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EX-31.1 - CERTIFICATION OF CEO - Moody National REIT I, Inc.ex31-1.htm
EX-31.2 - CERTIFICATION OF CFO - Moody National REIT I, Inc.ex31-2.htm
EX-32.2 - CERTIFICATION OF CFO - Moody National REIT I, Inc.ex32-2.htm
EX-32 - CERTIFICATION OF CEO - Moody National REIT I, Inc.ex32-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

(Mark One)  

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

 

For the quarterly period ended June 30, 2014

 

OR

  

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 000-55200

 

 

 

MOODY NATIONAL REIT I, INC.  

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Maryland   26-1812865
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
     
    6363 Woodway Drive, Suite 110
Houston, Texas
  77057
(Address of Principal Executive Offices)   (Zip Code)

  

(713) 977-7500  

(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 ☒   No

 

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   No

 

Indicate by check mark whether the registrant is a large accelerated filed, 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. (Check one):

 

  Large Accelerated filer    Accelerated filer
       
  Non-Accelerated filer     Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

Yes    No

 

As of August 11, 2014, there were 6,443,634 shares of the Registrant’s common stock issued and outstanding.

 

 
 

  

MOODY NATIONAL REIT I, INC.  

INDEX

  

PART I FINANCIAL INFORMATION   Page
     
Item 1.   Financial Statements   2
         
    Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013 (unaudited)   2
         
    Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2014 and 2013 (unaudited)   3
         
    Condensed Consolidated Statement of Equity for the six months ended June 30, 2014 (unaudited)   4
         
    Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013 (unaudited)   5
         
    Notes to Condensed Consolidated Financial Statements (unaudited)   6
         
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   23
         
Item 3.   Quantitative and Qualitative Disclosures about Market Risk   35
         
Item 4.   Controls and Procedures   36
         
PART II OTHER INFORMATION   37
         
Item 1.   Legal Proceedings   37
         
Item 1A.   Risk Factors   37
         
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   37
         
Item 3.   Defaults Upon Senior Securities   38
         
Item 4.   Mine Safety Disclosures   38
         
Item 5.   Other Information   38
         
Item 6.   Exhibits   38

 

1
 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

MOODY NATIONAL REIT I, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

   June 30, 2014   December 31, 2013 
ASSETS          
Investment in hotel properties, net  $80,109,697   $49,136,124 
Cash and cash equivalents   8,548,658    5,324,315 
Restricted cash   5,215,321    3,295,529 
Accounts receivable, net of allowance of $15,000 and $12,000, at June 30, 2014 and December 31, 2013, respectively   494,905    124,578 
Mortgage note receivable   12,165,202    12,269,485 
Prepaid expenses and other assets   350,636    107,193 
Deferred costs, net of accumulated amortization of $111,486 and $69,411, at June 30, 2014 and December 31, 2013, respectively   946,902    660,372 
           
Total Assets  $107,831,321   $70,917,596 
           
LIABILITIES AND EQUITY          
Liabilities:          
Notes payable  $62,309,220   $44,441,355 
Accounts payable and accrued expenses   2,000,897    1,194,726 
Due to related parties   319,636    427,985 
Dividends payable   351,117    217,877 
           
Total Liabilities   64,980,870    46,281,943 
           
Special Partnership Units— 100 Special Units of the Operating Partnership   1,000    1,000 
           
Commitments and Contingencies          
           
Equity:          
           
Stockholders’ equity:          
Preferred stock, $0.01 par value per share; 50,000,000 shares authorized, no shares issued and outstanding        
Common stock, $0.01 par value per share; 400,000,000 shares authorized, 5,714,073 and 3,331,439 issued and outstanding at June 30, 2014 and December 31, 2013, respectively   57,141    33,314 
Additional paid-in capital   49,153,289    28,279,101 
Distributions in excess of net income   (6,638,147)   (4,164,515)
Total stockholders’ equity   42,572,283    24,147,900 
Noncontrolling interest - 100 common units of the Operating Partnership   711    753 
Noncontrolling interest in consolidated joint venture   276,457    486,000 
           
Total Equity   42,849,451    24,634,653 
           
TOTAL LIABILITIES AND EQUITY  $107,831,321   $70,917,596 

 

See accompanying notes to condensed consolidated financial statements.

 

2
 

 

MOODY NATIONAL REIT I, INC. 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 

(Unaudited)

 

   Three months ended June 30,   Six months ended June 30, 
   2014   2013   2014   2013 
                 
Revenue                    
Room revenue  $5,278,099   $1,720,381   $8,679,734   $2,609,611 
Other hotel revenue   259,251    71,997    375,627    91,742 
Total hotel revenue   5,537,350    1,792,378    9,055,361    2,701,353 
Interest income from note receivable   158,898    163,038    316,469    323,190 
Total revenue   5,696,248    1,955,416    9,371,830    3,024,543 
                     
Expenses                    
Hotel operating expenses   3,337,185    1,033,914    5,358,568    1,534,041 
Property taxes, insurance and other   322,679    114,097    585,509    167,397 
Depreciation and amortization   765,329    236,612    1,363,039    350,637 
Property acquisition   303,276    410,520    751,892    442,054 
Corporate general and administrative   445,974    56,827    644,811    94,872 
Total expenses   5,174,443    1,851,970    8,703,819    2,589,001 
                     
Operating income   521,805    103,446    668,011    435,542 
                     
Interest expense and amortization of deferred loan costs   722,659    272,880    1,259,034    465,669 
                     
Loss before income tax expense   (200,854)   (169,434)   (591,023)   (30,127)
Income tax expense   93,000    42,100    145,900    63,100 
                     
Net loss   (293,854)   (211,534)   (736,923)   (93,227)
Income attributable to noncontrolling interest in consolidated joint ventures   (19,438)   (19,895)   (38,737)   (39,181)
                     
Loss (income) attributable to noncontrolling interest in common operating partnership units   (3)   13    2    4 
Net loss attributable to common shareholders  $(313,295)  $(231,416)  $(775,658)  $(132,404)
Per-share information – basic and diluted:                    
Net loss attributable to common shareholders  $(0.06)  $(0.11)  $(0.18)  $(0.08)
Dividends declared  $0.20   $0.20   $0.40   $0.40 
Weighted average shares outstanding   4,824,021    2,023,290    4,276,950    1,753,196 

 

See accompanying notes to condensed consolidated financial statements.

 

3
 

 

MOODY NATIONAL REIT I, INC.  

CONDENSED CONSOLIDATED STATEMENT OF EQUITY 

Six months ended June 30, 2014  

(Unaudited)

 

    

Preferred Stock

  

Common Stock

               Noncontrolling Interest in Operating Partnership              
  

Number of Shares

   Par Value   Number of Shares   Par Value   Additional Paid-In Capital   Distributions in Excess of Net Income    Number of Units    Value   

Noncontrolling Interest in
Consolidated
Joint Venture

   

Total Equity

                                                           
Balance at December 31, 2013      $    3,331,439   $33,314   $28,279,101   $ (4,164,515)     100    $ 753    $ 486,000    $ 24,634,653
Issuance of common stock, net of offering costs           2,335,024    23,351    20,380,339                             20,403,690
Issuance of common stock pursuant to dividend reinvestment plan           47,610    476    451,821                             452,297
Stock-based compensation expense                   42,028                             42,028
Net income (loss)                        (775,658)           (2)     38,737      (736,923)
Dividends and distributions declared                        (1,697,974)           (40)     (248,280)     (1,946,294)
                                                          
Balance at June 30, 2014      $    5,714,073   $57,141   $49,153,289   $ (6,638,147)     100    $ 711     $ 276,457    $ 42,849,451

 

See accompanying notes to condensed consolidated financial statements.

 

4
 

 

MOODY NATIONAL REIT I, INC.  

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

(Unaudited)

 

   Six months ended June 30, 
   2014   2013 
         
Cash flows from operating activities          
Net loss  $(736,923)  $(93,227)
Adjustments to reconcile net loss to net cash provided by operating activities:          
Depreciation and amortization   1,363,039    350,637 
Amortization of deferred loan costs   31,674    16,409 
Stock-based compensation   42,028    56,031 
Changes in operating assets and liabilities          
Accounts receivable   (370,327)   (9,594)
Prepaid expenses and other assets   (243,443)   (87,263)
Accounts payable and accrued expenses   806,171    359,225 
Due to related parties   (712,063)    
Net cash provided by operating activities   180,156    592,218 
Cash flows from investing activities          
Increase in restricted cash   (1,919,792)   (102,340)
Earnest money and deposits       (245,000)
Repayments of mortgage note receivable   104,283    99,048 
Improvements and additions to hotel properties   (1,826,211)    
Acquisitions of hotel properties   (25,439,507)   (11,300,000)
Net cash used in investing activities   (29,081,227)   (11,548,292)
Cash flows from financing activities          
Proceeds from issuance of common stock   23,350,238    8,135,784 
Offering costs paid   (2,342,834)   (1,159,606)
Dividends paid   (1,112,477)   (483,974)
Proceeds of notes payable   13,250,000    7,800,000 
Repayments of notes payable   (442,628)   (233,307)
Payments of deferred financing costs   (328,605)   (138,000)
Distributions to noncontrolling interest in joint venture   (248,280)   (34,477)
Net cash provided by financing activities   32,125,414    13,886,420 
           
Net change in cash and cash equivalents   3,224,343    2,930,346 
Cash and cash equivalents at beginning of period   5,324,315    2,710,101 
Cash and cash equivalents at end of period  $8,548,658   $5,640,447 
Supplemental Cash Flow Information          
Interest paid  $1,134,782   $428,471 
Income taxes paid  $16,003   $ 
Supplemental Disclosure of Non-Cash Investing and Financing Activity          
Accrued offering costs due to related party  $603,714   $424,119 
Assumption of note payable in connection with acquisition of hotel property  $5,060,493   $ 
Issuance of common stock from dividend reinvestment plan  $452,297   $162,384 
Accrued dividend payable  $351,117   $140,324 

 

See accompanying notes to condensed consolidated financial statements.

 

5
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

1. Organization

 

Moody National REIT I, Inc. (the “Company”) was formed on January 15, 2008, as a Maryland corporation and has elected to qualify as a real estate investment trust (“REIT”) commencing with the year ended December 31, 2011. The Company was organized to acquire a diverse portfolio of real properties, primarily in the hospitality sector, as well as other commercial properties, real estate securities and debt-related investments. As discussed in Note 6, the Company was initially capitalized with the sale of shares of its common stock to Moody National REIT Sponsor, LLC (“Sponsor”) on February 19, 2008. The Company’s fiscal year end is December 31.

 

On April 15, 2009, the Company commenced its initial public offering pursuant to a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to offer a maximum of $1,000,000,000 in shares of its common stock to the public in its primary offering and up to $100,000,000 in shares of its common stock to its stockholders pursuant to its distribution reinvestment plan (the “DRIP”). On October 12, 2012, the Company terminated its initial public offering and commenced its follow-on public offering (discussed below). As of October 12, 2012, the Company had accepted subscriptions for, and issued, 1,126,253 shares of its common stock in its initial public offering, including 29,582 shares of common stock pursuant to the DRIP, resulting in offering proceeds of $10,966,713.

 

On February 14, 2012, the Company filed a registration statement on Form S-11 with the SEC to register a following-on public offering of up to $1,000,000,000 in shares of the Company’s common stock. In the follow-on offering the Company is offering up to $900,000,000 in shares of the Company’s common stock to the public and up to $100,000,000 in shares of the Company’s common stock to its stockholders pursuant to the DRIP. As of June 30, 2014, the Company had accepted investors’ subscriptions for, and issued, 4,524,348 shares of its common stock in the follow-on offering, including 97,145 shares of common stock issued pursuant to the DRIP, resulting in aggregate gross offering proceeds of $44,272,027. As of June 30, 2014, the Company had accepted subscriptions for, and issued, 5,650,601 shares of common stock in the Company’s initial public offering and follow-on offering, including 126,727 shares of common stock pursuant to the DRIP, resulting in aggregate offering proceeds of $55,238,740.

 

The Company is offering shares to the public in the follow-on offering at a price of $10.00 per share, with discounts available for certain purchasers, and to its stockholders pursuant to the DRIP at a price of $9.50 per share. The Company’s board of directors may change the price at which the Company offers shares to the public in the follow-on offering from time to time during the follow-on offering, but not more frequently than quarterly, to reflect changes in the Company’s estimated per-share net asset value and other factors the Company’s board of directors deems relevant.

 

The Company’s board of directors has elected to extend the Company’s follow-on public offering of shares of common stock, in accordance with the terms established in the Company’s prospectus. The follow-on public offering, which was scheduled to terminate on October 12, 2014, has been extended for up to an additional year. However, the Company currently expects to terminate the follow-on public offering on January 31, 2015.

 

The Company intends to use substantially all of the net proceeds from its public offerings to acquire a diversified portfolio of real properties, real estate securities and debt-related investments. The Company’s real property will consist primarily of hotel properties located in the United States and Canada that it owns exclusively or in joint ventures or other co-ownership arrangements with other persons. The Company may also invest in other property types consisting of multifamily, office, retail and industrial assets located in the United States and Canada as well as securities of real estate companies and debt-related investments. The Company may also make opportunistic investments in properties that may be under-developed or newly constructed and in properties that it believes are undervalued.

