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 JUNE 30, 2008 |
| ¨ | 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 333-147414
Apple REIT Nine, Inc.
(Exact name of registrant as specified in its charter)
| Virginia | 26-1379210 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
814 East Main Street Richmond, Virginia | 23219 | |
| (Address of principal executive offices) | (Zip Code) |
(804) 344-8121
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company x | |||
| (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of registrant’s common shares outstanding as of August 1, 2008: 21,163,838
FORM 10-Q
INDEX
| Page Number | ||||||
PART I. FINANCIAL INFORMATION | ||||||
| Item 1. | Financial Statements (Unaudited) | |||||
| Consolidated Balance Sheets - June 30, 2008 and December 31, 2007 | 3 | |||||
| Consolidated Statements of Operations - Three months and six months ended June 30, 2008 | 4 | |||||
| Consolidated Statement of Cash Flows - Six months ended June 30, 2008 | 5 | |||||
| Notes to Consolidated Financial Statements | 6 | |||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 12 | ||||
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 17 | ||||
| Item 4. | Controls and Procedures | 17 | ||||
| Item 1. | Legal Proceedings (not applicable) | |||||
| Item 1A. | Risk Factors (not applicable) | |||||
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 18 | ||||
| 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 | 19 | ||||
| 20 | ||||||
This Form 10-Q includes references to certain trademarks or service marks. The Hilton Garden Inn®, Homewood Suites® and Hampton Inn and Suites® trademarks are the property of Hilton Hotels Corporation or one or more of its affiliates. The Courtyard® by Marriott trademark is the property of Marriott International, Inc. or one of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.
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CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| June 30, 2008 | December 31, 2007 | |||||||
| (unaudited) | ||||||||
ASSETS | ||||||||
Cash | $ | 162,579 | $ | 20 | ||||
Other assets | 242 | 317 | ||||||
Total Assets | $ | 162,821 | $ | 337 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Liabilities | ||||||||
Note payable | $ | — | $ | 151 | ||||
Accounts payable and accrued expenses | 51 | 155 | ||||||
Total Liabilities | 51 | 306 | ||||||
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 17,004,557 and 10 shares | — | — | ||||||
Series B convertible preferred stock, no par value, authorized 480,000 shares; issued and outstanding 480,000 shares | 48 | 48 | ||||||
Common stock, no par value, authorized 400,000,000 shares; issued and outstanding 17,004,557 and 10 shares | 163,359 | — | ||||||
Distributions greater than net income | (637 | ) | (17 | ) | ||||
Total Shareholders’ Equity | 162,770 | 31 | ||||||
Total Liabilities and Shareholders’ Equity | $ | 162,821 | $ | 337 | ||||
See accompanying notes to consolidated financial statements.
The Company was initially capitalized on November 9, 2007.
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CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
| Three Months Ended June 30, 2008 | Six Months Ended June 30, 2008 | |||||||
Revenue | $ | — | $ | — | ||||
Expenses: | ||||||||
General and administrative | 94 | 111 | ||||||
Interest income, net | (388 | ) | (385 | ) | ||||
Net income | $ | 294 | $ | 274 | ||||
Basic and diluted earnings per common share | $ | 0.05 | $ | 0.09 | ||||
Weighted average common shares outstanding—basic and diluted | 6,392 | 3,196 | ||||||
Distributions declared and paid per common share | $ | 0.07 | $ | 0.07 | ||||
See accompanying notes to consolidated financial statements.
The Company was initially capitalized on November 9, 2007.
