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APPLE REIT SIX INC 10-Q --12-31 90993530 false 0001277151 Yes No Non-accelerated Filer No 2011 Q2 2011-06-30

1. Basis of Presentation           The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not include all of the information required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its 2010 Annual Report on Form 10-K. Operating results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2011.

2. General Information and Summary of Significant Accounting Policies Organization           Apple REIT Six, Inc., together with its wholly owned subsidiaries (the “Company”), is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company was formed to invest in income-producing real estate in the United States. Initial capitalization occurred on January 20, 2004 and operations began on May 28, 2004 when the Company acquired its first hotel. The Company concluded its best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share) in March 2006. The Company’s fiscal year end is December 31. As of June 30, 2011 the Company owned 66 hotels. The Company has no foreign operations or assets and its operating structure includes only one segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. Significant Account Policies Use of Estimates           The preparation of the financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Earnings per Common Share            Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the period. Diluted earnings per share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the period. There were no potential common shares with a dilutive effect during the three and six months ended June 30, 2011 or 2010. As a result, basic and dilutive outstanding shares were the same. Series B convertible preferred shares are not included in earnings per common share calculations until such time that such shares are eligible to be converted to common shares. 3. Credit Facility           The Company has a $60 million unsecured credit facility with a commercial bank, that is utilized for working capital, hotel renovations, and other general corporate funding purposes, including the payment of redemptions and distributions. The Company extended the credit facility in June 2011. The outstanding principle is required to be paid by the maturity date of June 10, 2012 and may be prepaid without penalty. Interest payments are due monthly and the applicable interest rate is equal to LIBOR (the London Interbank Offered Rate) plus 3.5%, with a minimum interest rate of 5.0%. The credit facility also has an unused fee of 0.5%. At June 30, 2011 and December 31, 2010, the credit facility had an outstanding principal balance of $43.7 million and $39.6 million.

4. Notes Payable           To reduce interest costs, in April 2011, the Company retired the mortgage associated with its Hampton Inn hotel in Foothill Ranch, California four months prior to its scheduled maturity date, the first opportunity available to repay without a prepayment penalty. The outstanding principal balance of $4.0 million was paid using proceeds from the Company’s credit facility.

5. Fair Value of Financial Instruments           The Company estimates the fair value of its fixed rate debt and the credit spreads over variable market rates on its variable rate debt by discounting the future cash flows of each instrument at estimated market rates or credit spreads consistent with the maturity of the debt obligation with similar credit terms and credit characteristics. Market rates and credit spreads take into consideration general market conditions and maturity. As of June 30, 2011, the carrying value and estimated fair value of the Company’s debt was $63.5 million and $64.9 million. As of December 31, 2010, the carrying value and estimated fair value of the Company’s debt was $63.7 and $64.4 million. The carrying value of the Company’s other financial instruments approximates fair value due to the short-term nature of these financial instruments.