 

As of June 30, 2014, the Company’s portfolio consisted of (1) a 74.5% joint venture interest in a mortgage note (the “Hyatt Place Note”) secured by a hotel property located in Grapevine, Texas, commonly known as the Hyatt Place Grapevine hotel (the “Hyatt Place Property”); (2) a 91-suite hotel property located in The Woodlands, Texas, commonly known as the Homewood Suites by Hilton - Woodlands (the “Woodlands Hotel”); (3) a 127-guestroom hotel property located in Germantown, Tennessee, commonly known as the Hyatt Place - Germantown (the “Germantown Hotel”); (4) a 113-guestroom hotel property located in North Charleston, South Carolina, commonly known as the Hyatt Place - North Charleston (the “Charleston Hotel”); (5) a 123-suite hotel property located in Austin, Texas, commonly known as the Hampton Inn – Austin (the “Austin Hotel”); (6) a 133-suite hotel property located in Grapevine, Texas, commonly known as the Residence Inn by Marriott – Grapevine (the “Grapevine Hotel”); and (7) a 127-suite hotel property located in Newark, California, commonly known as the TownePlace Suites by Marriott Newark/Silicon Valley (the “Silicon Valley Hotel”). The Company began operations on May 27, 2010 with the acquisition of a 75% joint venture interest in a hotel property located in Atlanta, Georgia which was subsequently sold to a third-party buyer on August 23, 2012.

 

6
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

The Company’s advisor is Moody National Advisor I, LLC (“Advisor”), a Delaware limited liability company and an affiliate of Sponsor. Subject to certain restrictions and limitations, Advisor is responsible for managing the Company’s affairs on a day-to-day basis and for identifying and making acquisitions and investments on behalf of the Company pursuant to an amended and restated advisory agreement (the “Advisory Agreement”) by and among the Company, Moody National Operating Partnership I, L.P., the Company’s operating partnership (the “OP”), and Advisor.

 

The OP’s partnership agreement provides that the OP will be operated in a manner that will enable the Company to (1) satisfy the requirements for being classified as a REIT for tax purposes, (2) avoid any federal income or excise tax liability and (3) ensure that the OP will not be classified as a “publicly traded partnership” for purposes of Section 7704 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), which classification could result in the OP being taxed as a corporation rather than as a partnership. In addition to the administrative and operating costs and expenses incurred by the OP in acquiring and operating real estate assets, the OP will pay all of the Company’s administrative costs and expenses, and such expenses will be treated as expenses of the OP. The common units of the OP may be tendered for redemption once they have been outstanding for at least one year. At such time, the Company has the option to redeem the common units for shares of the Company’s common stock, cash or a combination thereof at the Company’s sole discretion. The Special Units of the OP (the “Special Units”) will be redeemed pursuant to the OP’s partnership agreement upon the termination or nonrenewal of the Advisory Agreement or upon certain other events outside of the control of the Special Unit holder. Upon the termination or nonrenewal of the Advisory Agreement by the Company for “cause” (as defined in the Advisory Agreement) all of the Special Units will be redeemed for $1.00. As described in more detail in Note 9, upon the occurrence of any of the events outside of the control of the Special Unit holder which trigger redemption of the Special Units, the Special Units will be redeemed, at the Advisor’s option, for shares of the Company’s common stock, a non-interest bearing promissory note payable solely from the proceeds of assets sales, or a combination thereof.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The Company’s consolidated financial statements include its accounts and the accounts of its subsidiaries over which it has control. All intercompany balances and transactions are eliminated in consolidation.

 

The Company includes the accounts of its consolidated subsidiaries in its consolidated financial statements when the Company is the primary beneficiary for entities deemed to be variable interest entities (“VIEs”) through which the Company has a controlling interest. Interests in entities acquired are evaluated based on U.S. generally accepted accounting principles (“GAAP”), which requires the consolidation of VIEs in which the Company is deemed to have the controlling financial interest. The Company has the controlling financial interest if the Company has the power to direct the activities of the VIE that most significantly impact its economic performance and the obligation to absorb losses or receive benefits from the VIE that could be significant to the Company. If the interest in the entity is determined not to be a VIE, then the entity is evaluated for consolidation based on legal form, economic substance, and the extent to which the Company has control and/or substantive participating rights under the respective ownership agreement. The Company did not have a VIE interest as of June 30, 2014 or December 31, 2013.

 

There are judgments and estimates involved in determining if an entity in which the Company has an investment is a VIE. The entity is evaluated to determine if it is a VIE by, among other things, determining if the equity investors as a group have a controlling financial interest in the entity and if the entity has sufficient equity at risk to finance its activities without additional subordinated financial support.

 

7
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with GAAP for interim financial statements and the rules and regulations of the SEC. Accordingly, the unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP 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. Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. For further information, readers should refer to the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the SEC on March 19, 2014.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the accompanying condensed consolidated financial statements and notes. Actual results could differ from those estimates.

 

Organization and Offering Costs

 

Organization and offering costs of the Company are incurred by Advisor on behalf of the Company. Pursuant to the Advisory Agreement, the Company is obligated to reimburse Advisor or its affiliates, as applicable, for organization and offering costs incurred by Advisor associated with each of the Company’s public offerings, provided that within 60 days of the last day of the month in which a public offering ends, Advisor is obligated to reimburse the Company to the extent organization and offering costs incurred by the Company in connection with the completed public offering exceed 15.0% of the gross offering proceeds from the sale of the Company’s shares of common stock in the completed public offering. Such organization and offering costs shall include selling commissions and dealer manager fees paid to the dealer manager, legal, accounting, printing and other offering expenses, including marketing, salaries and direct expenses of Advisor’s employees and employees of Advisor’s affiliates and others. Any reimbursement of Advisor or its affiliates for organization and offering costs will not exceed actual expenses incurred by Advisor.

 

All offering costs, including selling commissions and dealer manager fees, are recorded as an offset to additional paid-in-capital, and all organization costs are recorded as an expense when the Company has an obligation to reimburse Advisor.

 

As of June 30, 2014, total offering costs for the follow-on offering were $6,155,405. The Company directly incurred $4,442,041 of offering costs for the follow-on offering and reimbursed Advisor for $1,829,324 in offering costs for the follow-on offering. The Company has a $115,960 receivable from Advisor for offering costs related to the follow-on offering, which is recorded as an offset to other amounts owed to Advisor. As of June 30, 2014, offering costs related to the follow-on offering did not exceed 15.0% of the gross offering proceeds from the sale of the Company’s shares of common stock in the follow-on offering. The Company has not reimbursed Advisor any funds for organization costs for the follow-on offering.

 

Income Taxes

 

The Company has made an election to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code commencing with the taxable year ended December 31, 2011. Prior to qualifying to be taxed as a REIT, the Company was subject to normal federal and state corporation income taxes. The Company previously determined not to make an election to qualify as a REIT under the Internal Revenue Code because it had a net operating loss for the years ended December 31, 2009 and 2010 and had fewer than 100 stockholders as of December 31, 2009 and 2010.

 

8
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

As a REIT, the Company generally will not be subject to federal corporate income tax to the extent it distributes its REIT taxable income to its stockholders, so long as it distributes at least 90% of its REIT taxable income (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). REITs are subject to a number of other organizational and operations requirements. Even if the Company qualifies for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, and federal income and excise taxes on its undistributed income.

 

The Company leases the hotels it acquires to wholly-owned taxable REIT subsidiaries that are subject to federal, state and local income taxes. The Company accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company records a valuation allowance for net deferred tax assets that are not expected to be realized.

 

The Company has reviewed tax positions under GAAP guidance that clarifies the relevant criteria and approach for the recognition and measurement of uncertain tax positions. The guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition of a tax position taken, or expected to be taken, in a tax return. A tax position may only be recognized in the financial statements if it is more likely than not that the tax position will be sustained upon examination. The Company has no material uncertain tax positions as of June 30, 2014.

 

The preparation of the Company’s various tax returns requires the use of estimates for federal and state income tax purposes. These estimates may be subjected to review by the respective taxing authorities. A revision to an estimate may result in an assessment of additional taxes, penalties and interest. At this time, a range in which the Company’s estimates may change is not expected to be material. The Company will account for interest and penalties relating to uncertain tax provisions in the current period results of operations, if necessary. The Company has tax years 2009, 2010, 2011, 2012 and 2013 remaining subject to examination by various federal and state tax jurisdictions.

 

Concentration of Credit Risk

 

As of June 30, 2014, the Company had cash and cash equivalents and restricted cash deposited in certain financial institutions in excess of federally insured levels. The Company diversifies its cash and cash equivalents with several banking institutions in an attempt to minimize exposure to any one of these institutions. The Company regularly monitors the financial stability of these financial institutions and believes that it is not exposed to any significant credit risk in cash and cash equivalents or restricted cash.

 

The Company is also exposed to credit risk with respect to its joint venture interest in the Hyatt Place Note. As a significant investment of the Company, the failure of the borrower on the Hyatt Place Note to make payments of interest and principal when due, or any other event of default under the Hyatt Place Note, would have an adverse impact on the Company’s results of operations.

 

Valuation and Allocation of Real Property — Acquisition

 

Upon acquisition, the purchase price of real property is allocated to the tangible assets acquired, consisting of land, buildings and tenant improvements, any assumed debt, identified intangible assets and asset retirement obligations based on their fair values. Identified intangible assets consist of above-market and below-market leases, in-place leases, in-place contracts, tenant relationships and any goodwill or gain on purchase. Acquisition costs are charged to expense as incurred. Initial valuations are subject to change during the measurement period, but the measurement period ends as soon as the information is available. The measurement period shall not exceed one year from the acquisition date.

 

9
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

The fair value of the tangible assets acquired consists of land, buildings, furniture, fixtures and equipment. Land values are derived from appraisals, and buildings are calculated as replacement cost less depreciation or the Company’s estimates of the relative fair value of these assets using discounted cash flow analyses or similar methods. The value of the building is depreciated over the estimated useful life of thirty-nine years using the straight-line method. The value of furniture, fixtures and equipment is based on their fair value using replacement costs less depreciation.

 

The Company determines the fair value of assumed debt by calculating the net present value of the scheduled mortgage payments using interest rates for debt with similar terms and remaining maturities that the Company believes it could obtain at the date of acquisition. Any difference between the fair value and stated value of the assumed debt is recorded as a discount or premium and amortized over the remaining life of the loan as interest expense.

 

In allocating the purchase price of each of the Company’s properties, the Company makes assumptions and uses various estimates, including, but not limited to, the estimated useful lives of the assets, the cost of replacing certain assets, discount rates used to determine present values, market rental rates per square foot and the period required to lease the property up to its occupancy at acquisition as if it were vacant. Many of these estimates are obtained from independent third party appraisals. However, the Company is responsible for the source and use of these estimates. These estimates are judgmental and subject to being imprecise; accordingly, if different estimates and assumptions were derived, the valuation of the various categories of the Company’s real estate assets or related intangibles could in turn result in a difference in the depreciation or amortization expense recorded in the Company’s condensed consolidated financial statements. These variances could be material to the Company’s results of operations and financial condition.

 

Valuation and Allocation of Real Property — Ownership

 

Investment in real estate is recorded at historical cost. Major improvements that extend the life of an asset are capitalized and depreciated over a period equal to the shorter of the life of the improvement or the remaining useful life of the asset. The cost of ordinary repairs and maintenance are charged to expense when incurred.

 

Depreciation or amortization expenses are computed using the straight-line and accelerated methods based upon the following estimated useful lives:

 

   Years 
Buildings and improvements   39 
Exterior improvements   10-20 
Furniture, fixtures and equipment    5-10 

 

Impairments

 

For real estate the Company owns, the Company monitors events and changes in circumstances indicating that the carrying amounts of the real estate assets may not be recoverable. When such events or changes in circumstances are present, the Company assesses potential impairment by comparing estimated future undiscounted cash flows expected to be generated over the life of the asset from operating activities and from its eventual disposition, to the carrying amount of the asset. In the event that the carrying amount exceeds the estimated future undiscounted cash flows, the Company recognizes an impairment loss to adjust the carrying amount of the asset to estimated fair value for assets held for use and fair value less costs to sell for assets held for sale. There were no such impairment losses for the three and six months ended June 30, 2014 and 2013.

 

In evaluating the Company’s investments for impairment, the Company makes several estimates and assumptions, including, but not limited to, the projected date of disposition of the properties, the estimated future cash flows of the properties during the Company’s ownership and the projected sales price of each of the properties. A change in these estimates and assumptions could result in a change in the estimated fair value of the Company’s hotel properties which could then result in different conclusions regarding impairment which could result in material changes to the Company’s consolidated financial statements.

 

10
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

Revenue Recognition

 

Hotel revenues, including room, food, beverage and other ancillary revenues, are recognized as the related services are delivered. Interest income is recognized when earned.

 

Cash and Cash Equivalents

 

Cash and cash equivalents represent cash on hand or held in banks and short-term investments with an initial maturity of three months or less at the date of purchase.

 

Restricted Cash

 

Restricted cash includes reserves for debt service and insurance, as well as reserves for property improvements and furniture, fixtures, and equipment, as required by certain management or mortgage debt agreement restrictions and provisions. Restricted cash also includes cash collateral deposited with a bank related to a loan that may be used by the Company toward the payments of principal and interest of the loan and any other amounts due under the loan in the event of default.

