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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 MARCH 31, 2010

 

 

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   x

 

Smaller reporting company   o

(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 May 1, 2010: 121,954,466

 

 

 



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 — March 31, 2010 and December 31, 2009

 

3

 

 

 

 

 

 

 

Consolidated Statements of Operations - Three months ended March 31, 2010 and 2009

 

4

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows — Three months ended March 31, 2010 and 2009

 

5

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

6

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

17

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

28

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

28

 

 

 

 

 

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

 

29

 

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities (not applicable)

 

 

 

 

 

 

 

 

Item 4.

(Removed and Reserved)

 

 

 

 

 

 

 

 

Item 5.

Other Information (not applicable)

 

 

 

 

 

 

 

 

Item 6.

Exhibits

 

31

 

 

 

 

 

Signatures

 

 

 

33

 

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.

 

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Table of Contents

 

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

 

Apple REIT Nine, Inc.

Consolidated Balance Sheets

(in thousands, except share data)

 

 

 

March 31,
2010

 

December 31,
2009

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Investment in real estate, net of accumulated depreciation of $23,911 and $18,213, respectively

 

$

774,470

 

$

687,509

 

Cash and cash equivalents

 

319,827

 

272,913

 

Due from third party managers, net

 

5,249

 

2,591

 

Other assets, net

 

22,082

 

19,500

 

Total Assets

 

$

1,121,628

 

$

982,513

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Notes payable

 

$

58,367

 

$

58,688

 

Accounts payable and accrued expenses

 

3,232

 

6,420

 

Total Liabilities

 

61,599

 

65,108

 

 

 

 

 

 

 

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 114,848,474 and 98,509,650 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 114,848,474 and 98,509,650 shares, respectively

 

1,130,369

 

968,710

 

Distributions greater than net income

 

(70,388

)

(51,353

)

Total Shareholders’ Equity

 

1,060,029

 

917,405

 

 

 

 

 

 

 

Total Liabilities and Shareholders’ Equity

 

$

1,121,628

 

$

982,513

 

 

See accompanying notes to consolidated financial statements.

 

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

 

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Table of Contents

 

Apple REIT Nine, Inc.

Consolidated Statements of Operations

(Unaudited)

(in thousands, except per share data)

 

 

 

Three Months
Ended March 31,
2010

 

Three Months
Ended March 31,
2009

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

Room revenue

 

$

24,093

 

$

16,637

 

Other revenue

 

2,383

 

2,046

 

Total hotel revenue

 

26,476

 

18,683

 

Rental revenue

 

5,297

 

 

Total revenue

 

31,773

 

18,683

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

Operating expense

 

7,589

 

4,854

 

Hotel administrative expense

 

2,184

 

1,408

 

Sales and marketing

 

2,397

 

1,685

 

Utilities

 

1,395

 

868

 

Repair and maintenance

 

1,232

 

912

 

Franchise fees

 

1,004

 

788

 

Management fees

 

818

 

671

 

Taxes, insurance and other

 

2,130

 

1,345

 

General and administrative

 

1,310

 

839

 

Acquisition related costs

 

2,151

 

1,028

 

Depreciation expense

 

5,698

 

2,652

 

Total expenses

 

27,908

 

17,050

 

 

 

 

 

 

 

Operating income

 

3,865

 

1,633

 

 

 

 

 

 

 

Interest expense, net

 

(84

)

(83

)

 

 

 

 

 

 

Net income

 

$

3,781

 

$

1,550

 

 

 

 

 

 

 

Basic and diluted net income per common share

 

$

0.04

 

$

0.03

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic and diluted

 

104,768

 

45,554

 

 

 

 

 

 

 

Distributions declared and paid per common share

 

$

0.22

 

$

0.22

 

 

See accompanying notes to consolidated financial statements.

 

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

 

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Table of Contents

 

Apple REIT Nine, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

 

 

Three Months
Ended March 31,
2010

 

Three Months
Ended March 31,
2009

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

3,781

 

$

1,550

 

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

 

 

 

 

 

Depreciation

 

5,698

 

2,652

 

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

 

27

 

81

 

Straight-line rental income

 

(1,465

)

 

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in funds due from third party managers, net

 

(2,635

)

(1,503

)

(Increase) decrease in other assets, net

 

507

 

(386

)

Decrease in accounts payable and accrued expenses

 

(1,950

)

(190

)

Net cash provided by operating activities

 

3,963

 

2,204

 

 

 

 

 

 

 

Cash flows used in investing activities:

 

 

 

 

 

Cash paid for acquisitions, net

 

(88,409

)

(25,963

)

Deposits and other disbursements for potential acquisitions, net

 

(1,918

)

(153

)

Capital improvements

 

(5,391

)

(233

)

Decrease (increase) in capital improvement reserves

 

132

 

(100

)

Investment in other assets

 

 

(3,240

)

Net cash used in investing activities

 

(95,586

)

(29,689

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net proceeds related to issuance of common shares

 

162,845

 

118,135

 

Redemptions of common stock

 

(1,252

)

 

Distributions paid to common shareholders

 

(22,816

)

(9,889

)

Payments of notes payable

 

(240

)

(123

)

Deferred financing costs

 

 

(64

)

Net cash provided by financing activities

 

138,537

 

108,059

 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

46,914

 

80,574

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

272,913

 

75,193

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

319,827

 

$

155,767

 

 

 

 

 

 

 

Non-cash transactions:

 

 

 

 

 

Notes payable assumed in acquisitions

 

$

 

$

4,175

 

 

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 financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its 2009 Annual Report on Form 10-K.  Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2010.

 

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.