6. Related Parties           The Company has, and is expected to continue to engage in, significant transactions with related parties. These transactions cannot be construed to be arms length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties. The Company’s independent members of the Board of Directors oversee and annually review the Company’s related party relationships (which include the relationships discussed in this section) and are required to approve any significant modifications to the contracts, as well as any new significant related party transactions. There were no changes to the contracts discussed in this section and no new significant related party transactions during the six months ended June 30, 2011. The Board of Directors is not required to approve each individual transaction that falls under a related party relationship; however, under the direction of the Board of Directors, at least one member of the Company’s senior management team approves each related party transaction.           The Company is party to an advisory agreement with Apple Six Advisors, Inc. (“A6A”), pursuant to which A6A provides management services to the Company. An annual fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services. Total advisory fees incurred by the Company under the advisory agreement are included in general and administrative expenses and totaled approximately $0.8 million for both the six months ended June 30, 2011 and 2010.           Through its wholly-owned subsidiary, Apple Fund Management, LLC, the Company provides support services to Apple Six Realty Group (“A6RG”), Apple Suites Realty Group, Inc. (“ASRG”), A6A, Apple Seven Advisors, Inc. (“A7A”), Apple REIT Seven, Inc., Apple Eight Advisors, Inc. (“A8A”), Apple REIT Eight, Inc., Apple Nine Advisors, Inc. (“A9A”), Apple REIT Nine, Inc, Apple Ten Advisors, Inc. (“A10A”) and Apple REIT Ten, Inc. A7A provides day to day advisory and administrative functions for Apple REIT Seven, Inc. A8A provides day to day advisory and administrative functions for Apple REIT Eight, Inc. A9A provides day to day advisory and administrative functions for Apple REIT Nine, Inc. A10A provides day to day advisory and administrative functions for Apple REIT Ten, Inc. ASRG provides real estate brokerage services to the Company, Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. Each of these companies has agreed to reimburse the Company for its costs in providing these services. A6RG, ASRG, A6A, A7A, A8A, A9A, and A10A are 100% owned by Glade Knight, the Company’s Chairman and Chief Executive Officer. For the six months ended June 30, 2011 and 2010, the Company received reimbursement of its costs totaling approximately $3.6 million and $3.3 million from the participating entities. The Company’s net allocated cost for these support services was approximately $0.9 million and $0.7 million for the six months ended June 30, 2011 and 2010. As part of this arrangement, the day to day transactions may result in amounts due to or from the noted related parties. To efficiently manage cash disbursements, the individual companies may make payments for any or all of the related companies. The amounts due to or from the related companies are reimbursed or collected and are not significant in amount.           Although there is a potential conflict on time allocation of personnel due to the fact that a senior manager, officer or staff member will provide services to more than one company, the Company believes that the executives and staff compensation sharing arrangement allows the companies to share costs yet attract and retain superior executives and staff. The cost sharing structure also allows each entity to maintain a much more cost effective structure than having separate staffing arrangements. Amounts reimbursed to the Company include both compensation for personnel and “overhead” (office rent, utilities, benefits, office supplies, etc.) utilized by the companies. The allocation of costs is made by the management of the several REITs and is reviewed at least annually by the Compensation Committees of the several REITs. In making the allocation, management and the Compensation Committee consider all relevant facts related to the Company’s level of business activity and the extent to which the Company requires the services of particular personnel. The costs allocated are actual costs and do not include any profit/markup for the Company. Such payments are not based on formal record keeping regarding the time these personnel devote to the Company, but are based on a good faith estimate by the employee and/or his or her supervisor of the time devoted by the employee to each Company.           Including A6RG, ASRG, A6A, A7A, A8A, A9A and A10A discussed above, Mr. Knight is also Chairman and Chief Executive Officer of Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. Members of the Company’s Board of Directors are also on the boards of Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc.           Included in other assets, net on the Company’s consolidated balance sheet is a 26% equity investment in Apple Air Holding, LLC (“Apple Air”). The other members of Apple Air are Apple REIT Seven, Inc., Apple REIT Eight, Inc. and Apple REIT Nine, Inc. Through its equity investment the Company has access to Apple Air’s aircraft for asset management and renovation purposes. The Company’s equity investment was approximately $1.9 million and $1.8 million at June 30, 2011 and December 31, 2010. The Company has recorded its share of income and losses of the entity under the equity method of accounting and adjusted its investment in Apple Air accordingly. For the six months ended June 30, 2011 and 2010, the Company recorded a loss of approximately $98,000 and $231,000 in each period as its share of the net loss of Apple Air, which primarily relates to the depreciation of the aircraft, and is included in general and administrative expense in the Company’s consolidated statements of operations. Apple Air owned two aircraft during 2010, but reduced its ownership to one aircraft during the first quarter of 2011.

7. Shareholders’ Equity           The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to the lesser of: (1) the purchase price per Unit that the shareholder actually paid for the Unit; or (2) $11.00 per Unit. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. During the six months ended June 30, 2011 and 2010, the Company redeemed approximately 1.3 million Units and 1.4 million Units in the amount of $14.2 million and $15.2 million under the program. Since the inception of the program through June 30, 2011, the Company has redeemed approximately 15.2 million Units for $166.4 million under the program. The redemptions made through June 30, 2011 were 100% of the redemptions requested.           In February 2006, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of the proceeds from this plan may include purchasing Units under the Company’s Unit Redemption Program, enhancing properties, satisfying financing obligations and other expenses, increasing working capital, funding various corporate operations, and acquiring hotels. The Company has registered 20 million Units for potential issuance under the plan. During the six months ended June 30, 2011 and 2010, approximately 1.3 million and 1.4 million Units, representing $14.7 million and $15.7 million in proceeds to the Company, were issued under the plan. Since the inception of the plan through June 30, 2011, 15.6 million Units, representing $171.2 million in proceeds to the Company, were issued under the plan.           The Company’s annual distribution rate during the first six months of 2011 was $0.77 per common share, payable monthly. For the three months ended June 30, 2011 and 2010, the Company made distributions of $0.193 per common share for a total of $17.6 million for each period. For the six months ended June 30, 2011 and 2010 the Company made distributions of $0.385 and $0.407 per common share for a total of $35.2 million and $37.2 million. In June 2011, the Company’s Board of Directors increased the annual distribution rate to $0.792 per common share. The increase was effective with the July 2011 distribution and will continue to be paid monthly.