 

Valuation of Accounts Receivable

 

The Company takes into consideration certain factors that require judgments to be made as to the collectability of receivables. Collectability factors taken into consideration are the amounts outstanding, payment history and financial strength of the customer, which taken as a whole determines the valuation. Ongoing credit evaluations are performed and an allowance for potential credit losses is provided against the portion of accounts receivable that is estimated to be uncollectible.

 

Mortgage Note Receivable

 

The Company provides first-mortgage financing in the form of a note receivable. The loan is held for investment and is intended to be held to maturity and, accordingly, is recorded at cost and net of the allowance for losses when the loan is deemed to be impaired. Premiums, discounts, and net origination fees are amortized or accreted as an adjustment to interest income using the effective interest method over the life of the loan. The Company discontinues recording interest and amortizing discounts/premiums when the contractual payment of interest and/or principal is not received.

 

Impairment of Note Receivable

 

The Company reviews the note receivable for impairment in each reporting period pursuant to the applicable authoritative accounting guidance. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts recorded as assets on the consolidated balance sheet. The Company applies normal loan review and underwriting procedures (as may be implemented or modified from time to time) in making that judgment.

 

When a loan is impaired, the Company measures impairment based on the present value of expected cash flows discounted at the loan’s effective interest rate against the value of the asset recorded on the consolidated balance sheet. The Company may also measure impairment based on a loan’s observable market price or the fair value of collateral if the loan is collateral dependent. If a loan is deemed to be impaired, the Company records a valuation allowance through a charge to earnings for any shortfall. The Company’s assessment of impairment is based on considerable judgment and estimates. The Company did not record a valuation allowance during the three and six months ended June 30, 2014 or 2013.

 

11
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

Prepaid Expenses and Other Assets

 

Prepaid expenses include prepaid property insurance and hotel operating expenses. Other assets include accrued interest receivable.

 

Deferred Costs

 

Deferred costs consist of deferred financing fees and franchise costs. Deferred loan costs are recorded at cost and are amortized to interest expense using a straight-line method that approximates the effective interest method over the life of the related debt. The deferred franchise costs are recorded at cost and amortized over the term of the franchise contract. Accumulated amortization of deferred costs was $111,486 and $69,411 as of June 30, 2014 and December 31, 2013, respectively. Expected future amortization of deferred financing fees and franchise costs is as follows:

 

Years Ending             
December 31   Total   Loan Costs   Franchise Costs 
 2014   $56,049   $43,959   $12,090 
 2015    111,380    87,200    24,180 
 2016    110,846    86,666    24,180 
 2017    92,543    68,363    24,180 
 Thereafter    576,084    316,332    259,752 
 Total   $946,902   $602,520   $344,382 

 

Earnings per Share

 

Earnings per share (“EPS”) is calculated based on the weighted average number of shares outstanding during each period. Basic and diluted EPS are the same for all periods presented. Restricted stock was included in basic earnings per share because the restricted stock participates in dividends.

 

Comprehensive Income

 

For the periods presented, there were no differences between reported net loss attributable to common shareholders and comprehensive income.

 

Recent Accounting Pronouncements

 

In April 2014, the Financial Accounting Standards Board issued ASU No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360) - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” ASU 2014-08 changes the threshold for disclosing discontinued operations and the related disclosure requirements. Pursuant to ASU 2014-08, only disposals representing a strategic shift, such as a major line of business, a major geographical area or a major equity investment, should be presented as a discontinued operation. ASU 2014-08 is effective for annual periods beginning on or after December 15, 2014 with early adoption permitted but only for disposals or classifications as held for sale which have not been reported in financial statements previously issued or available for issuance. The Company implemented the provisions of the ASU as of January 1, 2014. The adoption of this guidance did not have a material effect on the Company’s condensed consolidated financial statements.

 

12
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

3. Investment in Hotel Properties

 

The following table sets forth summary information regarding the hotel properties the Company owned as of June 30, 2014:

 

Property Name   Date Acquired   Location   Ownership Interest     Purchase Price(1)     Rooms     Mortgage Debt Outstanding(2)  
Woodlands Hotel (Homewood Suites by Hilton)   November 8, 2012   The Woodlands, Texas     100 %   $ 12,000,000       91     $ 6,712,789  
                                         
Germantown Hotel (Hyatt Place)   April 9, 2013   Germantown, Tennessee     100 %     11,300,000       127       7,664,234  
                                         
Charleston Hotel (Hyatt Place)   July 2, 2013   North Charleston, South Carolina     100 %     11,800,000       113       7,702,948  
                                         
Austin Hotel (Hampton Inn)   December 30, 2013   Austin, Texas     100 %     15,350,000       123       11,437,327  
                                         
Grapevine Hotel (Residence Inn)    March 31, 2014    Grapevine, Texas     100 %     20,500,000       133       13,221,467  
                                         
Silicon Valley Hotel (TownPlace Suites)    June 24, 2014   Newark, California     100 %     10,000,000       127       5,060,493  
                                         
Totals                   $ 80,950,000       714     $ 51,799,258  

 

 

(1)Excludes closing costs.
(2)As of June 30, 2014.

 

Investments in hotel properties consisted of the following at June 30, 2014 and December 31, 2013:

 

   June 30, 2014   December 31, 2013 
Land  $12,680,000   $6,760,000 
Buildings and improvements   64,787,835    39,861,360 
Furniture, fixtures and equipment   5,461,736    3,982,000 
Total cost   82,929,571    50,603,360 
Accumulated depreciation   (2,819,874)   (1,467,236)
Investment in hotel properties, net  $80,109,697   $49,136,124 

 

13
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

First Quarter Acquisition

 

Grapevine Hotel

 

On March 31, 2014, Moody National 2020-Grapevine Holding, LLC, a wholly owned subsidiary of the OP (“Moody Grapevine Holding”) acquired fee simple title to the Grapevine Hotel from Moody National RI Grapevine S, LLC, an affiliate of the Company, Moody National RI Grapevine MT, LLC, an affiliate of the Company, and Moody National Management, LP, for an aggregate purchase price of $20,500,000, excluding acquisition costs. The Company financed the acquisition of the Grapevine Hotel with proceeds from its ongoing public offering and approximately $13,250,000 of indebtedness secured by the Grapevine Hotel. The purchase price of the Grapevine Hotel, excluding acquisition expenses, was preliminarily allocated to land, buildings and improvements and furniture, fixtures and equipment in the amounts of $2,600,000, $17,500,000, and $400,000, respectively. Acquisition costs of $443,190 were incurred and expensed in connection with the acquisition of the Grapevine Hotel. The Company has recognized approximately $1,463,000 in revenues and a $294,000 net loss, which includes acquisition costs, for the Grapevine Hotel for the six months ended June 30, 2014. In connection with the acquisition of the Grapevine Hotel, the Company formed a taxable REIT subsidiary (the “Grapevine Hotel TRS”). Upon the closing of the acquisition of the Grapevine Hotel, Moody National RI Grapevine MT, LLC, a wholly owned subsidiary of the Grapevine Hotel TRS (the “Grapevine Master Tenant”), entered into a Hotel Lease Agreement pursuant to which the Grapevine Master Tenant leases the Grapevine Hotel. Moody National Hospitality Management, LLC, an affiliate of the Company, manages the Grapevine Hotel pursuant to a Hotel Management Agreement with the Grapevine Master Tenant.

 

Second Quarter Acquisition

 

Silicon Valley Hotel

 

On June 24, 2014, Moody National Cedar-Newark Holding, LLC, a wholly owned subsidiary of the OP (“Moody Silicon Valley Holding”), acquired fee simple title to the Silicon Valley Hotel from Moody Newark, LLC, an unaffiliated third party, for an aggregate purchase price of $10,000,000, excluding acquisition costs. The Company financed the acquisition of the Silicon Valley Hotel with proceeds from its ongoing public offering and the assumption of the existing mortgage loan secured by the Silicon Valley Hotel with an original principal amount of $5,250,000 and a balance of $5,060,493 assumed on the date of acquisition. The purchase price of the Silicon Valley Hotel, excluding acquisition expenses, was preliminarily allocated to land, buildings and improvements and furniture, fixtures and equipment in the amounts of $3,320,000, $6,302,000 and $378,000, respectively. Acquisition costs of $283,276 were incurred and expensed in connection with the acquisition of the Silicon Valley Hotel. The Company has recognized approximately $84,000 in revenues and a $260,000 net loss, which includes acquisition costs, for the Silicon Valley Hotel for the six months ended June 30, 2014. In connection with the acquisition of the Silicon Valley Hotel, the Company formed a taxable REIT subsidiary (the “Silicon Valley Hotel TRS”). Upon the closing of the acquisition of the Silicon Valley Hotel, Moody National TPS Newark MT, LLC, a wholly owned subsidiary of the Silicon Valley Hotel TRS (the “Silicon Valley Master Tenant”), entered into a Hotel Lease Agreement pursuant to which the Silicon Valley Master Tenant leases the Silicon Valley Hotel. Moody National Hospitality Management, LLC, an affiliate of the Company, manages the Silicon Valley Hotel pursuant to a Hotel Management Agreement with the Silicon Valley Master Tenant.

 

The following unaudited pro forma consolidated financial information for the three and six months ended June 30, 2014 and 2013 is presented as if the Company acquired the Germantown Hotel, Charleston Hotel, Austin Hotel, Grapevine Hotel and Silicon Valley Hotel on January 1, 2013. This information is not necessarily indicative of what the actual results of operations would have been had the Company completed the acquisition of the Germantown Hotel, the Charleston Hotel, the Austin Hotel, the Grapevine Hotel and the Silicon Valley Hotel on January 1, 2013, nor does it purport to represent the Company’s future operations:

 

   Three months ended June 30,   Six months ended June 30, 
   2014   2013   2014   2013 
Revenue  $6,517,114   $5,907,670   $12,420,084   $12,527,590 
Net income (loss)   (135,435)   (185,701)   (672,523)   368,122 
Net income (loss) attributable to common shareholders   (154,876)   (205,583)   (711,258)   328,945 
Net income (loss) per common share attributable to common shareholders, basic and diluted  $(0.03)  $(0.10)  $(0.17)  $0.19 

 

14
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

4. Notes Receivable

 

As of June 30, 2014 and December 31, 2013, the note receivable was $12,165,202 and $12,269,485, respectively.

 

Hyatt Place Note

 

On June 3, 2011 (the “Closing Date”), and effective as of May 5, 2011 (the “Effective Date”), the Company acquired a joint venture interest in the Hyatt Place Note pursuant to the transaction described below. The Hyatt Place Note was issued by Moody National HP Grapevine Trust, a Delaware statutory trust (the “Trust”), in favor of Patriot Bank, a Texas banking association (the “Patriot Bank”), and is secured by a lien on the Hyatt Place Property. As of the Closing Date, the Hyatt Place Note had an outstanding principal balance of $12,759,199.

 

On the Closing Date, the OP, Moody National Mortgage Corporation (“Moody National Mortgage”), an affiliate of the Sponsor controlled by Brett C. Moody, and certain of the holders of ownership interests in the Trust (collectively, the “Trust Members,” and, together with the OP and Moody National Mortgage, the “Members”), entered into the limited liability company agreement (the “Note Joint Venture Agreement”) of MNHP Note Holder, LLC, a Delaware limited liability company (the “Note Joint Venture”). On the Closing Date, the Note Joint Venture acquired the Hyatt Place Note from Patriot Bank for an aggregate purchase price of $12,759,199, exclusive of closing costs. The Note Joint Venture financed the payment of the purchase price for the Hyatt Place Note with (1) a capital contribution to the Note Joint Venture from the OP and the Trust Members, and (2) the proceeds of a loan from Patriot Bank evidenced by a promissory note in the aggregate principal amount of $11,483,280 (the “Acquisition Note”). For additional information on the terms of the Acquisition Note, see Note 5. As of June 30, 2014, the OP’s membership interest in the Note Joint Venture was 74.5%, the Trust Members’ membership interest in the Note Joint Venture was 11.5% and Moody National Mortgage’s membership interest in the Note Joint Venture was 14%.

 

On the Closing Date and effective as of the Effective Date, the Note Joint Venture and the Trust entered into a Renewal, Extension and Modification Agreement which extended the maturity date of the Hyatt Place Note and amended the terms of the Hyatt Place Note. The entire unpaid principal balance of the Hyatt Place Note and all accrued and unpaid interest thereon is due and payable in full on February 1, 2018 (the “Maturity Date”). The Hyatt Place Note accrued interest at a fixed rate of 5.15% per annum from the Closing Date through August 21, 2012 (the “First Change Date”). For the period from the First Change Date through August 21, 2015 (the “Second Change Date”), the Hyatt Place Note will accrue interest at 5.15%, which is a fixed rate equal to (a) the variable interest rate per annum published in The Wall Street Journal as the “Prime Rate” for the U.S. (the “Prime Rate”) in effect as of the First Change Date, plus (b) 1.90%. For the period from the Second Change Date through the Maturity Date, the Hyatt Place Note will accrue interest at a fixed rate equal to (a) the Prime Rate in effect as of the Second Change Date, plus (b) 1.90%, provided that in no event will the interest rate exceed the maximum interest rate permitted by applicable law. The Prime Rate at June 30, 2014 was 3.25%. The Trust may prepay the Hyatt Place Note, in whole or in part, at any time without penalty or premium.

 

The estimated fair value of the Company’s note receivable as of June 30, 2014 and December 31 2013 was $12,165,202 and $12,269,485, respectively. The fair value of the note receivable was estimated based on discounted cash flow analyses using the current incremental borrowing rates for similar types of borrowing arrangements as of the respective reporting dates. The discounted cash flow method of assessing fair value results in a general approximation of value, and such value may never actually be realized.

