Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                TO

 

Commission File Number 000-53603

 

Apple REIT Nine, Inc.

 (Exact name of registrant as specified in its charter)

 

 

(804) 344-8121

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x   No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

 

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

 

 

Table of Contents

 

APPLE REIT NINE, INC.

FORM 10-Q

INDEX

 

		Page Number
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets – September 30, 2009 and December 31, 2008	3
	Consolidated Statements of Operations - Three and nine months ended September 30, 2009 and 2008	4
	Consolidated Statements of Cash Flows – Nine months ended September 30, 2009 and 2008	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings (not applicable)
Item 1A.	Risk Factors (not applicable)
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
Item 3.	Defaults Upon Senior Securities (not applicable)
Item 4.	Submission of Matters to a Vote of Security Holders (not applicable)
Item 5.	Other Information (not applicable)
Item 6.	Exhibits	33
Signatures		34

 

This Form 10-Q includes references to certain trademarks or service marks.  The Hampton Inn®, Hampton Inn and Suites®, Homewood Suites® by Hilton, Embassy Suites Hotels® and Hilton Garden Inn® trademarks are the property of Hilton Worldwide or one or more of its affiliates.  The Courtyard® by Marriott, Fairfield Inn® by Marriott, Fairfield Inn and Suites® by Marriott, TownePlace Suites® by Marriott, SpringHill Suites® by Marriott, Residence Inn® by Marriott and Marriott® trademarks are the property of Marriott International, Inc. or one of its affiliates.  For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.

 

2

Table of Contents

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

Apple REIT Nine, Inc.

Consolidated Balance Sheets

(in thousands, except share data)

 

		September 30,			December 31,
		2009			2008
		(unaudited)
Assets
Investment in real estate, net of accumulated depreciation of $12,055 and $2,277, respectively		$	686,620		$	346,423
Cash and cash equivalents		114,934			75,193
Due from third party managers, net		3,203			1,775
Other assets, net		17,557			8,228
Total Assets		$	822,314		$	431,619
Liabilities
Notes payable		$	58,998		$	38,647
Accounts payable and accrued expenses		6,414			3,232
Total Liabilities		65,412			41,879
Shareholders’ Equity
Preferred stock, authorized 30,000,000 shares; none issued and outstanding		—			—
Series A preferred stock, no par value, authorized 400,000,000 shares; issued and outstanding 80,754,695 and 41,013,517 shares, respectively		—			—
Series B convertible preferred stock, no par value, authorized 480,000 shares; issued and outstanding 480,000 shares, respectively		48			48
Common stock, no par value, authorized 400,000,000 shares; issued and outstanding 80,754,695 and 41,013,517 shares, respectively		793,395			400,569
Distributions greater than net income		(36,541		)	(10,877		)
Total Shareholders’ Equity		756,902			389,740
Total Liabilities and Shareholders’ Equity		$	822,314		$	431,619

 

See accompanying notes to consolidated financial statements.

 

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

 

3

Table of Contents

 

Apple REIT Nine, Inc.

Consolidated Statements of Operations

(Unaudited)

(in thousands, except per share data)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2009			2008			2009			2008
Revenues:
Room revenue		$	20,420		$	609		$	56,252		$	609
Other revenue		2,242			110			6,601			110
Total hotel revenue		22,662			719			62,853			719
Rental revenue		5,439			—			10,515			—
Total revenue		28,101			719			73,368			719
Expenses:
Operating expense		6,385			250			16,751			250
Hotel administrative expense		1,920			68			4,947			68
Sales and marketing		2,063			80			5,611			80
Utilities		1,283			47			3,096			47
Repair and maintenance		1,043			39			2,837			39
Franchise fees		894			30			2,586			30
Management fees		668			16			2,004			16
Taxes, insurance and other		1,498			20			4,529			20
General and administrative		937			394			2,835			505
Acquisition related costs		2,405			—			4,868			—
Depreciation expense		4,004			267			9,778			267
Total expenses		23,100			1,211			59,842			1,322
Operating income (loss)		5,001			(492		)	13,526			(603		)
Interest income (expense), net		(302		)	1,480			(930		)	1,865
Net income		$	4,699		$	988		$	12,596		$	1,262
Basic and diluted net income per common share		$	0.06		$	0.04		$	0.21		$	0.13
Weighted average common shares outstanding - basic and diluted		72,310			22,580			58,826			9,705
Distributions declared and paid per common share		$	0.22		$	0.22		$	0.66		$	0.29

