

 

Troy, AL

 

Courtyard

 

LBA

 

8,696

 

90

 

6/18/2009

 

Orlando, FL

 

Fairfield Inn & Suites

 

Marriott

 

25,800

 

200

 

7/1/2009

 

Orlando, FL

 

SpringHill Suites

 

Marriott

 

29,000

 

200

 

7/1/2009

 

Clovis, CA

 

Hampton Inn & Suites

 

Dimension

 

11,150

 

86

 

7/31/2009

 

Rochester, MN

 

Hampton Inn & Suites

 

White

 

14,136

 

124

 

8/3/2009

 

Johnson City, TN

 

Courtyard

 

LBA

 

9,880

 

90

 

9/25/2009

 

Baton Rouge, LA

 

SpringHill Suites

 

Dimension

 

15,100

 

119

 

9/25/2009

 

Total

 

 

 

 

 

$

525,362

 

3,900

 

 

 

 

Of the Company’s 33 hotels owned at September 30, 2009, 12 were purchased during the first nine months of 2009.  The total gross purchase price for these 12 hotels, with a total of 1,422 rooms, was $184.2 million.  The Company also acquired during the first nine months of 2009, land for the planned construction of a SpringHill Suites hotel to be completed over the next 18 months.  Upon completion, it is expected that the hotel will contain approximately 152 guest rooms and will be managed by Marriott.

 

The purchase price for these properties, net of debt assumed, was funded primarily by the Company’s ongoing best-efforts offering of Units.  The Company assumed approximately $53.8 million of debt secured by six of its hotel properties and $3.8 million of unsecured debt in connection with one of its hotel properties.  The following table summarizes the hotel location, interest rate, maturity date and the principal amount assumed associated with each note payable outstanding as of September 30, 2009. All dollar amounts are in thousands.

 

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Table of Contents

 

Location

 

Brand

 

Interest
Rate (1)

 

Maturity
Date

 

Principal
Assumed

 

Outstanding
balance as of
September 30,
2009

 

 

 

 

 

 

 

 

 

 

 

 

 

Lewisville, TX

 

Hilton Garden Inn

 

0.00

%

12/31/2016

 

$

3,750

 

$

3,750

 

Duncanville, TX

 

Hilton Garden Inn

 

5.88

%

5/11/2017

 

13,966

 

13,801

 

Allen, TX

 

Hilton Garden Inn

 

5.37

%

10/11/2015

 

10,787

 

10,630

 

Bristol, VA

 

Courtyard

 

6.59

%

8/1/2016

 

9,767

 

9,670

 

Round Rock, TX

 

Hampton Inn

 

5.95

%

5/1/2016

 

4,175

 

4,132

 

Austin, TX

 

Homewood Suites

 

5.99

%

3/1/2016

 

7,556

 

7,490

 

Austin, TX

 

Hampton Inn

 

5.95

%

3/1/2016

 

7,553

 

7,487

 

 

 

 

 

 

 

 

 

$

 57,554

 

$

56,960

 

 


(1)                  At acquisition, the Company adjusted the interest rates on these loans to market rates and is amortizing the adjustments to interest expense over the life of the loan.

 

The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary (or a subsidiary thereof) under master hotel lease agreements.  The Company also used the proceeds of its ongoing best-efforts offering to pay approximately $10.6 million, representing 2% of the gross purchase price for these properties, as a brokerage commission to Apple Suites Realty Group, Inc. (“ASRG”), 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive.

 

Land Acquisition and Lease

 

