Filed Pursuant to Rule 424(B)(3)
File No. 333-84098
SUPPLEMENT NO. 3 DATED NOVEMBER 13, 2002
TO PROSPECTUS DATED MAY 22, 2002
APPLE HOSPITALITY TWO, INC.
The following information supplements the prospectus of Apple Hospitality Two,
Inc. dated May 22, 2002 and is part of the prospectus. This Supplement should be
read in conjunction with Supplement No. 2, which supersedes and replaces
Supplement No. 1. Prospective investors should carefully review the prospectus,
Supplement No. 2 and this Supplement No. 3.
TABLE OF CONTENTS FOR SUPPLEMENT NO. 3
Additional Risk Factor ............................................................ S - 2
Status of the Offering ............................................................ S - 2
Recent Developments ............................................................... S - 2
Merger with Apple Suites, Inc. and Related Matters ................................ S - 2
Valuation Analyses of Hospitality Units undertaken in Connection with the Merger .. S - 5
Summary of Material Contracts ..................................................... S - 6
Description of Hospitality Capital Stock .......................................... S - 17
New REIT by Mr. Knight ............................................................ S - 23
Hospitality's Properties .......................................................... S - 24
Selected Financial Data ........................................................... S - 27
Experts ........................................................................... S - 29
Index to Financial Statements ..................................................... F - 1
The prospectus, and each supplement, contains forward-looking statements within
the meaning of the federal securities laws, and such statements are intended to
be covered by the safe harbors created by those laws. These forward-looking
statements may involve plans and objectives for future operations, including
future growth and availability of funds. These forward-looking statements are
based on current expectations, which are subject to numerous risks and
uncertainties. Assumptions relating to these statements involve judgments with
respect to, among other things, the continuation of Hospitality's offering of
units, future economic, competitive and market conditions and future business
decisions, together with local, national and international events (including,
without limitation, acts of terrorism or war, and their direct and indirect
effects on travel and the economy). All of these matters are difficult or
impossible to predict accurately and many of them are beyond our control.
Although Hospitality believes the assumptions relating to the forward-looking
statements, and the statements themselves, are reasonable, any of the
assumptions could be inaccurate and, therefore, there can be no assurance that
these forward-looking statements will prove to be accurate. In light of the
significant uncertainties inherent in these forward-looking statements, the
inclusion of this information should not be regarded as a representation by
Hospitality or any other person that its objectives and plans, which Hospitality
considers to be reasonable, will be achieved.
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ADDITIONAL RISK FACTOR
The Value of Hospitality Units May Be Less Than $10.00 Per Unit.
In connection with the proposed merger transaction between Hospitality and Apple
Suites, Inc., the boards of directors of each company retained separate
financial advisors to render an opinion as to the fairness, from a financial
point of view, of the proposed transaction. As part of the preparation of these
fairness opinions, the financial advisors to each company's board of directors
calculated valuation ranges for Hospitality units indicating that the value of
the Hospitality units may be less than $10.00 per unit. See "Valuation of
Hospitality Units in Connection with the Merger" on page S-5. These valuation
analyses were based on information as of a specific date, were prepared in
connection with analyzing the fairness, from a financial point of view, of a
proposed merger transaction, were not intended to indicate the price at which
Hospitality units might trade either before or after the proposed merger in any
public or private transaction and do not purport to be appraisals. These
valuation analyses also did not take into account the effect, if any, of the
proposed merger and related transactions on the per unit valuation of
Hospitality units.
STATUS OF THE OFFERING
Hospitality is continuing its offering of units, consisting of one common share
and one Series A preferred share, in accordance with the prospectus dated May
22, 2002. From that date through October 21, 2002, Hospitality has closed on the
following sales of units:
Proceeds Net of Selling
Price Per Number of Gross Commissions and Marketing
Unit Units Sold Proceeds Expense Allowance
---- ---------- -------- -----------------
$10.00 29,320,298 $291,624,036 $262,461,633
RECENT DEVELOPMENTS
For the quarter ended September 30, 2002, Hospitality's funds from operation
(FFO) were approximately $7.1 million, or $0.28 per share. During the quarter,
Hospitality's portfolio attained an average daily rate (ADR) of $97, an average
occupancy of 82%, and revenue per available room (RevPAR) of $79. On October 22,
2002, Hospitality paid a quarterly dividend of $0.25 per Hospitality common
share.
MERGER WITH APPLE SUITES, INC. AND RELATED MATTERS
On October 23, 2002, the boards of directors of Hospitality and Suites approved
a merger transaction in which Suites will become a subsidiary of Hospitality. On
October 24, 2002, an agreement and plan of merger was signed by Hospitality,
Hospitality Acquisition Company and Suites.
In the merger, holders of Suites common shares will receive either
. a Hospitality unit, consisting of one Hospitality common share and
one Hospitality Series A preferred share, for each Suites common
share, or
. if elected by a Suites common shareholder, $10.00 in cash per Suites
common share subject to a $25 million limit on the cash to be paid
in the merger.
If more Suites common shareholders elect to receive cash than the maximum amount
of cash available for payment, each Suites common shareholder who elects to
receive cash will receive a combination of cash and Hospitality units for that
shareholders common shares, based on a pro rata distribution of the cash
available for payment in the merger. For purposes of this distribution,
fractional Suites common shares will be rounded to the nearest whole share.
Hospitality, at its sole discretion, prior to the effective time of the merger,
may determine to
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increase the maximum amount of cash consideration to be paid in the merger to an
amount not to exceed $30 million.
As a result of the merger, the 240,000 outstanding Suites Class B convertible
shares will be convertible into 480,000 Suites common shares. Pursuant to the
merger, the Suites Class B convertible shares will be converted into the right
to receive 480,000 Hospitality units, or one Hospitality unit for each Suites
common share, the same exchange ratio applicable to all other Suites common
shareholders.
The merger is expected to be treated as a tax free reorganization for federal
income tax purposes, except for cash, if any, received by Suites shareholders.
Holders of Hospitality units will continue to own their existing Hospitality
units after the merger.
In connection with the merger, Hospitality will pay an extraordinary dividend to
Hospitality common shareholders. The extraordinary dividend will consist of an
aggregate payment of $15 million, which will be divided equally among the
outstanding Hospitality common shares (approximately $0.49 per share), and is
contingent on the merger becoming effective. The record date for the
extraordinary dividend will be the record date of the Hospitality shareholders
meeting to approve the merger or another date that the Hospitality board of
directors declares, as long as the record date is prior to the effectiveness of
the merger. The payment date for the extraordinary dividend will be after the
effective date of the merger.
In connection with the merger, the boards of directors of Hospitality and Suites
have determined that the companies will become self-advised, contingent upon the
merger occurring. Consequently, the advisory agreements Hospitality and Suites
have with Apple Suites Advisors, Inc. will be terminated concurrently with the
merger and thereafter no further advisory fees will be due under that agreement.
In addition, the property acquisition/distribution agreements that Hospitality
and Suites have with Apple Suites Realty, Inc. will also be terminated.
As a result of the termination of these agreements, the 240,000 Hospitality
Series B convertible preferred shares held by Glade M. Knight and two business
associates would become convertible into 1,272,000 Hospitality units. Mr. Knight
and the other holders of Hospitality Series B convertible preferred shares are
expected to exchange their Hospitality Series B convertible preferred shares for
1,272,000 newly created Hospitality Series C convertible preferred shares. These
new Hospitality Series C convertible preferred shares will have a liquidation
preference comparable to the Hospitality Series B convertible preferred shares.
Consequently, holders of Hospitality units will be entitled to receive $10.00
per share in cash on liquidation, before any payments will be made to Mr. Knight
or the other holders of the Hospitality Series C convertible preferred shares
for their Hospitality Series C convertible preferred shares. Each of the
Hospitality Series C convertible preferred shares will be convertible into one
Hospitality unit upon either of the following triggering events:
. Hospitality transfers substantially all of its assets, stock or
business as a going concern, whether through exchange, merger,
consolidation, lease, share exchange or otherwise, other than a sale
of assets in liquidation, dissolution or a winding up of
Hospitality's business.
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. Hospitality lists the Hospitality units on a securities exchange or
quotation system or in any established market.
The Hospitality Series C convertible preferred shares will also have the same
voting rights and rights to receive dividend distributions as if they had
already been converted to Hospitality units.
To implement the termination of the advisory agreement for Hospitality,
Hospitality and Mr. Knight, the sole shareholder of Apple Suites Advisors, have
reached an agreement in principle to acquire all of Mr. Knight's stock in Apple
Suites Advisors instead of paying a $6.48 million termination fee due Apple
Suites Advisors under the advisory agreement. In this acquisition, Mr. Knight
would receive a cash payment of $2 million and a non-interest-bearing promissory
note due in four years after the effective date of the merger, in a principal
amount of $4.48 million. This acquisition is subject to the execution of
definitive documentation and is conditioned upon the effectiveness of the
merger.
The merger is subject to a number of conditions, including the approval of:
.. the holders of at least a majority of Hospitality common shares present and
voting at the Hospitality meeting called to consider the merger, excluding
Hospitality common shares owned by or voted under the control of a
Hospitality or Suites director;
.. the holders of a majority of the outstanding Suites common shares; and
.. the holders of a majority of outstanding Suites common shares present and
voting at the Suites meeting called to consider the merger, excluding Suites
common shares owned by or voted under the control of a Hospitality or Suites
director.
The merger is expected to close shortly after the special meetings of
shareholders for both companies, if the companies obtain the requisite
shareholder approvals.
Suites is an externally advised real estate investment trust owning upper-end
extended-stay hotels in select metropolitan areas throughout the United States.
As of October 23, 2002, Suites owned 17 extended-stay hotels, comprising 1,922
suites as part of the Homewood Suites(R) by Hilton(R) franchise.
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If the merger is completed, Hospitality will own, directly and indirectly, a
total of 65 hotels, which contain 7,689 suites. The following map shows the
states where the hotels will be located if the merger is completed:
[MAP]
VALUATION ANALYSES OF HOSPITALITY UNITS UNDERTAKEN IN
CONNECTION WITH THE MERGER
In connection with the merger, the boards of directors of both Hospitality and
Suites established special committees to evaluate a proposed business
combination of Hospitality and Suites. Each of the special committees engaged a
financial advisor to render an opinion as to the fairness, from a financial
point of view, of the proposed merger. As part of the preparation of these
fairness opinions, the financial advisors to each company's board of directors
calculated valuation ranges for Hospitality units based upon various valuation
methodologies. These fairness opinions, and the respective valuation analyses
supporting the fairness opinions, were prepared for the use and benefit of the
special committees of the boards of directors of Hospitality and Suites, as the
case may be, in connection with their consideration of the proposed merger and
not for any other purpose.
The valuation analyses of these financial advisors indicated a range of per unit
values of Hospitality units, with the high end of the range of values slightly
above the $10.00 per unit offer price in this offering and the low end of the
range of values significantly lower than $10.00 per unit offer price in this
offering. The valuation analyses of the financial advisor for the Hospitality
special committee assumed completion of Hospitality's current $100 million
equity offering. These valuation analyses did not take into account the effect,
if any, of the proposed merger and related transactions on the per unit
valuation of Hospitality units.
These valuation analyses were necessarily based upon market, economic and other
conditions as they existed and could be evaluated on, and on the information
made available to Hospitality's and Suites' respective financial advisors as of
the date of their respective fairness opinions. The preparation of a fairness
opinion is a complex analytical process involving various determinations as to
the most appropriate and relevant methods of financial analysis and the
application of those methods to the particular circumstances. Accordingly, the
companies' financial advisors did not place any specific reliance or weight on
any individual valuation analysis, but instead concluded that their respective
analyses, taken as a whole, supported their respective determinations as to the
fairness, from a financial point of view, of the proposed merger. The ranges of
valuations resulting from any particular valuation analysis are not necessarily
indicative of actual values or future results, which may be significantly more
or less favorable than those suggested by these valuation analyses. In addition,
analyses relating to the value of businesses or securities do not necessarily
purport to be appraisals or to reflect the prices at which businesses or
securities actually may be sold.
S-5
SUMMARY OF MATERIAL CONTRACTS
Agreement and Plan of Merger
The merger agreement provides for the merger of Suites with and into Hospitality
Acquisition Company, a subsidiary of Hospitality. At the effective time of the
merger, the separate corporate existence of Suites will cease to exist and
Hospitality Acquisition Company will be the surviving corporation and will
change its name to Apple Suites, Inc.
The merger agreement provides that Suites shareholders will receive stock
consideration or cash consideration as described below.
Outstanding Suites Common Shares. In the merger, each Suites common share,
issued and outstanding immediately prior to the effective time of the merger,
will be converted into the right to either:
. one Hospitality unit, consisting of one Hospitality common share and
one Hospitality Series A preferred share; or
. if the holder of the Suites common share elects, $10.00 in cash per
share subject to a $25 million limit on the cash to be paid in the
merger.
If more Suites common shareholders elect to receive cash than the maximum amount
of cash available for payment, each Suites common shareholder who elects to
receives cash will receive a combination of cash and Hospitality units for such
shareholders common shares, based on a pro rata distribution of the cash
available for payment in the merger. For purposes of this distribution,
fractional Suites common shares will be rounded to the nearest whole share.
Hospitality, at its sole discretion, prior to the effective time of the merger,
may determine to increase the maximum amount of cash consideration to be paid in
the merger to an amount not to exceed $30 million.
Outstanding Suites Class B Convertible Shares. As a result of the merger, the
240,000 outstanding Suites Class B convertible shares will be convertible into
480,000 Suites common shares. Pursuant to the merger, the Suites Class B
convertible shares will be converted into the right to receive 480,000
Hospitality units, or one Hospitality unit for each Suites common share, the
same exchange ratio applicable to all other Suites common shareholders.
Rights of Holders of Suites Shares; Suites Stock Transfers After the Merger. At
the effective time of the merger, the rights of holders of Suites common shares
and Suites Class B convertible shares as shareholders of Suites will cease,
except for the right to receive:
.. any dividend or other distribution with respect to Suites common shares with
a record date occurring prior to or at the effective time of the merger; and
.. the applicable consideration in the merger.
S-6
Extraordinary Dividend on Hospitality Common Shares
The merger agreement provides that Hospitality will pay an extraordinary
dividend to Hospitality common shareholders. The extraordinary dividend will
consist of an aggregate payment of $15 million, which will be divided equally
among the outstanding Hospitality common shares (approximately $0.49 per share),
and is contingent on the merger becoming effective. The merger agreement
provides that the record date for the extraordinary dividend will be the record
date of the Hospitality shareholders meeting to approve the merger or another
date that the Hospitality board of directors declares, as long as the record
date is prior to the effectiveness of the merger. The merger agreement provides
that the payment date for the extraordinary dividend will be after the effective
date of the merger.
Representations And Warranties
The merger agreement contains reciprocal representations and warranties, subject
to identified exceptions, made by Hospitality and Suites relating to, among
other things:
. due organization, corporate power and good standing;
. subsidiaries;
. capital structure;
. corporate authority to enter into the merger agreement;
. required consents and non-contravention of certain organizational
documents, agreements or governmental orders;
. reports and other documents filed with the SEC, the accuracy of the
information contained in such documents and undisclosed liabilities;
. absence of certain material changes and events;
. litigation;
. employee benefit plans and ERISA compliance;
. tax matters;
. loans or payments to insiders;
. brokers;
. compliance with laws;
. defaults under contracts and debt instruments;
. environmental matters;
. real property;
. books and records;
. the vote required to approve the merger;
S-7
. labor matters; and
. the opinion of their financial advisors.
In addition to these representations and warranties, the merger agreement
contains representations and warranties specific to Suites regarding information
for inclusion within the registration statement to be filed relating to approval
of the merger and the offering of the Hospitality units to be issued in the
merger.
Certain Covenants
The merger agreement contains various covenants and agreements that govern
Suites' and Hospitality's actions prior to the effective time of the merger,
except as expressly contemplated by the merger agreement, including the
following:
Conduct of Business. Suites and Hospitality have each agreed to conduct their
respective businesses in the ordinary and usual course and to use reasonable
efforts to preserve intact their business organizations and assets, and to
maintain their respective status as a REIT within the meaning of the Internal
Revenue Code. Suites and Hospitality further agreed to restrict:
.. the declaration of dividends or other distributions, except for payment of
regular quarterly dividends not in excess of $.25 per common share for
Hospitality and $.201 per common share for Suites, with customary record and
payment dates;
.. stock splits and other reclassifications of their capital stock;
.. the repurchase or redemption of their capital stock;
.. the amendment of their charter or bylaws unless otherwise contemplated by the
merger agreement;
.. the merger or consolidation of either party with any person;
.. the issuance, delivery or sale of any option or right in respect of capital
stock;
.. the making or rescinding of any tax election, unless necessary to maintain
REIT status;
.. material changes in accounting methods;
.. the settlement of any claims, actions, suits, litigation or other type of
proceeding relating to taxes exceeding $250,000 individually or in the
aggregate, or changing methods of reporting income or deductions for tax
purposes;
.. the settlement of any shareholder derivative or class action claims arising
out of the merger without the other's consent;
.. the entering into, or amendment or modification of, material agreements with
officers, directors, employees or their affiliates; and
.. the entering into any transaction or series of transactions with respect to
which required financial statements could not be included or incorporated
into the applicable registration statement for the merger within 30 days
after that requirement arises.
S-8
The merger agreement contains various other covenants, including the following:
Best Efforts; Notification. Suites and Hospitality have each agreed to use their
best efforts to assist and cooperate with each other to fulfill the conditions
of the merger agreement. The tasks which Suites and Hospitality have agreed to
cooperate in accomplishing include:
.. the obtaining of all necessary actions, non-actions, waivers, consents and
approvals, etc. from governmental authorities;
.. the obtaining of all necessary consents, approvals, waivers or exemptions
from non-governmental third parties;
.. the defending of lawsuits or other legal proceedings challenging the merger;
and
.. the execution and delivery of any additional instruments necessary to
consummate the transactions contemplated by, and to fully carry out the
purposes of, the merger agreement.
Affiliates. Suites has agreed to deliver to Hospitality a list identifying all
persons who are affiliates of Suites for the purposes of Rule 145 under the
Securities Act and Suites also has agreed to use its best efforts to cause those
affiliates to deliver written agreements stating that they will not sell,
transfer or otherwise dispose of any of the Hospitality units issued to them in
the merger in violation of the Securities Act or the rules and regulations
thereunder.
Tax Treatment. Each of Suites and Hospitality have agreed to use its best
efforts to:
. cause the merger to qualify as a tax-free reorganization under Section
368(a) of the Internal Revenue Code, and
. obtain an opinion of counsel, which supports the qualification of the
merger under this status.