 

See accompanying notes to consolidated financial statements.

 

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

 

4

Table of Contents

 

Apple REIT Nine, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

		Nine Months Ended
		September 30,
		2009			2008
Cash flows from operating activities:
Net income		$	12,596		$	1,262
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation		9,778			267
Amortization of deferred financing costs, fair value adjustments and other non-cash expenses, net		179			26
Straight-line rental income		(3,043		)	—
Changes in operating assets and liabilities:
Increase in funds due from third party managers, net		(1,186		)	(263		)
Increase in other assets, net		(1,602		)	(57		)
Increase in accounts payable and accrued expenses		3,278			35
Net cash provided by operating activities		20,000			1,270
Cash flows used in investing activities:
Cash paid for acquisitions		(325,393		)	(60,819		)
Deposits and other disbursements for potential acquisitions, net		232			(3,287		)
Capital improvements		(4,951		)	—
Increase in capital improvement reserves		(539		)	—
Investment in other assets		(3,240		)	—
Net cash used in investing activities		(333,891		)	(64,106		)
Cash flows from financing activities:
Net proceeds related to issuance of common shares		393,972			264,678
Redeemptions of common stock		(1,254		)	—
Distributions paid to common shareholders		(38,260		)	(5,681		)
Payments of notes payable		(526		)	—
Deferred financing costs		(300		)	—
Payoff of the line of credit, net of borrowings		—			(151		)
Net cash provided by financing activities		353,632			258,846
Increase in cash and cash equivalents		39,741			196,010
Cash and cash equivalents, beginning of period		75,193			20
Cash and cash equivalents, end of period		$	114,934		$	196,030
Non-cash transactions:
Notes payable assumed in acquisitions		$	19,284		$	—

 

See accompanying notes to consolidated financial statements.

 

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

 

5

Table of Contents

 

Apple REIT Nine, Inc.

Notes to Consolidated Financial Statements

 

1. Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q.  Accordingly, they do not include all of the information required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  These unaudited financials should be read in conjunction with the Company’s audited consolidated financial statements included in its 2008 Annual Report on Form 10-K.  Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2009.

 

2.  General Information and Summary of Significant Accounting Policies

 

Organization

 

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

 

Significant Accounting Policies

 

Use of Estimates

 

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

 

Offering Costs

 

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

 

6

Table of Contents

 

Rental Income

 

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

 

Earnings Per Common Share

 

Basic earnings per common share is computed as net income divided by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period. There were no shares with a dilutive effect for the three and nine months ended September 30, 2009 or 2008.  As a result, basic and dilutive outstanding shares were the same.  Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are converted to common shares.

 

Recent Accounting Pronouncements

 

Accounting Standards Codification

 

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

 

Noncontrolling Interests

 

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

 

7

Table of Contents

 

Subsequent Events

 

In May 2009, the FASB issued a pronouncement which sets forth general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued.  Although there is new terminology, this pronouncement is based on the same principles as those that currently exist in the auditing standards.  This pronouncement, which includes a required disclosure of the date through which an entity has evaluated subsequent events, was effective for the Company beginning June 30, 2009.  The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

Assets Acquired or Liabilities Assumed in a Business Combination

 

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

 

Interim Disclosures about Fair Value of Financial Instruments

 

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

 

Business Combinations

 

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

 

8

Table of Contents

 

3.  Real Estate Investments

 

Hotel Acquisitions

 

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

 