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CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(in thousands)
| Six Months Ended June 30, 2008 | ||||
Cash flows from operating activities: | ||||
Net income | $ | 274 | ||
Adjustments to reconcile net income to cash provided by operating activities: | ||||
Stock option expense | 26 | |||
Changes in operating assets and liabilities: | ||||
Accounts payable and accrued expenses | 4 | |||
Net cash provided by operating activities: | 304 | |||
Cash flows used in investing activities: | ||||
Deposits and other disbursements for potential acquisitions | (210 | ) | ||
Net cash used in investing activities | (210 | ) | ||
Cash flows from financing activities: | ||||
Net proceeds from issuance of common shares | 163,509 | |||
Distributions paid to common shareholders | (893 | ) | ||
Payoff of the line of credit, net of borrowings | (151 | ) | ||
Net cash provided by financing activities | 162,465 | |||
Increase in cash and cash equivalents | 162,559 | |||
Cash and cash equivalents, beginning of period | 20 | |||
Cash and cash equivalents, end of period | $ | 162,579 | ||
See accompanying notes to consolidated financial statements.
The Company was initially capitalized on November 9, 2007.
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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 registration statement filed on Form S-11 with the Securities and Exchange Commission (File No. 333-147414). Operating results for the three months and six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2008.
2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Apple REIT Nine, Inc. together with its wholly owned subsidiaries (the “Company”) is a Virginia corporation that intends to qualify as a real estate investment trust (“REIT”) for federal income tax purposes. The Company, which owns no properties and has no 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. 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, Chief Executive Officer and President (see Note 4 and 6). The Company’s fiscal year end is December 31. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated.
Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less. The fair market value of cash and cash equivalents approximates their carrying value. All cash and cash equivalents are currently held at two institutions, Wachovia Bank, N.A. and BB&T Corporation and the balances may at times exceed federal depository insurance limits.
Income Taxes
The Company intends to make an election to be treated, and expects to qualify, as a REIT under the Internal Revenue Code of 1986, as amended. As a REIT, the Company will be allowed a deduction for the amount of dividends paid to its shareholders, thereby subjecting the distributed net income of the Company to taxation only at the shareholder level. The Company’s continued qualification as a REIT will depend on its compliance with numerous requirements, including requirements as to the nature of its income and distribution of dividends.
The Company has established Apple Nine Hospitality Management, Inc. as a 100% owned taxable REIT subsidiary (“TRS”). The TRS will lease all hotels from the Company and be subject to income tax at regular corporate rates on any income that it would earn.
Start Up Costs
Start up costs are expensed as incurred.
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Use of Estimates
The preparation of the financial statements in conformity with United States 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 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 June 30, 2008, the Company had sold 17.0 million Units for gross proceeds of $182.3 million and proceeds net of offering costs of $163.3 million.
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 year. Diluted earnings per share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the year. There were no shares with a dilutive effect for the three months and six months ended June 30, 2008. 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 (see Note 6).
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157,Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Statement applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, this Statement does not require any new fair value measurements. In February 2008, the FASB released FASB Staff Position (FSP) FAS 157-2 – Effective Date of FASB Statement No. 157, which defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and liabilities, except those items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The effective date of the statement related to those items not covered by the deferral (all financial assets and liabilities or nonfinancial assets and liabilities recorded at fair value on a recurring basis) is for fiscal years beginning after November 15, 2007. The adoption of this statement did not have and is not anticipated to have a material impact on the Company’s results of operations and financial position.
In February 2007, FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities(“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. SFAS 159 is effective for the Company beginning January 1, 2008. The Company has elected not to use the fair value measurement provisions of SFAS 159 and therefore, adoption of this standard did not have an impact on the financial statements.
In March 2008, FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 is intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity’s derivative instruments
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and hedging activities and their effects on the entity’s financial position, financial performance, and cash flows. SFAS 161 applies to all derivative instruments within the scope of SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”). It also applies to non-derivative hedging instruments and all hedged items designated and qualifying as hedges under SFAS 133. SFAS 161 is effective prospectively for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company does not currently have any instruments that qualify within the scope of SFAS 133, and therefore the adoption of this statement is not anticipated to have a material impact on the Company’s financial statements.
In May 2008, the FASB issued SFAS No. 162,The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 is effective 60 days following the Securities and Exchange Commission’s (“SEC”) approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 162 on its financial statements.