 

As of March 31, 2010, the Company owned 38 hotels (five purchased during the first quarter of 2010, 12 acquired in 2009 and 21 acquired during 2008).  The Company’s real estate portfolio also includes approximately 410 acres of land and improvements located on 111 sites in the Ft. Worth, Texas area (acquired in April 2009) that are being leased to a subsidiary of Chesapeake Energy Corporation (“Chesapeake”) for the production of natural gas.

 

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.

 

Other Assets

 

Included in other assets, net on the Company’s consolidated balance sheet is a 24% ownership interest in Apple Air Holding, LLC (“Apple Air”), purchased by the Company for $3.2 million in cash in January 2009.  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 acquisition, asset management and renovation purposes.  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 Company’s ownership interest was approximately $2.7 million and $2.8 million at March 

 

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Table of Contents

 

31, 2010 and December 31, 2009, respectively.  For the three months ended March 31, 2010 and 2009, the Company recorded a loss of approximately $110,000 and $100,000, respectively, as its share of the net loss of Apple Air, which primarily relates to the deprecation of the aircraft.  The loss is included in general and administrative expense in the Company’s consolidated statements of operations.

 

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 Units 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.  As of March 31, 2010, the Company had sold 115.2 million Units for gross proceeds of $1.3 billion and proceeds net of offering costs of $1.1 billion.  On April 15, 2010, the Company extended its best-efforts offering until April 25, 2011. As a result, the offering will continue until all Units have been sold or until April 25, 2011, whichever occurs sooner.

 

Rental Income

 

During April 2009, the Company entered into a ground lease with a subsidiary of Chesapeake, the second-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 revenue includes $1.5 million of adjustments to record rent on the straight line basis for the three months ended March 31, 2010.  Straight line rental receivable is included in other assets, net in the Company’s consolidated balance sheet and totaled $6.1 million and $- as of March 31, 2010 and 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 months ended March 31, 2010 or 2009.  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

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued a pronouncement (Accounting Standards Update No. 2009-17) 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

 

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Table of Contents

 

entity.  This pronouncement was adopted by the Company in the first quarter of 2010.  The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

3.  Real Estate Investments

 

Hotel Acquisitions

 

The Company acquired five hotels during the first three months of 2010.  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

 

Houston, TX

 

Marriott

 

Western

 

$

50,750

 

206

 

1/8/2010

 

Albany, GA

 

Fairfield Inn & Suites

 

LBA

 

7,920

 

87

 

1/14/2010

(a)

Panama City, FL

 

TownePlace Suites

 

LBA

 

10,640

 

103

 

1/19/2010

 

Clovis, CA

 

Homewood Suites

 

Dimension

 

12,435

 

83

 

2/2/2010

 

Jacksonville, NC

 

TownePlace Suites

 

LBA

 

9,200

 

86

 

2/16/2010

 

Total

 

 

 

 

 

$

90,945

 

565

 

 

 

 


(a)          Purchase contract includes a provision for an additional $500,000 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 was funded primarily by the Company’s on-going best-efforts offering of Units.  The Company also used the proceeds of its on-going best-efforts offering to pay approximately $2.2 million in acquisition related costs, including $1.8 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 Officer, and approximately $400,000 in other acquisition related costs, including title, legal and other related costs.  These costs are included in acquisition related costs in the Company’s consolidated statements of operations for the three months ended March 31, 2010.

 

The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary (or a subsidiary thereof) under master hotel lease agreements.

 

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

 

As of March 31, 2010, the Company owned 38 hotels, located in 15 states with an aggregate of 4,465 rooms and consisted of the following:  seven Hilton Garden Inn hotels, four Homewood Suites hotels, 11 Hampton Inn hotels, five Courtyard hotels, three Residence Inn hotels, two SpringHill Suites hotels, three Fairfield Inn hotels, two TownePlace Suites hotels and one full service Marriott hotel.  Additionally, the Company is in the process of constructing a SpringHill Suites hotel in Alexandria, Virginia which is expected to be completed over the next 12 months.  Upon completion, it is expected that the hotel will contain approximately 152 guest rooms and will be managed by Marriott.  To date the Company has incurred $2.5 million in construction costs and anticipates the total construction costs to be approximately $20-$25 million.

 

Land and Land Improvements

 

In February 2010, the Company agreed to sell back to Chesapeake two of the 113 sites originally purchased from Chesapeake in April 2009 and release Chesapeake from their associated lease obligation. The sales price for the two sites was equal to the Company’s original purchase price, approximately $2.6 million.  The Company earned and received rental income for the period held totaling approximately $240,000.

 

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Table of Contents

 

As of March 31, 2010, the Company owned approximately 410 acres of land and land improvements located on 111 sites in the Ft. Worth, Texas area that are being leased to Chesapeake for the production of natural gas.  Chesapeake is a publicly held company that is traded on the New York Stock Exchange.  Chesapeake is the second-largest independent producer of natural gas in the United States with interests in approximately 38,000 net drill sites.