Location

Brand

Manager

Gross Purchase Price

Rooms

Date of Purchase

Round Rock, TX

Hampton Inn

Vista

$

11,500

93

3/6/2009

Panama City, FL

Hampton Inn & Suites

LBA

11,600

95

3/12/2009

Alexandria, VA

SpringHill Suites

Marriott

5,100

—

3/31/2009

(a)

Austin, TX

Homewood Suites

Vista

17,700

97

4/14/2009

Austin, TX

Hampton Inn

Vista

18,000

124

4/14/2009

Dothan, AL

Hilton Garden Inn

LBA

11,601

104

6/1/2009

Troy, AL

Courtyard

LBA

8,696

90

6/18/2009

(b)

Orlando, FL

Fairfield Inn & Suites

Marriott

25,800

200

7/1/2009

Orlando, FL

SpringHill Suites

Marriott

29,000

200

7/1/2009

Clovis, CA

Hampton Inn & Suites

Dimension

11,150

86

7/31/2009

Rochester, MN

Hampton Inn & Suites

White

14,136

124

8/3/2009

Johnson City, TN

Courtyard

LBA

9,880

90

9/25/2009

Baton Rouge, LA

SpringHill Suites

Dimension

15,100

119

9/25/2009

Total

$

189,263

1,422

 

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

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

 

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

 

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

 

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

 

9

Table of Contents

 

Land Acquisition

 

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

 

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

 

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

 

Total Real Estate Investments

 

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

 

Land		$	214,126
Building and Improvements		448,039
Furniture, Fixtures and Equipment		36,510
		698,675
Less Accumulated Depreciation		(12,055		)
Investment in real estate, net		$	686,620

 

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

 

10

Table of Contents

 

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

 

Location		Brand		Rooms		Deposits Paid			Gross Purchase Price
Hillsboro, OR		Embassy Suites		165		$	100		$	32,500	(a)
Hillsboro, OR		Hampton Inn & Suites		106		100			14,500		(a)
Clovis, CA		Homewood Suites		83		55			12,435		(a)
Albany, GA		Fairfield Inn & Suites		87		5			7,920		(a)/(b)
Panama City, FL		TownePlace Suites		103		5			10,640		(a)/(b)
Houston, TX		Marriott		206		200			51,000		(a)/(b)
Holly Springs, NC		Hampton Inn		124		100			14,880		(a)
Ft. Worth, TX		TownePlace Suites		140		100			18,460		(a)/(b)
				1,014		$	665		$	162,335

 

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

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

 

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

 

4.  Notes Payable

 

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

 

11

Table of Contents

 

Location		Brand		Interest Rate (1)		Maturity Date		Principal Assumed			Outstanding balance as of September 30, 2009
Lewisville, TX		Hilton Garden Inn		0.00	%	12/31/2016		$	3,750		$	3,750
Duncanville, TX		Hilton Garden Inn		5.88	%	5/11/2017		13,966			13,801
Allen, TX		Hilton Garden Inn		5.37	%	10/11/2015		10,787			10,630
Bristol, VA		Courtyard		6.59	%	8/1/2016		9,767			9,670
Round Rock, TX		Hampton Inn		5.95	%	5/1/2016		4,175			4,132
Austin, TX		Homewood Suites		5.99	%	3/1/2016		7,556			7,490
Austin, TX		Hampton Inn		5.95	%	3/1/2016		7,553			7,487
								$	57,554		$	56,960

 

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

 

The Company estimates the fair value of its fixed rate debt and the credit spreads over variable market rates on its variable rate debt by discounting the future cash flows of each instrument at estimated market rates or credit spreads consistent with the maturity of the debt obligation with similar credit policies.  Credit spreads take into consideration general market conditions and maturity.  As of September 30, 2009, the carrying value and estimated fair value of the Company’s debt was $59.0 million and $58.2 million.  As of December 31, 2008, the carrying value and estimated fair value of the Company’s debt was $38.6 million and $40.4 million.  The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.