3. SUMMARY OF POTENTIAL ACQUISITIONS
On June 5, 2008, the Company entered into a purchase contract for the potential acquisition of a Hilton Garden Inn hotel located in Tucson, Arizona. The purchase price for the 125 guest room hotel is $18.4 million, and a refundable deposit of $150,000 was paid by the Company in connection with the contract and is included in other assets in the Company’s consolidated balance sheet as of June 30, 2008 and in deposits and other disbursements for potential acquisitions in the consolidated statement of cash flows. It is expected that the purchase price will be funded from the Company’s cash on hand. While the purchase of the hotel by the Company is expected to occur during 2008, there can be no assurance that all the conditions to closing will be satisfied.
4. RELATED PARTIES
The Company has significant transactions with related parties. These transactions cannot be construed to be at arms length and the results of the Company’s operations may be different than if conducted with non-related parties.
The Company has entered into a Property Acquisition and Disposition Agreement with Apple Suites Realty Group, Inc. (“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 will be payable for these services. There have been no amounts incurred by the Company under this agreement as of June 30, 2008.
The Company has entered into an advisory agreement with A9A to provide management of 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 will be 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. Total advisory fees and reimbursable expenses incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $49,000 for the six months ended June 30, 2008.
ASRG and A9A are 100% owned by Glade M. Knight, Chairman, Chief Executive Officer and President of the Company. ASRG and A9A may purchase in the “best efforts” offering up to 2.5% of the total number of shares sold in the offering.
Mr. Knight is also Chairman and Chief Executive Officer of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc., other REITS. Members of the Company’s Board of Directors are also on the Board of Directors of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Eight, Inc.
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5. STOCK INCENTIVE PLAN
During April 2008, the Company adopted a non-employee directors’ stock incentive plan (the “Directors’ Plan”) to provide incentives to attract and retain directors. The Directors’ Plan provides for the grant of options to purchase a specified number of shares of common stock (“Options”) to directors of the Company. A Compensation Committee (“Committee”) was established to administer the plan. The Committee is responsible for granting Options and for establishing the exercise price of Options. During the second quarter of 2008, the Company issued approximately 32,000 options under the Directors’ Plan and recorded approximately $26,000 in compensation expense.
6. SHAREHOLDERS’ EQUITY
Best-efforts Offering
The Company is currently conducting an on-going best-efforts offering. The Company registered its Units on Registration Statement Form S-11 (File No. 333-147414) filed on April 23, 2008 and was declared effective by the SEC on April 25, 2008. The Company began its best-efforts offering of Units the same day the registration statement was declared effective. The Offering is continuing as of the date of these financial statements. The managing underwriter is David Lerner Associates, Inc. and all of the Units are being sold for the Company’s account.
Each Unit consists of one common share and one Series A preferred share. The Series A preferred shares will have no voting rights, no conversion rights and no distribution rights. The only right associated with the Series A preferred shares will be a priority distribution upon the sale of the Company’s assets. The priority will be equal to $11.00 per Series A preferred share, and no more, before any distributions are made to the holders of any other shares. In the event the Company pays special dividends, the amount of the $11.00 priority will be reduced by the amount of any special dividends approved by the board. The Series A preferred shares will not be separately tradable from the common shares to which they relate.
Series B Convertible Preferred Stock
The Company has authorized 480,000 shares of Series B convertible preferred stock. The Company has issued 480,000 Series B convertible preferred shares to Glade M. Knight, Chairman, Chief Executive Officer and President 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;
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(2) the termination or expiration without renewal of the advisory agreement, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or
(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into a number of common shares based upon the gross proceeds raised through the date of conversion in the Company’s $2 billion offering according to the following table:
Gross Proceeds Raised from Sales of Units through Date of Conversion | Number of Common Shares through Conversion of One Series B Convertible Preferred Share | |
| $100 million | 0.92321 | |
| $200 million | 1.83239 | |
| $300 million | 3.19885 | |
| $400 million | 4.83721 | |
| $500 million | 6.11068 | |
| $600 million | 7.29150 | |
| $700 million | 8.49719 | |
| $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).