 

Total Real Estate Investments

 

At March 31, 2010, the Company’s investment in real estate consisted of the following (in thousands):

 

Land

 

$

123,636

 

Land Improvements

 

95,940

 

Building and Improvements

 

529,382

 

Furniture, Fixtures and Equipment

 

46,934

 

Construction in Progress

 

2,489

 

 

 

798,381

 

Less Accumulated Depreciation

 

(23,911

)

Investment in real estate, net

 

$

774,470

 

 

As of March 31, 2010, the Company had outstanding contracts for the potential purchase of 14 additional hotels for a total purchase price of $254.1 million.  Of these 14 hotels, four are under construction and should be completed over the next 12 months.  The other 10 hotels are expected to close within the next six 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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Table of Contents

 

Location

 

Brand

 

Rooms

 

Deposits
Paid

 

Gross Purchase
Price

 

Holly Springs, NC

 

Hampton Inn

 

124

 

$

100

 

$

14,880

(a)

Ft. Worth, TX

 

TownePlace Suites

 

140

 

500

 

18,460

(a)/(b)

Jacksonville, NC

 

Fairfield Inn & Suites

 

79

 

125

 

7,800

 

Santa Ana, CA

 

Courtyard

 

155

 

100

 

24,800

(a)

Miami, FL

 

Hampton Inn & Suites

 

121

 

150

 

11,900

 

Boise, ID

 

Hampton Inn & Suites

 

186

 

125

 

22,370

 

Rogers, AR

 

Hampton Inn

 

122

 

125

 

9,600

 

Rogers, AR

 

Homewood Suites

 

126

 

125

 

10,900

 

St. Louis, MO

 

Hampton Inn

 

190

 

125

 

23,000

 

St. Louis, MO

 

Hampton Inn & Suites

 

126

 

125

 

16,000

 

Kansas City, MO

 

Hampton Inn

 

122

 

125

 

10,130

 

Oklahoma City, OK

 

Hampton Inn & Suites

 

200

 

125

 

32,000

 

Anchorage, AK

 

Embassy Suites

 

169

 

50

 

42,000

 

Lafayette, LA

 

SpringHill Suites

 

103

 

3

 

10,232

(a)/(b)

 

 

 

 

1,963

 

$

1,903

 

$

254,072

 

 


(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.

 

Four of the hotels under contract require the Company to assume approximately $49.5 million in mortgage debt.  Each of these loans provide for monthly payments of principal and interest on an amortized basis.

 

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 (less any debt assumed) for the outstanding contracts will be funded from the proceeds of the Company’s on-going best-efforts offering of Units and cash on hand if a closing occurs.

 

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 “Study Period” to determine the viability of the hotels.  The Company can terminate the lease for any reason during the Study Period, which originally ended on April 14, 2010, and was extended for six months to October 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.

 

4.  Notes Payable

 

In conjunction with the acquisition of seven hotel properties, the Company assumed approximately $57.6 million in debt.  The following table summarizes the hotel location, interest rate, maturity date and

 

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Table of Contents

 

the principal amount assumed associated with each note payable outstanding as of March 31, 2010 and December 31, 2009.  All dollar amounts are in thousands.

 

Location

 

Brand

 

Interest
Rate (1)

 

Maturity
Date

 

Principal
Assumed

 

Outstanding
balance as of
March 31,
2010

 

Outstanding
balance as of
December 31,
2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Lewisville, TX

 

Hilton Garden Inn

 

0.00

%

12/31/2016

 

$

3,750

 

$

3,750

 

$

3,750

 

Duncanville, TX

 

Hilton Garden Inn

 

5.88

%

5/11/2017

 

13,966

 

13,704

 

13,754

 

Allen, TX

 

Hilton Garden Inn

 

5.37

%

10/11/2015

 

10,787

 

10,538

 

10,585

 

Bristol, VA

 

Courtyard

 

6.59

%

8/1/2016

 

9,767

 

9,607

 

9,640

 

Round Rock, TX

 

Hampton Inn

 

5.95

%

5/1/2016

 

4,175

 

4,085

 

4,110

 

Austin, TX

 

Homewood Suites

 

5.99

%

3/1/2016

 

7,556

 

7,406

 

7,448

 

Austin, TX

 

Hampton Inn

 

5.95

%

3/1/2016

 

7,553

 

7,402

 

7,445

 

 

 

 

 

 

 

 

 

$

57,554

 

$

56,492

 

$

56,732

 

 


(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 debt by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of the debt obligation with similar credit policies.  Market rates take into consideration general market conditions and maturity.  As of March 31, 2010, the carrying value and estimated fair value of the Company’s debt was $58.4 million and $54.3 million.  As of December 31, 2009, the carrying value and estimated fair value of the Company’s debt was $58.7 million and $56.7 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 March 31, 2010, payments to ASRG for services under the terms of this contract have totaled approximately $15.3 million since inception.

 

The Company is party to an advisory agreement with A9A to provide management services to the Company.  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 $810,000 and $460,000 for the three months ended March 31, 2010 and 2009.  Of this total expense, $287,000 and $124,000 were fees paid to A9A and $523,000 and $336,000 were expenses reimbursed by A9A to AR6 for the three months ended March 31, 2010 and 2009.

 

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 AR6, Apple REIT Seven, Inc. and

 

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Table of Contents

 

Apple REIT Eight, Inc.  Members of the Company’s Board of Directors are also on the Board of Directors of AR6, Apple REIT Seven, Inc. and Apple REIT Eight, Inc.

 

6.  Shareholders’ 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 three months ended March 31, 2010, the Company redeemed 120,742 Units in the amount of $1.3 million under the program.  There were no redemptions in the first quarter of 2009.

 

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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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

 

$ 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 March 31, 2010, if a triggering event had occurred, expense would have ranged from $0 to $76.7 million (assumes $11 per unit fair market value) and approximately 7.0 million common shares would have been issued.

 

8.  Industry Segments

 

The Company has two reportable segments:  hotel investments and real estate 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 been aggregated into a single operating segment.  In addition, the Company owns approximately 410 acres of land and land improvements on 111 sites in the Ft. Worth, Texas area (acquired in April 2009) that is leased to a tenant for the production of natural gas.  Under the ground lease, the Company receives monthly rental payments.  Prior to the acquisition of the land in Ft. Worth, Texas, 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 months ending March 31, 2010.  Dollar amounts are in thousands.