On April 7, 2009, the Company completed the preliminary closing with a subsidiary of Chesapeake Energy Corporation under the terms of the purchase and sale contract dated January 21, 2009, as amended, for the purchase of approximately 417 acres of land located on 113 sites in the Ft. Worth, Texas area.  The purchase price for the land was approximately $147 million.  The preliminary closing provides equitable title to the Company.  The recorded fee simple title will be completed and conveyed to the Company by the final closing date, which is the earlier of November 30, 2009 or the completion of platting each of the 113 sites with the relevant governmental localities.  Each of the 113 individual sites is between approximately two and eleven acres in size.  Simultaneous with the preliminary closing, the Company entered into a ground lease for this land (the “Lease”).  The Lease is with a subsidiary of Chesapeake Energy Corporation, Chesapeake Operating, Inc. (the “Tenant”).    Chesapeake Energy Corporation is a guarantor of the Lease.  The Lease has an initial term of 40 years with five renewal options of five years each, and annual rent ranging from approximately $15.5 million to $27.4 million with the average annual rent over the initial term being $21.8 million. Payments under the Lease are required to be made monthly in advance.  Currently, the Tenant is using approximately 70% of the sites for natural gas production and anticipates using the remaining land for natural gas production. Under the Lease, the Tenant is responsible for all operating costs associated with the land including, maintenance, insurance, property taxes, environmental, zoning, permitting, etc. and the Tenant is required to maintain the land in good condition.  During the term of the Lease, the Tenant has the option to purchase up to 30 sites (no more than 10 producing natural gas) for $1.4 million per site in years 1-5 of the Lease and $1.9 million for the remainder of the Lease.  For any sites purchased, the annual rent will be reduced proportionately to the remaining sites.

 

The purchase price for the 417 acres of land was funded primarily by the Company’s ongoing best-efforts offering of Units.  The Company also used the proceeds of its ongoing best-efforts offering to pay approximately $2.9 million, representing 2% of the gross purchase price, as a brokerage commission to ASRG.  The Company capitalized the commission as well as other closing costs of $1.1 million as part of the acquisition cost of the land.  The Company has preliminarily recorded the purchase price and associated costs to land on the Company’s consolidated balance sheets.  The Company is in the process of obtaining an independent valuation of each site and the Lease and will finalize its purchase price allocation upon completion of these valuations.

 

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Table of Contents

 

Results of Operations

 

The following is a summary of the Company’s consolidated financial results for the three and nine months ended September 30, 2009:

 

 

 

Three months

 

Nine months

 

 

 

ended

 

ended

 

 

 

September 30,

 

September 30,

 

(in thousands)

 

2009

 

2009

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

Hotel revenue

 

$

22,662

 

$

62,853

 

Rental revenue

 

5,439

 

10,515

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

Hotel direct expenses

 

14,256

 

37,832

 

Taxes, insurance and other expense

 

1,498

 

4,529

 

General and administrative expenses

 

937

 

2,835

 

Acquisition related costs

 

2,405

 

4,868

 

Depreciation

 

4,004

 

9,778

 

 

 

 

 

 

 

Interest expense, net

 

(302

)

(930

)

 

During the period from the Company’s initial capitalization on November 9, 2007 to July 30, 2008, the Company owned no properties, had no revenue, exclusive of interest income and was primarily engaged in capital formation activities.  During this period, the Company incurred miscellaneous start-up costs and interest expense related to an unsecured line of credit.  The Company began operations on July 31, 2008 when it purchased its first hotel.  During the remainder of 2008, the Company purchased an additional 20 hotel properties.  With the purchase of an additional 12 hotels in 2009, the Company owned 33 hotels as of September 30, 2009.  In April 2009, the Company purchased 417 acres of land located on 113 sites in the Ft. Worth, Texas area and simultaneously entered into a long-term, triple net lease with one of the nation’s largest producers of natural gas.  Due to the Company’s limited operating history, a comparison of operating results for the three and nine months ended September 30, 2009 to prior year results is not meaningful.

 

Hotel Performance

 

The following is summary of the operating results of the 33 hotels acquired through September 30, 2009 and their respective periods of ownership by the Company:

 

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Table of Contents

 

 

 

Three months

 

 

 

Nine months

 

 

 

 

 

ended

 

% of

 

ended

 

% of

 

 

 

September 30,

 

Hotel

 

September 30,

 

Hotel

 

(in thousands)

 

2009

 

Revenue

 

2009

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

Hotel Revenue:

 

 

 

 

 

 

 

 

 

Room revenue

 

$

20,420

 

 

 

$

56,252

 

 

 

Other revenue

 

2,242

 

 

 

6,601

 

 

 

 

 

22,662

 

 

 

62,853

 

 

 

 

 

 

 

 

 

 

 

 

 

Hotel Operating Expenses:

 

 

 

 

 

 

 

 

 

Hotel direct expenses

 

14,256

 

63

%

37,832

 

60

%

Taxes, insurance and other expense

 

1,472

 

6

%

4,476

 

7

%

 