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7. LINE OF CREDIT
Prior to the commencement of the Company’s “best-efforts” offering, the Company obtained an unsecured line of credit in a principal amount of $400,000 to fund certain start-up costs and offering expenses. The lender was Wachovia Bank, N.A. The line of credit bore interest at a variable rate based on the London Interbank Borrowing Rate (LIBOR). The line of credit was fully paid during May 2008 with net proceeds from the Company’s “best-efforts” offering.
8. SUBSEQUENT EVENTS
In July 2008, the Company declared and paid approximately $1.2 million in dividend distributions to its common shareholders, or $0.073334 per outstanding common share.
During July 2008, the Company closed on the issuance of 4.2 million Units through its ongoing “best-efforts” offering, representing gross proceeds to the Company of $45.8 million and proceeds net of selling and marketing costs of $41.2 million.
On July 24, 2008, the Company entered into a purchase contract for the potential acquisition of a Courtyard hotel in Santa Clarita, California. The gross purchase price for the 140 room hotel is $22.7 million, and a refundable deposit of $200,000 was paid by the Company in connection with the contract.
On July 31, 2008, the Company closed on the purchase of a Hilton Garden Inn located in Tucson, Arizona. The gross purchase price for this hotel, which contains a total of 125 guest rooms, was $18.4 million.
On August 1, 2008, the Company entered into a purchase contract for the potential acquisition of a Homewood Suites hotel in Charlotte, North Carolina. The gross purchase price for the 112 room hotel is $5.8 million, and a refundable deposit of $200,000 was paid by the Company in connection with the contract.
On August 1, 2008, the Company entered into five separate purchase contracts with a group of related sellers for the potential acquisition of five hotels. The purchase contracts are for a 142 room Hilton Garden Inn in Twinsburg, Ohio with a purchase price of $16.5 million, a 165 room Hilton Garden Inn in Lewisville, Texas with a purchase price of $28.0 million, a 142 room Hilton Garden Inn in Duncanville, Texas with a purchase price of $19.5 million, a 103 room Hampton Inn and Suites in Allen, Texas with a purchase price of $12.5 million and a 150 room Hilton Garden Inn in Allen, Texas with a purchase price of $18.5 million. The initial refundable deposit under each separate contract was $200,000.
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| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in economic cycles 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.
Overview
The Company is a Virginia corporation that intends to qualify as a REIT for federal income tax purposes. The Company, which owns no properties and has no 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. 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, Chief Executive Officer and President. The Company’s fiscal year end is December 31.
Related Party Transactions
The Company has significant transactions with related parties. These transactions cannot be construed to be at arms length and the results of the Company’s operations may be different than if conducted with non-related parties.
The Company has entered into a Property Acquisition and Disposition Agreement with Apple Suites Realty Group, Inc. (“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 will be payable for these services. There have been no amounts incurred by the Company under this agreement as of June 30, 2008.
The Company has entered into an advisory agreement with A9A to provide management of 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 will be 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. Total advisory fees and reimbursable expenses incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $49,000 for the six months ended June 30, 2008.
ASRG and A9A are 100% owned by Glade M. Knight, Chairman, Chief Executive Officer and President of the Company. ASRG and A9A may purchase in the “best efforts” offering up to 2.5% of the total number of shares sold in the offering.
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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.
Results of Operations
During the period from the Company’s initial formation on November 9, 2007 through June 30, 2008, the Company owned no properties, had no revenue, exclusive of interest income and was primarily engaged in capital formation activities.
Liquidity and Capital Resources
The Company’s principal source of liquidity will be the proceeds of the “best-efforts” offering and the cash flow generated from properties the Company will acquire and any short term investments. In addition, the Company may borrow funds, subject to the approval of the Company’s board of directors.