 

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Table of Contents

 

 

 

Hotels

 

Ground Lease

 

Corporate

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

26,476

 

$

5,297

 

$

 

$

31,773

 

Operating expenses

 

18,722

 

27

 

 

18,749

 

Acquisition related costs

 

2,151

 

 

 

2,151

 

Depreciation expense

 

5,140

 

558

 

 

5,698

 

General and administrative

 

 

 

1,310

 

1,310

 

Operating income/(loss)

 

463

 

4,712

 

(1,310

)

3,865

 

Interest income

 

 

 

436

 

436

 

Interest expense

 

(520

)

 

 

(520

)

Net income/(loss)

 

$

(57

)

$

4,712

 

$

(874

)

$

3,781

 

 

 

 

 

 

 

 

 

 

 

Total assets as of March 31, 2010

 

$

642,831

 

$

152,326

 

$

326,471

 

$

1,121,628

 

 

9.  Significant Tenant

 

A subsidiary of Chesapeake Energy Corporation leases properties with carrying values that represent approximately 14% of the Company’s total assets, at cost, as of March 31, 2010.  The following table presents summary financial information for Chesapeake Energy Corporation as of March 31, 2010 and December 31, 2009, and for the three months ended March 31, 2010 and 2009, as reported in its March 31, 2010 Earnings Release on Form 8-K furnished with the Securities and Exchange Commission (the “SEC”).

 

14


 

 


Table of Contents

 

Chesapeake Energy Corporation

Selected Financial Data

(In millions)

 

Consolidated Balance Sheet Data:

 

 

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Current assets

 

$

3,335

 

$

2,446

 

Noncurrent assets

 

26,953

 

27,468

 

Current liabilities

 

3,123

 

2,688

 

Noncurrent liabilities

 

14,949

 

14,885

 

Total equity

 

12,216

 

12,341

 

 

Consolidated Statements of Income Data:

 

 

 

Three Months Ended

 

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

Total revenues

 

$

2,798

 

$

1,995

 

Total operating costs

 

1,586

 

11,048

 

Operating income/(loss)

 

1,212

 

(9,053

)

Net income/(loss)

 

596

 

(5,740

)

 

Consolidated Statements of Cash Flows Data:

 

 

 

Three Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Cash provided by operating activities

 

$

1,183

 

$

1,261

 

Cash used in investing activities

 

(1,014

)

(2,367

)

Cash provided by (used in) financing activities

 

40

 

(560

)

Net increase (decrease) in cash and cash equivalents

 

209

 

(1,666

)

Cash and cash equivalents, beginning of period

 

307

 

1,749

 

Cash and cash equivalents, end of period

 

516

 

83

 

 

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.

 

10.  Pro Forma Information (unaudited)

 

The following unaudited pro forma information for the three months ended March 31, 2009 is presented as if the acquisitions of the Company’s hotels acquired after December 31, 2008, and considered significant to the Company’s results of operations, had occurred on the latter of January 1, 2009 or the opening date of the hotel.  The five hotels acquired by the Company in the first three months of 2010 did not have significant results of operations for the period not owned by the Company.  The pro forma information does not purport to represent what the Company’s results of operations would actually have

 

15



Table of Contents

 

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.

 

 

 

Three Months
Ended

 

 

 

March  31,

 

 

 

2009

 

 

 

 

 

Total revenues

 

$

21,233

 

Net income

 

1,081

 

Net income per share - basic and diluted

 

$

0.02

 

 

The pro forma information reflects adjustments for actual revenues and expenses of the hotels acquired during 2009 for the respective period 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.

 

11.  Subsequent Events

 

In April 2010, the Company declared and paid approximately $8.4 million in dividend distributions to its common shareholders, or $0.073334 per outstanding common share.

 

During April 2010, the Company closed on the issuance of 7.3 million Units through its ongoing best-efforts offering, representing gross proceeds to the Company of $80.2 million and proceeds net of selling and marketing costs of $72.2 million.

 

In April 2010, the Company redeemed 186,011 Units in the amount of $1.9 million under its Unit Redemption Program.

 

Subsequent to March 31, 2010, the Company closed on the purchase of five hotels.  The following table summarizes the hotel information.  All dollar amounts are in thousands.

 

Location

 

Brand

 

Gross
Purchase Price

 

Rooms

 

Date of
Purchase

 

Miami, FL

 

Hampton Inn & Suites

 

$

11,900

 

121

 

4/9/2010

 

Anchorage, AK

 

Embassy Suites

 

42,000

 

169

 

4/30/2010

 

Boise, ID

 

Hampton Inn & Suites

 

22,370

 

186

 

4/30/2010

 

Rogers, AR

 

Homewood Suites

 

10,900

 

126

 

4/30/2010

 

St. Louis, MO

 

Hampton Inn & Suites

 

16,000

 

126

 

4/30/2010

 

 

 

 

 

$

103,170

 

728

 

 

 

 

16



Table of Contents

 

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.  Any forward-looking statement that the Company makes speaks only as of the date of this report.  The Company undertakes no obligation to publically update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.

 

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 March 31, 2010, the Company owned 38 hotels (five purchased during the first quarter of 2010, 12 acquired in 2009 and 21 acquired during 2008).  The Company’s real estate portfolio also includes approximately 410 acres of land and improvements located on 111 sites in the Ft. Worth, Texas area (acquired in April 2009) that are being leased to a subsidiary of Chesapeake Energy Corporation (“Chesapeake”) for the production 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 that the hotel industry revenues are stabilizing and will be flat in 2010 as compared to 2009.  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.