 

15
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

5. Debt

 

The Company’s aggregate borrowings, secured and unsecured, are reviewed by the Company’s board of directors at least quarterly. Under the Company’s Second Articles of Amendment and Restatement (as amended, the “Charter”), the Company is prohibited from borrowing in excess of 300% of the value of the Company’s net assets. “Net assets” for purposes of this calculation is defined to be the Company’s total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts and other non-cash reserves, less total liabilities. The preceding calculation is generally expected to approximate 75% of the aggregate cost of the Company’s assets before non-cash reserves and depreciation. However, the Company may temporarily borrow in excess of these amounts if such excess is approved by a majority of the Company’s independent directors and disclosed to stockholders in the Company’s next quarterly report, along with an explanation for such excess. As of June 30, 2014, the Company’s debt levels did not exceed 300% of the value of the Company’s net assets.

 

As of June 30, 2014 and December 31, 2013, the Company’s notes payable consisted of the following:

 

   Principal as of
June 30, 2014
   Principal as of
December 31, 2013
   Interest Rate at
June 30, 2014
   Maturity Date
Hyatt Place Note Acquisition Note  $10,509,962   $10,677,350    3.00%  May 5, 2018
Woodlands Hotel Loan   6,712,789    6,777,812    6.00%  December 6, 2016
Germantown Hotel Loan   7,664,234    7,728,405    4.30%  May 6, 2023
Charleston Hotel Loan   7,702,948    7,757,788    5.193%  August 1, 2023
Austin Hotel Loan   11,437,327    11,500,000    5.426%  January 6, 2024
Grapevine Hotel Loan   13,221,467        5.250%  April 6, 2024
Silicon Valley Hotel Loan   5,060,493        5.500%  July 6, 2022
 Total  $62,309,220   $44,441,355         

 

The estimated fair value of the Company’s notes payable as of June 30, 2014 and December 31, 2013 was $62,309,220 and $44,441,355, respectively. The fair value of notes payable was estimated based on discounted cash flow analyses using the current incremental borrowing rates for similar types of borrowing arrangements as of the respective reporting dates. The discounted cash flow method of assessing fair value results in a general approximation of value, and such value may never actually be realized.

 

6. Equity

 

Capitalization

 

Under the Charter, the Company has the authority to issue 400,000,000 shares of common stock and 50,000,000 shares of preferred stock. All shares of common and preferred stock have a par value of $0.01 per share. As of June 30, 2014, the Company had issued 5,650,601 shares of common stock in the Company’s public offerings, including 126,727 shares issued pursuant to the DRIP. As of June 30, 2014, there were a total of 5,714,073 shares of the Company’s common stock issued and outstanding.

 

The Company’s board of directors is authorized to amend the Charter, without the approval of the stockholders, to increase the aggregate number of authorized shares of capital stock or the number of shares of any class or series that the Company has authority to issue.

 

16
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

Distributions

 

The Company’s board of directors has authorized and declared a distribution to its stockholders that (1) accrues daily to the Company’s stockholders of record as of the close of business on each day; (2) is payable in cumulative amounts on or before the 15th day of each calendar month; and (3) is calculated at a rate of $0.002192 per share of the Company’s common stock per day, which, if paid each day over a 365-day period, is equivalent to an 8.0% annualized distribution rate based on a purchase price of $10.00 per share of common stock.

 

The following table summarizes distributions paid in cash and pursuant to the DRIP for the six months ended June 30, 2013 and 2014.

 

Period (1)  Cash Distribution (1)   Distribution Paid Pursuant to DRIP (1)(2)   Total Amount of Distribution (1) 
First Quarter 2013  $200,579   $72,609   $273,188 
Second Quarter 2013   283,395    89,775    373,170 
Total  $483,974   $162,384   $646,358 
                
First Quarter 2014  $482,368   $194,592   $676,960 
Second Quarter 2014   630,109    257,705    887,814 
Total  $1,112,477   $452,297   $1,564,774 

 

(1)Distributions are paid on a monthly basis. Distributions for all record dates of a given month are paid approximately 15 days following the end of such month.
(2)Amount of distributions paid in shares of common stock pursuant to our distribution reinvestment plan.

 

Noncontrolling Interests in Consolidated Joint Ventures

 

Noncontrolling interest in consolidated joint ventures at June 30, 2014 was $276,457, which represented ownership interests in the Note Joint Venture, and is reported in equity in the consolidated balance sheets. Income from consolidated joint ventures attributable to these noncontrolling interests was $19,438 and $19,895 for the three months ended June 30, 2014 and 2013, respectively, and was $38,737 and $39,181 for the six months ended June 30, 2014 and 2013, respectively.

 

7. Related Party Arrangements

 

Advisor and certain affiliates of Advisor receive fees and compensation in connection with the Company’s public offering and the acquisition, management and sale of the Company’s real estate investments.

 

Selling Commissions and Dealer Manager Fees

 

Moody Securities, LLC (“Moody Securities”), the dealer manager of the Company’s public offering, receives a selling commission of up to 6.5% of gross offering proceeds raised in the Company’s public offerings. Moody Securities may re-allow all or a portion of such selling commissions earned to participating broker-dealers. In addition, the Company pays Moody Securities a dealer manager fee of up to 3.5% of gross offering proceeds raised in the Company’s public offerings, a portion of which may be reallowed to participating broker-dealers. No selling commissions or dealer manager fee are paid for sales pursuant to the DRIP. As of June 30, 2014, the Company had paid Moody Securities $746,368 and $3,296,362 in selling commissions related to the initial and follow-on offerings, respectively, and $190,626 and $972,030 in dealer manager fees related to the initial and follow-on offerings, respectively, which has been recorded as an offset to additional paid-in capital in the condensed consolidated balance sheets.

 

17
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

Organization and Offering Costs

 

Advisor and its affiliates will be reimbursed up to 15.0% of offering proceeds for reimbursement of organization and offering expenses (including selling commissions and the dealer manager fee payable to Moody Securities) not to exceed actual expenses incurred. Advisor will be responsible for the payment of organization and offering expenses, other than selling commissions and dealer manager fees, to the extent they exceed 15% of gross offering proceeds, without recourse against or reimbursement by the Company. As of June 30, 2014, Advisor and its affiliates had incurred organizational and offering expenses of $3,214,000 and $1,713,000 related to the initial and follow-on offerings, respectively.

 

As of June 30, 2014, total offering costs for the follow-on offering were $6,155,405. The Company directly incurred $4,442,041 of offering costs for the follow-on offering and reimbursed Advisor for $1,829,324 in offering costs for the follow-on offering. The Company has an $115,960 receivable from Advisor for offering costs related to the follow-on offering, which is recorded as an offset to other amounts owed to Advisor. As of June 30, 2014, offering costs related to the follow-on offering did not exceed 15.0% of the gross offering proceeds from the sale of the Company’s shares of common stock in the follow-on offering. The Company has not reimbursed Advisor any funds for organization costs for the follow-on offering.

 

Advisory Fees and Expense Reimbursement

 

Advisor, or its affiliates, receives an acquisition fee equal to 1.5% of (1) the cost of investments the Company acquires or (2) the Company’s allocable cost of investments acquired in a joint venture. With respect to investments in and originations of loans, Advisor will receive an origination fee in lieu of an acquisition fee. The origination fee will equal 1.5% of the amount funded by the Company to invest in or originate such loan. For the six months ended June 30, 2014, the Company paid Advisor acquisition fees of $478,500 in connection with the acquisition of the Grapevine Hotel and the Silicon Valley Hotel. For the six months ended June 30, 2013, the Company paid Advisor acquisition fees of $169,500 in connection with the acquisition of the Germantown Hotel. As of June 30, 2014, the Company had not paid any origination fees to Advisor.

 

Advisor will receive a debt financing fee of 1.0% of the amount available under any loan or line of credit made available to the Company. It is anticipated that Advisor will pay some or all of these fees to third parties with whom it subcontracts to coordinate financing for the Company. For the six months ended June 30, 2013, the Company paid $78,000 in debt financing fees to Advisor for financing incurred in connection with the acquisition of the Germantown Hotel. For the six months ended June 30, 2014, the Company paid $183,100 in debt financing fees to Advisor for financing incurred in connection with the acquisition of the Grapevine Hotel and the Silicon Valley Hotel.

 

The Company pays Advisor a monthly asset management fee of one-twelfth of 1.0% of the aggregate cost (before non-cash reserves and depreciation) of all real estate investments held by the Company at month-end. For the three months ended June 30, 2014 and 2013, the Company incurred asset management fees of $210,133 and $0, respectively, and for the six months ended June 30, 2014 and 2013, the Company incurred asset management fees of $366,891 and $0, respectively, payable to Advisor which are recorded in corporate general and administrative expenses in the accompanying condensed consolidated statements of operations. Advisor waived the asset management fee for the months of February 2012 and March 2012 and May 2012 through June 2013.

 

If Advisor provides a substantial amount of services in connection with the sale of a property or other investment, Advisor or its affiliates also will be paid a disposition fee equal to 3.0% of the contract sales price of each property or other investment sold, provided that total real estate commissions, including the disposition fee, do not exceed 6.0% of the contract sales price. As of June 30, 2014, the Company had not paid any disposition fees to Advisor because Advisor waived the disposition fee in connection with the sale of the Residence Inn Property.

 

18
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

The Company will reimburse Advisor for all operating expenses paid or incurred by Advisor in connection with the services provided to the Company, subject to the limitation that the Company will not reimburse Advisor for any amount by which its operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceeds the greater of: (1) 2% of the Company’s average invested assets, or (2) 25% of the Company’s net income determined without reduction for any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of the Company’s assets for that period (the “2%/25% Limitation”). Notwithstanding the above, the Company may reimburse Advisor for expenses in excess of this limitation if a majority of the independent directors determines that such excess expenses are justified based on unusual and non-recurring factors. For the four fiscal quarters ended June 30, 2014, total operating expenses of the Company were $1,359,945, which included $771,035 in operating expenses incurred directly by the Company and $588,910 incurred by Advisor on behalf of the Company. Of the $1,359,945 in total operating expenses incurred during the four fiscal quarters ended June 30, 2014, $75,038 exceeded the 2%/25% Limitation and is not an obligation of the Company. The Company reimbursed Advisor $165,000 in operating expenses during the four fiscal quarters ended June 30, 2014. Additionally, Advisor has incurred $3,622,281 in operating expenses on the Company’s behalf prior to the four fiscal quarters ended June 30, 2014. Subject to a future determination by the board of directors, this amount is not reimbursable to Advisor nor an obligation of the Company.

 

Advisor has waived all operating expenses reimbursable to Advisor for each of the 12 prior fiscal quarters ended March 31, 2014 (the “Waiver Period”) to the extent such expenses had not been previously reimbursed to Advisor. Advisor further agreed that all expenses incurred directly by the Company during the waiver period will be paid by Advisor on behalf of the Company. Total reimbursable expenses so waived or assumed by Advisor were $1,967,721 as of June 30, 2014.

 

Property Management Fees

 

The Company has engaged Moody National Hospitality Management, LLC, an affiliate of the Sponsor (the “Property Manager”), as its property manager. The Company pays Property Manager a market-based property management fee in connection with the operation and management of properties pursuant to the terms of hotel management agreements. For the three months ended June 30, 2014 and 2013, the Company paid the Property Manager property management fees of $166,114 and $53,759, respectively, and accounting fees of $37,500 and $15,000. For the six months ended June 30, 2014 and 2013, the Company paid the Property Manager property management fees of $271,654 and $81,028, respectively, and accounting fees of $67,500 and $22,500, respectively, which are included in hotel operating expenses in the accompanying consolidated statements of operations.

 

Note Joint Venture

 

As discussed in Note 4, as of June 30, 2014, the OP owns a 74.5% membership interest in the Note Joint Venture, Moody National Mortgage owns a 14% membership interest in the Note Joint Venture and the Trust Members own the remaining 11.5% membership interests in the Note Joint Venture. Pursuant to the terms of the Note Joint Venture Agreement, Moody National Mortgage is entitled to receive approximately 14% of all distributions of cash from operations of the Note Joint Venture and the OP and the other Members are entitled to receive the remaining approximately 86% of distributions of cash from operations of the Note Joint Venture in proportion to their respective membership interests in the Note Joint Venture.

 

The Note Joint Venture Agreement provides that cash proceeds from a sale, exchange, refinancing or other disposition of the Hyatt Place Note will be distributed as follows: (1) first, to each Member of the Note Joint Venture in proportion to their respective unreturned capital contributions to the Note Joint Venture until each member’s unreturned capital contributions have been reduced to zero; (2) second, to Moody National Mortgage until Moody National Mortgage has been distributed an amount equal to approximately 14% of all distributions made to all Members (inclusive of all prior distributions); and (3) thereafter, approximately 14% to Moody National Mortgage and approximately 86% to the OP and the Trust Members in proportion to their respective membership interests in the Note Joint Venture. In addition, so long as Moody National Mortgage or Moody National Management has any outstanding guaranty of any indebtedness of the Note Joint Venture, (1) the OP will in good faith consult with Moody National Mortgage and consider any proposals or recommendations of Moody National Mortgage regarding any possible refinancing of indebtedness on the Hyatt Place Note or any sale of the Hyatt Place Note and (2) any sale of the Hyatt Place Note will require the consent of Moody National Mortgage, which consent will not be unreasonably withheld.