 

5.  Related Parties

 

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

 

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

 

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

 

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

 

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

 

12

Table of Contents

 

6.  Shareholder’s Equity

 

The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year.  Shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any given year will be three percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program.  During the nine months ended September 30, 2009, the Company redeemed approximately 120,000 Units in the amount of $1.3 million under the program.

 

7.  Series B Convertible Preferred Stock

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

13

Table of Contents

 

 

Gross Proceeds Raised from Sales of Units through Date of Conversion		Number of Common Shares through Conversion of One Series B Convertible Preferred Share
$800 million		9.70287
$900 million		10.90855
$    1  billion		12.11423
$ 1.1  billion		13.31991
$ 1.2  billion		14.52559
$ 1.3  billion		15.73128
$ 1.4  billion		16.93696
$ 1.5  billion		18.14264
$ 1.6  billion		19.34832
$ 1.7  billion		20.55400
$ 1.8  billion		21.75968
$ 1.9  billion		22.96537
$    2  billion		24.17104

 

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

 

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

 

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

 

8.  Other Assets

 

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

 

9.  Segment Reporting

 

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

 

14

Table of Contents

 

 

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

 

		For the three months ended September 30, 2009
		Hotels			Ground Lease			Corporate			Consolidated
Total revenue		$	22,662		$	5,439		$	—		$	28,101
Operating expenses		15,728			26			—			15,754
Acquisition related costs		2,405			—			—			2,405
Depreciation expense		4,004			—			—			4,004
General and administrative		—			—			937			937
Operating income		525			5,413			(937		)	5,001
Interest income		—			—			248			248
Interest expense		(550		)	—			—			(550		)
Net income/(loss)		$	(25	)	$	5,413		$	(689	)	$	4,699

 

		For the nine months ended September 30, 2009
		Hotels			Ground Lease			Corporate			Consolidated
Total revenue		$	62,853		$	10,515		$	—		$	73,368
Operating expenses		42,308			53			—			42,361
Acquisition related costs		4,868			—			—			4,868
Depreciation expense		9,778			—			—			9,778
General and administrative		—			—			2,835			2,835
Operating income		5,899			10,462			(2,835		)	13,526
Interest income		—			—			836			836
Interest expense		(1,766		)	—			—			(1,766		)
Net income/(loss)		$	4,133		$	10,462		$	(1,999	)	$	12,596
Total assets as of September 30, 2009		$	548,524		$	154,309		$	119,481		$	822,314

 

10.  Significant Tenant

 

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

 

15

Table of Contents

 

Chesapeake Energy Corporation

Selected Financial Data

(In millions)

 

Consolidated Balance Sheet Data:

 

		September 30, 2009			December 31, 2008
Current assets		$	2,508		$	4,292
Noncurrent assets		27,211			34,301
Current liabilities		2,514			3,621
Noncurrent liabilities		14,376			17,955
Total equity		12,829			17,017

 

Consolidated Statements of Income Data:

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2009			2008			2009			2008
Total revenues		$	1,811		$	7,491		$	5,480		$	8,648
Total operating costs		1,414			2,013			13,712			5,806
Operating income (loss)		397			5,478			(8,232		)	2,842
Net income (loss)		192			3,322			(5,306		)	1,600

 

Consolidated Statements of Cash Flows Data:

 

		Nine Months Ended
		September 30,
		2009			2008
Cash provided by operating activities		$	3,131		$	4,387
Cash used in investing activities		(3,654		)	(8,283		)
Cash (used in) provided by financing activities		(706		)	5,859
Net increase (decrease) in cash and cash equivalents		(1,229		)	1,963
Cash and cash equivalents, beginning of period		1,749			1
Cash and cash equivalents, end of period		520			1,964

 

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

 

11.  Pro Forma Information (unaudited)

 

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

 

16

Table of Contents

 