 

 

 

 

 

 

 

 

 

Hotel Operating Statistics:

 

 

 

 

 

 

 

 

 

Number of hotels

 

33

 

 

 

33

 

 

 

ADR

 

$

100

 

 

 

$

107

 

 

 

Occupancy

 

62

%

 

 

64

%

 

 

RevPAR

 

$

62

 

 

 

$

68

 

 

 

 

Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality.  During the past several quarters, the overall weakness in the U.S. economy has had a considerable negative impact on both consumer and business travel.  As a result, lodging demand in most markets in the United States has declined.  The Company expects this trend to continue and will not reverse course until general economic conditions improve.  The Company’s hotels have shown results consistent with industry and brand averages for the short period of ownership.  In its acquisition process, the Company anticipated a certain amount of decline in income from historical results; however, the significant decline in the overall United States economy has been greater than anticipated.

 

Revenues

 

The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue.  For the three and nine months ended September 30, 2009, the Company had hotel revenue of $22.7 million and $62.9 million.  This revenue reflects hotel operations for the 33 hotels acquired through September 30, 2009 for their respective periods of ownership by the Company.  For the three months ended September 30, 2009, the hotels achieved combined average occupancy of approximately 62%, ADR of $100 and RevPAR of $62.  For the nine months ended September 30, 2009, the hotels achieved combined average occupancy of approximately 64%, ADR of $107 and RevPAR of $68.  ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.

 

The Company generates rental revenue from its purchase and leaseback transaction completed during the second quarter of 2009.  As noted above, during April 2009, the Company purchased 417 acres of land located on 113 sites in the Ft. Worth, Texas area and simultaneously entered into a long-term, triple net lease with one of the nation’s largest producers of natural gas.  Rental payments are fixed and have determinable rent increases during the initial lease term.  The lease is classified as an operating lease and rental income is recognized on a straight line basis over the initial term of the lease.  Rental income for the three and nine months ended September 30, 2009 was $5.4 million and $10.5 million, and includes $1.6 million and $3.0 million of adjustments necessary to record rent on the straight line basis.

 

Expenses

 

Hotel operating expenses relate to the 33 hotels acquired through September 30, 2009 for their respective periods owned and consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees.

 

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Table of Contents

 

For the three months ended September 30, 2009, hotel operating expenses totaled $14.3 million or 63% of hotel revenue.  For the nine months ended September 30, 2009, hotel operating expenses totaled $37.8 million or 60% of hotel revenue.  All six of the hotels acquired during the three months ended September 30, 2009 and nine of the twelve acquired in 2009 are new hotels and as a result, hotel operating expenses as a percentage of hotel revenue for these hotels are higher than is expected once the properties have established themselves within their markets.

 

Taxes, insurance, and other expense for the three and nine months ended September 30, 2009 totaled $1.5 million and $4.5 million.

 

General and administrative expense for the three and nine months ended September 30, 2009 was $937,000 and $2.8 million.  The principal components of general and administrative expense are advisory fees, legal fees, accounting fees and reporting expense.

 

Acquisition related costs for the three and nine months ended September 30, 2009 were $2.4 million and $4.9 million.  In accordance with the Accounting Standards Codification on business combinations, the Company has expensed as incurred all transaction costs associated with acquisitions of existing businesses that occur on or after January 1, 2009, including title, legal, accounting and other related costs, as well as the brokerage commission paid to ASRG, owned 100% by Glade M. Knight, Chairman and Chief Executive Officer of the Company.  Also, included in acquisition related costs for the nine months ended September 30, 2009 is $293,000 in transaction costs related to potential acquisitions as of December 31, 2008.  These costs were incurred during 2008 and were recorded as deferred costs and included in other assets, net in the Company’s consolidated balance sheet as of December 31, 2008.  For acquisitions that occurred prior to January 1, 2009, these costs were capitalized as part of the cost of the acquisition.

 

Depreciation expense for the three and nine months ended September 30, 2009 was $4.0 million and $9.8 million.  Depreciation expense represents expense of the Company’s 33 hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment) for their respective periods owned.