Solicitation of Transactions. Suites and Hospitality have agreed that they will
not directly or indirectly initiate or solicit any inquiries or the making of
any proposal that constitutes or may reasonably be expected to lead to any
competing transaction. Suites and Hospitality have agreed to notify the other
party in writing of any inquires or proposals of that type. However, the merger
agreement provides that the board of directors of Suites and the board of
directors of Hospitality may, in good faith based on the advice of outside
counsel, respond to and approve an unsolicited offer which it determines in good
faith, based on the advice of its investment banking firm, to be superior to the
merger.
Transfer and Gains Taxes. Hospitality and Suites have agreed to cooperate in the
preparation and filing of all returns or other documents regarding transfer
taxes and other fees or similar taxes which become payable in connection with
the merger.
Employee Matters. Suites and Hospitality have agreed as follows:
. Hospitality will have no liability or obligation to Suites or its
employees to employ or offer employment to any employee of Suites or any
group of employees of Suites, but may, in its sole discretion, offer
employment to such employees after the merger; and
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. All outstanding options to purchase Suites common shares will, at the
time of the merger, become options to purchase the same number of
Hospitality units as the holder of an option would have been entitled to
receive pursuant to the merger had that holder exercised the option in
full immediately prior to the effective time of the merger.
Indemnification. The merger agreement provides that for a period of six years
after the effective time of the merger, Hospitality will indemnify, defend and
hold harmless each individual who was, at any time prior to the effective time
of the merger, an officer, director, employee or agent of Suites who at any time
prior to the effective time of the merger was entitled to indemnification under
the articles of incorporation or bylaws of Suites or employment agreements
between Suites and its officers existing on the date of the merger agreement, to
the same extent those persons were entitled to indemnification prior to the
effective time of the merger.
Hospitality also has agreed to use its reasonable best efforts to cause the
persons serving as officers and directors of Suites immediately prior to the
effective time of the merger to be covered by "run-off" or "tail" directors and
officers liability insurance coverage, without a reduction of existing coverage,
for a period of six years after the effective time of the merger.
The indemnity provisions of the merger agreement are intended to be for the
benefit of, and will be enforceable by, each indemnified party, his or her heirs
and his or her personal representatives and will be binding on all successors
and assigns of Hospitality and Suites.
Certain Other Covenants. The merger agreement contains certain other covenants
of the parties relating to, among other things:
. the preparation and distribution of a joint proxy statement/prospectus;
. the respective Hospitality and Suites shareholders' meetings;
. cooperation in issuing public announcements;
. qualification of the merger as a reorganization under Section 368 of the
Internal Revenue Code;
. access to information;
. confidentiality;
. obtaining comfort letters from their respective independent public
accountants; and
. the fulfillment of conditions precedent to obligations found in the
merger agreement.
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Conditions To Consummate The Merger
The obligations of each party to consummate the merger are subject to the
satisfaction or waiver of several conditions, including:
. obtaining the affirmative vote of at least a majority of the
outstanding Suites common shares and at least a majority of Suites
common shares present and voting, excluding Suites common shares
owned by or voted under the control of a Suites or Hospitality
director;
. obtaining the affirmative vote of at least a majority of Hospitality
common shares present and voting, excluding Hospitality common shares
owned by or voted under the control of a Hospitality or Suites
director;
. the effectiveness of a registration statement on Form S-4 and the
absence of any stop order or proceedings seeking a stop order;
. the absence of injunctions, decrees, orders, laws, statutes or
regulations enjoining, preventing or making illegal the consummation
of the merger;
. obtaining all governmental approvals required to consummate the
transactions contemplated in the merger agreement; and
. completion of all material action by or in respect of any
governmental entity required for the consummation of the merger or
any of the other transactions contemplated by the merger agreement.
The obligations of Hospitality to consummate the merger are further subject to
satisfaction or waiver of the following conditions:
. each of the representations and warranties of Suites in the merger
agreement is true and correct as of the effective date of the merger
(except for representations and warranties made as of a specified
date which will be true and correct as of the specified date) except
that this condition will be deemed to be satisfied if the aggregate
losses as a result of a failure to meet any representations or
warranties does not and would not reasonably be expected to result in
a material adverse effect;
. all of the obligations of Suites under the merger agreement have been
performed in all material aspects, and Hospitality has received a
certificate signed on behalf of Suites by the chief executive officer
or chief financial officer to that effect;
. all consents and waivers from third parties pursuant to the merger
agreement have been obtained, other than consents from third parties,
which if not obtained would not result, individually or in the
aggregate, in a material adverse effect;
. from the date of the merger agreement through the effective time of
the merger, there has not have occurred any change in the financial
condition, business or operations of
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Suites and its subsidiaries, taken as a whole, that would have or
would be reasonably likely to have a material adverse effect;
. the fairness opinion of Merrill Lynch addressed to the Hospitality
special committee has not been withdrawn or materially modified; and
. the holders of no more than 1% of the outstanding Suites common
shares have indicated their intention to exercise their dissenters'
rights under the Virginia Stock Corporation Act.
The obligations of Suites to consummate the merger are further subject to
satisfaction or waiver of the following conditions:
. each of the representations and warranties of Hospitality in the
merger agreement is true and correct as of the effective date of the
merger (except for representations and warranties made as of a
specified date which will be true and correct as of the specified
date) except that this condition will be deemed to be satisfied if
the aggregate losses as a result of a failure to meet any
representations or warranties does not and would not reasonably be
expected to result in a material adverse effect;
. all of the obligations of Hospitality under the merger agreement
have been performed in all material aspects and Hospitality has
received a certificate signed on behalf of Hospitality by the chief
executive officer or chief financial officer to that effect;
. Suites has received an opinion dated as of the closing date from
McGuireWoods LLP, subject to certificates, letters and assumptions
reasonably satisfactory to Suites that the merger qualifies as a
tax-free reorganization under Section 368 of the Internal Revenue
Code;
. all consents and waivers from third parties pursuant to the merger
agreement have been obtained, other than consents from third parties,
which if not obtained would not result, individually or in the
aggregate, in a material adverse effect;
. from the date of the merger agreement through the effective time of
the merger, there has not occurred any change in the financial
condition, business or operations of Hospitality and its
subsidiaries, taken as a whole, that would have or would be
reasonably likely to have a material adverse effect; and
. the fairness opinion of Wachovia Securities addressed to the Suites
special committee has not been withdrawn or materially modified.
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Termination; Fees And Expenses
Termination. The merger agreement may be terminated at any time prior to the
filing of the articles of merger for the merger with the State Corporation
Commission of the Commonwealth of Virginia, whether before or after the approval
by the Suites common shareholders or the Hospitality common shareholders:
. by mutual written consent of Hospitality and Suites duly authorized
by the respective boards of directors of Hospitality and Suites;
. by Hospitality:
. upon a breach of any representation, warranty, covenant or
agreement on the part of Suites in the merger agreement, or
. if any representation or warranty of Suites shall have become
untrue, such that any of the conditions stated above would be
incapable of being satisfied by February 28, 2003 (except as
otherwise extended);
. by Suites:
. upon a breach of any representation, warranty, covenant or
agreement on the part of Hospitality in the merger agreement, or
. if any representation or warranty of Hospitality shall have
become untrue, such that any of the conditions stated above would
be incapable of being satisfied by February 28, 2003 (except as
otherwise extended);
. by either Hospitality or Suites if any judgment, injunction, order or
decree or action by a governmental authority of competent authority
preventing the consummation of the merger has become final and
non-appealable;
. by either Hospitality or Suites, if the merger has not been
consummated by February 28, 2003; provided however that a party that
has willfully and materially breached a representation will not be
entitled to exercise this right to terminate under this provision;
. by either Hospitality or Suites if:
. upon a vote at a duly held Suites common shareholders meeting or
adjournment thereof, the approval of the Suites shareholders has
not been obtained, or
. upon a vote at a duly held Hospitality common shareholders meeting
or adjournment thereof, the approval by the Hospitality common
shareholders has not been obtained;
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. by Suites upon prior notice to Hospitality, if prior to the Suites
common shareholders meeting the board of directors shall have
withdrawn or modified in any manner adverse to Hospitality its
approval of the merger in accordance with Section 7.1 of the
merger agreement;
. by Hospitality if:
. prior to the Suites common shareholders meeting, the board of
directors of Suites shall have withdrawn in any manner adverse
to Hospitality its approval of the merger in connection with a
competing transaction;
. Suites shall have entered into any agreement with respect to
any competing transaction, other than a confidentiality
agreement contemplated in Section 7.1 of the merger agreement;
or
. the board of directors of Suites or any committee of Suites
shall have resolved to carry out any action found in that
provision,
. by Hospitality upon prior notice to Suites, if prior to the
Hospitality common shareholders meeting the board of directors
shall have withdrawn or modified in any manner adverse to Suites
its approval of the merger in accordance with Section 7.1 of the
merger agreement; and
. by Suites if:
. prior to the Hospitality common shareholders meeting, the
board of directors of Hospitality shall have withdrawn in any
manner adverse to Suites its approval of the merger in
connection with a competing transaction;
. Hospitality shall have entered into any agreement with respect
to any competing transaction (other than a confidentiality
agreement contemplated in Section 7.1 of the merger
agreement); or
. the board of directors of Hospitality or any committee of
Hospitality shall have resolved to carry out any action found
in that provision.
Expenses. Suites and Hospitality will each bear all of their own expenses
incurred in connection with the merger agreement, except in the following
circumstances:
. if the merger and the transactions contemplated by the merger
agreement are consummated in accordance with the merger agreement,
all out-of-pocket costs will be paid by Hospitality; or
. if either party is required to pay break up expenses, as discussed
below.
S-14
Termination Fee and Break Up Expenses.
If the merger agreement is terminated:
. by Suites, if prior to the Suites common shareholders meeting, the
Suites board withdraws or modifies in any manner adverse to
Hospitality its approval of the merger in connection with a competing
transaction; or
. by Hospitality,
. if prior to the Suites common shareholders meeting, the Suites
board withdraws or modifies in any manner adverse to
Hospitality its approval of the merger in connection with a
competing transaction,
. if Suites shall have entered into any agreement with respect
to a competing transaction, or
. if the Suites board or any committee thereof shall have
resolved to do any of the foregoing;
then Suites will pay to Hospitality break up expenses equal to the lesser of:
. Hospitality's actual expenses incurred on or after January 31, 2002
in connection with the merger agreement and the transactions
contemplated thereby, and
. $1,000,000.
If the merger agreement is terminated:
. by Hospitality, if prior to the Hospitality common shareholders
meeting the Hospitality board withdraws or modifies in any manner
adverse to Suites its approval of the merger in connection with a
competing transaction; or
. by Suites,
. if prior to the Hospitality common shareholders meeting, the
Hospitality board withdraws or modifies in any manner adverse
to Suites its approval of the merger in connection with a
competing transaction;
. if Hospitality shall have entered into any agreement with
respect to a competing transaction, or
. if the Hospitality board or any committee thereof shall have
resolved to do any of the foregoing;
S-15
then Hospitality will pay to Suites break up expenses equal to the lesser of:
. Suites' actual expenses incurred on or after January 31, 2002 in
connection with the merger agreement and the transactions contemplated
thereby, and
. $1,000,000.
Amendment; Extension; Waiver
Subject to compliance with applicable law, prior to the effective time of the
merger, any provision of the merger agreement may:
. be waived by the party benefited by the provision;
. be amended or modified at any time, by an agreement in writing between
the parties, if approved by their respective boards of directors and
executed in the same manner as the merger agreement; or
. have extended the respective time required for the performance of any
of the obligations or other acts of a party.
Survival Of Certain Provisions
If the Merger Agreement is Terminated Before the Effective Time of the Merger.
If the merger agreement is terminated before the effective time of the merger,
certain provisions of the merger agreement will survive and remain effective,
including provisions regarding:
. confidentiality of information obtained in connection with the merger
agreement; and
. liability of the companies to each other as a result of the
termination of the merger agreement; except that if any termination
results from a willful breach by a party of any of its
representations, warranties, covenants or agreements set forth in the
merger agreement, then other provisions of the merger agreement would
apply to claims asserted in response to such a breach.
If the Merger Agreement Becomes Effective. After the effective time of the
merger, none of the representations and warranties in the merger agreement will
survive; however, any covenant or agreement which contemplates performance after
the effective time of the merger will survive.
S-16
DESCRIPTION OF HOSPITALITY CAPITAL STOCK
The information set forth below is only a summary of the material terms of the
Hospitality common shares and the Hospitality preferred shares. You should refer
to the Hospitality articles of incorporation and bylaws for a complete
description of the Hospitality common shares and the Hospitality preferred
shares.
The Hospitality authorized capital stock consists of:
. 200,000,000 Hospitality common shares, no par value,
. 200,000,000 Hospitality Series A preferred shares, no par value,
. 240,000 Hospitality Series B convertible preferred shares, no par
value,
. 1,272,000 Hospitality Series C convertible preferred shares, no par
value, and
. 13,728,000 additional Hospitality preferred shares, no par value.
As of October 21, 2002, there were 29,320,298 Hospitality common shares
29,320,298 Hospitality Series A preferred shares, 240,000 Hospitality Series B
convertible preferred shares and no Hospitality Series C convertible preferred
shares issued and outstanding.
Hospitality Common Shares
Dividend And Distribution Rights. Hospitality common shares have equal rights in
connection with:
. dividends;
. distributions; and
. liquidations.
If the Hospitality board of directors determines, in its sole discretion, to
declare a dividend, the right to that dividend is subject to the following
restrictions:
. the dividend rights of the Hospitality common shares may be
subordinate to the dividends right of any other of Hospitality shares
ranking senior to the Hospitality common shares; and
. the amount of the dividend may be limited by law.
If Hospitality liquidates its assets or dissolves entirely, the holders of the
Hospitality common shares will share, on a pro rata basis, in the assets
Hospitality is legally allowed to distribute. Hospitality must pay all of its
known debts and liabilities or have made adequate provision for payment of these
debts and liabilities before holders of Hospitality common shares can share in
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its assets. Upon liquidation, the rights of the holders of the Hospitality
common shares will initially arise out of their rights as holders of the
Hospitality Series A preferred shares. The Hospitality Series A preferred shares
provide that the holders of Series A preferred shares will have a priority
distribution of $10.00 per share before any distribution to the holders of any
other shares. If the assets of Hospitality are insufficient to make these
payments in full, payments will be made to the holders of Hospitality Series A
preferred shares on a pro rata basis. Before the merger and the related
conversion of the Hospitality Series B convertible preferred shares, holders of
Hospitality Series B convertible preferred shares will be entitled to be paid
$10.00 per number of common shares each Hospitality Series B convertible
preferred share would be convertible into. If the assets of Hospitality are
insufficient to make these payments in full, payments will be made to the
holders of Hospitality Series B convertible preferred shares on a pro rata
basis. After payments in full to the Hospitality Series A preferred shares and
the Hospitality Series B convertible preferred shares, the remaining assets will
be distributed between the holders of the Hospitality common shares and the
holders of the Hospitality Series B convertible preferred shares, on an as
converted basis.
Immediately after the effective time of the merger, the outstanding Hospitality
Series B convertible preferred share will be exchanged for Hospitality Series C
convertible preferred shares. After this exchange, no Hospitality Series B
convertible shares will be outstanding and 1,272,000 Hospitality Series C
convertible preferred shares will be outstanding. All 240,000 authorized
Hospitality Series B convertible preferred shares are held by Glade M. Knight
and two business associates. After the merger, if the assets of Hospitality are
sufficient to pay in full the distribution rights of $10.00 per share for the
outstanding Hospitality Series A preferred shares, the remaining assets will
first be used to pay $10.00 per share to the holders of the Hospitality Series C
convertible preferred shares, on an as converted basis and then, any remaining
assets will be distributed pro rata to the holders of Hospitality common shares
and the holders of Hospitality Series C convertible preferred shares, on an as
converted basis. Consequently, holders of Hospitality units will be entitled to
receive $10.00 per share in cash on liquidation, before any payments will be
made to Mr. Knight or the other holders of the Hospitality Series C convertible
preferred shares for their Hospitality Series C convertible preferred shares.
Holders of Hospitality common shares do not have the right to convert or redeem
their shares. In addition, they do not have rights to a sinking fund or to
subscribe for any of Hospitality's securities.
Voting Rights. Each outstanding Hospitality common share entitles the holder to
one vote on all matters submitted to a vote of shareholders. The holders of
Hospitality common shares and the holders of Hospitality Series C convertible
preferred shares, on an as converted basis, will have exclusive voting power
with respect to the election of directors, except as otherwise required by law
or except as provided with respect to any other class or series of shares. There
is no cumulative voting in the election of directors. Therefore the holders of a
majority of the outstanding Hospitality common shares and Hospitality Series C
convertible preferred shares, on an as converted basis, will be able to elect
all of the directors then standing for election and the holders of the remaining
Hospitality common shares and Hospitality Series C convertible preferred shares
will not be able to elect any directors. Currently, the Hospitality board of
directors is divided into three classes, as nearly equal in size as possible.
The terms of one class of directors expire each year.
S-18
The Hospitality articles will provide that a majority of Hospitality common
shares and Hospitality Series C convertible preferred shares, on an as converted
basis, outstanding and entitled to vote on a matter may approve Hospitality
taking any of the following actions:
. dissolve;
. amend Hospitality's articles of incorporation, except for amendments
to Hospitality's articles relating to the classification of the board
of directors which requires the approval of at least two-thirds of the
shares entitled to vote;
. merge;
. sell all or substantially all of Hospitality's assets;
. engage in a share exchange or similar transactions.
Transfer Agent and Registrar. The transfer agent and registrar for the
Hospitality common shares is Wachovia Bank, N.A.
Hospitality Series A Preferred Shares
The Hospitality Series A preferred shares have no voting rights, no distribution
rights and no conversion rights. In addition, the Hospitality Series A preferred
shares are not separately tradable from the Hospitality common shares to which
they relate. The only right associated with each Hospitality Series A preferred
share is a priority distribution upon the sale of Hospitality's assets or other
event of liquidation. The priority distribution will be equal to $10.00 per
Hospitality Series A preferred share, and no more, before any distribution will
be made to the holders of any other shares. Upon that distribution the
Hospitality Series A preferred shares will have no other distribution rights.
Hospitality Series B Convertible Preferred Shares
Hospitality authorized capital stock includes 240,000 Hospitality Series B
convertible preferred shares. There are no dividends payable on the Hospitality
Series B convertible preferred shares. Holders of more than two-thirds of the
Hospitality Series B convertible preferred shares must approve any proposed
amendment to the Hospitality articles of incorporation that would adversely
affect the Hospitality Series B convertible preferred shares. Upon Hospitality's
liquidation, the holders of the Hospitality Series B convertible preferred
shares are entitled to a priority liquidation payment. However the priority
liquidation payment of the holders of the Hospitality Series B convertible
preferred shares is junior to the holders of the Hospitality Series A preferred
shares distribution rights. The holder of a Hospitality Series B convertible
preferred share is entitled to a liquidation payment of $10.00 per number of
common shares each Hospitality Series B convertible preferred share would be
convertible into according to the formula described below. Prior to the exchange
of Hospitality Series B convertible preferred shares for Hospitality Series C
convertible preferred shares, in the event that the liquidation of Hospitality's
assets results in proceeds that exceed the distribution rights of the
Hospitality
S-19
Series A preferred shares and the Hospitality Series B convertible preferred
shares, the remaining proceeds will be distributed between the Hospitality
common shares and the Hospitality Series B convertible preferred shares, on an
as converted basis.