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2009			2008			2009			2008
Total revenues		$	28,101		$	20,832		$	76,177		$	61,028
Net income		4,699			3,339			14,554			9,564
Net income per share - basic and diluted		$	0.06		$	0.10		$	0.25		$	0.31

 

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

 

12.  Subsequent Events

 

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

 

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

 

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

 

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

 

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

 

17

Table of Contents

 

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

 

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.  Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles, including the current economic recession throughout the United States; and competition within the real estate industry.  Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in the quarterly report will prove to be accurate.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved.  In addition, the Company’s qualification as a real estate investment trust involves the application of highly technical and complex provisions of the Internal Revenue Code.  Readers should carefully review the Company’s financial statements and the notes thereto, as well as the risk factors described in the Company’s filings with the Securities and Exchange Commission.

 

General

 

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

 

Hotel Operations

 

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

 

Hotels Owned

 

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

 

18

Table of Contents

 

Location

Brand

Manager

Gross Purchase Price

Rooms

Date of Purchase

Tucson, AZ

Hilton Garden Inn

Western

$

18,375

125

7/31/2008

Santa Clarita, CA

Courtyard

Dimension

22,700

140

9/24/2008

Charlotte, NC

Homewood Suites

McKibbon

5,750

112

9/24/2008

Allen, TX

Hampton Inn & Suites

Gateway

12,500

103

9/26/2008

Twinsburg, OH

Hilton Garden Inn

Gateway

17,792

142

10/7/2008

Lewisville, TX

Hilton Garden Inn

Gateway

28,000

165

10/16/2008

Duncanville, TX

Hilton Garden Inn

Gateway

19,500

142

10/21/2008

Santa Clarita, CA

Hampton Inn

Dimension

17,129

128

10/29/2008

Santa Clarita, CA

Residence Inn

Dimension

16,600

90

10/29/2008

Santa Clarita, CA

Fairfield Inn

Dimension

9,337

66

10/29/2008

Beaumont, TX

Residence Inn

Western

16,900

133

10/29/2008

Pueblo, CO

Hampton Inn & Suites

Dimension

8,025

81

10/31/2008

Allen, TX

Hilton Garden Inn

Gateway

18,500

150

10/31/2008

Bristol, VA

Courtyard

LBA

18,650

175

11/7/2008

Durham, NC

Homewood Suites

McKibbon

19,050

122

12/4/2008

Hattiesburg, MS

Residence Inn

LBA

9,793

84

12/11/2008

Jackson, TN

Courtyard

Vista

15,200

94

12/16/2008

Jackson, TN

Hampton Inn & Suites

Vista

12,600

83

12/30/2008

Pittsburgh, PA

Hampton Inn

Vista

20,458

132

12/31/2008

Fort Lauderdale, FL

Hampton Inn

Vista

19,290

109

12/31/2008

Frisco, TX

Hilton Garden Inn

Western

15,050

102

12/31/2008

Round Rock, TX

Hampton Inn

Vista

11,500

93

3/6/2009

Panama City, FL

Hampton Inn & Suites

LBA

11,600

95

3/12/2009

Austin, TX

Homewood Suites

Vista

17,700

97

4/14/2009

Austin, TX

Hampton Inn

Vista

18,000

124

4/14/2009

Dothan, AL

Hilton Garden Inn

LBA

11,601

104

6/1/2009

Troy, AL

Courtyard

LBA

8,696

90

6/18/2009

Orlando, FL

Fairfield Inn & Suites

Marriott

25,800

200

7/1/2009

Orlando, FL

SpringHill Suites

Marriott

29,000

200

7/1/2009

Clovis, CA

Hampton Inn & Suites

Dimension

11,150

86

7/31/2009

Rochester, MN

Hampton Inn & Suites

White

14,136

124

8/3/2009

Johnson City, TN

Courtyard

LBA

9,880

90

9/25/2009

Baton Rouge, LA

SpringHill Suites

Dimension

15,100

119

9/25/2009

Total

$

525,362

3,900

 

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

 

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

 

19