8. Dispositions           Based on the performance, location, and capital requirements of the Tempe, Arizona TownePlace Suites and SpringHill Suites, the Company committed to sell these two properties in the third quarter of 2010. On June 6, 2011, the Company sold these hotels for net proceeds of $10.8 million. These hotels were classified on the consolidated balance sheet as “Hotels held for sale” at December 31, 2010, and were recorded at the fair value less cost to sell. The results of operations for these properties for the three and six months ended June 30, 2011 and 2010 are classified on the consolidated statements of operations in the line item “Income (loss) from discontinued operations”.           The following table sets forth the components of income from discontinued operations for the three and six months ended June 30, 2011 and 2010 (in thousands): <table border="0" cellspacing="0" cellpadding="0" width="100%"> <tr style="FONT-SIZE:1PX"> <td width="42%" valign="bottom">   </td> <td width="3%" valign="bottom">   </td> <td width="1%" valign="bottom">   </td> <td width="10%" valign="bottom">   </td> <td width="3%" valign="bottom">   </td> <td width="1%" valign="bottom">   </td> <td width="10%" valign="bottom">   </td> <td width="3%" valign="bottom">   </td> <td width="1%" valign="bottom">   </td> <td width="10%" valign="bottom">   </td> <td width="3%" valign="bottom">   </td> <td width="1%" valign="bottom">   </td> <td width="10%" valign="bottom">   </td> <td width="1%" valign="bottom">   </td> </tr> <tr> <td valign="bottom">   </td> <td valign="bottom">   </td> <td colspan="5" valign="bottom"> Three months ended June 30, </td> <td valign="bottom">   </td> <td colspan="5" valign="bottom"> Six months ended June 30, </td> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom">   </td> <td valign="bottom">   </td> <td colspan="5" valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td colspan="5" valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom">   </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> 2011 </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> 2010 </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> 2011 </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> 2010 </td> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom">   </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td colspan="2" valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom" style="background-color: #E5FFFF;"> Total revenue </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> 563 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> 790 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> 1,915 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> 2,228 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> </tr> <tr> <td valign="bottom"> Hotel operating expenses </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> 350 </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> 589 </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> 1,110 </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> 1,430 </td> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom" style="background-color: #E5FFFF;"> Taxes, insurance and other </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> 57 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> 77 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> 134 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> 154 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> </tr> <tr> <td valign="bottom"> Depreciation expense </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> — </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> 131 </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> — </td> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> 262 </td> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> </tr> <tr> <td valign="bottom" style="background-color: #E5FFFF;"> Income (loss) from discontinued operations </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> 156 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> (7 </td> <td valign="bottom" style="background-color: #E5FFFF;"> ) </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> 671 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> <td valign="bottom" style="background-color: #E5FFFF;"> $ </td> <td valign="bottom" style="background-color: #E5FFFF;"> 382 </td> <td valign="bottom" style="background-color: #E5FFFF;">   </td> </tr> <tr> <td valign="bottom">   </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom"> <hr size="1" width="100%" noshade="noshade" /> </td> <td valign="bottom">   </td> </tr> </table>           During the second half of 2010, the Company recorded a loss of $3.6 million based on the fair value of the two properties less cost to sell, as compared to net book value. No gain or loss was incurred by the Company upon the completion of the sale of the two properties in June 2011.

9. Legal Proceedings and Related Matters           The term the “Apple REIT Companies” means the Company, Apple REIT Seven, Inc., Apple REIT Eight, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc.           On June 20, 2011, two shareholders of the Apple REIT Companies filed a putative class action captioned Kronberg et al. v. David Lerner Associates Inc., et al, Case No. 2:11-cv-03558, in the United States District Court for the District of New Jersey against David Lerner Associates, Inc. and certain of its officers, and the Apple REIT Companies and Glade M. Knight. The complaint, purportedly brought on behalf of purchasers of Units in the Apple REIT Companies, asserts claims and seeks, among other things, certification of the class, compensatory, special and general damages, and other costs and expenses. The complaint alleges, among other things, that: (1) David Lerner Associates, Inc. made false and misleading misrepresentations about (a) the value of the Units of the Apple REIT Companies, (b) previous distribution payments made by the Apple REIT Companies, and (c) the operations of the Apple REIT Companies, (2) the significant risks associated with the illiquid investment in the Apple REIT Companies were not properly disclosed to investors, and (3) under the various agency agreements between David Lerner Associates, Inc. and the Apple REIT Companies, the Apple REIT Companies and Glade M. Knight are responsible for the actions and representations of David Lerner Associates, Inc. and its certain officers regarding the sale of Units of the Apple REIT Companies. The Company believes that these claims against the Apple REIT Companies and Glade M. Knight are without merit, and the Company intends to defend against them vigorously. At this time, the Company cannot reasonably predict the outcome of these proceedings or provide a reasonable estimate of the possible loss or range of loss due to these proceedings, if any.           In addition to the lawsuit discussed above, there were two additional lawsuits filed against David Lerner Associates, Inc., Apple REIT Nine, Inc. and Apple REIT Ten, Inc. The Company was not named in these suits.           On May 27, 2011, the Financial Industry Regulatory Authority (“FINRA”) filed a complaint against David Lerner Associates, Inc., related to its sales practices relative to the Units of Apple REIT Ten, Inc. David Lerner Associates, Inc. was also the sole distributor (managing dealer) of the Company. The Company is unaffiliated with David Lerner Associates, Inc.; however, the Company relies upon it for administration of the Units. The Company intends on cooperating with regulatory or governmental inquiries.

10. Subsequent Events           In July 2011, the Company declared and paid approximately $6.0 million, or $0.066 per share, in distributions to its common shareholders of which $2.3 million or 211,000 Units were reinvested under the Company’s Dividend Reinvestment Plan.           In July 2011, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed 737,000 Units in the amount of $8.1 million. As contemplated in the program, the Company redeemed Units on a pro-rata basis. Whereby a percentage of each requested redemption was fulfilled at the discretion of the Company’s Board of Directors. This redemption was approximately 17% of the requested redemption amount.