The Hospitality Series B convertible preferred shares are convertible into
Hospitality units upon and for 180 days following the occurrence of either of
the following events:
(1) Hospitality transfers substantially all of its assets, stock or
business, whether through exchange, merger, consolidation, lease,
share exchange or otherwise; or
(2) the advisory agreement with Apple Suites Advisors is terminated or
expires without renewal and Hospitality ceases to use Apple Suites
Realty to provide substantially all of its property acquisition and
disposition services.
Upon the occurrence of either triggering event and for purposes of determining
the liquidation payment due to each holder of a Hospitality Series B convertible
preferred share, each Hospitality Series B convertible preferred share is
convertible into 5.3 Hospitality units, based upon the gross public offering
proceeds raised through the date of conversion in the offering made by this
prospectus.
No additional consideration is due upon the conversion of the Hospitality Series
B convertible preferred shares. The conversion into Hospitality units of the
Hospitality Series B convertible preferred shares will result in dilution of the
shareholders' interests.
The outstanding Hospitality Series B convertible preferred shares will be
exchanged for 1,272,000 Hospitality Series C convertible preferred shares
immediately following the merger. Mr. Knight and two business associates own the
outstanding Hospitality Series B convertible preferred shares.
Hospitality Series C Convertible Preferred Shares
Dividend and Distribution Rights. The holders of Hospitality Series C
convertible preferred shares, on an as converted basis, will be entitled to
receive the same dividends and distributions as declared for the holders of
Hospitality common shares, except for distributions in liquidation.
If Hospitality liquidates its assets or dissolves entirely and the assets of
Hospitality are sufficient to pay the distribution rights of the Hospitality
Series A preferred shares in full, the remaining assets will first be used to
pay $10.00 per share to the holders of the Hospitality Series C convertible
preferred shares, on an as converted basis. Then, any remaining assets will be
distributed pro rata to the holders of Hospitality common shares and holders of
Hospitality Series C convertible preferred shares, on an as converted basis.
Conversion. The Hospitality Series C convertible preferred shares will be
convertible into Hospitality units upon and for 180 days following the
occurrence of either of the following events:
(1) Hospitality transfers substantially all of its assets, stock or
business as a going concern, whether through exchange, merger,
consolidation, lease, share exchange
S-20
or otherwise, other than a sale of assets in liquidation, dissolution
or winding up of Hospitality's business; or
(2) Hospitality lists the Hospitality units on a national securities
exchange or quotation system or in any established market.
Upon the occurrence of either triggering event, each Hospitality Series C
convertible preferred share will be convertible into one Hospitality unit,
subject to adjustment to reflect stock dividends on, or split, subdivision or
combination of, the Hospitality common shares.
Voting Rights. The holders of Hospitality Series C convertible preferred shares
will be entitled to vote on all matters submitted to a vote of shareholders as
if they were converted into Hospitality common shares, except as otherwise
provided by law. The holders of Hospitality common shares and the holders of
Hospitality Series C convertible preferred shares, on an as converted basis,
will have exclusive voting power with respect to the election of directors,
except as provided with respect to any other class or series of shares. There is
no cumulative voting in the election of directors. Therefore the holders of a
majority of the outstanding Hospitality common shares and Hospitality Series C
convertible preferred shares, on an as converted basis, will be able to elect
all of the directors then standing for election and the holders of the remaining
Hospitality common shares and Hospitality Series C convertible preferred shares
will not be able to elect any directors. Currently the Hospitality board of
directors is divided into three classes, as nearly equal in size as possible.
The terms of one class of directors expires each year.
Preferred Shares
The Hospitality articles of incorporation authorize the issuance of up to
13,728,000 additional Hospitality preferred shares. At the present time, no
preferred shares other than the Hospitality Series A preferred shares and the
Hospitality Series B convertible preferred shares have been issued.
Hospitality believes that the authorization to issue additional preferred shares
benefit Hospitality and its shareholders by permitting flexibility in financing
additional growth, giving it additional financing options in its corporate
planning and in responding to developments in its business, including financing
of additional acquisitions and other general corporate purposes. Having
authorized preferred shares available for issuance in the future gives
Hospitality the ability to respond to future developments and allow preferred
shares to be issued without the expense and delay of a special shareholders'
meeting.
At present, Hospitality has no specific financing or acquisition plans involving
the issuance of additional preferred shares, other than the issuance of
1,272,000 Hospitality Series C convertible preferred shares discussed above, and
does not propose to fix the characteristics of any series of preferred shares in
anticipation of issuing preferred shares. Hospitality cannot now predict whether
or to what extent, if any, additional preferred shares will be used or, if so
used, what the characteristics of a particular series may be.
The voting rights and rights to distributions of the holders of Hospitality
common shares will be subject to the prior rights of the holders of any
subsequently issued preferred shares. Unless
S-21
otherwise required by applicable law or regulation, the preferred shares would
be issuable without further authorization by holders of the Hospitality common
shares and on the terms and for the consideration as may be determined by the
Hospitality board of directors. The preferred shares could be issued in one or
more series having varying voting rights, redemption and conversion features,
distribution (including liquidating distribution), rights and preferences, and
other rights, including rights of approval of specified transactions. A series
of preferred shares could be given rights that are superior to rights of holders
of Hospitality common shares and a series having preferential distribution
rights could limit common share distributions and reduce the amount holders of
Hospitality common shares would otherwise receive on dissolution.
Restrictions on Transfer
To qualify as a REIT under the Internal Revenue Code, Hospitality common shares
must be beneficially owned by 100 or more persons during at least 335 days of a
taxable year of twelve months or during a proportionate part of a shorter
taxable year. Further, not more than 50% of the value of the issued and
outstanding Hospitality common shares may be owned, directly or indirectly, by
five or fewer individuals or, in limited circumstances, entities such as
qualified private pension plans, during the last half of a taxable year or
during a proportionate part of a shorter taxable year.
Since the Hospitality board of directors believes it is essential that
Hospitality maintain its REIT status, the Hospitality bylaws provide that no
person may own or be deemed to own more than 9.8% of the issued and outstanding
shares of any class or series. The Hospitality board may exempt a proposed
transferee from this ownership limit. The Hospitality board may require opinions
of counsel, affidavits, undertakings or agreements at it may deem necessary or
advisable in order to determine or ensure Hospitality's status as a REIT.
Any acquisition or transfer of Hospitality common shares that would:
. result in the Hospitality common shares and any other stock being
owned by fewer than 100 persons, or
. result in Hospitality being "closely-held" within the meaning of
Section 856(h) of the Internal Revenue Code,
will be null and void, and the intended transferee will acquire no rights to the
Hospitality common shares. These restrictions on transferability and ownership
will not apply if the Hospitality board determines that it is no longer in
Hospitality's best interests to attempt to qualify, or to continue to qualify,
as a REIT and Hospitality's articles are amended accordingly.
Any purported transfer of Hospitality common shares or any other stock that
would result in a person owning shares of capital stock in excess of the
ownership limit will result in the transfer being declared null and void. The
shares subject to the purported transfer will be considered to be "excess
shares." Under the Hospitality bylaws, excess shares will be deemed to have been
acquired and to be held on Hospitality's behalf. The excess shares will not be
considered to be outstanding for quorum and voting purposes. The excess shares
will not be entitled to receive dividends or any other distributions.
S-22
Any dividends or distributions paid to a purported transferee of excess shares
prior to our discovery that the shares have been transferred in violation of the
Hospitality bylaws must be repaid to us upon demand.
The Hospitality bylaws provide that Hospitality may redeem any excess shares.
The redemption price for any excess share will be equal to:
. the price paid for the excess shares by the intended transferee; or
. if no consideration was paid, the fair market value of the shares
measured on the last business day prior to date on which Hospitality
elects to redeem the excess shares.
Fair market value means the average daily closing price of a share if listed on
a national securities exchange. If the shares are quoted on the NASD National
Market System, fair market value will be the average of closing bid prices and
closing asked prices. If there have been no sales or published bid and asked
quotations with respect to the shares, the fair market value will be as
determined in good faith by the Hospitality board.
In addition, each shareholder shall, upon demand, be required to disclose in
writing all information regarding the direct and indirect beneficial ownership
of shares of capital stock as the Hospitality board deems reasonably necessary
to comply with the provisions of the Internal Revenue Code applicable to a REIT,
to comply with the requirements of any taxing authority or governmental agency
or to determine any compliance with those provisions or requirements.
These ownership limitations could have the effect of discouraging a takeover or
other transaction in which holders of some, or a majority, of shares of capital
stock might receive a premium for their shares over the then-prevailing market
price or which these holders might believe to be otherwise in their best
interest.
NEW REIT BY MR. KNIGHT
Currently Mr. Knight is in the process of creating another real estate
investment trust to be called Apple Hospitality Five, Inc. Apple Five will focus
on purchasing and owning upper-end, extended-stay hotel properties and other
upper-end, limited-service hotel properties located in selected metropolitan
areas. Some of the hotels owned by Apple Five may be in the same markets and may
compete with hotels owned by Hospitality and Suites. Apple Five's hotels may be
operated as part of the Homewood Suites(R) by Hilton or the Residence Inn(R) by
Marriott(R) franchise systems. Hospitality anticipates that Apple Five will have
the same board of directors and executive officers as Hospitality and Suites.
S-23
HOSPITALITY'S PROPERTIES
If the merger occurs, Hospitality, directly or through its subsidiaries, will
own a total of 65 extended-stay hotels, which contain 7,689 suites that are part
of the Residence Inn(R) by Marriott(R) and Homewood Suites(R) by Hilton
franchise systems. The hotels first began their operations during the period
from 1984 through 1990. Each hotel was in business when acquired. Each hotel
offers one and two room suites with the amenities generally offered by upscale
extended-stay hotels. The hotels are located in developed areas in competitive
markets. Hospitality believes the hotels are well-positioned to compete in these
markets based on their location, amenities, rate structure and franchise
affiliation. In the opinion of management, all of the hotels are adequately
covered by insurance. All of the hotels are listed in the table below, with the
hotels being acquired by Hospitality through the merger indicated by an
asterisk:
S-24
HOTEL SUMMARY
- ------------------------------------------------------------------------------------------------------------------
State Hotel Suites State Hotel Suites
- ------------------------------------------------------------------------------------------------------------------
Alabama Birmingham ...................... 128 Mississippi Jackson ....................... 120
Montgomery ...................... 94 Jackson* ...................... 91
California Arcadia ......................... 120 Missouri St. Louis-Chesterfield ........ 104
Bakersfield ..................... 114 St. Louis-Galleria ............ 152
Concord-Pleasant Hill ........... 126 St. Louis* .................... 145
Costa Mesa ...................... 144
Irvine .......................... 112 Nevada Las Vegas ..................... 192
La Jolla ........................ 288
Long Beach ...................... 216 New Mexico Santa Fe ...................... 120
Placentia ....................... 112
San Ramon ....................... 106 North Carolina Charlotte ..................... 91
Greensboro .................... 128
Colorado Boulder ......................... 128
Boulder* ........................ 112 Ohio Akron ......................... 112
Cincinnati-Blue Ash ........... 118
Connecticut Meriden ......................... 106 Cincinnati-Sharonville ........ 144
Columbus ...................... 96
Florida Boca Raton ...................... 120 Dayton North .................. 64
Clearwater-St. Petersburg ....... 88 Dayton South .................. 96
Clearwater* ..................... 112
Jacksonville .................... 112 Oregon Portland* ..................... 123
Pensacola ....................... 64
Pennsylvania Philadelphia-Berwyn ........... 88
Georgia Atlanta Airport-Hapeville ....... 126 Philadelphia* ................. 123
Atlanta-Buckhead ................ 136
Altanta-Buckhead* .............. 92 South Carolina Columbia ...................... 128
Atlanta-Cumberland ............. 130 Spartanburg ................... 88
Altanta-Cumberland* ............ 124
Atlanta-Dunwoody ............... 144 Tennessee Memphis ....................... 105
Atlanta-Peachtree* ............. 92
Texas Dallas-Addison* ............... 120
Illinois Chicago-Deerfield .............. 128 Dallas-Irving ................. 120
Chicago-Lombard ................ 144 Dallas-Las Colinas* ........... 80
Dallas-Plano* ................. 99
Louisiana Shreveport-Bossier City ........ 72 Houston-Clear Lake ............ 110
Lubbock ....................... 80
Maryland Baltimore* ..................... 147
Utah Salt Lake City* ............... 91
Massachusetts Boston-Danvers ................. 96
Boston-Tewksbury ................ 130
Virginia Herndon* ...................... 109
Michigan Detroit* ........................ 76 Richmond* ..................... 123
Kalamazoo ....................... 83
Southfield ...................... 144
* To be acquired upon the completion of the merger with Suites.
S-25
Because of the number of hotels Hospitality owns, the effect of an individual
hotel on its overall operations is minimal, and specific operating data and real
estate information is not presented for each hotel. Such data and information,
including average daily occupancy rate and revenue per available suite, varies
among the hotels and depends on a variety of factors, including location,
condition, and overall demand for hotel suites in the area. These factors, in
turn, are affected by general and local economic conditions and the proximity of
employers, business travelers and other sources of occupancy. Hospitality
believes the combined operating data for its hotels is within the normal range
for comparable hotels in the same or similar markets. Hospitality is not
presently aware of any circumstances or factors that have caused, or are
expected to cause, the operating data for a particular hotel to be materially
below such normal range. Hospitality's hotels are subject to real estate taxes
levied by various governmental authorities. Hospitality believes these taxes are
also within the normal range for comparable hotels in the same or similar
markets.
Eight of Hospitality's hotels are located in the same markets as extended-stay
hotels owned by Suites. These hotels are the hotels located in Atlanta-Buckhead,
Atlanta-Cumberland, Boulder, Clearwater, Dallas-Irving, Jackson, Philadelphia
and St. Louis-Chesterfield. The day-to-day operations of Hospitality's hotels
have been contracted to Residence Inn by Marriott, Inc. and Hospitality's hotels
operate under the Residence Inn(R) by Marriott(R) brand. The hotels owned by
Suites are operated on a day-to-day basis by a separate management company and
operate under the Homewood Suites(R) by Hilton brand. Hospitality may in the
future acquire additional hotels located in the same markets as hotels owned by
Suites or Apple Five. Hospitality's chairman of the board and president, Glade
M. Knight, is also chairman of the board and President of Suites and Apple Five.
S-26
APPLE HOSPITALITY TWO, INC. SELECTED FINANCIAL INFORMATION
The following table presents selected consolidated financial
information for Hospitality and should be read in conjunction with the
consolidated financial statements and related notes of Hospitality included in
the prospectus and the other financial, pro forma and statistical information
included in the prospectus.
SELECTED FINANCIAL DATA
APPLE HOSPITALITY TWO, INC.
(As of June 30, 2002 or, as applicable, for the period from
January 1, 2002 - June 30, 2002)
REVENUES:
Suite Revenue .............................................. $ 33,381,932
Interest income and other revenue .......................... 1,524,608
-------------
Total Revenue ........................................... $ 34,906,540
EXPENSES:
Hotel expenses ............................................. $ 18,902,697
Taxes, insurance and other ................................. 2,212,034
General and administrative ................................. 683,325
Depreciation ............................................... 2,639,286
Interest ................................................... 4,952,602
-------------
Total expenses .......................................... $ 29,389,944
-------------
Net income ................................................. $ 5,516,596
=============
PER SHARE
Earnings per share - basic and diluted ..................... $ .33
Distributions to common shareholders ....................... $ .50
Weighted-average common shares outstanding - basic ......... 16,810,654
BALANCE SHEET DATA AT JUNE 30, 2002:
Cash and cash equivalents .................................. $ 68,794,802
Investment in hotels, net .................................. $ 249,532,341
Total assets ............................................... $ 336,680,450
Notes payable - secured .................................... $ 142,912,276
Shareholders' equity ....................................... $ 189,828,076
OTHER DATA:
Cash flow from:
Operating activities .................................... $ 7,775,877
Investing activities .................................... $ (11,733,934)
Financing activities .................................... $ 57,284,018
Number of hotels owned at end of period .................... 25
FUNDS FROM OPERATIONS CALCULATION
Net income ................................................. $ 5,516,596
Depreciation ............................................... $ 2,639,286
Interest expense (imputed) ................................. $ 450,000
Funds from Operation (a) ................................... $ 8,605,882
FFO per share .............................................. $ .51
(a) Funds from operations (FFO) is defined as net income (computed in
accordance with generally accepted accounting principles-GAAP) excluding
gains and losses from sales of depreciable property, plus depreciation and
amortization. We consider FFO in evaluating property acquisitions and
operating performance. We believe that FFO should be considered along with,
but not as an alternative to, net income and cash flows as a measure of our
activities in accordance with GAAP and that it is not necessarily
indicative of cash available to fund cash needs.
S-27
APPLE SUITES, INC. SELECTED FINANCIAL INFORMATION
The following table presents selected consolidated financial information
for and should be read in conjunction with the financial statements and related
notes of Suites included in the prospectus and the other financial, pro forma
and statistical information included in the prospectus.