 

17



Table of Contents

 

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 38 hotels the Company owned as of March 31, 2010.  All dollar amounts are in thousands.

 

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

 

Houston, TX

 

Marriott

 

Western

 

50,750

 

206

 

1/8/2010

 

Albany, GA

 

Fairfield Inn & Suites

 

LBA

 

7,920

 

87

 

1/14/2010

 

Panama City, FL

 

TownePlace Suites

 

LBA

 

10,640

 

103

 

1/19/2010

 

Clovis, CA

 

Homewood Suites

 

Dimension

 

12,435

 

83

 

2/2/2010

 

Jacksonville, NC

 

TownePlace Suites

 

LBA

 

9,200

 

86

 

2/16/2010

 

Total

 

 

 

 

 

$

616,307

 

4,465

 

 

 

 

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Of the Company’s 38 hotels owned at March 31, 2010, five were purchased during the first three months of 2010.  The total gross purchase price for these five hotels, with a total of 565 rooms, was $90.9 million.

 

During 2009, the Company acquired land in Alexandria, Virginia totaling $5.1 million, for the planned construction of a SpringHill Suites hotel to be completed over the next 12 months.  Upon completion, it is expected that the hotel will contain approximately 152 guest rooms and will be managed by Marriott.  To date the Company has incurred $2.5 million in construction costs and anticipates the total construction costs to be approximately $20-$25 million.

 

The purchase price for these properties, net of debt assumed, was funded primarily by the Company’s on-going 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 March 31, 2010. All dollar amounts are in thousands.

 

Location

 

Brand

 

Interest
Rate (1)

 

Maturity
Date

 

Principal
Assumed

 

Outstanding
balance as of
March 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

13,704

 

Allen, TX

 

Hilton Garden Inn

 

5.37

%

10/11/2015

 

10,787

 

10,538

 

Bristol, VA

 

Courtyard

 

6.59

%

8/1/2016

 

9,767

 

9,607

 

Round Rock, TX

 

Hampton Inn

 

5.95

%

5/1/2016

 

4,175

 

4,085

 

Austin, TX

 

Homewood Suites

 

5.99

%

3/1/2016

 

7,556

 

7,406

 

Austin, TX

 

Hampton Inn

 

5.95

%

3/1/2016

 

7,553

 

7,402

 

 

 

 

 

 

 

 

 

$

57,554

 

$

56,492

 

 


(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.

 

Land and Improvements and Lease

 

In April 2009, the Company acquired approximately 417 acres of land on 113 sites in the Ft. Worth, Texas area for approximately $147 million from Chesapeake.  Simultaneous to the closing, the Company entered into a ground lease with Chesapeake for the 113 sites.  Chesapeake is using the land for natural gas production.  In February 2010, the Company agreed to sell back to Chesapeake two of the 113 sites originally purchased from Chesapeake in April 2009 and release Chesapeake from their associated lease obligation. The sales price for the two sites was equal to the Company’s original purchase price, approximately $2.6 million.  The Company earned and received rental income for the period held totaling approximately $240,000.  The lease has an initial term of 40 years and annual rent ranging from $15.2 million to $26.9 million with the average annual rent being $21.4 million.  Under the lease, Chesapeake is responsible for all operating costs of the real estate.

 

Chesapeake is a publicly held company that is traded on the New York Stock Exchange.  Chesapeake is the second-largest independent producer of natural gas in the United States with interests in approximately 38,000 net drill sites.

 

Results of Operations

 

The following is a summary of the Company’s consolidated financial results for the three months ended March 31, 2010 and 2009:

 

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Three Months Ended

 

 

 

March  31,

 

March  31,

 

(in thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

Hotel revenue

 

$

26,476

 

$

18,683

 

Rental revenue

 

5,297

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

Hotel direct expenses

 

16,619

 

11,186

 

Taxes, insurance and other expense

 

2,130

 

1,345

 

General and administrative expenses

 

1,310

 

839

 

Acquisition related costs

 

2,151

 

1,028

 

Depreciation

 

5,698

 

2,652

 

 

 

 

 

 

 

Interest expense, net

 

(84

)

(83

)

 

During the period from the Company’s initial capitalization on November 9, 2007 to July 30, 2008, the Company owned no properties, had no revenue, exclusive of interest income and was primarily engaged in capital formation activities.  The Company began operations on July 31, 2008 when it purchased its first hotel.  As of March 31, 2010, the Company owned 38 hotels (of which five were acquired during 2010) with 4,465 rooms as compared to 23 hotels, with a total of 2,666 rooms as of March 31, 2009.  The Company’s real estate portfolio also includes approximately 410 acres of land and improvements located on 111 sites in the Ft. Worth, Texas area (acquired in April 2009) that are being leased to Chesapeake for the production of natural gas.  As a result of the acquisition activity during 2009 and 2010, a comparison of operations for 2010 to prior periods is not representative of the results that would have occurred if all properties had been owned for the entire periods presented.