 

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Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

As discussed in Note 3, on March 31, 2014, Moody Grapevine Holding acquired fee simple title to the Grapevine Hotel from Moody National RI Grapevine S, LLC, Moody National RI Grapevine MT, LLC, and Moody National Management, LP, each an affiliate of the Company, for an aggregate purchase price of $20,500,000, excluding acquisition costs.

 

8. Incentive Award Plan

 

The Company has adopted an incentive plan (the “Incentive Award Plan”) that provides for the grant of equity awards to its employees, directors and consultants and those of the Company’s affiliates. The Incentive Award Plan authorizes the grant of non-qualified and incentive stock options, restricted stock awards, restricted stock units, stock appreciation rights, dividend equivalents and other stock-based awards or cash-based awards. Shares of common stock will be authorized and reserved for issuance under the Incentive Award Plan. The Company has also adopted an independent directors compensation plan (the “Independent Directors Compensation Plan”) pursuant to which each of the Company’s then current independent directors were entitled to receive 5,000 shares of restricted stock when the Company raised the minimum offering amount of $2,000,000 in its initial public offering. Each new independent director that subsequently joins the Company’s board of directors will receive 5,000 shares of restricted stock on the date he or she joins the Company’s board of directors. In addition, on the date of each of the first four annual meetings of the Company’s stockholders at which an independent director is re-elected to the Company’s board of directors, he or she will receive 2,500 restricted shares. Subject to certain conditions, the non-vested shares of restricted stock granted pursuant to the Independent Directors Compensation Plan will vest and become non-forfeitable in four equal quarterly installments beginning on the first day of the first quarter following the date of grant; provided, however, that the restricted stock will become fully vested on the earlier to occur of (1) the termination of the independent director’s service as a director due to his or her death or disability, or (2) a change in control of the Company. As of June 30, 2014, there were 1,958,750 common shares remaining available for future issuance under the Incentive Award Plan and the Independent Directors Compensation Plan.

 

No shares of restricted stock were granted pursuant to the Independent Directors Compensation Plan during the three months and six ended June 30, 2014 and 2013. As of June 30, 2014, a total of 41,250 shares of restricted stock have been issued by the Company to the Company’s independent directors pursuant to the Independent Directors Compensation Plan.

 

The weighted average grant date fair value of the shares of restricted stock issued by the Company pursuant to the Independent Directors Compensation Plan was $10.00 per share based on observable market transactions occurring near the dates of the grants. The Company recorded compensation related to such shares of restricted stock ratably from the grant date to the date the shares become fully vested based on the fair market value of such shares at the date they were granted. The Company recorded compensation related to such shares of restricted stock based on the fair market value of such shares at the date they became vested of $21,130 and $21,349 for the three months ended June 30, 2014 and 2013, respectively, and $42,028 and $56,031 for the six months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, there were 1,875 non-vested shares of restricted common stock granted pursuant to the Independent Directors Compensation Plan which were granted August 13, 2013. The remaining unrecognized compensation expense of $232 will be recognized during the third quarter of 2014.

 

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Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

The following is a summary of activity under the Independent Directors Compensation Plan for the six months ended June 30, 2014 and year ended December 31, 2013:

 

    Number of Shares   Weighted Average Grant Date Fair Value 
Balance of non-vested shares as of January 1, 2013    8,125   $10.00 
Shares granted on August 13, 2013    7,500    10.00 
Shares vested    (10,000)   10.00 
            
Balance of non-vested shares as of December 31, 2013    5,625    10.00 
Shares vested    (3,750)   10.00 
Balance of non-vested shares as of June 30, 2014   1,875   $10.00 

 

9. Subordinated Participation Interest

 

Pursuant to the limited partnership agreement of the OP, the holders of the Special Units will be entitled to distributions from the OP in an amount equal to 15.0% of net sales proceeds received by the OP on dispositions of its assets and dispositions of real properties by joint ventures or partnerships in which the OP owns a partnership interest, after the other holders of common units, including the Company, have received in the aggregate cumulative distributions from operating income, sales proceeds or other sources equal to their capital contributions plus an 8.0% cumulative non-compounded annual pre-tax return thereon. The Special Units will be redeemed for the above amount upon the earliest of: (1) the occurrence of certain events that result in the termination or non-renewal of the advisory agreement or (2) a listing of the Company’s common stock on a national securities exchange.

 

10. Commitments and Contingencies

 

Restricted Cash

 

Under certain management and debt agreements existing at June 30, 2014, the Company escrows payments required for insurance, real estate taxes, capital improvements, hotel furniture and fixtures and debt service.

 

The composition of the Company’s restricted cash as of June 30, 2014 and December 31, 2013 are as follows:

 

   June 30, 2014   December 31, 2013 
Property improvement plan  $3,805,765   $2,212,866 
Real estate taxes   490,043    538,263 
Insurance   159,219    210,849 
Hotel furniture and fixtures   645,266    333,551 
Seasonality   115,028     
Total restricted cash  $5,215,321   $3,295,529 

 

11. Income Taxes

 

The Company has formed taxable REIT subsidiaries (each a “TRS”) that are C-Corporations for federal income tax purposes and use the consolidated asset and liability method of accounting for income taxes. Tax return positions are recognized in the consolidated financial statements when they are “more-likely-than-not” to be sustained upon examination by the taxing authority. Deferred income tax assets and liabilities result from temporary differences. Temporary differences are differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future periods. A valuation allowance may be placed on deferred income tax assets, if it is determined that it is more likely than not that a deferred tax asset may not be realized.

 

21
 

 

Moody National REIT I, Inc.

 

Notes to Condensed Consolidated Financial Statements

 

June 30, 2014

 

(unaudited)

 

No provision for income taxes has been made for the Company (other than each TRS) for the three and six months ended June 30, 2014 and 2013 as it made an election to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code commencing with the taxable year ended December 31, 2011. Prior to January 1, 2011, the Company was subject to federal and state income taxes as it had not elected to be taxed as a REIT.

 

The TRSs had no deferred tax assets or liabilities as of June 30, 2014 and December 31, 2013.

 

As of June, 2014, the Company had operating loss carry-forwards of $335,800.

 

The income tax expense for the three months and six months ended June 30, 2014 and 2013 consisted of the following:

 

   Three months ended June 30,   Six months ended June 30,  
   2014   2013   2014   2013 
Current expense  $93,000   $42,100   $145,900   $63,100 
Deferred expense                
Total expense, net  $93,000   $42,100   $145,900   $63,100 
                     
Federal  $84,300   $35,000   $136,300   $56,000 
State   8,700    7,100    9,600    7,100 
Total tax expense  $93,000   $42,100   $145,900   $63,100 

 

Income tax expense recognized is based on the taxable income of the Company’s taxable REIT subsidiaries and not the taxable income of the Company.

 

13. Subsequent Events

 

Status of Offering

 

As of August 11, 2014, the Company had accepted investors’ subscriptions for, and issued 6,372,662 shares of the Company’s common stock in the Company’s initial public offering and follow-on offering, including 138,230 shares issued pursuant to the DRIP, resulting in aggregate gross offering proceeds to the Company of $62,344,320.

 

Distributions Declared

 

On June 30, 2014 the Company declared a distribution in the aggregate amount of $351,117, of which $241,796 was paid in cash on July 15, 2014 and $109,321 was paid pursuant to the DRIP in the form of additional shares of the Company’s common stock. On July 31, 2014, the Company declared a distribution in the aggregate amount of $406,474 which is scheduled to be paid in cash and through the DRIP in the form of additional shares of the Company’s common stock on August 15, 2014.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion and analysis should be read in conjunction with the accompanying financial statements of Moody National REIT I, Inc. and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to Moody National REIT I, Inc., a Maryland corporation, and, as required by context, Moody National Operating Partnership I, L.P., a Delaware limited partnership, which we refer to as our “operating partnership,” and to their subsidiaries.

 

Forward-Looking Statements

 

Certain statements included in this Quarterly Report on Form 10-Q that are not historical facts (including any statements concerning investment objectives, other plans and objectives of management for future operations or economic performance, or assumptions or forecasts related thereto) are forward-looking statements. These statements are only predictions. We caution that forward-looking statements are not guarantees. Actual events or our investments and results of operations could differ materially from those expressed or implied in any forward-looking statements. Forward-looking statements are typically identified by the use of terms such as “may,” “should,” “expect,” “could,” “intend,” “plan,” “anticipate,” “estimate,” “believe,” “continue,” “predict,” “potential” or the negative of such terms and other comparable terminology.

 

The forward-looking statements included herein are based upon our current expectations, plans, estimates, assumptions and beliefs, which involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:

 

our ability to raise capital in our ongoing public offering;

 

our ability to effectively deploy the proceeds raised in our public offering;

 

our ability to obtain financing on acceptable terms;

 

our levels of debt and the terms and limitations imposed on us by our debt agreements;

 

our ability to identify and acquire real estate and real estate-related assets on terms that are favorable to us;

 

risks inherent in the real estate business, including the lack of liquidity of real estate and real estate-related assets on terms that are favorable to us;

 

changes in demand for rooms at our hotel properties;

 

our ability to compete in the hotel industry;

 

adverse developments affecting our sponsor and its affiliates;

 

a decrease in the level of participation in our distribution reinvestment plan;

 

the availability of cash flow from operating activities for distributions;

 

changes in economic conditions generally and the real estate and debt markets specifically;

 

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conflicts of interest arising out of our relationship with our advisor and its affiliates;

 

legislative or regulatory changes (including changes to the laws governing the taxation of REITs);

 

the availability of capital; and

 

interest rates.

 

Any of the assumptions underlying the forward-looking statements included herein could be inaccurate, and undue reliance should not be placed upon any forward-looking statements included herein. All forward-looking statements are made as of the date this Quarterly Report on Form 10-Q is filed with the Securities and Exchange Commission, or the SEC, and the risk that actual results will differ materially from the expectations expressed herein will increase with the passage of time. Except as otherwise required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements made herein, whether as a result of new information, future events, changed circumstances or any other reason.

 

All forward-looking statements included herein should be read in light of the factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 19, 2014.

 

Overview

 

We were formed as a Maryland corporation on January 15, 2008, to invest in a diversified portfolio of real estate investments. We will seek to acquire primarily hotel properties and, to a lesser extent, multifamily, office, retail and industrial properties as well as real estate securities and debt-related investments. We are dependent upon proceeds received from the sale of shares of our common stock in our continuous public offering and any indebtedness that we may incur in order to conduct our proposed real estate investment activities.

 

On April 15, 2009, we commenced our initial public offering of up to $1,000,000,000 in shares of our common stock to the public in our primary offering at $10.00 per share and $100,000,000 in shares of our common stock to our stockholders pursuant to our distribution reinvestment plan at $9.50 per share. On October 12, 2012, we terminated our initial public offering and commenced our follow-on public offering (discussed below). As of the termination of our initial public offering on October 12, 2012, we had accepted subscriptions for, and issued, 1,126,253 shares of our common stock in our initial public offering, including 29,582 shares of our common stock issued pursuant to our distribution reinvestment plan, resulting in aggregate offering proceeds of $10,966,713.

 

On October 12, 2012, we commenced our follow-on offering of up to $1,000,000,000 in shares of our common stock. In our follow-on offering we are offering up to $900,000,000 in shares of our common stock to the public at a price of $10.00 per share, with discounts available for certain purchasers, and up to $100,000,000 in shares of our common stock to our stockholders pursuant to our distribution reinvestment plan at a price of $9.50 per share. Our board of directors may change the price at which we offer shares to the public in our follow-on offering from time to time during the follow-on offering, but not more frequently than quarterly, to reflect changes in our estimated per-share net asset value and other factors our board of directors deems relevant. As of June 30, 2014, we had accepted investors’ subscriptions for, and issued, 4,524,348 shares of our common stock in our follow-on offering, including 97,145 shares of our common stock issued pursuant to our distribution reinvestment plan, resulting in aggregate gross offering proceeds of $44,272,027. As of June 30, 2014, we had accepted investors’ subscriptions for, and issued, 5,650,601 shares of our common stock in our initial public offering and follow-on offerings, including 126,727 shares of common stock pursuant to our distribution reinvestment plan, resulting in aggregate gross offering proceeds of $55,238,740.

 

Our board of directors has elected to extend our follow-on public offering of shares of our common stock, in accordance with the terms established in our prospectus. Our follow-on public offering, which was scheduled to terminate on October 12, 2014, has been extended for up to an additional year. However, we currently expect to terminate our follow-on public offering on January 31, 2015.

 

We intend to use substantially all of the net proceeds from our public offering to invest in a diversified portfolio of real properties, real estate securities and debt-related investments. We anticipate that our portfolio will consist primarily of hotel properties located in the United States and Canada that we own exclusively or in joint ventures or other co-ownership arrangements with other persons. We may also invest in other property types consisting of multifamily, office, retail and industrial assets located in the United States and Canada as well as securities of real estate companies and debt-related investments. We may also make opportunistic investments in properties that may be under-developed or newly constructed and in properties that we believe are undervalued.