The Company is raising capital through a “best-efforts” offering of shares by David Lerner Associates, Inc., the managing dealer, which receives selling commissions and a marketing expense allowance based on proceeds of the shares sold. The minimum offering of 9,523,810 Units at $10.50 per Unit was sold as of May 14, 2008, with proceeds net of commissions and marketing expenses totaling $90 million. Subsequent to the minimum offering and through June 30, 2008, an additional 7.5 million Units, at $11 per Unit, were sold, with the Company receiving proceeds, net of commissions, marketing expenses and other offering costs of approximately $73.3 million. The Company is continuing its offering at $11.00 per Unit.
Each Unit consists of one common share and one Series A preferred share. The Series A preferred shares will have no voting rights, no conversion rights and no distribution rights. The only right associated with the Series A preferred shares will be a priority distribution upon the sale of the Company’s assets. The priority will be equal to $11.00 per Series A preferred share, and no more, before any distributions are made to the holders of any other shares. In the event the Company pays special dividends, the amount of the $11.00 priority will be reduced by the amount of any special dividends approved by the board. The Series A preferred shares will not be separately tradable from the common shares to which they relate.
Prior to the commencement of the Company’s “best-efforts” offering, the Company obtained an unsecured line of credit in a principal amount of $400,000 to fund certain start-up costs and offering expenses. The line of credit was fully paid during May 2008 with net proceeds from the Company’s “best-efforts” offering.
As of June 30, 2008, the Company had cash and cash equivalents totaling $162.6 million, primarily resulting from the sale of Units through that date. The Company intends to use funds generated from its “best-efforts” offering to invest in hotels, residential apartment communities and other income-producing real estate. As of June 30, 2008 the Company had entered into a purchase contract for the potential acquisition of a Hilton Garden Inn hotel located in Tucson, Arizona. The purchase price for the 125 guest room hotel is $18.4 million, and a refundable deposit of $150,000 was paid by the Company in connection with the contract. It is expected that the purchase price will be funded from the Company’s cash on hand. While the purchase of the hotel by the Company is expected to occur during 2008, there can be no assurance that all the conditions to closing will be satisfied.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Although the Company owns no real estate, distributions since the initial capitalization through June 30, 2008 totaled approximately $893,000 and were paid at a monthly rate of $0.073334 per common share beginning in June 2008. For the same period the Company’s cash generated from operations was approximately $304,000. Due to the inherent delay between raising capital and investing that same capital
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in income producing real estate, the Company has had significant amounts of cash earning interest at short term money market rates. As a result, the difference between distributions paid and cash generated from operations has been funded from proceeds from the offering of Units, and this portion of distributions is expected to be treated as a return of capital for federal income tax purposes. The Company intends to continue paying dividends on a monthly basis, at an annualized dividend rate of $0.88 per common share. Since a portion of distributions has to date been funded with proceeds from the offering of Units, the Company’s ability to maintain its current intended rate of distribution will be based on its ability to fully invest its offering proceeds and thereby increase its cash generated from operations. Since there can be no assurance of the Company’s ability to acquire properties that provide income at this level, there can be no assurance as to the classification or duration of distributions at the current rate. Proceeds of the offering which are distributed are not available for investment in properties.
Series B Convertible Preferred Stock
The Company has authorized 480,000 shares of Series B convertible preferred stock. The Company has issued 480,000 Series B convertible preferred shares to Glade M. Knight, chairman, chief executive officer and president 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, 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.
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Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into a number of common shares based upon the gross proceeds raised through the date of conversion in the Company’s $2 billion offering according to the following table:
Gross Proceeds Raised from Sales of Units through Date of Conversion | Number of Common Shares through Conversion of One Series B Convertible Preferred Share | |
| $100 million | 0.92321 | |
| $200 million | 1.83239 | |
| $300 million | 3.19885 | |
| $400 million | 4.83721 | |
| $500 million | 6.11068 | |
| $600 million | 7.29150 | |
| $700 million | 8.49719 | |
| $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).