SELECTED FINANCIAL DATA
- --------------------------------------------------------------------------------------------------------------------------
MARCH 26,
1999
YEAR ENDED YEAR ENDED THROUGH SIX MONTHS
DECEMBER DECEMBER DECEMBER ENDED JUNE
31, 2001 31, 2000 31, 1999 (B) 30, 2002
- --------------------------------------------------------------------------------------------------------------------------
REVENUES:
Suite revenue $ 43,338,533 $ -- $ -- $ 24,052,840
Lease revenue -- 15,807,258 2,518,031 1,091,234
Interest income and other revenue 2,523,462 395,671 169,086 12,001
Total revenue $ 45,861,995 $ 16,202,929 $ 2,687,117 25,156,075
EXPENSES:
Hotel expenses $ 26,588,906 $ -- $ -- $ --
Taxes, insurance and other 2,297,935 2,083,533 426,592 1,337,177
General and administrative 894,121 1,048,212 153,807 555,482
Depreciation of real estate owned 4,787,486 2,990,381 496,209 2,700,916
Interest 5,849,378 6,611,716 1,245,044 3,442,549
Management termination fees 1,413,520 -- -- --
--------------- --------------- --------------- ----------------
Total expenses 41,831,346 12,733,842 2,321,652 22,771,492
--------------- --------------- --------------- ----------------
Net income $ 4,030,649 $ 3,469,087 $ 365,465 $ 2,384,583
- --------------------------------------------------------------------------------------------------------------------------
PER SHARE
Earnings per share--basic and diluted $ 0.34 $ 0.66 $ 0.14 $ 0.19
Distributions paid to common shareholders $ 1.03 $ 1.02 $ 0.33 $ 0.46
Weighted-average common shares outstanding--basic 11,907,721 5,274,633 2,648,196 12,666,667
- --------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Cash and cash equivalents $ 8,331,891 $ 2,653,058 $ 581,344 $ 6,159,579
Investment in hotels, net $ 170,437,222 $ 124,576,257 $ 93,719,632 $ 168,631,669
Total assets $ 185,177,085 $ 134,073,848 $ 99,489,008 $ 180,976,008
Notes payable--secured $ 77,041,296 $ 57,670,866 $ 68,569,500 $ 76,612,135
Shareholders' equity $ 103,999,875 $ 72,964,622 $ 28,098,000 $ 100,589,458
OTHER DATA
Cash flow from:
Operating activities $ 9,118,279 $ 5,512,154 $ 548,015 $ 4,816,678
Investing activities -$ 31,211,032 -$ 10,987,264 -$ 28,411,941 -$ 756,916
Financing activities $ 27,771,586 $ 7,546,824 $ 28,445,170 -$ 6,232,074
Number of hotels owned at end of period 17 13 11 17
- --------------------------------------------------------------------------------------------------------------------------
FUNDS FROM OPERATIONS CALCULATION
Net income $ 4,030,649 $ 3,469,087 $ 365,465 $ 2,384,583
Depreciation of real estate owned 4,787,486 2,990,381 496,209 2,700,916
Start-up costs -- -- 22,002 --
Management termination fees 1,413,520 -- -- --
--------------- --------------- --------------- ----------------
Funds from operations (a) $ 10,231,655 $ 6,459,468 $ 883,676 $ 5,085,499
- --------------------------------------------------------------------------------------------------------------------------
(a) Funds from operations (FFO) is defined as net income (computed in
accordance with generally accepted accounting principles-GAAP) excluding
gains and losses from sales of depreciable property, plus depreciation and
amortization. We consider FFO in evaluating property acquisitions and
operating performance. We believe that FFO should be considered along with,
but not as an alternative to, net income and cash flows as a measure of our
activities in accordance with GAAP and that it is not necessarily
indicative of cash available to fund cash needs.
S-28
EXPERTS
Ernst & Young LLP, independent auditors, have audited Apple Suites, Inc.'s
consolidated financial statements at December 31, 2001 as set forth in their
report. Hospitality has included Suites consolidated financial statements in the
prospectus and in reliance on Ernst & Young LLP's report, given on their
authority as experts in accounting and auditing.
(Remainder of Page is Intentionally Blank)
S-29
INDEX TO FINANCIAL STATEMENTS
Pro Forma Financial Information
Apple Hospitality Two, Inc.
(Unaudited)
Pro Forma Condensed Consolidated Balance Sheet As of June 30, 2002 .................. F-2
Notes to Pro Forma Condensed Consolidated Balance Sheet ............................. F-2
Pro Forma Condensed Consolidated Statements of Operations For the
Year Ended December 31, 2001 and the six months ended June 30, 2002 ............ F-3
Notes to Pro Forma Condensed Consolidated Statements of Operations .................. F-3
Financial Statements of Apple Suites, Inc.
Apple Suites, Inc.
(Audited)
Report of Independent Public Accountants ............................................ F-4
Consolidated Balance Sheet as of December 31, 2001, 2000 and 1999 ................... F-5
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999 ............................................... F-6
Consolidated Statement of Shareholder's Equity
for the Years Ended December 31, 2001, 2000 and 1999 ........................... F-7
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 ............................................... F-8
Notes to Consolidated Financial Statements .......................................... F-9
(Unaudited)
Consolidated Balance Sheet as of June 30, 2002 and December 31, 2001 ................ F-18
Consolidated Statements of Operations for the Three and Six Months
Ended June 30, 2002 and June 30, 2001 ............................................... F-19
Consolidated Statement of Shareholders' Equity
for the Six Months Ended June 30, 2002 ......................................... F-20
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2002 and June 30, 2001 ................................................ F-21
Notes to Consolidated Financial Statements .......................................... F-22
F-1
HOSPITALITY
UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED BALANCE SHEET
AS OF JUNE 30, 2002
Basis of Presentation
The following Unaudited Pro Forma Condensed Combined Consolidated Balance Sheet
gives effect to the merger between Apple Hospitality Two, Inc. ("Hospitality")
and Apple Suites, Inc. ("Suites"). Concurrent with the following transactions
related to the merger: 1) exchange of Suites Class B convertible shares to
480,000 Suites common shares 2) conversion of Hospitality Class B converible
preferred shares to 1,272,000 Hospitality Series C convertible preferred shares
3) termination of Hospitality and Suites advisory contracts with Apple Suites
Advisors, Inc., including payment of $2 million cash and non-interest bearing
note, due four years after the merger, for $4.48 million and 4) payment of a
special distribution to Hospitality shareholders of $15 million just prior to
the closing of the merger. The merger is accounted for under the purchase method
of accounting in accordance with Accounting Standards Board Opinion No, 16. In
the opinion of management, all significant adjustments necessary to reflect the
effects of the merger have been made.
The following unaudited Pro Forma Condensed Consolidated Balance Sheet of
Hospitality also gives effect to the purchase of Marriott Residence Inn II
Limited Partnership (the "Partnership") on August 28, 2002, containing 23
Residence Inn by Marriott hotels, from Host Mariott Corporation ("Host") for
approximately $136 million in total purchase price net of cash acquired of $24
million as if this transaction had occurred on June 30, 2002, and gives effect
to the merger of Hospitality and Suites as if the merger had occurred on June
30, 2002.
This pro forma Balance Sheet also assumes all of the hotels had been leased to
our wholly owned taxable REIT subsidiaries pursuant to master hotel lease
agreements. Residence Inn by Marriott will continue to manage the hotels owned
by Hospitality under agreements not materially different from historical
contractual arrangements. Promus Hotels, Inc., a wholly-owned subsidiary of
Hilton Hotels Corporation, will continue to manage the hotels owned by Suites
under the same agreements.
Such pro forma information is based in part upon the historical Consolidated
Balance Sheet of Hospitality, the historical balance sheet of Suites, and the
historical Balance Sheet of the Marriott Residence Inn I and II Limited
Partnerships and Residence Inn III LLC. In management's opinion, all adjustments
necessary to reflect the effects of these transactions have been made.
The following unaudited Pro Forma Condensed Combined Consolidated Balance Sheet
of Hospitality is not necessarily indicative of what actual financial condition
of Hospitality and Suites would have been assuming such transactions had been
completed on June 30, 2002, nor does it purport to represent the future combined
financial position of Hospitality and Suites. These unaudited pro forma
condensed combined financial statements should be read in conjunction with, and
are qualified in their entirety by, Hospitality and Suites historical
consolidated financial statements included in the prospectus.
Hospitality (A)
Historical Historical Pro
Consolidated Marriott Forma
Balance Sheet Residence Inn II LP Adjustments (B)
------------------------------------------------------------
ASSETS
Investment in hotel properties $ 252,171,627 $ 129,888,000 $ 1,646,703
(6,625,000)
Accumulated depreciation (2,639,286)
------------------------------------------------------------
Investment in hotel properties, net
Cash and cash equivalents 68,794,802 25,854,000 (30,942,703)
Restricted cash reserves 6,316,000
Deposit for potential acquisition 3,000,000 - (3,000,000)
Accounts receivable, net
Inventories
Due from Residence Inn by Marriott, Inc. 2,535,282 4,308,000
Furniture, fixtures & equipment reserve 7,132,744 5,188,000 -
Deferred financing costs, net of accumulated amortizaton 1,548,000 (1,548,000)
Deposit for refinancing 2,000,105 - -
Deferred franchise fees
Other assets 3,685,176 - -
- - -
------------------------------------------------------------
Total Assets $ 336,680,450 $ 173,102,000 $ (40,469,000)
============================================================
LIABILITIES and SHAREHOLDERS' EQUITY
Liabilities
Mortgage notes payable $ 142,912,276 $ 131,130,000
Accounts payable - affiliate 123,610 -
Due to third party manager
Accounts payable and accrued expenses 2,476,954 1,503,000
Capital lease obligations 153,066 -
Interest payable 367,888 -
Deferred incentive management fees payable 818,580 6,625,000 (6,625,000)
------------------------------------------------------------
Total Liabilities 146,852,374 139,258,000 (6,625,000)
Shareholders' equity
Total partmers' capital 33,844,000 (33,844,000)
Preferred stock, no par value, authorized 15,000,000 shares; none
issued or outstanding -
Common stock, no par value, authorized 200,000,000
shares; issued and outstanding 21,344,510 shares 190,484,388
Class B convertible stock, no par value, authorized 240,000 shares;
issued and outstanding 240,000 shares 24,000
Series C convertible stock -
Distributions greater than net income (680,312)
------------------------------------------------------------
Total Shareholders' Equity 189,828,076 33,844,000 (33,844,000)
------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 336,680,450 $ 173,102,000 $ (40,469,000)
============================================================
Hospitality
Proforma Historical
before Apple Suites, Inc. Merger
merger Balance Sheet Adjustments
------------------------------------------------------------
ASSETS
Investment in hotel properties (C)$ 383,706,330 $ 179,606,662 $ 23,232,219 (H)
(D) (6,625,000)
Accumulated depreciation (2,639,286) (10,974,993) 10,974,993 (H)
--------------------------------------------------
Investment in hotel properties, net
Cash and cash equivalents (B) 63,706,099 6,159,579 (3,330,000) (G)
Restricted cash reserves 6,316,000 146,615
Deposit for potential acquisition (B) - -
Accounts receivable, net 2,211,170
Inventories 145,300
Due from Residence Inn by Marriott, Inc. 6,843,282 -
Furniture, fixtures & equipment reserve 12,320,744 338,724
Deferred financing costs, net of accumulated amortizaton (E) - 1,293,934
Deposit for refinancing 2,000,105 -
Deferred franchise fees 771,078
Other assets 3,685,176 1,277,939
-
------------------------------------------------------------
Total Assets $ 469,313,450 $ 180,976,008 $ 30,877,212
============================================================
LIABILITIES and SHAREHOLDERS' EQUITY
Liabilities
Mortgage notes payable $ 274,042,276 $ 76,612,135
Accounts payable - affiliate 123,610 62,817
Due to third party manager 664,200
Accounts payable and accrued expenses 3,979,954 2,491,141
Capital lease obligations 153,066 -
Interest payable 367,888 556,257
Deferred incentive management fees payable (D) 818,580 -
-------------------------------------------------------
Total Liabilities 279,485,374 80,386,550
Shareholders' equity
Total partmers' capital (F) - -
Preferred stock, no par value, authorized 15,000,000 shares; none
issued or outstanding -
Common stock, no par value, authorized 200,000,000
shares; issued and outstanding 21,344,510 shares 190,484,388 111,099,353 15,591,317 (L)
4,776,000 (K)
Class B convertible stock, no par value, authorized 240,000 shares;
issued and outstanding 240,000 shares 24,000 24,000 (24,000) (K)
Series C convertible stock
Distributions greater than net income (680,312) (10,533,895) 15,309,895 (L)
(4,776,000) (K)
------------------------------------------------------------
Total Shareholders' Equity 189,828,076 100,589,458 31,253,212
------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 469,313,450 $ 180,976,008 $ 30,877,212
============================================================
Hospitality
Hospitality Combined
Adjustments Pro forma
---------------------------------------
ASSETS
Investment in hotel properties $ 586,545,211
(6,625,000)
Accumulated depreciation (2,639,286)
--------------- ---------------
Investment in hotel properties, net
Cash and cash equivalents (15,000,000) (N)
(2,000,000) (I) 49,535,678
Restricted cash reserves 6,462,615
Deposit for potential acquisition -
Accounts receivable, net 2,211,170
Inventories 145,300
Due from Residence Inn by Marriott, Inc. 6,843,282
Furniture, fixtures & equipment reserve 12,659,468
Deferred financing costs, net of accumulated amortizaton 1,293,934
Deposit for refinancing 2,000,105
Deferred franchise fees 771,078
Other assets 4,963,115
-
---------------------------------------
Total Assets $ (17,000,000) $ 664,166,670
=======================================
LIABILITIES and SHAREHOLDERS' EQUITY
Liabilities
Mortgage notes payable $ 350,654,411
Accounts payable - affiliate 3,400,000 (I) 3,586,427
Due to third party manager 664,200
Accounts payable and accrued expenses 6,471,095
Capital lease obligations 153,066
Interest payable 924,145
Deferred incentive management fees payable 818,580
---------------------------------------
Total Liabilities 3,400,000 363,271,924
Shareholders' equity
Total partmers' capital -
Preferred stock, no par value, authorized 15,000,000 shares; none
issued or outstanding -
Common stock, no par value, authorized 200,000,000
shares; issued and outstanding 21,344,510 shares
321,951,058
Class B convertible stock, no par value, authorized 240,000 shares;
issued and outstanding 240,000 shares (24,000) (M) -
Series C convertible stock 12,720,000 (M) 12,720,000
Distributions greater than net income (12,696,000) (M)
(15,000,000) (N)
(5,400,000) (I) (33,776,312)
---------------------------------------
Total Shareholders' Equity (20,400,000) 300,894,746
---------------------------------------
Total Liabilities and Shareholders' Equity $ (17,000,000) $ 664,166,670
=======================================
Notes to Unaudited Pro Forma Condensed Combined Consolidated Balance Sheet
Property acquisition adjustments:
(A) Represents the historical June 30, 2002 balance sheet of the partnership.
(B) Total purchase price consists of the following:
Purchase price per contract, net of cash acquired $ 135,756,718
Fair value of deferred incentive management fee liability
assumed 6,625,000
Fair value of other liabilities assumed 1,503,000
------------------
Sub-total 143,884,718
Acquisition fee payable to ASRG 3,199,732
Additional closing costs 262,253
------------------
Total purchase price $ 147,346,703
==================
The purchase price was satisfied by the following:
Cash:
-on hand $ 5,088,703
-deposit previously made to seller 3,000,000
Assumption of mortgage loan at fair value 131,130,000
Assumption of other liabilities 8,128,000
------------------
$ 147,346,703
==================
(C) Allocation of purchase price (see Note B above) to assets acquired at fair
value are as follows:
Purchase price (See Note B) $ 147,346,703
Less:
Restricted cash - FF&E reserves (11,504,000)
Other assets and prepaids (4,308,000)
------------------
Amount allocated to investment in hotel properties 131,534,703
Net book value of investment in hotel properties 129,888,000
------------------
Net increase in book value of investment in hotels $ 1,646,703
==================
(D) Represents elimination of deferred incentive management fees since payment
is not probable and can not be reasonably estimated.
(E) Represents elimination of deferred financing costs.
(F) Represents the elimination of Partners' capital account from prior owner.
Merger Adjustments:
(G) The merger will be accounted for in accordance with the purchase method of
accounting. The following represents the purchase price of common shares at
fair value, plus assumption of liabilities at fair value and estimated
transaction costs associated with the merger:
Purchase price for Apple Suites common shares (see below) $ 131,466,670
Mortgage notes assumed-at estimated fair value 76,612,135
Other liabilities assumed-at estimated fair value 3,774,415
Value of vested options ($.50 per 40,000 shares o/s) 20,000
------------------
Sub-total 211,853,220
Estimated transaction costs (see below) 3,330,000
------------------
Total purchase price $ 215,183,220
==================
The following is the calculation of the purchase price of shareholder
equity, reflecting the issuance of 13,146,667 shares of Hospitality Units
consisting of common shares and Series A Convertible Preferred Shares at an
estimated fair value of $10 per share in exchange for all of Apple Suites
outstanding common shares and Class B Convertible Share at June 30, 2002 as
follows:
Apple Suites common shares outstanding at June 30, 2002 12,666,667
Plus conversion of Class B Convertible Shares to Apple Suties
common shares (see Note K) 480,000
------------------
Adjusted Apple Suites common shares outstanding at June 30, 2002 13,146,667
Estimated fair market value per share of Hospitality Units $ 10
Consisting of common shares and Series A Convertible ------------------
Preferred Shares to be issued $ 131,466,670
==================
The following is an estimate of the fees and other expenses related to the
merger:
Advisory fees $ 1,500,000
Legal and accounting fees 500,000
Printing 350,000
Proxy solicitation and consulting fees 200,000
Other 780,000
------------------
Total adjustment for estimated transaction costs $ 3,330,000
==================
(H) Increase of $33,414,395 in the net book value of Suites real estate assets
based upon Hospitality's purchase price and the adjustment to eliminate
Suites historical accumulated depreciation of $10,974,993 as follows:
Purchase price $ 215,183,220
Less:
Purchase price allocated to cash and cash equivalents (6,306,194)
Other assets and prepaid expenses (6,038,145)
------------------
Amount allocated to investment in rental property 202,838,881
Net book value of Suites investment in real estate 168,631,669
------------------
Net increase in book value of Suites investment in real estate 34,207,212
Eliminate accumulated depreciation (10,974,993)
------------------
Adjustment to reflect new cost basis of rental property $ 23,232,219
==================
Amount allocated to investment in rental property $ 202,838,881
Less: Amount allocated to land (33,804,510)
------------------
Depreciable basis of rental property $ 169,034,371
==================
(I) To record the termination fee payable to Apple Suites Advisors, Inc. by
Hospitality. This following also will be reflected in Hospitality's
statement of operations upon termination of the advisory agreement:
Cash payment $ 2,000,000
Present value at a market rate of 7%, of $4.48 million non-interest
bearing note due January 1, 2007 3,400,000
------------------
$ 5,400,000
(J) Not used.