 

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As of June 30, 2014, our portfolio consisted of seven investments: (1) the Woodlands hotel, a 91-suite hotel property in The Woodlands, Texas, (2) the Germantown hotel, a 127-guestroom hotel property located in Germantown, Tennessee, (3) the Charleston hotel, a 113-guestroom hotel property located in North Charleston, South Carolina, (4) the Austin hotel, a 123-suite hotel property located in Austin, Texas, (5) the Grapevine hotel, a 133-suite hotel property located in Grapevine, Texas, (6) the Silicon Valley hotel, a 127-suite hotel property located in Newark, California, and (7) a 74.5% joint venture interest in the Hyatt Place note, a mortgage note secured by a hotel property located in Grapevine, Texas commonly known as Hyatt Place hotel.

 

We believe that we have sufficient capital to meet our existing debt service and other operating obligations for the next year and that we have adequate resources to fund our cash needs until we reach sustainable profitable operations. However, our operations are subject to a variety of risks, including, but not limited to, our ability to raise additional funds in our continuous public offering, changes in national economic conditions, the restricted availability of financing, changes in demographic trends and interest rates, declining real estate valuations and downward pressure on room rates for hotels. As a result of these uncertainties, there can be no assurance that we will meet our investment objectives or that the risks described above will not have an adverse effect on our properties or results of operations.

 

We made an election to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, of the Internal Revenue Code, commencing with the taxable year ended December 31, 2011. As a REIT, we generally are not subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year after the taxable year in which we initially elect to be taxed as a REIT, we will be subject to federal income tax on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied. Failing to qualify as a REIT could materially and adversely affect our net income.

 

Market Outlook

 

The recession from 2007 to 2009 in the United States impacted the real estate and credit markets, primarily in the form of escalating default rates on mortgages, declining home values and increasing inventory of properties nationwide. The constraints on available credit resulted in illiquidity and volatility in the markets for corporate bonds, asset-backed securities and commercial real estate bonds and loans. During the downturn, economic conditions negatively impacted the commercial real estate sector, resulting in lower occupancy, lower rental rates and declining values. The economy in the United States is currently improving; however, there is no assurance that economic conditions will continue to improve or will not worsen in the future. We believe that as the economic environment improves, we will have unique investment opportunities, particularly in the hospitality sector. We believe that the hospitality sector has the greatest supply-demand imbalance among all real estate asset classes at this time. As the economy continues to improve, room rates for hotels should increase due to the fact that increased demand for hotel rooms is generally correlated with growth in the U.S. gross domestic product (GDP). Demand growth, combined with the current undersupply of hotel rooms, should result in improved fundamentals in the hospitality space, particularly upward pressure on room rates. The ability of hotels to adjust room rates quickly should allow hotel property owners to take advantage of this anticipated trend.

 

Liquidity and Capital Resources

 

Our principal demand for funds will be for the acquisition of real estate assets, the payment of operating expenses, principal and interest payments on our outstanding indebtedness and the payment of distributions to our stockholders. Over time, we intend to generally fund our cash needs for items other than asset acquisitions from operations. Our cash needs for acquisitions and investments will be funded primarily from the sale of shares of our common stock in our continuous public offering, including those offered for sale through our distribution reinvestment plan, and through the assumption and origination of debt.

 

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There may be a delay between the sale of shares of our common stock and our purchase of assets, which could result in a delay in the benefits to our stockholders, if any, of returns generated from our investment operations. Our advisor, subject to the oversight of our investment committee and board of directors, will evaluate potential acquisitions and will engage in negotiations with sellers and lenders on our behalf. If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures.

 

We may, but are not required to, establish working capital reserves from offering proceeds, out of cash flow generated by our real estate assets or out of proceeds from the sale of our real estate assets. We do not anticipate establishing a general working capital reserve; however, we may establish working capital reserves with respect to particular investments. We also may, but are not required to, establish reserves out of cash flow generated by our real estate assets or out of net sale proceeds in non-liquidating sale transactions. Working capital reserves are typically utilized to fund tenant improvements, leasing commissions and major capital expenditures. Our lenders also may require working capital reserves.

 

To the extent that any working capital reserve we establish is insufficient to satisfy our cash requirements, additional funds may be provided from cash generated from operations or through short-term borrowing. In addition, subject to certain limitations, we may incur indebtedness in connection with the acquisition of any real estate asset, refinance the debt thereon, arrange for the leveraging of any previously unfinanced property or reinvest the proceeds of financing or refinancing in additional properties.

 

Net Cash Provided by Operating Activities

 

As of June 30, 2014, we owned six hotel properties. Net cash provided by operating activities for the six months ended June 30, 2014 and 2013 was $180,156 and $592,218, respectively. The decrease in cash provided by operating activities for the six months ended June 30, 2014 was primarily due to an increase in accounts receivable due to four acquisitions since June 30, 2013, an increase in prepaid expenses, principally insurance premiums, and payments of amounts due to related parties.

 

Net Cash Used In Investing Activities

 

Our cash used in investing activities will vary based on how quickly we raise funds in our ongoing public offering and how quickly we invest those funds towards acquisitions of real estate and real-estate related investments. Net cash used in investing activities for the six months ended June 30, 2014 and 2013 was $29,081,227 and $11,548,292, respectively. The increase in cash used in investing activities for the six months ended June 30, 2014 was due primarily to acquisitions of hotel properties of $26,039,507.

 

Net Cash Provided by Financing Activities

 

Our cash flows from financing activities consist primarily of proceeds from our ongoing public offering and proceeds from newly originated notes payable, net of distributions paid to our stockholders. Net cash provided by financing activities for the six months ended June 30, 2014 and 2013 was $32,125,414 and $13,886,420, respectively. For the six months ended June 30, 2014, the cash provided by financing activities consisted primarily of gross offering proceeds of $23,350,238 and proceeds of a note payable of $13,250,000, which was used to fund acquisitions of hotel properties of $26,039,507, offering costs of $2,342,834 and the payment of dividends of $1,112,477.

 

Cash and Cash Equivalents

 

As of June 30, 2014, we had cash on hand of $8,548,658.

 

Debt

 

We use, and intend to use in the future, secured and unsecured debt as a means of providing additional funds for the acquisition of real property, securities and debt-related investments. By operating on a leveraged basis, we expect that we will have more funds available for investments. This will generally allow us to make more investments than would otherwise be possible, potentially resulting in enhanced investment returns and a more diversified portfolio. However, our use of leverage increases the risk of default on loan payments and the resulting foreclosure on a particular asset. In addition, lenders may have recourse to assets other than those specifically securing the repayment of the indebtedness. When debt financing is unattractive due to high interest rates or other reasons, or when financing is otherwise unavailable on a timely basis, we may purchase certain assets for cash with the intention of obtaining debt financing at a later time.

 

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As of June 30, 2014, our outstanding indebtedness totaled $62,309,220. Our aggregate borrowings are reviewed by our board of directors at least quarterly. Under our charter, we are prohibited from borrowing in excess of 300% of the value of our net assets. “Net assets” for purposes of this calculation is defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts and other non-cash reserves, less total liabilities. The preceding calculation is generally expected to approximate 75% of the aggregate cost of our assets before non-cash reserves and depreciation. However, we may temporarily borrow in excess of these amounts if such excess is approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report, along with an explanation for such excess. As of June 30, 2014 and 2013, our debt levels did not exceed 300% of the value of our assets.

 

Contractual Commitments and Contingencies

 

The following is a summary of our contractual obligations as of June 30, 2014:

 

   Payments Due By Period 
Contractual Obligations  Total   2014   2015-2016   2017-2018   Thereafter 
Long-term debt obligations(1)  $62,309,220   $566,092   $8,776,495   $11,226,747   $41,739,887 
Interest payments on outstanding debt obligations(2)   22,352,034    1,541,309    6,014,263    4,840,103    9,956,359 
Purchase obligations(3)                    
Total  $84,661,254   $2,107,401   $14,790,758   $16,066,850   $51,696,246 

 

(1)Amounts include principal payments only.
(2)Projected interest payments are based on the outstanding principal amounts and weighted-average interest rates at June 30, 2014.
(3)Purchase obligations were excluded from contractual obligations as there were no binding purchase obligations as of June 30, 2014.

 

Organization and Offering Costs

 

Pursuant to our advisory agreement with our advisor, we are obligated to reimburse our advisor and its affiliates, as applicable, for organization and offering costs incurred on our behalf associated with our public offering, but only to the extent that such reimbursements do not exceed actual expenses incurred by our advisor and would not cause sales commissions, the dealer manager fee and other organization and offering costs borne by us in a public offering to exceed 15.0% of gross offering proceeds from the sale of our shares in such public offering as of the date of reimbursement. Our advisor is obligated to reimburse us to the extent organization and offering costs (including sales commissions and dealer manager fees) incurred by us in a public offering exceed 15.0% of the gross offering proceeds from the sale of our shares of common stock in such public offering.

 

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As of June 30, 2014, total offering costs for our follow-on offering were $6,155,405. We directly incurred $4,442,041 of offering costs for our follow-on offering and reimbursed our advisor for $1,829,324 in offering costs for our follow-on offering. We have an $115,960 receivable from our advisor for offering costs related to our follow-on offering, which is recorded as an offset to other amounts owed to our advisor. As of June 30, 2014, offering costs related to our follow-on offering did not exceed 15.0% of the gross offering proceeds from the sale of our shares of common stock in our follow-on offering. We have not reimbursed our advisor any funds for organization costs for our follow-on offering.

 

Operating Expenses

 

Pursuant to our charter, we are required to reimburse our advisor for all operating expenses paid or incurred by our advisor in connection with the services provided to us, provided that we will not reimburse our advisor for any amount by which our operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceeds the greater of: (1) 2% of our average invested assets, or (2) 25% of our net income determined without reduction for any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of our assets for that period, or the “2%/25% limitation.” We may reimburse our advisor for operating expenses in excess of the 2%/25% limitation if a majority of our independent directors determines that such excess expenses are justified based on unusual and non-recurring factors. For the four fiscal quarters ended June 30, 2014, our total operating expenses were $1,359,945, which included $771,035 in operating expenses incurred directly by us and $588,910 incurred by our advisor on our behalf. Of the $1,359,945 in total operating expenses incurred during the four fiscal quarters ended June 30, 2014, $75,038 exceeded the 2%/25% limitation and is not reimbursable to our advisor. We reimbursed our advisor $165,000 in operating expenses for the four fiscal quarters ended June 30, 2014.

 

Our advisor has waived all operating expenses reimbursable to our advisor for each of the 12 prior fiscal quarters ended March 31, 2014, which we refer to as the “waiver period” to the extent such expenses had not been previously reimbursed to our advisor. Our advisor has also acknowledged that all such expenses incurred directly by us during the waiver period will be paid by our advisor on our behalf. Total reimbursable expenses waived or assumed on our behalf by our advisor were $1,967,721 as of June 30, 2014. Additionally, our advisor has incurred $3,622,381 in operating expenses on our behalf prior to the four fiscal quarters ended June 30, 2014. Subject to a future determination by the board of directors, this amount is not reimbursable to our advisor and is not our obligation.

 

Results of Operations

 

As of June 30, 2013, we owned the Woodlands hotel, the Germantown Hotel and the joint venture interest in the Hyatt Place note. As of June 30, 2014, we owned the Woodlands hotel, the Germantown hotel, the Charleston hotel, the Austin hotel, the Grapevine hotel, the Silicon Valley hotel and the joint venture interest in the Hyatt Place note. Because we owned two hotel properties at June 30, 2013 compared to six hotel properties at June 30, 2014, our results of operations for the three and six months ended June 30, 2013 are not directly comparable to those for the three and six months ended June 30, 2014. In general, we expect that our income and expenses related to our investment portfolio will increase in future periods as a result of anticipated future acquisitions of real estate and real estate-related investments.

 

Comparison of the three months ended June 30, 2014 versus the three months ended June 30, 2013

 

Revenue

 

Total revenue increased to $5,696,248 for the three months ended June 30, 2014 from $1,955,416 for the three months ended June 30, 2013. Total hotel revenue increased to $5,537,350 for the three months ended June 30, 2014 from $1,792,378 for the three months ended June 30, 2013. The increase in hotel revenue was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013. Interest income from real estate loan receivable related to the Hyatt Place note decreased to $158,898 for the quarter ended June 30, 2014 from $163,038 for the quarter ended June 30, 2013. We expect that room revenue, other hotel revenue and total revenue will each increase in future periods as a result of anticipated future acquisitions of real estate assets and owning the Silicon Valley hotel for the entire reporting period.

 

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Hotel Operating Expenses

 

Hotel operating expenses increased to $3,337,185 for the three months ended June 30, 2014 from $1,033,914 for the three months ended June 30, 2013. The increase in hotel operating expenses was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013.

 

Property Taxes, Insurance and Other

 

Property taxes, insurance and other increased to $322,679 for the three months ended June 30, 2014 from $114,097 for the three months ended June 30, 2013. This increase was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013.

 

Depreciation and Amortization

 

Depreciation and amortization expense increased to $765,329 for the three months ended June 30, 2014 from $236,612 for the three months ended June 30, 2013. The increase in depreciation and amortization expense was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013.

 

Property Acquisition Expenses

 

Property acquisition expenses decreased to $303,276 for the three months ended June 30, 2014 from $410,520 for the three months ended June 30, 2013. We acquired one property in each of the quarters ended June 30, 2014 and 2013.

 

Corporate General and Administrative Expenses

 

Corporate general and administrative expenses increased to $445,974 for the three months ended June 30, 2014 from $56,827 for the three months ended June 30, 2013. These general and administrative expenses consisted primarily of asset management fees, restricted stock compensation, directors’ fees and professional fees. The increase in general and administrative expense is partially due to the fact that our advisor waived asset management fees for the three months ended June 30, 2013. We expect corporate general and administrative expenses to increase in future periods as a result of anticipated future acquisitions, but to decrease as a percentage of total revenue.