 

Hotel Performance

 

The following is summary of the operating results of the 38 hotels acquired through March 31, 2010 for their respective periods of ownership by the Company:

 

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Three Months
Ended

 

% of

 

Three Months
Ended

 

% of

 

 

 

March 31,

 

Hotel

 

March 31,

 

Hotel

 

(in thousands)

 

2010

 

Revenue

 

2009

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

Hotel Revenue:

 

 

 

 

 

 

 

 

 

Room revenue

 

$

24,093

 

 

 

$

16,637

 

 

 

Other revenue

 

2,383

 

 

 

2,046

 

 

 

 

 

26,476

 

 

 

18,683

 

 

 

 

 

 

 

 

 

 

 

 

 

Hotel Operating Expenses:

 

 

 

 

 

 

 

 

 

Hotel direct expenses

 

16,619

 

63

%

11,186

 

60

%

Taxes, insurance and other expense

 

2,103

 

8

%

1,345

 

7

%

 

 

 

 

 

 

 

 

 

 

Hotel Operating Statistics:

 

 

 

 

 

 

 

 

 

Number of hotels

 

38

 

 

 

23

 

 

 

ADR

 

$

102

 

 

 

$

114

 

 

 

Occupancy

 

61

%

 

 

64

%

 

 

RevPAR

 

$

61

 

 

 

$

73

 

 

 

 

Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality.  During the past two years, 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.  Although economic conditions appear to be stabilizing, the Company expects demand for the industry to continue to be below pre-recession levels until general economic conditions improve.  The Company’s hotels have shown results consistent with industry and brand averages for the period of ownership.

 

Hotel Revenues

 

The Company’s principal source of revenue is hotel revenue consisting of room and other related revenue.  For the three months ended March 31, 2010 and 2009, the Company had hotel revenue of $26.5 million and $18.7 million, respectively.  This revenue reflects hotel operations for the 38 hotels acquired through March 31, 2010 for their respective periods of ownership by the Company.  For the three months ended March 31, 2010, the hotels achieved combined average occupancy of approximately 61%, ADR of $102 and RevPAR of $61.  For the three months ended March 31, 2009, the hotels achieved combined average occupancy of approximately 64%, ADR of $114 and RevPAR of $73.  ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR.

 

The overall decline in occupancy, ADR and RevPAR is due to several factors.  General economic conditions in the United States have caused industry declines.  In addition, of the 15 hotels acquired by the Company since March 31, 2009, 12 were newly constructed.  Generally, newly constructed hotels require 12-24 months to establish themselves in their respective markets.  Therefore, revenue is below anticipated or market levels for this period of time.  Lastly, many of the 15 hotels acquired by the Company since March 31, 2009 have been in markets with ADR below the average of the markets of the first 23 hotels acquired by the Company, thus reducing the overall average.

 

Due to industry-wide hotel demand declines from a general weakening economy, the Company’s hotel revenue has been lower than anticipated.  While reflecting the impact of declining economic activity, the Company’s hotels continue to lead their respective markets.  The Company’s average RevPAR index was 134 for the first quarter of 2010 (the index excludes hotels under renovation or open less than two years).  The RevPAR index is a measure of each hotel’s RevPAR compared to the average in the market, with 100 being the average, and is provided by Smith Travel Research, Inc.®, an independent company that

 

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tracks historical hotel performance in most markets throughout the world.  Although it is not possible to predict when economic conditions will improve or their impact on the hotel industry, many industry analysts are forecasting RevPAR for 2010 to be flat as compared to 2009.  The Company will continue to pursue market opportunities to improve revenue.

 

Hotel Operating Expenses

 

Hotel operating expenses relate to the 38 hotels acquired through March 31, 2010 for their respective periods owned and consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees.  For the three months ended March 31, 2010, hotel operating expenses totaled $16.6 million or 63% of hotel revenue.  For the three months ended March 31, 2009, hotel operating expenses totaled $11.2 million or 60% of hotel revenue.  Nine of the 12 hotels acquired in 2009 and four of the five hotels acquired in 2010 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.  In addition, operating expenses were impacted by several hotel renovations, with approximately 9,200 room nights out of service during the first quarter of 2010 due to such renovations.  While weakened economic conditions persist, the Company will continue to work with its management companies to reduce costs as aggressively as possible, however it is not anticipated that these reductions will offset any future revenue declines.

 

Taxes, insurance, and other expense for the three months ended March 31, 2010 and 2009 totaled $2.1 million or 8% of hotel revenue and $1.3 million or 7% of hotel revenue.

 

Rental Revenue

 

The Company generates rental revenue from its purchase and leaseback transaction completed during the second quarter of 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 Chesapeake, one of the nation’s largest producers of natural gas.  In February 2010, the Company agreed to sell back to Chesapeake two of the 113 sites originally purchased and release Chesapeake from their associated lease obligations.  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 months ended March 31, 2010 and 2009 was $5.3 million and $-, respectively and includes $1.5 million and $- of adjustments to record rent on the straight line basis.

 

Other Expenses

 

General and administrative expense for the three months ended March 31, 2010 and 2009 was $1.3 million and $839,000, respectively.  The principal components of general and administrative expense are advisory fees, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expenses.

 

Acquisition related costs for the three months ended March 31, 2010 and 2009 were $2.2 million and $1.0 million, respectively.  In accordance with the Accounting Standards Codification on business combinations, the Company has expensed as incurred all transaction costs associated with the acquisitions of existing businesses that occurred on or after January 1, 2009, including title, legal, accounting and other related costs, as well as the brokerage commission paid to Apple Suites Realty Group, Inc. (“ASRG”), owned 100% by Glade M. Knight, Chairman and Chief Executive Officer of the Company.  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 months ended March 31, 2010 and 2009 was $5.7 million and $2.7 million, respectively.  Depreciation expense primarily represents expense of the Company’s 38 hotel buildings and related improvements, and associated personal property (furniture, fixtures, and equipment) for their respective periods owned.  Also, included in depreciation expense for the three months ended

 

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March 31, 2010 is the depreciation of the Company’s land improvements (acquired in April 2009) located on 111 sites in Fort Worth, Texas which is leased to one of the nation’s largest producers of natural gas.