 

Interest expense for the three and nine months ended September 30, 2009 was $550,000 and $1.8 million.  Interest expense primarily arose from debt assumed with the acquisition of seven of the Company’s hotels (four loan assumptions during 2008 and three in 2009).  During the three and nine months ended September 30, 2009, the Company also recognized $248,000 and $836,000 in interest income, representing interest on excess cash invested in short-term money market instruments and certificates of deposit.

 

Related Party Transactions

 

The Company has significant transactions with related parties.  These transactions cannot be construed to be at arm’s length and the results of the Company’s operations may be different than if conducted with non-related parties.

 

The Company has a contract with ASRG, to acquire and dispose of real estate assets for the Company.  A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services.  As of September 30, 2009, payments to ASRG for services under the terms of this contract have totaled approximately $13.6 million since inception.

 

The Company is party to an advisory agreement with Apple Nine Advisors, Inc. (“A9A”) to provide management services to the Company and its assets. An annual fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services.  A9A has entered into an agreement with Apple REIT Six, Inc. (“AR6”) to provide certain management services to the Company.  The Company will reimburse A9A for the cost of the services provided by AR6.  A9A will in turn reimburse AR6.  Total advisory fees and reimbursable expenses incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $1,490,000 and $271,000 for the nine months ended September 30,

 

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Table of Contents

 

2009 and 2008, respectively.

 

ASRG and A9A are 100% owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company.

 

Mr. Knight is also Chairman and Chief Executive Officer of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc., other REITS.  Members of the Company’s Board of Directors are also on the Board of Directors of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc.

 

In January 2009, the Company purchased a 24% ownership interest in Apple Air Holding, LLC (“Apple Air”), for $3.2 million in cash. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly.  The other members of Apple Air are Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc.  The interest was purchased to allow the Company access to two Lear jets for asset management and renovation purposes. The investment is included in other assets, net in the Company’s consolidated balance sheet.

 

Series B Convertible Preferred Stock

 

The Company has issued 480,000 Series B convertible preferred shares to Glade M. Knight, Chairman and Chief Executive Officer of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $48,000.  The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.

 

There are no dividends payable on the Series B convertible preferred shares.  Holders of more than two-thirds of the Series B convertible preferred shares must approve any proposed amendment to the articles of incorporation that would adversely affect the Series B convertible preferred shares.

 

Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares.  However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares distribution rights.  The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below.  In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.

 

Each holder of outstanding Series B convertible preferred shares shall have the right to convert any of such shares into common shares of the Company upon and for 180 days following the occurrence of any of the following events:

 

(1) substantially all of the Company’s assets, stock or business is sold or transferred through exchange, merger, consolidation, lease, share exchange, sale or otherwise, other than a sale of assets in liquidation, dissolution or winding up of the Company;

 

(2) the termination or expiration without renewal of the advisory agreement with A9A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or

 

(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.

 

Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into a number of common shares based upon the gross proceeds raised through the date of conversion in the Company’s $2 billion offering according to the following table:

 

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Table of Contents

 

Gross Proceeds Raised from Sales of
Units through Date of Conversion

 

Number of Common Shares
through Conversion of
One Series B Convertible Preferred
Share

 

$800 million

 

9.70287

 

$900 million

 

10.90855

 

$    1  billion

 

12.11423

 

$ 1.1  billion

 

13.31991

 

$ 1.2  billion

 

14.52559

 

$ 1.3  billion

 

15.73128

 

$ 1.4  billion

 

16.93696

 

$ 1.5  billion

 

18.14264

 

$ 1.6  billion

 

19.34832

 

$ 1.7  billion

 

20.55400

 

$ 1.8  billion

 

21.75968

 

$ 1.9  billion

 

22.96537

 

$    2  billion

 

24.17104

 

 

In the event that after raising gross proceeds of $2 billion, the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/100 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest 100 million.

 

No additional consideration is due upon the conversion of the Series B convertible preferred shares. The conversion into common shares of the Series B convertible preferred shares will result in dilution of the shareholders’ interests.

 

Expense related to the issuance of 480,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B shares can be reasonably estimated and the event triggering the conversion of the Series B shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B shares can be converted and the amounts paid for the Series B shares. Although the fair market value cannot be determined at this time, expense if the maximum offering is achieved could range from $0 to in excess of $127 million (assumes $11 per unit fair market value).  Based on equity raised through September 30, 2009, if a triggering event had occurred, expense would have ranged from $0 to $51.2 million (assumes $11 per unit fair market value) and approximately 4.7 million common shares would have been issued.