 

Interest Expense and Amortization of Deferred Loan Costs

 

Interest expense and amortization of deferred loan costs increased to $722,659 for the three months ended June 30, 2014 from $272,880 for the three months ended June 30, 2013. This increase in interest expense and amortization of deferred loan costs was due to the fact that we incurred additional indebtedness related to four hotel property acquisitions since June 30, 2013. In future periods our interest expense will vary based on the amount of our borrowings, which will depend on the availability and cost of borrowings, the amount of proceeds we raise in our ongoing public offering and our ability to identify and acquire real estate and real estate-related assets that meet our investment objectives.

 

Income Tax Expense

 

Income tax expense for the three months ended June 30, 2014 was $93,000 compared to $42,100 for the three months ended June 30, 2013.

 

Net Loss

 

We had a net loss of $293,854 for the three months ended June 30, 2014 compared to a net loss of $211,534 for the three months ended June 30, 2013. Excluding income attributable to a noncontrolling interest in a consolidated joint venture of $19,438 and $19,895 for the three months ended June 30, 2014 and 2013, respectively, and income (loss) attributable to a noncontrolling interest in common operating partnership units of $3 and $(13) for the three months ended June 30, 2014 and 2013, respectively, net loss attributable to us was $313,295 and $231,416 for the three months ended June 30, 2014 and 2013, respectively.

 

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Comparison of the six months ended June 30, 2014 versus the six months ended June 30, 2013

 

Revenue

 

Total revenue increased to $9,371,830 for the six months ended June 30, 2014 from $3,024,543 for the six months ended June 30, 2013. Total hotel revenue increased to $9,055,361 for the six months ended June 30, 2014 from $2,701,353 for the six months ended June 30, 2013. The increase in hotel revenue was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013. Interest income from real estate loan receivable related to the Hyatt Place note decreased to $316,469 for the six months ended June 30, 2014 from $323,190 for the six months ended June 30, 2013. We expect that room revenue, other hotel revenue and total revenue will each increase in future periods as a result of anticipated future acquisitions of real estate assets and owning the Grapevine hotel and Silicon Valley hotel for the entire reporting period.

 

Hotel Operating Expenses

 

Hotel operating expenses increased to $5,358,568 for the six months ended June 30, 2014 from $1,534,041 for the six months ended June 30, 2013. The increase in hotel operating expenses was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013.

 

Property Taxes, Insurance and Other

 

Property taxes, insurance and other increased to $585,509 for the six months ended June 30, 2014 from $167,397 for the six months ended June 30, 2013. This increase was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013.

 

Depreciation and Amortization

 

Depreciation and amortization expense increased to $1,363,039 for the six months ended June 30, 2014 from $350,637 for the six months ended June 30, 2013. The increase in depreciation and amortization expense was primarily due to the fact that we owned six hotel properties at June 30, 2014 compared to two hotel properties at June 30, 2013.

 

Property Acquisition Expenses

 

Property acquisition expenses increased to $751,892 for the six months ended June 30, 2014 from $442,054 for the six months ended June 30, 2013. The increase in property acquisition expenses was due to the fact that we acquired two properties during the six months ended June 30, 2014 compared to one property during the six months ended June 30, 2013.

 

Corporate General and Administrative Expenses

 

Corporate general and administrative expenses increased to $644,811 for the six months ended June 30, 2014 from $94,872 for the six months ended June 30, 2013. These general and administrative expenses consisted primarily of asset management fees, restricted stock compensation, directors’ fees and professional fees. The increase in general and administrative expenses is partially due to the fact that our advisor waived asset management fees for the six months ended June 30, 2013. We expect corporate general and administrative expenses to increase in future periods as a result of anticipated future acquisitions, but to decrease as a percentage of total revenue.

 

Interest Expense and Amortization of Deferred Loan Costs

 

Interest expense and amortization of deferred loan costs increased to $1,259,034 for the six months ended June 30, 2014 from $465,669 for the six months ended June 30, 2013. This increase in interest expense and amortization of deferred loan costs was due to the fact that we incurred additional indebtedness related to our four hotel property acquisitions since June 30, 2013. In future periods our interest expense will vary based on the amount of our borrowings, which will depend on the availability and cost of borrowings, the amount of proceeds we raise in our ongoing public offering and our ability to identify and acquire real estate and real estate-related assets that meet our investment objectives.

 

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Income Tax Expense

 

Income tax expense for the six months ended June 30, 2014 was $145,900 compared to $63,100 for the six months ended June 30, 2013.

 

Net Loss

 

We had a net loss of $736,923 for the six months ended June 30, 2014 compared to a net loss of $93,227 for the six months ended June 30, 2013. Excluding income attributable to a noncontrolling interest in a consolidated joint venture of $38,737 and $39,181 for the six months ended June 30, 2014 and 2013, respectively, and loss attributable to a noncontrolling interest in common operating partnership units of $2 and $4 for the six months ended June 30, 2014 and 2013, respectively, net loss attributable to common shareholders was $775,658 and $132,404 for the six months ended June 30, 2014 and 2013, respectively.

 

Critical Accounting Policies

 

Our accounting policies have been established to conform with U.S. generally accepted accounting principles, or GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If management’s judgment or interpretation of the facts and circumstances relating to various transactions is different, it is possible that different accounting policies will be applied or different amounts of assets, liabilities, revenues and expenses will be recorded, resulting in a different presentation of the financial statements or different amounts reported in the financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses. A discussion of the accounting policies that management considers critical in that they involve significant management judgments, assumptions and estimates is included in our Form 10-K for the year ended December 31, 2013, which was filed with the SEC on March 19, 2014. Other than as described immediately below, there have been no significant changes to our accounting policies during 2014.

 

Recent Accounting Pronouncements

 

In April 2014, the FASB issued ASU No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360) - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” ASU 2014-08 changes the threshold for disclosing discontinued operations and the related disclosure requirements. Pursuant to ASU 2014-08, only disposals representing a strategic shift, such as a major line of business, a major geographical area or a major equity investment, should be presented as a discontinued operation. ASU 2014-08 is effective for annual periods beginning on or after December 15, 2014 with early adoption permitted but only for disposals or classifications as held for sale which have not been reported in financial statements previously issued or available for issuance. We implemented the provisions of ASU 2014-08 as of January 1, 2014. The adoption of this guidance did not have a material effect on our condensed consolidated financial statements.

 

Inflation

 

As of June 30, 2014, our investments consisted of our six hotel properties and our 74.5% joint venture interest in the Hyatt Place note. 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. We are currently not experiencing any material impact from inflation.

 

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REIT Compliance

 

To continue to qualify as a REIT for tax purposes, we are required to distribute at least 90% of our REIT taxable income to our stockholders. We must also meet certain asset and income tests, as well as other requirements. We monitor the business and transactions that may potentially impact our REIT status. If we fail to qualify as a REIT in any taxable year following the taxable year in which we initially elect to be taxed as a REIT, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which our REIT qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.

 

Distributions

 

Our board of directors has authorized distributions to our stockholders that (1) accrue daily to our stockholders of record on each day; (2) are payable in cumulative amounts on or before the 15th day of each calendar month; and (3) are calculated at a rate of $0.002192 per share of the our common stock per day, which, if paid each day over a 365-day period, is equivalent to an 8.0% annualized distribution rate based on a purchase price of $10.00 per share of our common stock.

 

The following table summarizes distributions paid in cash and pursuant to our distribution reinvestment plan (DRIP) for the six months ended June 30, 2014 and 2013:

 

Period (1)  Cash Distribution (1)   Distribution Paid Pursuant to DRIP (1)(2)   Total Amount of Distribution (1) 
First Quarter 2013  $200,579   $72,609   $273,188 
Second Quarter 2013   283,395    89,775    373,170 
Total  $483,974   $162,384   $646,358 
                
First Quarter 2014  $482,368   $194,592   $676,960 
Second Quarter 2014   630,109    257,705    887,814 
Total  $1,112,477   $452,297   $1,564,774 

 

(1)Distributions are paid on a monthly basis. Distributions for all record dates of a given month are paid approximately 15 days following the end of such month.
(2)Amount of distributions paid in shares of common stock pursuant to our distribution reinvestment plan.

 

We paid $646,358 in aggregate distributions in the first two quarters of 2013 which was comprised of $483,974 in cash distributions and $162,384 in shares issued pursuant to our distribution reinvestment plan. We paid $1,564,774 in aggregate distributions for the first two quarters of 2014, which was comprised of $1,112,477 in cash distributions and $452,297 in shares issued pursuant to our distribution reinvestment plan. For the six months ended June 30, 2013 and 2014, we had cash provided by operating activities of $592,218 and $180,156, respectively. For the six months ended June 30, 2014, approximately 12% of distributions were paid from cash provided by operating activities and the remaining approximately 88% was paid from offering proceeds.

 

Funds from Operations and Modified Funds from Operations

 

One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. Cash generated from operations is not equivalent to net income as determined under GAAP. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, an industry trade group, or NAREIT, has promulgated a standard known as Funds from Operations, or FFO, which it believes more accurately reflects the operating performance of a REIT. As defined by NAREIT, FFO means net income computed in accordance with GAAP, excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures in which the REIT holds an interest. We have adopted the NAREIT definition for computing FFO because, in our view, FFO is a meaningful supplemental performance measure in conjunction with net income.

 

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Changes in the accounting and reporting rules under GAAP that have been put into effect since the establishment of NAREIT’s definition of FFO have prompted a significant increase in the magnitude of non-cash and non-operating items included in FFO, as defined. As a result, in addition to FFO, we also calculate modified funds from operations, or MFFO, a non-GAAP supplemental financial performance measure that our management uses in evaluating our operating performance. Similar to FFO, MFFO excludes items such as depreciation and amortization. However, MFFO excludes non-cash and non-operating items included in FFO, such as amortization of certain in-place lease intangible assets and liabilities and the amortization of certain tenant incentives. Our calculation of MFFO will exclude these items, as well as the effects of straight-line rent revenue recognition, fair value adjustments to derivative instruments that do not qualify for hedge accounting treatment, non-cash impairment charges and certain other items, when applicable. Our calculation of MFFO will also include, when applicable, items such as master lease rental receipts, which are excluded from net income (loss) and FFO, but which we consider in the evaluation of the operating performance of our real estate investments.

 

We believe that MFFO reflects the overall impact on the performance of our real estate investments of occupancy rates, rental rates, property operating costs and development activities, as well as general and administrative expenses and interest costs, which is not immediately apparent from net income (loss). As such, we believe MFFO, in addition to net income (loss) as defined by GAAP, is a meaningful supplemental performance measure which is used by our management to evaluate our operating performance and determine our operating, financing and dividend policies.

 

Please see the limitations listed below associated with the use of MFFO as compared to net income (loss):

 

Our calculation of MFFO will exclude any gains (losses) related to changes in estimated values of derivative instruments related to any interest rate swaps which we may hold from time to time. Although we would expect to hold these instruments to maturity, if we were to settle these instruments prior to maturity, it would have an impact on our operations. We do not currently hold any such derivate instruments and thus our calculation of MFFO set forth in the table below does not reflect any such exclusion.

 

Our calculation of MFFO will exclude any impairment charges related to long-lived assets that have been written down to current market valuations. Although these losses will be included in the calculation of net income (loss), we will exclude them from MFFO because we believe doing so will more appropriately present the operating performance of our real estate investments on a comparative basis. We have not recognized any such impairment charges and thus our calculation of MFFO set forth in the table below does not reflect any such exclusion.

 

Our calculation of MFFO will exclude organizational and offering expenses and acquisition expenses payable to our advisor. Although these amounts reduce net income, we fund such costs with proceeds from our offering and acquisition-related indebtedness and do not consider these expenses in the evaluation of our operating performance and determining MFFO. Our calculation of MFFO set forth in the table below reflects such exclusions.

 

We believe MFFO is useful to investors in evaluating how our portfolio might perform after our offering and acquisition stage has been completed and, as a result, may provide an indication of the sustainability of our distributions in the future. However, as described in greater detail below, MFFO should not be considered as an alternative to net income (loss) or as an indication of our liquidity. Many of the adjustments to MFFO are similar to adjustments required by SEC rules for the presentation of pro forma business combination disclosures, particularly acquisition expenses, gains or losses recognized in business combinations and other activity not representative of future activities. MFFO is also more comparable in evaluating our performance over time and as compared to other real estate companies, which may not be as involved in acquisition activities or as affected by impairments and other non-operating charges.

 

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MFFO has limitations as a performance measure in an offering such as ours where the price of a share of common stock is a stated value and there is no net asset value determination during the offering stage and for a period thereafter. MFFO is useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete and net asset value is disclosed. MFFO is not a useful measure in evaluating net asset value because impairments are taken into account in determining net asset value but not in determining MFFO. Investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and given the relatively limited term of our operations, it could be difficult to recover any impairment charges.