 

Interest expense for the three months ended March 31, 2010 and 2009 was $520,000 and $523,000, respectively and is net of approximately $206,000 and $- of interest capitalized associated with renovation and construction projects.  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 months ended March 31, 2010 and 2009, the Company also recognized $436,000 and $440,000 in interest income, representing interest on excess cash invested in short-term money market instruments and certificates of deposit.

 

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 March 31, 2010, payments to ASRG for services under the terms of this contract have totaled approximately $15.3 million since inception.

 

The Company is party to an advisory agreement with A9A to provide management services to the Company.  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 $810,000 and $460,000 for the three months ended March 31, 2010 and 2009.  Of this total expense, $287,000 and $124,000 were fees paid to A9A and $523,000 and $336,000 were expenses reimbursed by A9A to AR6 for the three months ended March 31, 2010 and 2009.

 

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 AR6, Apple REIT Seven, Inc. and Apple REIT Eight, Inc.  Members of the Company’s Board of Directors are also on the Board of Directors of AR6, Apple REIT Seven, Inc. and Apple REIT Eight, Inc.

 

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

 

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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:

 

Gross Proceeds Raised from Sales of
Units through Date of Conversion

 

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

 

$ 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 March 31, 2010, if a triggering event had occurred, expense would have ranged from $0 to $76.7 million (assumes $11 per unit fair market value) and approximately 7.0 million common shares would have been issued.

 

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Table of Contents

 

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 debt service, capital improvements and anticipated distributions to shareholders.  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.

 

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 March 31, 2010, an additional 105.7 million Units, at $11 per Unit, were sold, with the Company receiving proceeds, net of commissions, marketing expenses and other offering costs of approximately $1.0 billion.  On April 25, 2010, the offering was extended for one additional year.  The offering expires on April 25, 2011, provided that the offering will be terminated if all of the Units are sold before then.  As of March 31, 2010, 67,029,405 Units remained unsold.

 

To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income.  Distributions during the first three months of 2010 totaled approximately $22.8 million of which approximately $14.2 million was used to purchase additional Units under the Company’s best-efforts offering.   Thus the net cash distributions were $8.6 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 $4.0 million.  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.  The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company taking into account acquisitions and capital improvements, ramp up of new properties and varying economic cycles.  To meet this objective, the Company may require the use of debt or offering proceeds in addition to cash from operations.  Since a portion of distributions has to date been funded with proceeds from the offering of Units, 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.  As 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 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

 

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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 three months ended March 31, 2010, the Company redeemed 120,742 Units in the amount of $1.3 million under the program.  There were no redemptions for the first quarter of 2009.

 

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 March 31, 2010, the Company held with various lenders $6.2 million in reserves for capital expenditures.  As of March 31, 2010, the Company had six major renovations scheduled to be completed in 2010.  Total capital expenditures on properties owned at March 31, 2010 are anticipated to be approximately $10 million for the remainder of 2010.  Additionally, the Company is in the process of constructing a SpringHill Suites hotel in Alexandria, Virginia which is expected to be completed over the next 12 months.  To date the Company has incurred $2.5 million in construction costs and anticipates the total construction costs to be approximately $20-$25 million.

 

As of March 31, 2010, the Company had outstanding contracts for the potential purchase of 14 additional hotels for a total purchase price of $254.1 million.  Of these 14 hotels, four are under construction and should be completed over the next 12 months.  The other 10 hotels are expected to close within the next six 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.

 

Location

 

Brand

 

Rooms

 

Deposits
Paid

 

Gross Purchase Price

 

Holly Springs, NC

 

Hampton Inn

 

124

 

$

100

 

$

14,880

(a)

Ft. Worth, TX

 

TownePlace Suites

 

140

 

500

 

18,460

(a)/(b)

Jacksonville, NC

 

Fairfield Inn & Suites

 

79

 

125

 

7,800

 

Santa Ana, CA

 

Courtyard

 

155

 

100

 

24,800

(a)

Miami, FL

 

Hampton Inn & Suites

 

121

 

150

 

11,900

 

Boise, ID

 

Hampton Inn & Suites

 

186

 

125

 

22,370

 

Rogers, AR

 

Hampton Inn

 

122

 

125

 

9,600

 

Rogers, AR

 

Homewood Suites

 

126

 

125

 

10,900

 

St. Louis, MO

 

Hampton Inn

 

190

 

125

 

23,000

 

St. Louis, MO

 

Hampton Inn & Suites

 

126

 

125

 

16,000

 

Kansas City, MO

 

Hampton Inn

 

122

 

125

 

10,130

 

Oklahoma City, OK

 

Hampton Inn & Suites

 

200

 

125

 

32,000

 

Anchorage, AK

 

Embassy Suites

 

169

 

50

 

42,000

 

Lafayette, LA

 

SpringHill Suites

 

103

 

3

 

10,232

(a)/(b)

 

 

 

 

1,963

 

$

1,903

 

$

254,072

 

 


(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.

 

Four of the hotels under contract require the Company to assume approximately $49.5 million in mortgage debt.  Each of these loans provide for monthly payments of principal and interest on an amortized basis.

 

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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 (less any debt assumed) for the outstanding contracts will be funded from the proceeds of the Company’s on-going best-efforts offering of Units and cash on hand if a closing occurs.

 

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 “Study Period” to determine the viability of the hotels.  The Company can terminate the lease for any reason during the Study Period, which originally ended on April 14, 2010, and was extended for six months to October 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.