 

Liquidity and Capital Resources

 

The Company was initially capitalized on November 9, 2007, with its first investor closing on May 14, 2008.  The Company’s principal source of liquidity is cash on hand, the proceeds of its on-going best-efforts offering and the cash flow generated from properties the Company has or will acquire and any short term investments.  In addition, the Company may borrow funds, subject to the approval of the Company’s board of directors.

 

The Company anticipates that cash flow, and cash on hand, will be adequate to cover its operating expenses and to permit the Company to meet its anticipated liquidity requirements, including anticipated distributions to shareholders and capital improvements.  The Company intends to use the proceeds from the Company’s on-going best-efforts offering, and cash on hand, to purchase income producing real estate.

 

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Table of Contents

 

The Company is raising capital through a best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) by David Lerner Associates, Inc., the managing dealer, which receives selling commissions and a marketing expense allowance based on proceeds of the Units sold. The minimum offering of 9,523,810 Units at $10.50 per Unit was sold as of May 14, 2008, with proceeds net of commissions and marketing expenses totaling $90 million. Subsequent to the minimum offering and through September 30, 2009, an additional 71.4 million Units, at $11 per Unit, were sold, with the Company receiving proceeds, net of commissions, marketing expenses and other offering costs of approximately $704.6 million.  The Company is continuing its offering at $11.00 per Unit.  The Company will offer Units until April 25, 2010 unless the offering is extended, or terminated if all of the Units are sold before then.

 

To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income.  Distributions during the first nine months of 2009 totaled approximately $38.3 million of which approximately $24 million was used to purchase additional Units under the Company’s best-efforts offering.   Thus the net cash distributions were $14.3 million.  The distributions were paid at a monthly rate of $0.073334 per common share.  For the same period the Company’s net cash generated from operations was approximately $20 million, which exceeded the net cash distributions.  During the initial phase of the Company’s operations, the Company may, due to the inherent delay between raising capital and investing that same capital in income producing real estate, have a portion of its distributions funded from offering proceeds.  The portion of the distributions funded from offering proceeds is expected to be treated as a return of capital for federal income tax purposes.  In May, 2008, the Company’s Board of Directors established a policy for an annualized dividend rate of $0.88 per common share, payable in monthly distributions.  The Company intends to continue paying dividends on a monthly basis, consistent with the annualized dividend rate established by its Board of Directors.  The Company’s Board of Directors, upon the recommendation of the Audit Committee, may amend or establish a new annualized dividend rate and may change the timing of when distributions are paid.  Since a portion of distributions has to date been funded with proceeds from the offering of Units, the Company’s ability to maintain its current intended rate of distribution will be based on its ability to fully invest its offering proceeds and thereby increase its cash generated from operations.  Since there can be no assurance of the Company’s ability to acquire properties that provide income at this level, or that the properties already acquired will provide income at this level, there can be no assurance as to the classification or duration of distributions at the current rate.  Proceeds of the offering which are distributed are not available for investment in properties.

 

The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels.  As of September 30, 2009, the Company held with various lenders $6.0 million in reserves for capital expenditures.  The Company has 11 major renovations scheduled for 2009 and into the first half of 2010.  Total capital expenditures are anticipated to be approximately $15 million for that period.

 

As of September 30, 2009, the Company had outstanding contracts for the potential purchase of eight additional hotels for a total purchase price of $162.3 million.  All of these hotels are under construction and are expected to be completed over the next 12 to 18 months.  Although the Company is working towards acquiring these hotels, there are many conditions to closing that have not yet been satisfied and there can be no assurance that closings will occur under the outstanding purchase contracts.  The following table summarizes the location, brand, number of rooms, refundable (if the seller does not meet its obligations under the contract) contract deposits paid, and gross purchase price for each of the contracts.  All dollar amounts are in thousands.