(K) The Suites Class B Convertible Shares are converible into Apple Suites
common shares and then into
Hospitality Units consisting of common shares with Series A Convertible
Preferred Shares upon the merger with Suites. The expense that results upon
conversion is estimated to be $4,776,000 and will be reflected in Suites
statement of operations upon approval of the merger. The Class B Convertible
Shares will be converted and exchanged as follows:
Class B Convertible Shares of Suites 240,000
Conversion ratio to Suites common stock 2
------------------
480,000
Estimated fair value (see note J) $ 10
------------------
4,800,000
Less: Amount originally paid for Class B Convertible Shares (24,000)
------------------
$ 4,776,000
==================
(L) To adjust Suites historical shareholders' equity to reflect the issuance of
Hospitaliy Units consisting of common shares with Series A Convertible
Preferred Shares at an assumed price of $10.00 per share, in exchange for
all of Suites outstanding common shares and to reflect the conversion of
Suites Class B Convertible Shares to Suites common shares and subsequent
exchange for Hospitality Units consisting of common shares with Series A
Convertible Preferred Shares as follows:
Series A Distributions in
Common Class B Convertible Excess of
Stock Convertible Stock Preferred Stock Earnings
----- ----------------- --------------- --------
Issuance of Hospitality Units consisting of common shares
with Series A Convertible Preferred Shares for Suites
common shares 131,466,670
Conversion of Suites Class B Convertible Shares to
Hospitality Units consisting of common shares with
Series A Convertible Preferred Shares (see Note K) (4,776,000) - 4,776,000
Elimination of Apple Suites historical shareholders'
equity (111,099,353) (24,000) 10,533,895
-------------------------------------------------------------------
Pro forma adjustments $ 15,591,317 $ (24,000) $ - $ 15,309,895
===================================================================
(M) Hospitality Class B Convertible Shares are exchanged for Hospitality
Series C convertible shares. The expense that results upon exchange is
estimated to be $12,696,000 and will be reflected in Hospitality's statement
of operations upon approval of the merger. The Class B Convertible Shares
will be exchanged as follows:
Class B Convertible Shares 240,000
Conversion ratio to Hospitality Series C convertible stock 5
------------------
1,272,000
Estimated fair value $ 10
------------------
12,720,000
Less: Amount originally paid for Hospitality Class B Convertible Shares (24,000)
------------------
$ 12,696,000
==================
(N) Special distribution to Hospitality shareholders to be paid prior to closing
of merger.
HOSPITALITY
UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2001 AND FOR THE SIX MONTHS ENDED JUNE 30, 2002
The Unaudited Pro Forma Condensed Combined Consolidated Statement of Operations
for the year ended December 31, 2001 and the six months ended June 30, 2002 are
presented as if the merger had occurred at the beginning of each period
presented. In addition to the merger, the Unaudited Pro Forma Condensed Combined
Statements of Operations give effect to two mergers and one acquisition made by
Hospitality during 2001 and 2002. The Unaudited Pro Forma Condensed Combined
Statements of Operations give effect to the merger under the purchase method of
accounting in accordance with Accounting Standards Board Opinion No, 16, and the
combined entity qualifying as a REIT, distributing at least 95% of its taxable
income, and therefore, incurring no federal tax liability for the periods
presented.
This pro forma Statement of Operations also assumes all of the hotels had been
leased to our wholly owned taxable REIT subsidiaries pursuant to master hotel
lease agreements. Residence Inn by Marriott will continue to manage the hotels
owned by Hospitality under agreements not materially different from historical
contractual arrangements. Promus Hotels, Inc. a wholly-owned subsidiary of
Hilton Hotels Corporation, will continue to manage the hotels owned by Suties
under the same agreements.
The following Unaudited Pro Forma Condensed Combined Consolidated Statement of
Operations of Hospitality also present the purchase of Marriott Residence Inn II
Limited Partnership (the "Partnership"), containing 23 Residence Inn by Marriott
hotels, from Host Mariott Corporation ("Host") for approximately approximately
$136 million in total purchase price, net of cash acquired of $24 million had
occurred on January 1, 2001 for the twelve month and January 1, 2002.
In addition, the unaudited Pro Forma Condensed Statement of Operations includes
the purchase of 15 Residence Inn (R) by Marriott hotels from Host in March 2002
for an aggregate purchase price of $133 million; as well as, 10 Residence Inn
(R) by Marriott hotels from Crestline Capital Corporation in September 2001, for
an aggregate purchase price of $123.5 million. The results of operations
subsequent to our purchase are included in the historical statement of
operations of the Company.
Such pro forma information is based in part upon the historical Consolidated
Statements of Operations of the Company, and the historical Statements of
Operations of the Marriott Residence Inn I and II Limited Partnerships and
Residence Inn III LLC. In management's opinion, all adjustments necessary to
reflect the effects of these transactions have been made.
The following unaudited Pro Forma Condensed Consolidated Statement of Operations
of the Company are not necessarily indicative of what actual results of
operations of the Company would have been assuming such transactions had been
completed on January 1, 2001 for the twelve month and January 1, 2002 for the
six month statement of operations, nor does it purport to represent the results
of operations for future periods.
Hospitality did not commence operations until May 1, 2001. Accordingly,
Hospitality's historical 2001 historical consolidated statement of operations
contained less than a complete fiscal year of operations.
These unaudited pro forma condensed financial statements should be read in
conjunction with the Company's historical consolidated financial statements.
For the year ended December 31, 2001
Hospitality
Historical
Statement of Historical Historical
Operations Residence Inn Pro forma Pro forma before Marriott Residence
(May 1- Dec. 31) III LLC (A) Adjustments 2002 acquisitions Inn LP (A)
---------------------------------------------- ------------------------------------
Revenue:
Suite revenue $ 10,022,272 $ 27,564,918 $ - $ 37,587,190 $ 61,423,000
Other operating revenue 414,493 - - 414,493 2,621,000
Interest income 2,005,006 - (1,827,669) (B) 177,337 664,000
---------------------------------------------- ------------------------------------
Total revenue 12,441,771 27,564,918 (1,827,669) 38,179,020 64,708,000
Expenses:
Operating expenses 4,516,264 12,288,306 - 16,804,570 28,116,000
General and administrative 491,009 - 372,897 (C) 863,906 1,636,000
Franchise fees (Residence Inn System Fee) 400,888 1,055,127 - 1,456,015 2,457,000
Management fees 474,041 551,298 - 1,025,339 1,281,000
Permits, licenses & lease payments - 128,688 - 128,688 -
Chain services 233,643 552,449 - 786,092 -
Incentive management fees - 841,983 - 841,983 3,375,000
Taxes, insurance and other 552,734 1,322,418 - 1,875,152 5,807,000
Depreciation of real estate owned 1,084,933 - 2,019,336 (D) 3,104,269 6,479,000
- -
Management termination fees
Interest 1,371,540 - 2,868,745 (E) 4,240,285 10,152,000
-
--------------------------------------------- ------------------------------------
Total expenses 9,125,052 16,740,269 5,260,978 31,126,299 59,303,000
Income tax expense - - - - -
--------------------------------------------- ------------------------------------
Net income $ 3,316,719 10,824,649 (7,088,647) 7,052,721 5,405,000
============================================= ====================================
Earnings per common share:
Basic and Diluted $ 0.52 0.75
============== ==============
Basic and diluted weighted average
common shares outstanding 6,334,649 3,038,590 9,373,239
Pro forma before Historical
acquisition of Marriott
Pro forma Marriott Residence Residence Pro Forma
Adjustments Inn II LP Inn II LP (A) Adjustments
-------------------------------------------------------------------------------
Revenue:
Suite revenue $ - $ 99,010,190 $ 63,727,000 $ -
Other operating revenue - 3,035,493 2,804,000 -
Interest income (664,000) (B) 177,337 1,463,000 (1,463,000) (B)
(100,000) (C)
------------- ---------------------------------------------------
Total revenue (664,000) 102,223,020 67,994,000 (1,563,000)
Expenses:
Operating expenses - 44,920,570 37,459,000 -
General and administrative (1,636,000) (C) 863,906 - 325,000 (D)
Franchise fees (Residence Inn System Fee) 440,837 (D) 4,353,852 2,549,000 -
Management fees - 2,306,339 1,331,000 -
Permits, licenses & lease payments - 128,688 1,165,000 -
Chain services - 786,092 -
Incentive management fees (3,375,000) (K) 841,983 2,545,000 (2,545,000) (H)
Taxes, insurance and other - 7,682,152 2,262,000 -
Depreciation of real estate owned (6,479,000) (E) 7,295,000 (7,295,000) (E)
3,006,965 (F) 6,111,234 3,885,419 (F)
Management termination fees
Interest (10,152,000) (G) 12,362,000 -
9,370,685 (H) 13,610,970
--------------------------------------------------------------------------
Total expenses (8,823,514) 81,605,786 66,968,000 (5,629,581)
Income tax expense - - - - (G)
-------------------------------------------------------------------------
Net income 8,159,514 (I) 20,617,234 $ 1,026,000 $ 4,066,581
=========================================================================
Earnings per common share:
Basic and Diluted 1.38
==============
Basic and diluted weighted average
common shares outstanding 5,603,630 (J) 14,976,869
Total Historical
Pro Forma Homewood Suites Historical
before Historical Statement of Apple Suites
merger Apple Suites, Inc. Operations Adjustments
---------------------------------------------------------------------------------
Revenue:
Suite revenue $ 162,737,190 $ 43,338,533 $ 3,486,143 -
Other operating revenue 5,839,493 2,141,832 175,521
Interest income 381,630
77,337
---------------------------------------------------------------------------
Total revenue 168,654,020 45,861,995 3,661,664 -
Expenses:
Operating expenses 82,379,570 23,337,764 1,835,894
General and administrative 1,188,906 894,121 - 14,226 (S)
Franchise fees (Residence Inn System Fee) 6,902,852 1,729,446 144,054
Management fees 3,637,339 1,521,696 122,117
Permits, licenses & lease payments 1,293,688 -
Chain services 786,092 -
Incentive management fees 841,983 -
Taxes, insurance and other 9,944,152 2,297,935 238,355
Depreciation of real estate owned 4,787,486 513,062 (513,063) (T)
359,606 (T)
9,996,653
Management termination fees 1,413,520
Interest 5,849,378 188,401 (188,401) (U)
25,972,970 366,396 (V)
---------------------------------------------------------------------------
Total expenses 142,944,205 41,831,346 3,041,883 38,764
Income tax expense - - -
---------------------------------------------------------------------------
Net income $ 25,709,815 $ 4,030,649 $ 619,781 $ (38,764)
===========================================================================
Earnings per common share:
Basic and Diluted $ 1.72 $ 0.34
===================================
Basic and diluted weighted average
common shares outstanding 14,976,869 11,907,721 677,592 (X)
Total
Pro Forma Hospitality
before Merger Apple Hospitality Combined
merger Adjustments Adjustments Pro Forma
----------------------------------------------------------------------------------------
Revenue:
Suite revenue $ 209,561,866 $ 209,561,866
Other operating revenue 8,156,846 8,156,846
Interest income 381,630 (66,600) (Q) (300,000) (J) 15,030
77,337 77,337
---------------------------------- ------------------ ------------------
Total revenue 218,177,679 (66,600) (300,000) 217,811,079
Expenses:
Operating expenses 107,553,228 107,553,228
General and administrative 2,097,253 (298,270) (L) 12,696,000 (K)
- (200,000) (O) (12,696,000) (K) 1,598,983
Franchise fees (Residence Inn System Fee) 8,776,352 8,776,352
Management fees 5,281,152 5,281,152
Permits, licenses & lease payments 1,293,688 1,293,688
Chain services 786,092 786,092
Incentive management fees 841,983 841,983
Taxes, insurance and other 12,480,442 12,480,442
Depreciation of real estate owned 4,787,485 815,978 (P) 5,603,463
359,606 359,606
9,996,653 9,996,653
Management termination fees 1,413,520 5,400,000 (M) -
- (5,400,000) (M) 1,413,520
Interest 5,849,378 5,849,378
26,339,366 313,600 (N) 26,652,966
---------------------------------- ------------------- -------------------
Total expenses 187,856,198 317,708 313,600 188,487,506
Income tax expense - - -
---------------------------------- ------------------- -------------------
Net income $ 30,321,481 $ (384,308) $ (613,600) $ 29,323,573
================================== =================== ===================
Earnings per common share:
Basic and Diluted $ 1.10 $ 1.00
=============== ===================
Basic and diluted weighted average
common shares outstanding 27,562,182 480,000 1,272,000 29,314,182
For the six months ended June 30, 2002 (unaudited)
Hospitality Historical Pro forma before
Historical Marriot Residence acquisition of
Statement of Inn LP for Periods Pro forma Marriott Residence
Operations 1 & 2 2002 Adjustments Inn II LP
--------------------------------------------------------- -----------------------
Revenue:
Suite revenue $ 33,381,932 $ 7,516,099 - 40,898,031
Other operating revenue 1,188,221 296,191 - 1,484,412
Interest income 336,387 - - 336,387
----------------------------------------------------- ------------------------
Total revenue 34,906,540 7,812,290 - 42,718,830
Expenses:
Operating expenses 15,513,207 3,931,579 - 19,444,786
General and administrative 683,325 - 215,348 (D) 898,673
Franchise fees (Residence Inn System Fee) 1,335,276 300,644 - 1,635,920
Management fees 1,515,880 156,246 - 1,672,126
Permits, licenses & lease payments - 46,747 - 46,747
Chain Services 538,334 143,542 - 681,876
Incentive management fees - - - -
Taxes, insurance and other 2,212,034 434,737 - 2,646,771
Depreciation of real estate owned 2,639,286 - 443,527 (F) 3,082,813
- -
Imputed interest expense on Res I 450,000 - - 450,000
Management termination fees
Ground lease
Interest 4,502,602 - 1,365,355 (H) 5,867,957
----------------------------------------------------- ------------------------
Total expenses 29,389,944 5,013,495 2,024,230 36,427,669
Income tax expense - - - -
----------------------------------------------------- ------------------------
Net income $ 5,516,596 $ 2,798,795 $ (2,024,230) $ 6,291,161
===================================================== ========================
Earnings per common share: $ 0.33 0.37
=============== ========================
Basic and Diluted
Basic and diluted weighted average
common shares outstanding 16,810,654 - 16,810,654
=============== ========================
Historical
Marriott Hospitality
Residence Pro Forma Pro Forma Historical Merger
Inn II LP (A) Adjustments Before Merger Apple Suites, Inc. Adjustments
---------------------------------------------------------------------------------------
Revenue:
Suite revenue $ 28,805,000 $ - 69,703,031 $ 24,052,840
Other operating revenue 1,100,000 - 2,584,412 1,091,234 (33,000) (Q)
Interest income 294,000 (294,000) (B) 12,001
(50,000) (C) 286,387
--------------------------------- ------------------------------------------------
Total revenue 30,199,000 (344,000) 72,573,830 25,156,075 (33,000)
Expenses:
Operating expenses 16,546,000 35,990,786 12,866,178
General and administrative - 365,000 (D) 1,263,673 555,482 (156,252) (L)
Franchise fees (Residence Inn System Fee) 1,073,000 - 2,708,920 962,114 (100,000) (O)
Management fees 598,000 - 2,270,126 857,076 -
Permits, licenses & lease payments 1,040,000 - 1,086,747 -
Chain Services - 681,876 -
Incentive management fees 1,185,000 (1,185,000) (H) - -
Taxes, insurance and other 1,102,000 - 3,748,771 1,337,177
Depreciation of real estate owned 3,319,000 (3,319,000) (E) - 2,700,916 407,939 (P)
1,942,710 (F) 5,025,523
Imputed interest expense on Res I 450,000 -
Management termination fees -
Ground lease 50,000
Interest 5,531,000 11,398,957 3,442,549
--------------------------------- ------------------------------------------------
Total expenses 30,394,000 (2,196,290) 64,625,379 22,771,492 151,687
Income tax expense - - (G) - - -
--------------------------------- ------------------------------------------------
Net income $ (195,000) $ 1,852,290 7,948,451 2,384,583 $ (184,687)
=======================================================================================
Earnings per common share: 0.47 $ 0.19
===============================
Basic and Diluted
Basic and diluted weighted average
common shares outstanding - 16,810,654 12,666,677 480,000 (R)
=================================================
Hospitality
Hospitality Combined
Adjustments Pro Forma
------------------------- -----------------------
Revenue:
Suite revenue $ 93,755,871
Other operating revenue 3,642,646
Interest income 12,001
(150,000) (J) 136,387
------------------------- ----------------------
Total revenue (150,000) 97,546,905
Expenses:
Operating expenses 48,856,964
General and administrative 1,662,903
Franchise fees (Residence Inn System Fee) 3,571,034
Management fees 3,127,202
Permits, licenses & lease payments 1,086,747
Chain Services 681,876
Incentive management fees -
Taxes, insurance and other 5,085,948
Depreciation of real estate owned 3,108,855
5,025,523
Imputed interest expense on Res I 450,000
Management termination fees -
Ground lease 50,000
Interest 156,800 (N) 14,998,306
------------------------- ----------------------
Total expenses 156,800 87,705,358
Income tax expense - -
------------------------- ----------------------
Net income $ (306,800) $ 10,217,547
========================= ======================
Earnings per common share: $ 0.33
======================
Basic and Diluted
Basic and diluted weighted average
common shares outstanding 1,272,000 (R) 31,229,331
========================= ======================
Notes to Unaudited Pro Forma Condensed Combined Consolidated Statements of
Operations for Residence Inn III LLC:
(A) Represents results of operations for the hotels acquired on a pro forma
basis as if the hotels were owned by the Company at January 1, 2001 for the
respecitve periods prior to acquisition by the Company in September 2001.
(B) Represents the elimination of the interst income recorded on the $47
million promissory note with Cresline, as the note receivable was used to
purchase the Partnership.
(C) Represents the advisory fee of .25% of accumulated capital contributions
under the "best efforts" offering for the period of time not owned by the
company plus anticipated legal and accounting fees, employee costs,
salaries and other costs of operating as a public company of $814, 377 and
$372, 896 for the year ended December 31, 2000, and the period ended
December 31, 2001, respectively.
(D) Represents the depreciation on the hotels acquired based on the purchase
price allocation of $98 million to depreciable property. The weighted
average lives of the depreciable assets are 39 years for building and 7
years for FF&E. The estimated useful lives are based on management's
knowledge of the properties and the hotel industry in general.
(E) Represents the interst expense for the hotel acquisitions for the period in
which the hotels were not owned. Interest was computed using the interest
rate of 8.08% on the mortgage debt of $53 million.
(F) Represents the combined state and federal income tax expense of our wholly
owned taxable REIT subsidiary estimated based on the contractual agreements
put in place between the Company and our lessee based on a combined rate of
40%. Based on the terms of the lease agreements our taxable subsidiary
would have incurred a loss. No operating loss benefit has been recorded as
a realization is not certain.
(G) Represents the number of shares assumin Residence Inn III LLC was acquired
at the beginning of the period presented.
Notes to Unaudited Pro Forma Condensed Combined Consolidated Statements of
Operations for Marriott Residence Inn LP:
(A) Represents results of operations for the hotels acquired on a pro forma
basis as if the Partnership was owned by the Company on January 1, 2001.
(B) Represents the elimination of historical interest income recorded by the
prior owner.
(C) Represents the elimination of the historical general and administrative
expense allocated ot the hotels by the prior owner, which will not be
incurred by the Company. The amount indicated for general and
administrative expense was extracted from the Partnership's historical
statements.
(D) Represents the advisory fee of .25% of accumulated capital contributions
under the "best efforts" offering for the period of time not owned bu the
Company plus anticipated legal and accounting fees, employee costs,
salaries and other costs of operating as a public company of $330,628 for
the year ended December 31, 2001 and $215,348 for the two months not owned
in 2001.
(E) Represents the elimination of the historical depreciation expense recorded
by the prior owner.