 

Impact of Inflation

 

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

 

Business Interruption

 

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

 

Seasonality

 

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

 

Recent Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued a pronouncement (Accounting Standards Update No. 2009-17) 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

 

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entity.  This pronouncement was adopted by the Company in the first quarter of 2010.  The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

Subsequent Events

 

In April 2010, the Company declared and paid approximately $8.4 million in dividend distributions to its common shareholders, or $0.073334 per outstanding common share.

 

During April 2010, the Company closed on the issuance of 7.3 million Units through its ongoing best-efforts offering, representing gross proceeds to the Company of $80.2 million and proceeds net of selling and marketing costs of $72.2 million.

 

In April 2010, the Company redeemed 186,011 Units in the amount of $1.9 million under its Unit Redemption Program.

 

Subsequent to March 31, 2010, the Company closed on the purchase of five hotels.  The following table summarizes the hotel information.  All dollar amounts are in thousands.

 

Location

 

Brand

 

Gross
Purchase Price

 

Rooms

 

Date of
Purchase

 

Miami, FL

 

Hampton Inn & Suites

 

$

11,900

 

121

 

4/9/2010

 

Anchorage, AK

 

Embassy Suites

 

42,000

 

169

 

4/30/2010

 

Boise, ID

 

Hampton Inn & Suites

 

22,370

 

186

 

4/30/2010

 

Rogers, AR

 

Homewood Suites

 

10,900

 

126

 

4/30/2010

 

St. Louis, MO

 

Hampton Inn & Suites

 

16,000

 

126

 

4/30/2010

 

 

 

 

 

$

103,170

 

728

 

 

 

 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments.  As of March 31, 2010, 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 March 31, 2010, of $320 million, every 100 basis points change in interest rates will impact the Company’s annual net income by approximately $3.2 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 March 31, 2010.  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

 

 

 

105,698

 Units

$11 per Unit

 

1,162,677

 

Totals:

 

115,222

 Units

 

 

1,262,677

 

 

 

 

 

 

 

 

 

Expenses of Issuance and Distribution of Units

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1. Underwriting discounts and commission

 

 

 

 

 

126,268

 

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

 

 

 

 

 

2,258

 

Total Expenses of Issuance and Distribution of Common Shares

 

 

 

 

 

128,526

 

Net Proceeds to the Company

 

 

 

 

 

$

1,134,151

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

$

714,728

 

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

 

 

 

 

 

2,643

 

3. Repayment of other indebtedness, including interest expense paid

 

 

 

 

 

5,064

 

4. Investment and working capital

 

 

 

 

 

392,424

 

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

 

 

 

 

 

 

 

a. Apple Nine Advisors, Inc.

 

 

 

 

 

3,971

 

b. Apple Suites Realty Group, Inc.

 

 

 

 

 

15,321

 

6. Fees and expenses of third parties

 

 

 

 

 

 

7. Other

 

 

 

 

 

 

Total of Application of Net Proceeds to the Company

 

 

 

 

 

$

1,134,151

 

 

Unit Redemption Program

 

The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year.  Shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned 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.  The following is a summary of redemptions during the first quarter of 2010.

 

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Issuer Purchases of Equity Securities

 

 

 

(a)

 

(b)

 

(c)

 

(d)

 

Period

 

Total Number
of Units
Purchased

 

Average Price Paid
per Unit

 

Total Number of
Units Purchased as
Part of Publicly
Announced Plans
or Programs

 

Maximum Number
of Units that May
Yet Be Purchased
Under the Plans or
Programs

 

January 2010

 

120,742

 

$

10.37

 

373,213

 

(1

)

 


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

 

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ITEM 6.  EXHIBITS

 

Exhibit
Number

 

Description of Documents

3.1

 

 

Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008)

 

 

 

 

3.2

 

 

Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008)

 

 

 

 

10.72

 

 

Purchase Agreement dated as of March 16, 2010 between Denali Lodging, LLC and Apple Nine Services Anchorage, LLC (Incorporated by reference to Exhibit 10.72 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

 

 

 

10.73

 

 

Purchase Contract dated as of March 16, 2010 between Boise Lodging Investors, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.73 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

 

 

 

10.74

 

 

Purchase Contract dated as of March 16, 2010 between Forest Park Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.74 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

 

 

 

10.75

 

 

Purchase Contract dated as of March 16, 2010 between Liberty Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.75 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

 

 

 

10.76

 

 

Purchase Contract dated as of March 16, 2010 between OKC-Bricktown Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.76 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

 

 

 

10.77

 

 

Purchase Contract dated as of March 16, 2010 between Rodgers Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.77 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

 

 

 

10.78

 

 

Purchase Contract dated as of March 16, 2010 between Rodgers Lodging Associates 58, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.78 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

 

 

 

10.79

 

 

Purchase Contract dated as of March 16, 2010 between St. Louis Lodging Associates, LLC, Apple Nine Hospitality Ownership, Inc. and Raymond Management Company, Inc. (Incorporated by reference to Exhibit 10.79 to registrant’s Post-effective Amendment No. 8 to Form S-11 (SEC File No. 333-147414 ) filed April 21, 2010)

 

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31.1

 

 

Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH)

 

 

 

 

31.2

 

 

Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH)

 

 

 

 

32.1

 

 

Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH)

 

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SIGNATURES

 

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

 

Apple REIT Nine, Inc.

 

 

 

 

 

 

By:

/s/    GLADE M. KNIGHT

 

Date: May 5, 2010

 

Glade M. Knight,

 

 

 

Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)

 

 

 

 

 

 

By:

/s/    BRYAN PEERY

 

Date: May 5, 2010

 

Bryan Peery,

 

 

 

Chief Financial Officer
(Principal Financial and Principal Accounting Officer)

 

 

 

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