 

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Location

 

Brand

 

Rooms

 

Deposits
Paid

 

Gross Purchase
Price

 

Hillsboro, OR

 

Embassy Suites

 

165

 

$

100

 

$

32,500

(a)

Hillsboro, OR

 

Hampton Inn & Suites

 

106

 

100

 

14,500

(a)

Clovis, CA

 

Homewood Suites

 

83

 

55

 

12,435

(a)

Albany, GA

 

Fairfield Inn & Suites

 

87

 

5

 

7,920

(a)/(b)

Panama City, FL

 

TownePlace Suites

 

103

 

5

 

10,640

(a)/(b)

Houston, TX

 

Marriott

 

206

 

200

 

51,000

(a)/(b)

Holly Springs, NC

 

Hampton Inn

 

124

 

100

 

14,880

(a)

Ft. Worth, TX

 

TownePlace Suites

 

140

 

100

 

18,460

(a)/(b)

 

 

 

 

1,014

 

$

665

 

$

162,335

 

 


(a) The hotels are currently under construction. The table shows the expected number of rooms upon hotel completion and the expected franchise.

(b) If the seller meets all of the conditions to closing, the Company is obligated to specifically perform under the contract.  As the properties are under construction, at this time, the seller has not met all of the conditions to closing.

 

As there can be no assurance that all conditions to closing will be satisfied, the Company includes deposits paid for hotels under contract in other assets, net in the Company’s consolidated balance sheets, and in deposits and other disbursements for potential acquisitions in the Company’s consolidated statements of cash flows.  It is anticipated that the purchase price for the outstanding contracts will be funded from the proceeds of the Company’s ongoing best-efforts offering of Units and cash on hand.

 

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 for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any given year will be three 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.  During the nine months ended September 30, 2009, the Company redeemed approximately 120,000 Units in the amount of $1.3 million under the program.

 

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

 

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operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand to make distributions.

 

Recent Accounting Pronouncements

 

Accounting Standards Codification

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued a pronouncement establishing the FASB Accounting Standards Codification™ as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with United States generally accepted accounting principles (“GAAP”).  The standard explicitly recognizes rules and interpretive releases of the Securities Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. This standard is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

Noncontrolling Interests

 

In June 2009, the FASB issued a pronouncement which amends its guidance surrounding a company’s analysis to determine whether any of its variable interests constitute controlling financial interests in a variable interest entity.  This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics:  (a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.  Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity’s economic performance. The new pronouncement also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and enhanced disclosure about an enterprise’s involvement with a variable interest entity.  This pronouncement will be applied prospectively and will be effective for interim and annual reporting periods beginning after November 15, 2009.  The adoption of this standard is not anticipated to have a material impact on the Company’s consolidated financial statements.

 

Subsequent Events

 

In May 2009, the FASB issued a pronouncement which sets forth general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued.  Although there is new terminology, this pronouncement is based on the same principles as those that currently exist in the auditing standards.  This pronouncement, which includes a required disclosure 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 a material impact on the Company’s consolidated financial statements.

 

Assets Acquired or Liabilities Assumed in a Business Combination

 

In April 2009, the FASB issued a pronouncement which amends its guidance for all assets acquired and all liabilities assumed in a business combination that arise from contingencies.  This pronouncement states that the acquirer will recognize such an asset or liability if the acquisition-date fair value of that asset or liability can be determined during the measurement period.  If it cannot be determined during the measurement period, then the asset or liability should be recognized as of the acquisition date if the following criteria are met: (1) information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date, and (2) the amount of the asset or liability can be reasonably estimated.  This pronouncement was adopted by the Company in the first quarter of 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

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Interim Disclosures about Fair Value of Financial Instruments

 

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

 

Business Combinations

 

In December 2007, the FASB issued a pronouncement which amends its guidance for business combinations by requiring an acquirer to recognize the assets of existing businesses acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions.  This method replaces the cost-allocation process, which required the cost of an acquisition of an existing business to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values.  A significant change included in the new pronouncement is the requirement that costs incurred to effect an acquisition of an existing business, must be accounted for separately as expenses.  Such costs include title, legal, accounting and other related costs, as well as commissions including the commission paid to Apple Suites Realty Group, Inc. (“ASRG”), a related party 100% owned by Glade M. Knight, Chairman and CEO of the Company.  This pronouncement was effective January 1, 2009.  For acquisitions of existing businesses prior to January 1, 2009, these costs were capitalized as part of the cost of the acquisition.  During the nine months ended September 30, 2009, the Company expensed $4.9 million in acquisition related costs.  Included in this amount is $293,000 in transaction costs related to potential acquisitions as of December 31, 2008.  These costs were incurred during 2008 and recorded as deferred acquisition costs and included in other assets, net in the Company’s consolidated balance sheet as of December 31, 2008.  In accordance with this pronouncement, these costs were expensed on January 1, 2009.  The adoption of this standard has had a material impact on the Company’s financial position and results of operations and will continue to have a material impact on the Company’s consolidated financial statements as it acquires other operating businesses.