(F) Represents the depreciation on the hotels acquired based on the purchase
price allocation. The weighted average lives of the depreciable assets are
39 years for building and 7 years for FF&E. The estimated useful lives are
based on management's knowledge of the properties and hotel industry in
general.
(G) Represents the elimination of the histornical interest expense recorded by
the prior owner.
(H) Represents the interest expense for the hotel acquisitions for the period
in which the hotels were not owned. Interest was computed using the
interest rates of 8.6% on the mortgage debt of $70.9 million and 15.6% on
the mortgage debt of $20.7 million.
(I) Represents the combined state and federal income tax expense of our wholly
owned taxable REIT subsidiary estimated based on the contractual agreements
put in place between the Company and our lessee based on a combined rate of
40%. Based on the terms of the lease agreements our taxable subsidiary
would have incurred a loss. No operating loss benefit has been recorded as
realization is not certain.
(J) Represents additional common shares assuming the Partnership was acquired
at the beginning of the period presented.
(K) Represents elimination of incentive management fees from prior owner, since
payment is not considered probable.
Notes to Unaudited Pro Forma Condensed Combined Consolidated Statements of
Operations (unaudited) for Marriott Residence Inn II Limited Partnership:
(A) Represents results of operations for the hotels acquired on a pro forma
basis as if the Partnership was owned by the Company on January 1 of the
respective period.
(B) Represents the elimination of historical interest income recorded by the
prior owner as cash was used to fund acquisition.
(C) Represents the elimination of interest income on Company cash of
approximately $5 million used to fund acquisition at interest rates in
effect during periods presented.
(D) Represents the advisory fee of .25% of accumulated capital contributions
under the "best efforts" offering for the period of time not owned by the
Company plus anticipated legal and accounting fees, employee costs,
salaries and other costs of operating as a public company.
(E) Represents the elimination of the historical depreciation expense recorded
by the prior owner.
(F) Represents the depreciation on the hotels acquired based on the purchase
price allocation. The weighted average lives of the depreciable assets are
39 years (fair value allocation of approximately $116.67 million) for
building and 7 years for FF&E (fair value allocation of $6.25 million). The
estimated useful lives are based on management's knowledge of the
properties and hotel industry in general.
(G) Represents the combined state and federal income tax expense of our wholly
owned taxable REIT subsidiary estimated based on the contractual agreements
put in place between the Company and our lessee based on a combined rate of
40%. Based on the terms of the lease agreements our taxable subsidiary
would have incurred a loss. No operating loss benefit has been recorded as
realization is not certain.
(H) Represents elimination of incentive management fees from prior owner, since
payment is not considered probable.
Merger and Hospitality Adjustments:
(J) Represents reduction of interest income on $15 million special distribution
to Hospitality's shareholders just prior to the merger at money market
interest rates in effect during the period, 2%.
(K) Represents expense associated with conversion of Hospitality Class B
convertible shares and Suites Class B convertible shares to Hospitality
Series C convertible shares and Hospitality units, respectively (see Note K
and M to Unaudited Pro Forma Condensed Combined Consolidated Balance
Sheet). Amount is eliminated since this transaction is directly
attributable to the merger and is not expected to have on-going impact.
(L) Elimination of Apple Suites advisory fee, as advisory contract will
terminate upon merger.
(M) Represents expense associated with advisor termination (see Note I to
Unaudited Pro Forma Condensed Combined Consolidated Balance Sheet). Amount
is eliminated since it is in connection with the merger and will not have
on-going impact.
(N) Represents imputed interest at 7% on $4.48 million non-interest bearing
note issued in connection with the termination of the advisor agreement.
(O) Reduction of operating expenses to operate as a public company eliminated
as a result of the merger, such as audit fees and costs associated with
producing the annual report.
(P) Represents additional depreciation expense on the increase of fair market
value of Apple Suites real estate using a depreciable life of 39 years.
$ 23,232,219 New additional interest in basis of
Suites depreciable rental property
(See Note G on Balance Sheet)
allocated to building (19.54% allocated to
80.46% land)
--------------
$ 18,692,022
39 Depreciable life
--------------
$ 479,283 Full year
$ 239,641 Half year
(Q) Represents a reduction to interest income resulting from the use of cash
for payment of transaction costs and purchase price as a result of the
merger at a money market interest rate of 2%.
$ 3,330,000 Transaction costs
0.02
---------------
$ 66,600 Full year
$ 33,300 Six months
(R) Represents increase in shares resulting from the exchange of Hospitality
Class B Convertible Shares into Hospitality Series C shares and conversion
of Suites Class B Convertible Shares into Hospitality Common Shares as
follows:
Hospitality Class B Convertible Shares 240,000 Suites Class B Convertible Shares 240,000
Conversion ratio to Hospitality Common Shares-Series C 5 Conversion ratio to Suites Common Shares 2
------------ ---------
Hospitality Common Shares 1,272,000 Suites Common Shares 480,000
Conversion ratio to Common Shares 1
---------
Hospitality Common Shares 480,000
Apple Suites Adjustments:
(S) Represents the advisory fee of .25% of accumulated capital contributions
under the "best efforts" offering for the period of time not owned by Apple
Suites for the periods presented.
(T) Represents the depreciation on the hotels acquired based on the purchase
price, excluding amounts allocated to land, for the period of time not
owned. The weighted average life of the depreciable assets was 39 years.
(U) Represents the elimination of the expense recorded by the prior owner since
it will not be an on-going expense to the Company.
(V) Represents the interest expense on Apple Suites long-term refinancings of
$50 million at a rate of 9% and $10.7 million at a rate of 8.15% and a
portion of the $10 million short-term financing ($6,569,500) at a rate of
one month LIBOR plus 200 basis points (8.67%) for the term of the financing
(6 months) for the periods presented.
(W) Management termination fees have been eliminated in 2001, since it will not
have an on-going impact.
(X) Represents additional common shares assuming the properties were acquired
at the beginning of the periods presented with the net proceeds from the
"best efforts" offering of $10 per share (net $8.95 per share) for the
remiander.
F-3
Independent Auditors' Report
THE BOARD OF DIRECTORS AND SHAREHOLDERS
Apple Suites, Inc.
We have audited the accompanying consolidated balance sheets of Apple Suites,
Inc. (the "company") as of December 31, 2001 and December 31, 2000, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the years ended December 31, 2001 and 2000, and for the period from
March 26, 1999 through December 31, 1999. These financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Apple Suites, Inc. at
December 31, 2001 and 2000 and the consolidated results of its operations and
its cash flows for the years ended December 31, 2001 and 2000, and for the
period March 26, 1999 through December 31, 1999, in conformity with accounting
principles generally accepted in the United States.
/s/ Ernst & Young LLP
Richmond, Virginia
February 15, 2002
F-4
Consolidated Balance Sheets
December 31, December 31,
2001 2000
- --------------------------------------------------------------------------------------------
Assets
A S S E T S
Investment in hotels-net of accumulated depreciation
of $8,274,076 and $3,486,590 $170,437,222 $124,576,257
Cash and cash equivalents 8,331,891 2,653,058
Restricted cash 184,962 263,686
Rent receivable from Apple Suites Management, Inc. -- 1,872,832
Notes and other receivables from Apple Suites Management, Inc. -- 1,774,684
Accounts receivable, net 1,002,160 --
Inventories 145,300 --
Capital improvement reserve 438,823 504,413
Deferred financing costs, net 1,364,499 1,265,107
Deferred franchise fees, net 792,794 --
Other assets 2,479,434 1,163,811
------------ ------------
Total Assets $185,177,085 $134,073,848
============ ============
Liabilities and Shareholders' Equity
L I A B I L I T I E S
Notes payable--secured $ 77,041,296 $ 57,670,866
Interest payable 510,119 19,988
Accounts payable and accrued expenses 2,850,311 1,570,372
Due to third party manager 700,969 --
Accounts payable--affiliate 74,515 --
Distributions payable -- 1,848,000
------------ ------------
Total Liabilities 81,177,210 61,109,226
S H A R E H O L D E R S ' E Q U I T Y
Preferred stock, 15,000,000 authorized shares;
none issued or outstanding -- --
Class B convertible stock, no par value, authorized
240,000 shares; issued and outstanding 240,000 shares 24,000 24,000
Common stock, no par value, authorized 200,000,000 shares;
issued and outstanding 12,666,677 shares and 8,666,348,
respectively 111,099,353 75,223,218
Distributions greater than net income (7,123,478) (2,282,596)
------------ ------------
Total Shareholders' Equity 103,999,875 72,964,622
------------ ------------
Total Liabilities and Shareholders' Equity $185,177,085 $134,073,848
============ ============
See accompanying notes to consolidated financial statements
F-5
Consolidated Statements of Operations
Year ended March 26, 1999
Year ended December through December
December 31, 2001 31, 2000 31, 1999
- ---------------------------------------------------------------------------------------------------
R E V E N U E S
Suite revenue $ 43,338,533 $ -- $ --
Lease revenue -- 15,807,258 2,518,031
Interest income 381,630 395,671 169,086
Other revenue 2,141,832 -- --
------------- ------------- -------------
Total revenues 45,861,995 16,202,929 2,687,117
------------- ------------- -------------
E X P E N S E S
Operating expenses 13,728,597 -- --
Hotel administrative expense 3,480,879 -- --
Advertising and promotion 4,184,900 -- --
Utilities 1,943,388 -- --
Franchise fees 1,729,446 -- --
Management fees 1,521,696 -- --
Taxes, insurance and other 2,297,935 2,083,533 426,592
General and administrative 894,121 1,048,212 153,807
Depreciation of real estate owned 4,787,486 2,990,381 496,209
Interest 5,849,378 6,611,716 1,245,044
Management termination fees 1,413,520 -- --
------------- ------------- -------------
Total expenses 41,831,346 12,733,842 2,321,652
------------- ------------- -------------
Net income $ 4,030,649 $ 3,469,087 $ 365,465
============= ============= =============
Basic and diluted earnings per common share $ 0.34 $ 0.66 $ 0.14
============= ============= =============
Distributions paid per common share $ 1.03 $ 1.02 $ 0.33
============= ============= =============
(a) The company was initially capitalized on March 26, 1999; however, operations
did not commence until September 1, 1999.
See accompanying notes to consolidated financial statements.
F-6
Consolidated Statements of Shareholders' Equity
Common Stock Class B Convertible Stock
---------------------------------------------------------
Number Number
of Shares Amount of Shares Amount
- ------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 26, 1999 10 $ 100 -- --
Issuance of Convertible Class B Stock -- -- 240,000 24,000
Net proceeds from the sale
of common shares 3,420,110 28,507,514 -- --
Net income -- -- -- --
Cash distributions declared to
shareholders ($.33 per share) -- -- -- --
Common shares issued through
reinvestment of distributions 9,294 83,646 -- --
-----------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 3,429,414 28,591,260 240,000 24,000
Net proceeds from the sale
of common shares 5,040,740 44,866,217 -- --
Net income -- -- -- --
Cash distributions declared to common
shareholders ($1.02 per share) -- -- -- --
Common shares issued through
reinvestment of distributions 196,194 1,765,741 -- --
-----------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 8,666,348 75,223,218 240,000 24,000
Net proceeds from the sale
of common shares 3,806,801 34,134,371 -- --
Net income -- -- -- --
Cash distributions declared to common
shareholders ($.77 per share) -- -- -- --
Common shares issued through
reinvestment of distributions 193,528 1,741,764 -- --
-----------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 12,666,677 $ 111,099,353 240,000 $ 24,000
===========================================================
See accompanying notes to Consolidated financial statements
Consolidated Statements of Shareholders' Equity (continued)
Distribution Total
Greater Than Shareholders'
Net Income Equity
- -------------------------------------------------------------------------
BALANCE AT MARCH 26, 1999 -- $ 100
Issuance of Convertible Class B Stock -- 24,000
Net proceeds from the sale
of common shares -- 28,507,514
Net income 365,465 365,465
Cash distributions declared to
shareholders ($.33 per share) (882,725) (882,725)
Common shares issued through
reinvestment of distributions -- 83,646
------------------------------
BALANCE AT DECEMBER 31, 1999 (517,260) 28,098,000
Net proceeds from the sale
of common shares -- 44,866,217
Net income 3,469,087 3,469,087
Cash distributions declared to common
shareholders ($1.02 per share) (5,234,423) (5,234,423)
Common shares issued through
reinvestment of distributions -- 1,765,741
------------------------------
BALANCE AT DECEMBER 31, 2000 (2,282,596) 72,964,622
Net proceeds from the sale
of common shares -- 34,134,371
Net income 4,030,649 4,030,649
Cash distributions declared to common
shareholders ($.77 per share) (8,871,531) (8,871,531)
Common shares issued through
reinvestment of distributions -- 1,741,764
------------------------------
BALANCE AT DECEMBER 31, 2001 $ (7,123,478) $ 103,999,875
==============================
See accompanying notes to Consolidated financial statements
F-7
Consolidated Statement of Cash Flow
March 26, 1999
Year ended through
Year ended December 31, December 31,
December 31, 2001 2000 1999 (a)
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 4,030,649 $ 3,469,087 $ 365,465
Non-cash portion of management termination fees 470,090 -- --
Depreciation of real estate owned 4,787,486 2,990,381 496,209
Amortization of deferred franchise fees 40,242
Amortization of deferred financing costs 156,056 124,233 --
Changes in operating assets and liabilities
(net of amounts acquired/assumed from acquisitions)
Prepaid expenses (1,097,212) 13,456 (270,229)
Rent and notes receivable from Apple Suites Management, Inc. -- (777,054) (2,152,203)
Other assets (308,688) 210,464 --
Receivables 119,212 --
Accounts payable (150,951) 53,362 65,214
Accounts payable--affiliate 74,515 (708,751) 708,751
Due to third party manager 621 -- --
Accrued expenses 506,128 583,128 868,668
Interest payable 490,131 (446,152) 466,140
--------------------------------------------------------
Net cash provided by operating activities 9,118,279 5,512,154 548,015
CASH FLOW FROM INVESTING ACTIVITIES:
Cash assumed in the acquisition of hotels 2,793,106 -- --
Net (increase) decrease in cash restricted for property
improvement plan and cap improvement reserve held with
third party 144,314 1,009,549 (1,604,363)
Deposit for acquisition of Apple Suites Management -- (900,000) --
Cash paid for acquisition of hotels (32,356,608) (8,712,253) (26,045,300)
Capital improvements (1,791,844) (2,483,503) (464,026)
Payments received on notes receivable -- 98,943 1,748
Earnest money deposit for pending acquisitions -- -- (300,000)
--------------------------------------------------------
Net cash used in investing activities (31,211,032) (10,987,264) (28,411,941)
CASH FLOW FROM FINANCING ACTIVITIES:
Repayment of secured notes payable (24,829,570) (83,679,134) --
Repayment of unsecured notes payable -- (10,000,000) --
Proceeds from secured notes payable 27,700,000 50,000,000 --
Proceeds from unsecured notes payable -- 10,000,000 --
Net proceeds from issuance of common stock 35,876,135 46,631,958 28,591,160
Payment from officer-shareholder for Convertible
Class B stock -- -- 24,000
Cash payments for financing costs (255,448) (1,306,842) --
Cash distributions paid to shareholders (10,719,531) (4,099,158) (169,990)
--------------------------------------------------------
Net cash provided by financing activities 27,771,586 7,546,824 28,445,170
--------------------------------------------------------
Increase in cash and cash equivalents 5,678,833 2,071,714 581,244
Cash and cash equivalents, beginning of period 2,653,058 581,344 100
--------------------------------------------------------
Cash and cash equivalents, end of period $ 8,331,891 $ 2,653,058 $ 581,344
========================================================
SUPPLEMENTAL CASH FLOW INFORMAION:
Interest paid $ 5,203,192 $ 6,933,634 $ 550,147
Non-cash transactions:
Debt assumed in connection with acquisitions $ 16,500,000 $ 22,780,500 $ 68,569,500
(a) The company was initially capitalized on March 26, 1999; however,
operations did not commence until September 1, 1999.
See accompanying notes to consolidated financial statements.
F-8
Notes to Consolidated Financial Statements
NOTE 1 GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION Apple Suites, Inc., together with its subsidiaries (the "company"),
is a Virginia corporation formed in March of 1999 to invest primarily in
extended-stay hotels. Hotel operations commenced on September 1, 1999.
Effective January 1, 2001 (the effective date for the REIT Modernization Act),
the company acquired Apple Suites Management, Inc. and its subsidiaries (the
"lessee"). In 2000, the company paid Mr. Glade M. Knight, the company's
president and chairman, a deposit of $900,000 in exchange for all the issued and
outstanding stock of the lessee. For financial reporting purposes, the company
recorded the $900,000 of cash, plus the fair value of net liabilities assumed of
$513,520, from lessee as a management termination fee (a total of $1,413,520)
in 2001, as the lessee's only business is its lease with the company. Effective
January 1, 2001, all inter-company transactions, including lease revenue and
rental expenses, between the company and the lessee are eliminated in
consolidation.
The company operates in one defined business segment consisting of upscale
extended-stay hotels. At December 31, 2001, the company owned, either directly
or through its subsidiaries, a total of 17 Homewood Suites(R) by Hilton hotel
properties, comprising 1,922 suites, located throughout the United States. The
company leases to the lessee all of its hotels acquired to date pursuant to the
terms of master hotel lease agreements ("Percentage Leases"). Beginning in 2001,
the lessee operates as a taxable REIT subsidiary under the same percentage lease
agreements in place before the management termination transaction. The lessee
hired Promus Hotels, Inc. ("Promus"), a wholly owned subsidiary of Hilton Hotels
Corporation ("Hilton"), to manage the company's hotels under the terms of a man-
agement agreement.
CASH AND CASH EQUIVALENTS Cash equivalents include highly liquid investments
with original maturities of three months or less. The fair market value of cash
and cash equivalents approximate their carrying value.
RESTRICTED CASH Restricted cash consists of cash restricted for property
improvements under the franchise-required Property Improvement Plans.
DEFERRED EXPENSES Deferred financing costs include fees and other costs incurred
to obtain debt financing, net of accumulated amortization of $197,732 at
December 31, 2001 and $41,735 at December 31, 2000. These costs are amortized on
a straight-line basis, over the term of the related debt which is not
materially different than the effective interest method.
Deferred franchise fees represent the costs incurred in connection with entering
into hotel license agreements, net of accumulated amortization of $70,492 at
December 31, 2001 and $31,164 at December 31, 2000. Deferred franchise fees are
being amortized over the term of the hotel license agreements, which is 20
years.
INVESTMENT IN HOTELS The hotels are stated at cost, net of depreciation, and
include real estate brokerage commissions paid to Apple Suites Realty Group,
Inc., a related party (see Note 6). Repair and maintenance costs are expensed as
incurred, while significant improvements, renovations, and replacements are
capitalized. Depreciation is computed using the straight-line method over
estimated useful lives of the assets, which are 39 years for buildings, ten
years for major improvements and three to seven years for furniture and
equipment.