 

The calculation of FFO and MFFO may vary from entity to entity because capitalization and expense policies tend to vary from entity to entity. Consequently, our presentation of FFO and MFFO may not be comparable to other similarly titled measures presented by other REITs. In addition, FFO and MFFO should not be considered as an alternative to net income (loss) or to cash flows from operating activities and are not intended to be used as a liquidity measure indicative of cash flow available to fund our cash needs. In particular, as we are currently in the acquisition phase of our life cycle, acquisition costs and other adjustments which are increases to MFFO are, and may continue to be, a significant use of cash. MFFO also excludes impairment charges, rental revenue adjustments and unrealized gains and losses related to certain other fair value adjustments. Accordingly, both FFO and MFFO should be reviewed in connection with other GAAP measurements.

 

 The table below summarizes our calculation of FFO and MFFO for the three and six months ended June 30, 2014 and 2013 and a reconciliation of such non-GAAP financial performance measures to our net income (loss).

 

   Three months ended June 30   Six months ended June 30, 
   2014   2013   2014   2013 
Net Loss  $(293,854)  $(211,534)  $(736,923)  $(93,227)
Adjustments:                    
Depreciation of real estate assets and amortization of deferred costs   765,329    236,612    1,363,039    350,637 
Adjustments for noncontrolling interests   (19,438)   (19,895)   (38,737)   (39,181)
Funds from Operations   452,037    5,183    587,379    218,229 
Adjustments:                    
Stock-based compensation   21,130    21,349    42,028    56,031 
Amortization of deferred loan costs   17,711    9,125    31,674    16,409 
Property acquisition expense   303,276    410,520    751,892    442,054 
Adjustments for noncontrolling interests   (685)   (685)   (1,363)   (1,363)
Modified Funds from Operations  $793,469   $445,492   $1,411,610   $731,360 

 

Off-Balance Sheet Arrangements

 

As of June 30, 2014, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Related-Party Transactions and Agreements

 

We have entered into agreements with our advisor and its affiliates whereby we have paid, and will continue to pay, certain fees to, or reimburse certain expenses of, our advisor or its affiliates for acquisition and advisory fees and expenses, financing coordination fees, organization and offering costs, sales commissions, dealer manager fees, asset and property management fees and expenses, leasing fees and reimbursement of certain operating costs. Additionally, we have entered into a joint venture arrangement with affiliates of our advisor in connection with the acquisition of the Hyatt Place note. See Note 7 (Related Party Arrangements) to the consolidated financial statements included in this quarterly report for a discussion of the various related-party transactions, agreements and fees.

 

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Subsequent Events

 

Status of Offering

 

As of August 11, 2014, we had accepted investors’ subscriptions for, and issued 6,372,662 shares of our common stock in our initial public offering and follow-on offering, including 138,230 shares issued pursuant to the DRIP, resulting in aggregate gross offering proceeds to us of $62,344,320.

 

Distributions Declared

 

On June 30, 2014, we declared a distribution in the aggregate amount of $351,117, of which $241,796 was paid in cash on July 15, 2014 and $109,321 was paid pursuant to our distribution reinvestment plan in the form of additional shares of our common stock. On July 31, 2014, we declared a distribution in the aggregate amount of $406,474, which is scheduled to be paid in cash and through our distribution reinvestment plan in the form of additional shares of our common stock on August 15, 2014.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We may be exposed to interest rate changes primarily as a result of long-term debt used to maintain liquidity, fund capital expenditures and expand our real estate investment portfolio and operations. Market fluctuations in real estate financing may affect the availability and cost of funds needed to expand our investment portfolio. In addition, restrictions upon the availability of real estate financing or high interest rates for real estate loans could adversely affect our ability to dispose of real estate in the future. We will seek to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. We may use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets. The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

 

With regard to variable rate financing, our advisor will assess our interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. Our advisor will maintain risk management control systems to monitor interest rate cash flow risk attributable to both our outstanding and forecasted debt obligations as well as our potential offsetting hedge positions. While this hedging strategy will be designed to minimize the impact on our net income and funds from operations from changes in interest rates, the overall returns on your investment may be reduced.

 

As of June 30, 2014, all of our outstanding indebtedness accrued interest at a fixed rate and therefore an increase or decrease in interest rates would have no effect on our interest expense. Interest rate fluctuations will generally not affect our future earnings or cash flows on our fixed rate debt unless such instruments mature or are otherwise terminated. However, interest rate changes will affect the fair value of our fixed rate instruments. As we expect to hold our fixed rate instruments to maturity and the amounts due under such instruments would be limited to the outstanding principal balance and any accrued and unpaid interest, we do not expect that fluctuations in interest rates, and the resulting change in fair value of our fixed rate instruments, would have a significant impact on our operations.

 

The carrying value of our debt approximates fair value as of June 30, 2014, as all of our debt has a fixed interest rate and the rate approximates market interest rates.

 

We are also exposed to interest rate risk and credit risk with respect to our joint venture interest in the Hyatt Place note. The Hyatt Place note bears interest at a fixed rate that resets twice during the term of the note. Interest rate changes may affect the fair value of the Hyatt Place note. As of June 30, 2014, the carrying value of the Hyatt Place note approximated the fair value. Additionally, each reset of the interest rate of the Hyatt Place note may affect our future earnings or cash flow.

 

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We will also be exposed to credit risk with respect to any derivative contracts we enter into. Credit risk is the failure of the counterparty to perform under the terms of a derivative contract. If the fair value of a derivative contract is positive, the counterparty will owe us, which creates credit risk for us. If the fair value of a derivative contract is negative, we will owe the counterparty and, therefore, do not have credit risk. We will seek to minimize the credit risk in derivative instruments by entering into transactions with high-quality counterparties. We did not hold any derivative contracts during the three and six months ended June 30, 2014 and 2013.

  

ITEM 4.  CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this Quarterly Report, management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 13d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act). Based upon, and as of the date of, the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

None.

 

ITEM 1A.  RISK FACTORS.

 

None.

 

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

 

During the six months ended June 30, 2014, we did not repurchase any of our securities.

 

During the six months ended June 30, 2014, we did not sell any equity securities which were not registered under the Securities Act of 1933, as amended.

 

On October 12, 2012, our Registration Statement on Form S-11 (File No. 333-179521) registering our follow-on public offering of up to $1,000,000,000 in shares of our common stock, was declared effective by the SEC and our initial public offering terminated. In our follow-on offering we are offering up to $900,000,000 in shares of our common stock to the public at $10.00 per share and up to $100,000,000 in shares of our common stock to our stockholders pursuant to our distribution reinvestment plan at $9.50 per share.

 

As of June 30, 2014, we had accepted subscriptions for, and issued, 4,524,347 shares of our common stock in our follow-on offering, including 97,145 shares of our common stock pursuant to our distribution reinvestment plan, resulting in gross offering proceeds from our follow-on offering of $44,272,027.

 

As of June 30, 2014, we had incurred selling commissions, dealer manager fees and organization and other offering costs in our follow-on offering in the amounts set forth in the table below. Moody Securities, LLC, our dealer manager, reallowed all of the selling commissions and a portion of the dealer manager fees to participating broker-dealers.

 

Type of Expense  Amount    Estimated/Actual 
Selling commissions and dealer manager fees  $4,268,392   Actual 
Finders’ fees       
Expenses paid to or for underwriters       
Other organization and offering costs   1,819,013   Actual 
Total expenses  $6,087,405     

 

Through June 30, 2014, the net offering proceeds to us from our follow-on offering, after deducting the total expenses incurred as described above, were approximately $38,184,622, excluding $922,877 in offering proceeds from shares of our common stock issued pursuant to our distribution reinvestment plan.

 

As of June 30, 2014, we had used $3,500,000 of the net proceeds from our follow-on offering to acquire the Germantown hotel; $4,000,000 to acquire the Charleston hotel; $3,850,000 to acquire the Austin hotel; $7,250,000 to acquire the Grapevine hotel; and $4,939,507 to acquire the Silicon Valley hotel. For more information regarding how we used our net offering proceeds through June 30, 2014, see our financial statements included in this Quarterly Report.

 

37
 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4. MINE SAFTEY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

None.

 

ITEM 6. EXHIBITS.

 

3.1   Articles of Amendment and Restatement of Moody National REIT I, Inc. (filed as Exhibit 3.1 to Pre-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (No. 333-150612) and incorporated herein by reference)    
     
3.2   Bylaws of Moody National REIT I, Inc. (filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-11 (No. 333-150612) and incorporated herein by reference)    
     
3.3   Amendment No. 1 to Bylaws of Moody National REIT I, Inc. (filed as Exhibit 3.3 to Pre-Effective Amendment No. 4 to the Company’s Registration Statement on Form S-11 (No. 333-150612) and incorporated herein by reference)    
     
4.1   Form of Subscription Agreement (included as Appendix B to prospectus, incorporated by reference to Exhibit 4.1 to Pre-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (No. 333-150612))
     
4.2   Moody National REIT I, Inc. Distribution Reinvestment Plan (included as Appendix C to prospectus, incorporated by reference to Exhibit 4.2 to Pre-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (No. 333-150612))
     
10.1   Loan Agreement, dated June 15, 2012, by and between MN Newark, LLC and Ladder Capital Financing, LLC (incorporated by reference to Exhibit 10.90 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.2   Promissory Note, dated June 15, 2012, by MN Newark, LLC in favor of Ladder Capital Financing, LLC (incorporated by reference to Exhibit 10.91 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.3   Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filings, dated June 15, 2012, by MN Newark, LLC in favor of Ladder Capital Financing, LLC (incorporated by reference to Exhibit 10.92 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)
     
10.4   Relicensing Franchise Agreement, dated January 29, 2014, by and between MIF L.L.C. and Moody National TPS Newark MT, LLC (incorporated by reference to Exhibit 10.93 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)
     
10.5   Amendment to Relicensing Franchise Agreement, dated June 24, 2014, by and between MIF L.L.C. and Moody National TPS Newark MT, LLC (incorporated by reference to Exhibit 10.94 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)
     
10.6   Guaranty, dated January 29, 2014, by Brett C. Moody in favor of MIF L.L.C. (incorporated by reference to Exhibit 10.95 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)

 

38
 

 

10.7   Hotel Management Agreement, dated January 29, 2014, by and between Moody National TPS Newark MT, LLC and Moody National Hospitality Management, LLC (incorporated by reference to Exhibit 10.96 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.8   Amended and Restated Master Lease Agreement, effective June 24, 2014, by and between Moody National Cedar-Newark Holding, LLC and Moody National TPS Newark MT, LLC (incorporated by reference to Exhibit 10.97 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)
     
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002    
     
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002    
     
32.1   Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    
     
32.2   Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema Document
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

  

39
 

 

SIGNATURES

 

Pursuant to the requirements 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.

 

  MOODY NATIONAL REIT I, INC.
     
Date: August 14, 2014 By: /s/ Brett C. Moody
     Brett C. Moody
    Chairman of the Board, Chief Executive Officer and President
    (Principal Executive Officer)

 

Date: August 14, 2014 By: /s/ Robert W. Engel
    Robert W. Engel
    Chief Financial Officer and Treasurer
    (Principal Financial and Accounting Officer)

 

 
 

  

EXHIBIT INDEX

 

3.1   Articles of Amendment and Restatement of Moody National REIT I, Inc. (filed as Exhibit 3.1 to Pre-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (No. 333-150612) and incorporated herein by reference)    
     
3.2   Bylaws of Moody National REIT I, Inc. (filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-11 (No. 333-150612) and incorporated herein by reference)    
     
3.3   Amendment No. 1 to Bylaws of Moody National REIT I, Inc. (filed as Exhibit 3.3 to Pre-Effective Amendment No. 4 to the Company’s Registration Statement on Form S-11 (No. 333-150612) and incorporated herein by reference)    
     
4.1   Form of Subscription Agreement (included as Appendix B to prospectus, incorporated by reference to Exhibit 4.1 to Pre-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (No. 333-150612))    
     
4.2   Moody National REIT I, Inc. Distribution Reinvestment Plan (included as Appendix C to prospectus, incorporated by reference to Exhibit 4.2 to Pre-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (No. 333-150612))    
     
10.1   Loan Agreement, dated June 15, 2012, by and between MN Newark, LLC and Ladder Capital Financing, LLC (incorporated by reference to Exhibit 10.90 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.2   Promissory Note, dated June 15, 2012, by MN Newark, LLC in favor of Ladder Capital Financing, LLC (incorporated by reference to Exhibit 10.91 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.3   Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filings, dated June 15, 2012, by MN Newark, LLC in favor of Ladder Capital Financing, LLC (incorporated by reference to Exhibit 10.92 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.4   Relicensing Franchise Agreement, dated January 29, 2014, by and between MIF L.L.C. and Moody National TPS Newark MT, LLC (incorporated by reference to Exhibit 10.93 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.5   Amendment to Relicensing Franchise Agreement, dated June 24, 2014, by and between MIF L.L.C. and Moody National TPS Newark MT, LLC (incorporated by reference to Exhibit 10.94 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.6   Guaranty, dated January 29, 2014, by Brett C. Moody in favor of MIF L.L.C. (incorporated by reference to Exhibit 10.95 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)
     
10.7   Hotel Management Agreement, dated January 29, 2014, by and between Moody National TPS Newark MT, LLC and Moody National Hospitality Management, LLC (incorporated by reference to Exhibit 10.96 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)    
     
10.8   Amended and Restated Master Lease Agreement, effective June 24, 2014, by and between Moody National Cedar-Newark Holding, LLC and Moody National TPS Newark MT, LLC (incorporated by reference to Exhibit 10.97 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11, filed on July 29, 2014)  
     
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   
     
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002    
     
32.1   Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    

 

 
 

 

32.2   Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema Document
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document