 

Subsequent Events

 

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

 

In October 2009, the Company declared and paid approximately $5.9 million in dividend distributions to its common shareholders, or $0.073334 per outstanding common share.

 

During October 2009, the Company closed on the issuance of 6.1 million Units through its ongoing best-efforts offering, representing gross proceeds to the Company of $67.5 million and proceeds net of selling and marketing costs of $60.8 million.

 

In October 2009, the Company redeemed 132,000 Units in the amount of $1.35 million under its Unit Redemption Program.

 

On October 14, 2009, the Company entered into a ground lease for approximately one acre of land located in downtown Richmond, Virginia.  The lease terminates on December 31, 2098, subject to the Company’s right to exercise two renewal periods of ten years each.  The Company intends to use the land to build two nationally recognized brand hotels.  Under the terms of the lease the Company has a six month “Study Period” to determine the viability of the hotels.  The Company can terminate the lease for any reason during the Study Period, which ends on April 14, 2010.  After the Study Period, the lease continues to be subject to various conditions, including but not limited to obtaining various permits, licenses, zoning

 

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variances and franchise approvals.  If any of these conditions are not met the Company has the right to terminate the lease at any time.  Rent payments are not required until the Company decides to begin construction on the hotels.  Annual rent under the lease is $300,000 with adjustments throughout the lease term based on the Consumer Price Index.  As there are many conditions to beginning construction on the hotels, there are no assurances that the Company will construct the hotels or continue the lease.

 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments.  As of September 30, 2009, the Company’s financial instruments were not exposed to significant market risk due to interest rate risk, foreign currency exchange risk, commodity price risk or equity price risk.  The Company will be exposed to changes in short term money market rates as it invests the proceeds from the sale of Units pending use in acquisitions and renovations.  Based on the Company’s cash invested at September 30, 2009, of $115 million, every 100 basis points change in interest rates will impact the Company’s annual net income by approximately $1.1 million, all other factors remaining the same.

 

Item 4.    Controls and Procedures

 

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

 

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PART II.  OTHER INFORMATION

 

ITEM 2.        UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Use of Proceeds from Offering

 

The following tables set forth information concerning the best-efforts offering and the use of proceeds from the offering as of September 30, 2009.  All amounts in thousands, except per Unit data:

 

Units Registered:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9,524

 

Units $10.50 per Unit

 

$

100,000

 

 

 

172,727

 

Units $11 per Unit

 

1,900,000

 

Totals:

 

182,251

 

Units

 

$

2,000,000

 

 

 

 

 

 

 

 

 

Units Sold:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9,524

 

Units $10.50 per Unit

 

$

100,000

 

 

 

71,351

 

Units $11 per Unit

 

784,864

 

Totals:

 

80,875

 

Units

 

884,864

 

 

Expenses of Issuance and Distribution of Units

 

 

 

 

 

 

 

1. Underwriting discounts and commission

 

88,486

 

2. Expenses of underwriters

 

 

3. Direct or indirect payments to directors or officers of the Company or their associates, to ten percent shareholders, or to affiliates of the Company

 

 

4. Fees and expenses of third parties

 

1,819

 

Total Expenses of Issuance and Distribution of Common Shares

 

90,305

 

Net Proceeds to the Company

 

$

794,559

 

 

 

 

 

1. Purchase of real estate (net of debt proceeds and repayment)

 

$

626,574

 

2. Deposits and other costs associated with potential real estate acquisitions

 

808

 

3. Repayment of other indebtedness, including interest expense paid

 

3,013

 

4. Investment and working capital

 

148,339

 

5. Fees to the following (all affiliates of officers of the Company):

 

 

 

a. Apple Nine Advisors, Inc.

 

2,271

 

b. Apple Suites Realty Group, Inc.

 

13,554

 

6. Fees and expenses of third parties