The carrying value of each hotel is evaluated periodically to determine if
circumstances exist that indicate an impairment in the carrying value of the
investment in the hotel. Adjustments are made based on fair value of the
underlying property if impairment is indicated. No impairment losses have been
recorded to date.
F-9
REVENUE RECOGNITION Revenue is recognized as earned, which is generally defined
as the date upon which a guest occupies a room or utilizes the hotel's services.
INVENTORIES Inventories, consisting primarily of food, beverages and hotel
supplies, are stated at the lower of cost or market, with cost determined on a
method that approximates the first-in, first-out basis.
STOCK INCENTIVE PLANS The company elected to follow Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees" and related
Interpretations in accounting for its employee stock options. As discussed in
Note 5, the alternative fair value accounting provided for under Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" requires use
of option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
EARNINGS PER COMMON SHARE Basic earnings per common share are computed based
upon the weighted-average number of shares outstanding during the year. Diluted
earn- ings per share is calculated after giving effect to all potential common
shares that were dilutive and outstanding for the year. Class B convertible
shares are not included in earnings per common share calculations until such
time it becomes probable that such shares can be converted to common shares (see
Note 4).
FEDERAL INCOME TAXES The company is operated as, and will annually elect to be
taxed as, a real estate investment trust under the Internal Revenue Code of
1986, as amended (the "Code"). A real estate investment trust which complies
with the provisions of the Code and distributes at least 90% (reduced from 95%
prior to the REIT Modernization Act which became effective January 1, 2001) of
its taxable income to its shareholders generally does not pay federal income
taxes on its distributed income. Accordingly, no provision has been made for
federal income taxes.
For federal income tax purposes, distributions paid to shareholders consist of
ordinary income and return of capital, or a combination thereof. Distributions
declared per share were $.77, $1.02 and $.33 for the periods ended December 31,
2001, 2000 and 1999, respectively. In 2001, of the total distribution, 68% was
taxable as ordinary income, and 32% was a non-taxable return of capital. In
2000, 70% was taxable as ordinary income and 30% was a non-taxable return of
capital. In 1999, 68% was taxable as ordinary income and 32% was a non-taxable
return of capital.
The taxable REIT subsidiary provides for income taxes under the provisions of
SFAS No. 109 "Accounting for Income Taxes." SFAS No. 109 requires an asset and
liability based approach in accounting for income taxes. This approach also
requires the recognition of future tax benefits, such as net operating loss
carryforwards, to the extent that realization of such benefits is more likely
than not.
The lessee incurred a loss during the period and as such has no income tax
liability at December 31, 2001. No operating loss benefit has been recorded in
the consolidated balance sheet since realization is uncertain. At December 31,
2001, the lessee has approximately $600,000 of net operating loss carryforwards
that begin to expire in 2020.
ADVERTISING AND PROMOTION COSTS Advertising and promotion costs are expensed
when incurred. Advertising and promotion costs represent the expense for
franchise advertising and reservation systems under the terms of the hotel
franchise agreements and general and administrative expenses that are directly
attributable to advertising and promotion.
USE OF ESTIMATES The preparation of financial statements in accordance with
accounting principles generally accepted in the United States requires
management to make certain estimates and assumptions that affect amounts
reported in the financial statements and accompanying notes. Actual results may
differ from those estimates.
SEASONALITY The hotel industry is seasonal in nature. Seasonal variations in
revenues at the hotels under lease may cause quarterly fluctuations in the
company's revenues. Revenues for 1999 primarily consist of fourth quarter
revenues which may not be indicative of a full year.
COMPREHENSIVE INCOME The company does not currently have any items of
comprehensive income requiring separate reporting and disclosure.
DERIVATIVE INSTRUMENTS FASB Statements No. 133 and 138 "Accounting for Certain
Derivative Instruments and Hedging Activities" became effective January 1, 2001.
The company currently does not have any derivatives subject to these statements.
F-10
CREDIT RISK The company maintains cash on deposit with Promus in a pooled
investment account that potentially subjects the company to a concentration of
credit risk. At December 31, 2001, the company had $2,426,752 on deposit with
Promus.
RECLASSIFICATIONS Certain reclassifications have been made to the 2000 and 1999
financial statements to conform with the 2001 presentation. These
reclassifications have no effect on net income or shareholders' equity.
RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangibles,"
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill and intangible assets deemed to have indefinite lives will no
longer be amortized but will be subject to annual impairment tests in accordance
with the Statements. Other intangible assets will continue to be amortized over
their useful lives. The company will adopt these new accounting standards
beginning the first quarter of fiscal 2002. The company believes the adoption of
these standards will not have a material impact on its financial statements.
In August 2001, the FASB issued Statement 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The Statement supercedes Statement 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" and APB. Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions for
segments of a business to be disposed of." SFAS No. 144 retains the requirements
of SFAS No. 121 relating to the recognition and measurement of an impairment
loss and resolves certain implementation issues resulting from SFAS No. 121.
This Statement is effective for fiscal years beginning after December 15, 2001.
We are currently assessing the impact of this statement on the company; however,
we do not anticipate this statement will have a material impact on the
consolidated financial position or results of operations of the company.
NOTE 2 INVESTMENT IN HOTELS
At December 31, 2001, the company owned the following Homewood Suites(R) by
Hilton Hotels:
Initial
Acquisition Accumulated Acquired
Description Cost Gross Value* Depreciation Encumbrances Date Acquired
- -------------------------------------------------------------------------------------------------------------------------
Dallas/Addison, Texas $ 9,500,000 $ 10,465,034 $ 643,577 $ 5,436,474 September 1999
Dallas/Las Colinas, Texas 11,200,000 12,253,110 726,849 5,634,164 September 1999
Dallas/Plano, Texas 5,400,000 5,624,242 441,836 2,471,125 September 1999
Richmond, Virginia 9,400,000 9,794,179 730,537 5,436,474 September 1999
Atlanta/Cumberland, Georgia 9,800,000 10,732,488 657,117 4,942,249 October 1999
Baltimore, Maryland 16,348,000 17,026,552 1,013,482 8,896,050 November 1999
Clearwater, Florida 10,416,000 10,752,701 559,209 5,930,699 November 1999
Detroit, Michigan 4,330,000 4,964,282 346,104 2,471,125 November 1999
Atlanta/Peachtree, Georgia 4,033,000 4,507,792 317,207 2,767,660 November 1999
Salt Lake City, Utah 5,153,000 5,423,952 381,232 2,471,125 November 1999
Jackson, Mississippi 5,846,000 6,090,685 377,904 2,965,350 December 1999
Philadelphia, Pennsylvania 15,489,000 16,149,665 818,870 -- May 2000
Boulder, Colorado 14,885,000 15,827,810 584,464 10,640,378 June 2000
Atlanta/Buckhead, Georgia 12,800,000 13,388,681 218,811 -- April 2001
St. Louis, Missouri 11,500,000 11,802,116 155,809 4,750,000 June 2001
Portland, Oregon 10,500,000 10,792,237 124,183 4,750,000 June 2001
Herndon, Virginia 12,750,000 13,115,772 176,885 7,478,423 June 2001
--------------------------------------------------------------------------------------
$169,350,000 $178,711,298 $ 8,274,076 $ 77,041,296
======================================================================================
*Includes real estate commissions (see Note 6), closing costs, and improvements
capitalized since the date of acquisition for hotels acquired to date.
F-11
The following is a reconciliation of the carrying amount of real estate owned:
2001 2000 1999
- -----------------------------------------------------------------------------------------------
Balance at January 1 $128,062,847 $ 94,215,841 $ --
Real estate purchased 48,856,607 31,363,503 93,751,815
Development of real estate assets 1,791,844 2,483,503 464,026
-------------------------------------------
Balance at December 31 $178,711,298 $128,062,847 $ 94,215,841
===========================================
Investment in hotels at December 31, 2001 and 2000, consist of the following:
2001 2000
- -------------------------------------------------------------------------------
Land $ 29,923,592 $ 18,374,917
Building and improvements 137,549,729 101,314,421
Furniture and equipment 11,237,977 8,373,509
---------------------------------
$ 178,711,298 $ 128,062,847
Less accumulated depreciation (8,274,076) (3,486,590)
---------------------------------
Investments in hotels, net $ 170,437,222 $ 124,576,257
=================================
In conjunction with one of the acquisitions made in 2000, the company leased
land from a third party under an operating lease. The annual rent will be
adjusted by a CPI inflation factor in May 2002. It will be adjusted every five
years following that date by a similarly calculated CPI factor. The future
minimum lease payments under the company's land lease obligation at December 31,
2001 are as follows:
2002 $ 100,000
2003 100,000
2004 100,000
2005 100,000
2006 100,000
Thereafter 1,335,214
----------
$1,835,214
==========
NOTE 3 NOTES PAYABLE
On December 28, 2001, the company placed $9.5 million of secured debt. The loans
are amortized over 25 years and bear interest at a fixed rate of 8.3% per annum,
with a maturity date of January 2012. The loans are payable in monthly
installments, including principal and interest, and are secured by two hotels.
At December 31, 2001, the outstanding balance on this debt was $9.5 million. A
portion of the proceeds were used to pay off the outstanding balance of the
short-term Hilton notes.
On August 15, 2001, the company placed $7.5 million of secured debt. The loan is
amortized over 25 years and bears interest at a fixed rate of 8.14% per annum,
with a maturity date of September 2011. The loan is payable in monthly
installments, including principal and interest, and is secured by one hotel. The
proceeds were used to reduce the outstanding balance of the short-term Hilton
notes. At December 31, 2001, the outstanding balance on this debt was
$7,478,423.
In connection with the purchase of the Portland and St. Louis hotels, notes were
executed by the company payable to Hilton in the amount of $16,500,000. The
notes bore interest at a fixed rate of 8.5% per annum. These notes were paid off
in December, 2001 with proceeds from the secured financings.
On June 1, 2001, the company placed $10.7 million of secured debt. The loan is
amortized over twenty-five years and bears interest at a fixed rate of 8.15% per
annum with a maturity date of June 2011. The loan is payable in monthly
installments, including principal and interest, and is secured by one hotel. The
proceeds were used to reduce the outstanding balance of the short-term Hilton
notes. At December 31, 2001, the outstanding balance on this debt was
$10,640,378.
Assets encumbered by the debt discussed above are held in separate legal
entities. These special purpose entities are wholly-owned subsidiaries of the
company included in the consolidated financial statements.
On September 8, 2000, the company refinanced much of its short-term debt with
loans from a commercial bank in the amount of $60 million. The proceeds were
used to repay four promissory notes the company executed in 1999 when acquiring
11 of the hotels. The company has a $50 million secured loan with a term of 10
years. The $50 million loan bears a fixed interest rate of 9% per annum and is
secured by 11 of our hotels. Prepayment penalties apply for early retirement.
The loan is amortized over twenty-five years with a maturity date in September
2010. At December 31, 2001, the outstanding balance on this debt was
$49,422,447. The remaining $10 million represented a short-term loan which was
repaid on October 25, 2000 with proceeds from the company's equity offering. The
loan bore an interest rate of 8.6% per annum.
F-12
The aggregate maturities of the secured debt for the five years subsequent to
December 31, 2001 are as follows:
2002 $ 874,253
2003 954,575
2004 1,022,857
2005 1,136,295
2006 1,240,751
Thereafter 71,812,565
-----------
$77,041,296
===========
The carrying value of the notes at December 31, 2001 and 2000 approximates fair
value. Fair value is estimated based on current rates offered to the company for
debt of the same term.
NOTE 4 SHAREHOLDERS' EQUITY
On April 17, 2001, the company closed its "best efforts" offering of shares. The
total gross proceeds raised from the "best efforts" offering was $125,000,000.
As the Managing Dealer, David Lerner Associates, Inc. received selling
commissions of 7.5% and a marketing expense allowance of 2.5% of proceeds of the
shares sold. The company received gross proceeds of $40,003,301, $52,369,223 and
$32,627,476 from the sale of 4,000,329, 5,236,934 and 3,429,414 shares,
including shares sold through the reinvestment of distributions, for the years
ended December 31, 2001, 2000, and 1999, respectively. The net proceeds of the
offering, including shares issued through reinvestment of distributions and
after deducting selling commissions and other offering costs, were $111,099,353
($35,876,135 in 2001, $46,631,958 in 2000 and $28,591,260 in 1999).
The company issued 240,000 Class B convertible shares, consisting of 202,500
shares to Mr. Knight, and a combined 37,500 Class B convertible shares to two
other individuals. The Class B convertible shares were issued by the company
before the initial closing of the minimum offering of $15,000,000, in exchange
for payment of $.10 per Class B convertible share, or an aggregate of $24,000.
There will be no dividend payable on the Class B convertible shares. On
liquidation of the company, the holders of the Class B convertible shares will
be entitled to a liquidation payment of $.10 per share before any distributions
of liquidation proceeds to holders of the common shares. Holders of more than
two-thirds of the Class B convertible shares must approve any proposed amendment
to the Articles of Incorporation that would adversely affect the Class B
convertible shares or create a new class of stock senior to, or on a parity
with, the Class B convertible shares. The Class B convertible shares may not be
redeemed by the company.
Each holder of outstanding Class B convertible 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 either of the following conversion events:
(1) the sale or transfer of substantially all of the company's assets,
stock or business, whether through sale, exchange, merger, consolidation,
lease, share exchange or otherwise, or
(2) the termination or expiration without renewal of the Advisory
Agreement with Apple Suites Advisors, Inc., and if the company ceases to
use Apple Suites Realty Group, Inc. to provide substantially all of its
property acquisition and disposition services.
Upon the occurrence of either conversion event, each of the Class B convertible
shares may be converted into two common shares, based upon the gross proceeds in
the public offering of the company's common shares and as disclosed in the
company's prospectus.
No additional consideration is due upon the conversion of the Class B
convertible shares. Upon the probable occurrence of a conversion event, the
company will record expense for the difference between the market value of the
company's common stock and issue price of the Class B convertible shares, which
would have been $4,776,000 at December 31, 2001, based on a price of $10 per
common share.
Compensation expense related to issuance of 240,000 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 is probable. 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.
The issuance of the Series B convertible preferred shares to other individuals
not employed by the company will be accounted for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation." Expense related to the issuance of
the Series B shares will be determined based on fair value of the Series B
shares at grant date in excess of amounts paid by these individuals. Since the
number of common shares to which the Series B shares can be converted is not
known at grant date, and ultimate convertibility to common shares is only
allowed through a defined triggering event, the fair value of the Series B
F-13
shares will be remeasured and not recorded as expense until likely occurrence of
an event triggering the conversion of the Series B convertible preferred shares
to common stock.
NOTE 5 STOCK INCENTIVE PLANS
In July 1999, the Board of Directors approved a Non-Employee Directors Stock
Option Plan (the "Directors Plan") whereby Directors, who are not employees of
the company or affiliates (see Note 6), automatically receive options to
purchase stock five years from the adoption of the plan. Under the Directors
Plan, the maximum number of shares to be issued is equal to 45,000 plus 1.8% of
the number of shares sold in excess of 1,666,667. As the offering is closed at
12,666,667, the maximum number of shares to be issued under the Directors Plan
is 243,000. The options expire 10 years from the date of grant. As of December
31, 2001, 243,000 had been reserved for issuance.
In July 1999, the Board of Directors approved an Incentive Stock Option Plan
(the "Incentive Plan") whereby incentive awards may be granted, either as
options or as restricted shares, to certain employees of the company or
affiliates. Under the Incentive Plan, the maximum number of shares be issued is
equal to 35,000 plus 4.625% of the number of shares sold in excess of 1,666,667.
As the offering is closed at 12,666,667, the maximum number of shares that can
be issued under the Incentive Plan is 543,750. As of December 31, 2001, 543,750
shares had been reserved for issuance.
Both plans generally provide, among other things, that options be granted at
exercise prices not lower than the market value of the shares on the date of
grant. Under the Incentive Plan, at the earliest, options become exercisable the
date of grant. The optionee has up to 10 years from the date on which the
options first become exercisable during which to exercise the options. In 2001,
the company granted 10,132 options to purchase shares under the Directors Plan
and no options under the Incentive Plan. Activity in the company's share options
plan during 2001 and 2000 is summarized in the following table:
2001 2000 1999
------------------------------------------------------------------------
Weighted- Weighted-
Average Average
Exercise Exercise Weighted-Average
Options Price Options Price Options Exercise Price
- -------------------------------------------------------------------------------------------------------------
Outstanding, beginning of period 25,624 $ 9.14 22,000 $ 9.00 -- $ --
Granted 10,132 $ 10.00 3,624 $ 10.00 22,000 $ 9.00
Exercised -- -- -- -- -- --
Forfeited -- -- -- -- -- --
-----------------------------------------------------------------------
Outstanding, end of year 35,756 $ 9.38 25,624 $ 9.14 22,000 $ 9.00
Exercisable at end of year 35,756 $ 9.38 25,624 $ 9.14 22,000 $ 9.00
-----------------------------------------------------------------------
Weighted-average fair value of
options granted during the year $ .48 $ .40 $ .31
-----------------------------------------------------------------------
Pro forma information regarding net income and earnings per share is required by
FASB 123, under the fair value method described in that statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 2001
and 2000, respectively: risk-free interest rates of 5.3% and 6.2%, a dividend
yield of 10.3% for 2001 and 10.2% for 2000, a volatility factor of the expected
market price of the company's common stock of .48 for 2001 and .214 for 2000,
and a weighted-average expected life of the options of 10 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility.
For purposes of FASB 123 pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. As the options
are exercisable within six months of the date of grant, the full impact of the
pro forma adjustment to net income is disclosed below.
2001 2000 1999
- -------------------------------------------------------------------------------------------
Net income available to common shareholders
Pro forma $4,025,786 $3,467,637 $358,645
As reported $4,030,649 $3,469,087 $365,465
Earnings per common share-diluted
Pro forma $.34 $.66 $.14
As reported $.34 $.66 $.14
NOTE 6 COMMITMENTS AND RELATED PARTIES
The company is committed under management agreements to fund up to 5% of suite
revenues per month for capital expenditures to include periodic replacement or
refurbish- ment of furniture, fixtures and equipment. At December
F-14
31, 2001 and 2000, $438,823 and $504,413, respectively, was held by Promus for
these capital improvement reserves. In addition, in accordance with the
franchise agreements, at December 31, 2001 and 2000, $184,962 and $263,686,
respectively, was held for the Property Improvement Plan with a financial
institution and treated as restricted cash.
Promus manages the day-to-day operations of the hotels. For the hotels acquired
prior to 2001, Promus charges fees equal to 4% of total revenue for this
function. For two of the hotels acquired in 2001, Promus charges a base
management fee of 2% of total revenue and an incentive management fee calculated
on the basis of operating profit of the hotels. No incentive management fees
were paid in 2001. For the other two hotels acquired in 2001, Promus charges 2%
of total revenues for the first twelve months, 3% of total revenues for the
second twelve months and 4% of total revenues thereafter.