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157,Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Statement applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, this Statement does not require any new fair value measurements. In February 2008, the FASB released FASB Staff Position (FSP) FAS 157-2 – Effective Date of FASB Statement No. 157, which defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and liabilities, except those items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The effective date of the statement related to those items not covered by the deferral (all financial assets and liabilities or nonfinancial assets and liabilities recorded at fair value on a recurring basis) is for fiscal years beginning after November 15, 2007. The adoption of this statement did not have and is not anticipated to have a material impact on the Company’s results of operations and financial position.
In February 2007, FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities(“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by
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measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. SFAS 159 is effective for the Company beginning January 1, 2008. The Company has elected not to use the fair value measurement provisions of SFAS 159 and therefore, adoption of this standard did not have an impact on the financial statements.
In March 2008, FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 is intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity’s derivative instruments and hedging activities and their effects on the entity’s financial position, financial performance, and cash flows. SFAS 161 applies to all derivative instruments within the scope of SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”). It also applies to non-derivative hedging instruments and all hedged items designated and qualifying as hedges under SFAS 133. SFAS 161 is effective prospectively for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company does not currently have any instruments that qualify within the scope of SFAS 133, and therefore the adoption of this statement is not anticipated to have a material impact on the Company’s financial statements.
In May 2008, the FASB issued SFAS No. 162,The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 is effective 60 days following the Securities and Exchange Commission’s (“SEC”) approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 162 on its financial statements.
Subsequent Events
In July 2008, the Company declared and paid approximately $1.2 million in dividend distributions to its common shareholders, or $0.073334 per outstanding common share.
During July 2008, the Company closed on the issuance of 4.2 million Units through its ongoing “best-efforts” offering, representing gross proceeds to the Company of $45.8 million and proceeds net of selling and marketing costs of $41.2 million.
On July 24, 2008, the Company entered into a purchase contract for the potential acquisition of a Courtyard hotel in Santa Clarita, California. The gross purchase price for the 140 room hotel is $22.7 million, and a refundable deposit of $200,000 was paid by the Company in connection with the contract.
On July 31, 2008, the Company closed on the purchase of a Hilton Garden Inn located in Tucson, Arizona. The gross purchase price for this hotel, which contains a total of 125 guest rooms, was $18.4 million.
On August 1, 2008, the Company entered into a purchase contract for the potential acquisition of a Homewood Suites hotel in Charlotte, North Carolina. The gross purchase price for the 112 room hotel is $5.8 million, and a refundable deposit of $200,000 was paid by the Company in connection with the contract.
On August 1, 2008, the Company entered into five separate purchase contracts with a group of related sellers for the potential acquisition of five hotels. The purchase contracts are for a 142 room Hilton Garden Inn in Twinsburg, Ohio with a purchase price of $16.5 million, a 165 room Hilton Garden Inn in Lewisville, Texas with a purchase price of $28.0 million, a 142 room Hilton Garden Inn in Duncanville, Texas with a purchase price of $19.5 million, a 103 room Hampton Inn and Suites in Allen, Texas with a purchase price of $12.5 million and a 150 room Hilton Garden Inn in Allen, Texas with a purchase price of $18.5 million. The initial refundable deposit under each separate contract was $200,000.
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| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of June 30, 2008, the Company’s financial instruments were not exposed to significant market risk due to interest rate risk, foreign currency exchange risk, commodity price risk or equity price risk. The Company will be exposed to changes in short term money market rates as it invests its cash. Based on the Company’s cash invested at June 30, 2008, of $162.6 million, every 100 basis points change in interest rates will impact the Company’s annual net income by $1.6 million, all other factors remaining the same.
| Item 4. | Controls and Procedures |
Senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective and that there have been no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Since that evaluation process was completed, there have been no significant changes in internal controls or in other factors that could significantly affect these controls.