The lessee has entered into license agreements with Promus to operate the hotels
as Homewood Suites(R) by Hilton properties and to participate in the Hilton
reservation system. These agreements have terms of 20 years and expire in 2019
through 2021. These agreements require the lessee to, among other things, pay
monthly franchise fees equal to 4% of suite revenue. Total expenses for these
services were $4,985,872, $4,203,049 and $653,010 in 2001, 2000 and 1999,
respectively. Prior to 2001, these fees were included in the lessee's financial
statements.
The company has contracted with Apple Suites Realty Group, Inc. ("ASRG") to
acquire and dispose of real estate assets for the company. In accordance with
the contract, ASRG is to be paid a fee of 2% of the purchase price of any
acquisitions or sale price of any dispositions of real estate investments,
subject to certain conditions. During 2001, 2000 and 1999, ASRG earned $953,000,
$607,480 and $1,828,520, respectively, under the agreement.
The company has contracted with Apple Suites Advisors, Inc. ("ASA") to advise
and provide day-to-day management services to the company. In accordance with
the con- tract, the company will pay ASA a fee equal to .1% to .25% of total
equity contributions received by the company in addition to certain reimbursable
expenses. During 2001, 2000 and 1999, ASA earned fees of $298,270, $134,579 and
$23,574, respectively, under this agreement.
ASA holds a three-year contract for the monthly maintenance and support of
accounting software. During 2001, the company paid an upfront fee of $70,000 for
the implementation of this software and began paying a monthly fee for the
maintenance and support.
ASRG and ASA are 100% owned by Mr. Knight. Mr. Knight also serves as the
chairman and chief executive officer of Cornerstone Realty Income Trust, Inc.,
an apartment REIT, and Apple Hospitality Two, Inc., a hospitality REIT formed in
2001. During 2001, Cornerstone Realty Income Trust, Inc. provided the company
with services and rental space and was paid approximately $58,764 in return.
During 2001, the company provided services and rented office space to Apple
Hospitality Two, Inc. and received payment of $190,010.
NOTE 7 WARRANTS
The company has agreed to sell to the Managing Dealer for an aggregate of $100,
warrants (the "Warrants") to purchase 10% of the shares sold in this offering,
up to 3,000,000 common shares, at an exercise price of $16.50 per common share
(165% of the public offering price per common share). The Warrants may not be
sold, transferred, assigned, or hypothecated for one year from the date of
issuance, except to the officers and employees of the Managing Dealer, and are
exercisable at any time and from time to time, in whole or in part, during the
five-year period commencing on the date of the final closing after the
termination of the offering (the "Warrant Exercise Term"). At the company's
expense, the company may be required to register the Warrants under the
Securities Act during the Warrant Exercise Term.
F-15
NOTE 8 EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
2001 2000 1999
- -------------------------------------------------------------------------------------------------
Numerator:
Net income and numerator for basic and diluted earnings $4,010,099 $3,469,087 $ 365,465
Denominator:
Denominator for basic earnings per
share--weighted-average shares 11,907,721 5,274,633 2,648,196
Effect of dilutive securities:
Stock options 2,200 2,200 2,200
Denominator for diluted earnings per share--adjusted
weighted-average shares and assumed conversions 11,909,921 5,276,833 2,650,396
Basic and diluted earnings per common share $ .34 $ .66 $ .14
NOTE 9 QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of quarterly results of operations for the year ended
December 31, 2001 and 2000:
First Second Third Fourth
2001 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------
Revenues $ 10,651,744 $ 11,595,975 $ 12,771,843 $ 10,842,433
Net income 263,126 2,207,215 1,442,993 117,315
Basic and diluted earnings per
common share .03 .18 .11 .01
Distributions paid per share .2575 .2575 .2575 .2575
First Second Third Fourth
2000 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------
Revenues $ 3,454,685 $ 3,934,735 $ 4,662,836 $ 4,150,673
Net income 506,063 689,696 1,359,123 914,205
Basic and diluted earnings per
common share .14 .16 .25 .12
Distributions paid per share .2500 .2500 .2575 .2575
F-16
NOTE 10 PRO FORMA INFORMATION (UNAUDITED)
The following unaudited pro forma information for the years ended December 31,
2001 and 2000 is presented as if the acquisition of three of the four hotels
purchased in 2001 and the two hotels purchased in 2000 occurred on January 1 of
each year. The pro forma information does not purport to represent what the
company's results of operations would actually have been if such transaction, in
fact, had occurred as of the beginning of each period presented, nor does it
purport to represent the results of operations for future periods.
Year ended 2001 2000
- -----------------------------------------------------
Total revenue $49,523,658 $49,575,739
Net income $ 6,030,185 $ 6,791,859
Net income per share--
basic and diluted $ .48 $ .56
The pro forma information reflects adjustments for actual revenue and expenses
for the periods of 2001 and 2000 prior to acquisition of three of the four
hotels acquired in 2001 and two hotels acquired in 2000. The pro forma also
assumes that the acquisition of the lessee took place as of January 1, 2001. Net
income has been adjusted as follows: (1) depreciation has been adjusted based on
the company's basis in the hotels; (2) advisory expenses have been adjusted
based on the company's contractual arrangements; (3) interest expense has been
adjusted to reflect the acquisition as of January 1, 2000; and (4) common stock
raised to purchase these hotels has been adjusted to reflect issuance as of
January 1 of each year.
NOTE 11 SUBSEQUENT EVENTS
During January 2002, the company declared and paid a dividend of .2575 per
share, totaling $3,261,667.
F-17
APPLE SUITES, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
June 30, December 31,
2002 2001
------------- -------------
ASSETS
Investment in hotel-net of accumulated depreciation of $10,974,993 and $8,274,076,
respectively $ 168,631,669 $ 170,437,222
Cash and cash equivalents 6,159,579 8,331,891
Restricted cash 146,615 184,962
Accounts receivable, net 2,211,170 1,002,160
Inventories 145,300 145,300
Capital improvement reserve 338,724 438,823
Deferred financing costs, net 1,293,934 1,364,499
Deferred franchise fees 771,078 792,794
Other assets 1,277,939 2,479,434
------------- -------------
Total Assets $ 180,976,008 $ 185,177,085
============= =============
LIABILITIES and SHAREHOLDERS' EQUITY
Liabilities
Notes payable-secured $ 76,612,135 $ 77,041,296
Interest payable 556,257 510,119
Accounts payable and accrued expenses 2,491,141 2,850,311
Due to third party manager 664,200 700,969
Account payable-affiliate 62,817 74,515
Distributions payable -- --
------------- -------------
Total Liabilities 80,386,550 81,177,210
Shareholders' equity
Preferred stock 15,000,000 authorized shares, none issued or outstanding -- --
Common stock, no par value, authorized 200,000,000 shares; issued and outstanding
12,666,677 shares as of June 30, 2002 and December 31, 2001 111,099,353 111,099,353
Class B convertible stock, no par value, authorized 240,000 shares; issued and
outstanding 240,000 shares 24,000 24,000
Distributions greater than net income (10,533,895) (7,123,478)
------------- -------------
Total Shareholders' Equity 100,589,458 103,999,875
------------- -------------
Total Liabilities and Shareholders' Equity $ 180,976,008 $ 185,177,085
============= =============
See accompanying notes to consolidated financial statements.
F-18
APPLE SUITES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
----------------- ------------------ ------------------ --------------------
REVENUES:
Suite revenue $ 12,411,658 $ 10,857,055 $ 24,052,840 $ 20,919,569
Other revenue 553,066 524,519 1,091,234 1,019,711
Interest income 4,099 214,401 12,001 308,440
----------------- ------------------ ------------------ --------------------
Total revenues 12,968,823 11,595,975 25,156,075 22,247,720
EXPENSES:
Operating expenses 4,053,874 3,171,595 7,734,595 6,255,114
Hotel administrative expenses 937,541 850,247 1,865,497 1,653,452
Advertising and promotion 1,195,987 977,535 2,295,641 1,946,376
Utilities 487,706 388,779 970,445 843,675
Franchise fees 496,466 430,182 962,114 832,683
Management fees 446,145 412,496 857,076 823,556
Taxes, insurance and other 671,012 502,482 1,337,177 885,774
General and administrative 309,413 191,101 555,482 507,507
Depreciation of real estate owned 1,380,458 1,147,185 2,700,916 2,146,695
Interest 1,743,951 1,248,728 3,442,549 2,419,026
Ground lease 25,000 25,000 50,000 50,000
Management termination fees -- 43,430 -- 1,413,520
----------------- ------------------ ------------------ ------------------
Total expenses 11,747,553 9,388,760 22,771,492 19,777,378
----------------- ------------------ ------------------ ------------------
Net income $ 1,221,270 $ 2,207,215 $ 2,384,583 $ 2,470,342
================= ================== ================== ==================
Basic and diluted earnings per common
share $ 0.10 $ 0.18 $ 0.19 $ 0.23
================= ================== ================== ==================
Distributions per common share $ 0.20 $ 0.26 $ 0.46 $ 0.52
================= ================== ================== ==================
See accompanying notes to consolidated financial statements.
F-19
APPLE SUITES, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
Common Stock Class B Convertible Stock
--------------------------- ------------------------- Distributions Total
Number Number Greater Than Shareholders'
of Shares Amount of Shares Amount Net Income Equity
---------- ------------- ----------- ---------- --------------- -------------
Balance at December 31, 2001 12,666,677 $ 111,099,353 240,000 $ 24,000 $ (7,123,478) $ 103,999,875
Net proceeds from the sale of
common shares -- -- -- -- -- --
Net income -- -- -- -- 2,384,583 2,384,583
Cash distributions declared to
common shareholders ($.46 per
share) -- -- -- -- (5,795,000) (5,795,000)
Common stock issued through
reinvestment of distributions -- -- -- -- -- --
---------- ------------- ------- -------- ------------- -------------
Balance at June 30, 2002 12,666,677 $ 111,099,353 240,000 $ 24,000 $ (10,533,895) $ 100,589,458
========== ============= ======= ======== ============= =============
See accompanying notes to consolidated financial statements.
F-20
APPLE SUITES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED):
Six Months Ended June 30,
2002 2001
-------------- --------------
Cash flow from operating activities:
Net income $ 2,384,583 $ 2,470,342
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation of real estate owned 2,700,916 2,146,695
Amortization of deferred financing costs 78,478 70,716
Amortization of deferred franchise fees 21,716 16,228
Management termination fees (non-cash portion) -- 470,090
Changes in operating assets and liabilities (excluding amounts acquired from Apple
Suites Management, Inc.):
Prepaid expenses 1,195,396 (155,853)
Receivables (1,209,010) (1,070,569)
Other assets 6,099 105,037
Accounts payable (8,947) (137,316)
Accounts payable-affiliates (11,698) 78,127
Due to third party manager (36,769) 600,972
Accrued expenses (350,224) 199,329
Interest payable 46,138 38,450
-------------- --------------
Net cash provided by operating activities 4,816,678 4,832,248
Cash flow from investing activities:
Cash assumed in the acquisition of Apple Suites Management, Inc. -- 2,793,106
Cash paid in the acquisition of hotels -- (31,099,671)
Net (increase) decrease in cash restricted for property and capital
improvement reserve held with third party 138,446 (1,001,991)
Capital improvements (895,362) (1,344,382)
-------------- --------------
Net cash used in investing activities (756,916) (30,652,938)
Cash flow from financing activities:
Repayment of secured notes payable (429,161) (8,056,652)
Proceeds from secured notes payable -- 10,700,000
Payment of financing costs (7,913) (79,483)
Net proceeds from issuance of common stock -- 35,933,303
Cash distributions paid to shareholders (5,795,000) (4,287,297)
-------------- --------------
Net cash provided by (used in) financing activities (6,232,074) 34,209,871
Increase (decrease) in cash and cash equivalents (2,172,312) 8,389,181
Cash and cash equivalents, beginning of period 8,331,891 2,653,058
-------------- --------------
Cash and cash equivalents, end of period $ 6,159,579 $ 11,042,239
============== ==============
Supplemental Information:
non-cash transactions:
Apple Suites Management, Inc. acquisition
Operating assets acquired -- $ 2,009,431
Operating liabilities acquired -- 5,272,627
Notes payable - secured issued to seller in connection with hotel acquisitions -- 16,500,000
See accompanying notes to consolidated financial statements.
F-21
APPLE SUITES, INC
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2002
General Information and Summary of Significant Accounting Policies
Basis of Presentation
The accompanying interim unaudited consolidated financial statements have been
prepared in accordance with the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information required
by generally accepted accounting principles. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation of financial position have been included. Operating results
for the three months ended June 30, 2002 are not necessarily indicative of the
results that may be expected for the period ended December 31, 2002. These
consolidated financial statements should be read in conjunction with the
Company's December 31, 2001 Annual Report on Form 10-K.
Organization
Apple Suites, Inc. (the "Company"), a Virginia corporation, was initially
capitalized on March 26, 1999, and commenced operations on September 1, 1999.
The unaudited consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.
The Company operates in one defined business segment consisting of upscale,
extended stay hotel properties. The Company leases all hotel properties owned to
Apple Suites Management, Inc. (the "Lessee"), a 100% owned taxable REIT
subsidiary. Each hotel is leased by the Company to the Lessee under a master
hotel lease agreement. Promus Hotels, Inc. ("Promus"), a wholly owned subsidiary
of Hilton Hotels Corporation ("Hilton"), manages the Company's hotels under the
terms of a management agreement, as part of the Homewood Suites(R) by Hilton(R)
franchise.
Summary of Significant Accounting Policies
In June 2001, the FASB issued Statement of Financial Accounting Standards (SFAS)
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangibles," effective for fiscal years beginning after December 15, 2001.
Under the new rules, goodwill and intangible assets deemed to have indefinite
lives will no longer be amortized but are subject to annual impairment tests in
accordance with the Statements. Other intangible assets continue to be amortized
over their useful lives. The Company adopted these new accounting standards
beginning the first quarter of fiscal 2002. The adoption of these standards did
not have a material impact on the Company's financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The statement supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed of" and
F-22
Accounting Principles Board (APB) Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for segments of a business to be disposed of. SFAS No. 144
retains the requirements of SFAS No. 121 relating to recognition and
measurement of an impairment loss and resolves certain implementation issues
resulting from SFAS No. 121. The Company adopted SFAS No. 144 as of January
1, 2002. The statement did not have a material impact on the consolidated
financial position or results of operations of the Company as of June 30,
2002.
(2) Investment in Hotels
At June 30, 2002, the Company owned 17 hotels. Investment in hotels
consisted of the following:
June 30, December 31,
2002 2001
------------- -------------
Land $ 29,926,099 $ 29,923,592
Building 134,666,539 137,549,729
Furniture and equipment 15,014,024 11,237,977
------------- -------------
$ 179,606,662 $ 178,711,298
Less accumulated depreciation (10,974,993) (8,274,076)
------------- -------------
$ 168,631,669 $ 170,437,222
============= =============
General location of hotel Number of Suites
----------------------------- ------------------
Richmond, Virginia 123
Plano, Texas 99
Irving/ Las Colinas, Texas 136
Addison, Texas 120
Atlanta/ Cumberland, Georgia 124
Baltimore, Maryland 147
Boulder, Colorado 112
Clearwater, Florida 112
Detroit/ Warren, Michigan 76
Atlanta/ Peachtree, Georgia 92
Philadelphia, Pennsylvania 123
Salt Lake City, Utah 98
Jackson, Mississippi 91
Atlanta/ Buckhead, Georgia 92
St. Louis, Missouri 145
Portland, Oregon 123
Dulles/ Washington, D.C 109
------
Total Suites 1,922
======
(3) Management Agreements
The Company is obligated to pay the costs of real estate and personal
property taxes, property
F-23
insurance and maintenance of the hotels. The Company is committed under
management agreements to fund up to 5% of gross revenues for capital
expenditures to include periodic replacement or refurbishment of furniture,
fixtures, and equipment. At June 30, 2002 and June 30, 2001, Promus held
$338,724 and $1,694,119, respectively, for these capital improvement
reserves. In addition, in accordance with the franchise agreements, at June
30, 2002 and 2001, $146,615 and $75,971, respectively, were held for
property improvements with a financial institution and treated as
restricted cash.
Promus manages day-to-day operations of the hotels. For the hotels acquired
prior to 2001, Promus charges fees equal to 4% of total revenue for this
function. For two of the hotels acquired in 2001, Promus charges a base
management fee of 2% of total revenue and an incentive management fee
calculated on the basis of operating profit of the hotels. No incentive
management fees were paid in 2002. For the other two hotels acquired in
2001, Promus charges 2% of total revenues for the first twelve months, 3%
of total revenues for the second twelve months and 4% of total revenues
thereafter. Promus also charges a fee of 4% of suite revenue for franchise
licenses to operate as a Homewood Suites(R) by Hilton(R) and to participate
in its reservation system. Total expenses for these services were
$1,819,190 and $1,656,239 for the first six months of 2002 and 2001,
respectively. These expenses are included in the hotel operating expenses
mentioned above.
(4) Shareholders' Equity
In July 2002, the Company declared and distributed to its shareholders
$2,546,002 ($0.201 per share).
It is anticipated that the revenues generated from the hotels and the
remaining funds from financings will be used to meet normal hotel operating
expenses, payment of distributions and monthly debt service. The Company's
ability to pay regular quarterly distributions is dependent upon the
results of operations of the Company's hotels. Because dividends were in
excess of cash flow during 2001 and the first two quarters of 2002, and due
to the uncertain economic climate, the company will make decisions
regarding any future 2002 distributions to shareholders on a
quarter-by-quarter basis. It is the Company's objective to maximize the
shareholders' returns while preserving the value of their investment. In
general, the Company's liquidity and capital resources are believed to be
adequate to meet its cash requirements during the upcoming period, given
the previous discussion. The Company set the first quarter 2002 dividend at
$0.20, and after improved second quarter revenues, raised the second
quarter dividend slightly to $0.201 per share. We will continue to evaluate
the dividend on a quarter-by-quarter basis for the remainder of the year.
(5) Commitments and Related Parties
The Company has contracted with Apple Suites Advisors, Inc. ("ASA") to
advise and provide day to day advisory and management services to the
Company. In accordance with the advisory contract, the Company will pay ASA
a fee equal to .1% to .25% of total equity contributions received by the
Company. For the six months ended June 30, 2002 and June 30, 2001, ASA
earned $156,252 and $142,022 respectively, under the advisory agreement. In
addition, the Company reimburses ASA for certain reimbursable expenses.
The Company has contracted with Apple Suites Realty Group, Inc. ("ASRG") to
acquire and dispose of real estate assets for the Company. In accordance
with the contract, ASRG is to be
F-24