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| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
The following tables set forth information concerning the “best-efforts” offering and the use of proceeds from the offering as of June 30, 2008. All amounts in thousands, except per Unit data:
Units Registered: | |||||||
| 9,524 | Units $10.50 per Unit | $ | 100,000 | ||||
| 172,727 | Units $11 per Unit | 1,900,000 | |||||
Totals: | 182,251 | Units | $ | 2,000,000 | |||
Units Sold: | |||||||
| 9,524 | Units $10.50 per Unit | $ | 100,000 | ||||
| 7,481 | Units $11 per Unit | 82,288 | |||||
Totals: | 17,005 | Units | 182,288 | ||||
Expenses of Issuance and Distribution of Units | |||||||
1. Underwriting discounts and commission | 18,229 | ||||||
2. Expenses of underwriters | — | ||||||
3. Direct or indirect payments to directors or officers of the Company or their associates, to ten percent shareholders, or to affiliates of the Company | — | ||||||
4. Fees and expenses of third parties | 727 | ||||||
Total Expenses of Issuance and Distribution of Common Shares | 18,956 | ||||||
Net Proceeds to the Company | $ | 163,332 | |||||
1. Deposits and other costs associated with potential real estate acquisitions | $ | 210 | |||||
2. Repayment of other indebtedness, including interest expense paid | 154 | ||||||
3. Investment and working capital | 162,919 | ||||||
4. Fees to the following (all affiliates of officers of the Company): | |||||||
a. Apple Nine Advisors, Inc. | 49 | ||||||
b. Apple Suites Realty Group, Inc. | — | ||||||
5. Fees and expenses of third parties | — | ||||||
6. Other | — | ||||||
Total of Application of Net Proceeds to the Company | $ | 163,332 | |||||
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| ITEM 6. | EXHIBITS |
Exhibit | Description of Documents | |
| 1.1 | Agency Agreement between the Registrant and David Lerner Associates, Inc. with form of selected Dealer Agreement attached as Exhibit A thereto. (Incorporated by reference to Exhibit 1.1 to amendment no. 4 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed April 23, 2008 and effective April 25, 2008) | |
| 1.2 | Escrow Agreement. (Incorporated by reference to Exhibit 1.2 to amendment no. 4 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed April 23, 2008 and effective April 25, 2008) | |
| 3.1 | Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008) | |
| 3.2 | Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed November 15, 2007 and effective April 25, 2008) | |
| 10.1 | Advisory Agreement between the Registrant and Apple Nine Advisors, Inc. (Incorporated by reference to Exhibit 10.1 to amendment no. 4 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed April 23, 2008 and effective April 25, 2008) | |
| 10.2 | Property Acquisition/Disposition Agreement between the Registrant and Apple Suites Realty Group, Inc. (Incorporated by reference to Exhibit 10.2 to amendment no. 4 to the registrant’s registration statement on Form S-11 (SEC File No. 333-147414) filed April 23, 2008 and effective April 25, 2008) | |
| 10.4 | Apple REIT Nine, Inc. 2008 Non-Employee Directors Stock Option Plan. (Incorporated by reference to Exhibit 10.4 to registrant’s quarterly report on Form 10-Q (SEC File No. 333-147414) filed May 8, 2008) | |
| 10.5 | Purchase contract dated June 5, 2008 between Valencia Tucson, L.L.C. and Apple Nine Hospitality Ownership, Inc.(FILED HEREWITH) | |
| 31.1 | Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(FILED HEREWITH) | |
| 31.2 | Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(FILED HEREWITH) | |
| 32.1 | Certification of the registrant’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(FILED HEREWITH) | |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Apple REIT Nine, INC. | ||||||
| By: | /s/ GLADE M. KNIGHT | Date: August 4, 2008 | ||||
| Glade M. Knight, | ||||||
Chairman of the Board, Chief Executive Officer, and President (Principal Executive Officer) | ||||||
| By: | /s/ BRYAN PEERY | Date: August 4, 2008 | ||||
| Bryan Peery, | ||||||
Chief Financial Officer (Principal Financial and Principal Accounting Officer) | ||||||
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