10-Q 1 d10q.htm FORM 10-Q FORM 10-Q
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

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

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

 

OR

 

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

 

FOR THE TRANSITION PERIOD FROM              TO             

 

Commission File Number 333-112169

 


 

APPLE REIT SIX, INC.

(Exact name of registrant as specified in its charter)

 


 

VIRGINIA   20-0620523

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

814 EAST MAIN STREET

RICHMOND, VIRGINIA

  23219
(Address of principal executive offices)   (Zip Code)

 

(804) 344-8121

(Registrant’s telephone number, including area code)

 

FORMER ADDRESS: 10 SOUTH THIRD STREET, RICHMOND, VA 23219

 


 

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

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12 b-2 of the Exchange Act).    Yes  ¨    No  x

 

At October 31, 2004, there were 23,560,883 outstanding shares of common stock, no par value, of the registrant.

 



Table of Contents

APPLE REIT SIX, INC.

 

FORM 10-Q

 

INDEX

 

              Page
Number


PART I. FINANCIAL INFORMATION     
   

Item 1. Financial Statements (Unaudited)

    
        

Consolidated Balance Sheets - September 30, 2004 and January 20, 2004 (initial capitalization)

   3
        

Consolidated Statements of Operations - For the period January 20, 2004 (initial capitalization) Through September 30, 2004 and Three Months Ending September 30, 2004

   4
        

Consolidated Statement of Cash Flows - For the period January 20, 2004 (initial capitalization) Through September 30, 2004

   5
        

Notes to Consolidated Financial Statements

   6
   

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

   13
   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

   19
   

Item 4. Controls and Procedures

   19
PART II. OTHER INFORMATION:     
   

Item 1. Legal Proceedings (not applicable)

    
   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   20
   

Item 3. Defaults Upon Senior Securities (not applicable)

    
   

Item 4. Submission of Matters to a Vote of Security Holders (not applicable)

    
   

Item 5. Other Information (not applicable)

    
   

Item 6. Exhibits

   21
Signatures    23
Certifications     

 

2


Table of Contents

Apple REIT Six, Inc.

Consolidated Balance Sheets (unaudited)

(in thousands, except share data)

 

    September 30, 2004

   

January 20, 2004

(initial capitalization)


Assets

             

Investment in properties, net of accumulated depreciation of $675

  $ 89,332     $  —  

Cash and cash equivalents

    102,565       24

Restricted cash-furniture, fixtures and equipment escrow

    350       —  

Due from third party manager, net

    576       —  

Other assets

    3,429       —  
   


 

Total Assets

  $ 196,252     $ 24
   


 

Liabilities

             

Accounts payable and accrued expenses

  $ 168     $  —  
   


 

Total Liabilities

    168       —  

Shareholders’ Equity

             

Preferred stock, authorized 15,000,000 shares; none issued and outstanding

    —         —  

Series A preferred stock, no par value, authorized 200,000,000 shares; issued and outstanding 20,459,702 and 10 shares, respectively

    —         —  

Series B preferred convertible stock, no par value, authorized 240,000 shares; issued and outstanding 240,000 shares, respectively

    24       24

Common stock, no par value, authorized 200,000,000 shares; issued and outstanding 20,459,702 and 10 shares, respectively

    199,699       —  

Distributions greater than net income

    (3,639 )     —  
   


 

Total Shareholders’ Equity

    196,084       24
   


 

Total Liabilities and Shareholders’ Equity

  $ 196,252     $ 24
   


 

 

See notes to consolidated financial statements.

 

3


Table of Contents

Apple REIT Six, Inc.

Consolidated Statements of Operations (unaudited)

(in thousands, except share data)

 

    Three months ended
September 30, 2004


    For the period
January 20, 2004
(initial capitalization)
through September 30, 2004


 

Revenue

               

Suite revenue

  $ 4,431     $ 4,837  

Other revenue

    697       718  
   


 


Total revenue

    5,128       5,555  

Expenses

               

Hotel operating expenses

    2,104       2,199  

Hotel administrative expenses

    590       625  

Sales and marketing

    398       428  

Utilities

    197       213  

Repair and maintenance

    209       226  

Management fees

    189       216  

Taxes, insurance and other

    184       211  

General and administrative

    257       395  

Depreciation

    592       675  
   


 


Total expenses

    4,720       5,188  
   


 


Operating income

    408       367  

Interest income

    166       243  

Interest expense

    (100 )     (105 )
   


 


Net income

  $ 474     $ 505  
   


 


Basic and diluted net income per common share

  $ 0.03     $ 0.07  
   


 


Weighted average shares outstanding

    15,528       7,633  

Distributions paid per common share

  $ 0.22     $ 0.33  

 

See notes to consolidated financial statements.

 

4


Table of Contents

Apple REIT Six, Inc.

Consolidated Statement of Cash Flows (unaudited)

(in thousands)

 

    

For the period

January 20, 2004

(initial capitalization)

through September
30, 2004


 

Cash flow from operating activities:

        

Net income

   $ 505  

Adjustments to reconcile net income to cash used in operating activities:

        

Depreciation

     675  

Changes in operating assets and liabilities, net of amounts acquired / assumed:

        

Due from third party manager

     (344 )

Other assets and liabilities

     (39 )
    


Net cash provided by operating activities

     797  

Cash flow from investing activities:

        

Increase in cash restricted for capital improvements

     (95 )

Cash paid for future acquisitions

     (3,231 )

Cash paid for acquisitions of hotels

     (89,381 )

Cash paid for other assets

     (1,104 )
    


Net cash used in investing activities

     (93,811 )

Cash flow from financing activities:

        

Cash paid for offering costs

     (22,976 )

Proceeds from the issuance of common stock

     222,675  

Cash distributions paid to common shareholders

     (4,144 )
    


Net cash provided by financing activities

     195,555  

Increase in cash and cash equivalents

     102,541  

Cash and cash equivalents, beginning of period

     24  
    


Cash and cash equivalents, end of period

   $ 102,565  
    


 

See notes to consolidated financial statements.

 

5


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1

 

Basis of Presentation

 

The accompanying 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 accounting principles generally accepted in the United States. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited financials should be read in conjunction with the Company’s audited financial statements included in its registration statement filed with the Securities and Exchange Commission. Operating results for the period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the period ending December 31, 2004.

 

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 intends to qualify as a real estate investment trust (“REIT”) for federal income tax purposes. The Company, which began operations and acquired its first hotel on May 28, 2004, was formed to invest in hotels, residential apartment communities and other selected real estate in selected metropolitan areas in the United States. Initial capitalization occurred on January 20, 2004, when 10 shares of common stock and Series A preferred stock were purchased by Apple Six Advisors, Inc. and 240,000 shares of Series B Preferred shares were purchased by Mr. Glade M. Knight. The Company’s fiscal year end is December 31. The consolidated financial statements include the accounts of the Company and its direct or indirect subsidiaries Apple Six Hospitality, Apple Six Residential, Apple Six Ventures and Apple Six Hospitality Management. All intercompany accounts and transactions have been eliminated.

 

Offering Costs

 

The Company is raising capital through a “best-efforts” offering of Units by David Lerner Associates, Inc., which receives selling commissions and a marketing expense allowance based on proceeds of the shares sold.

 

Each Unit consists of one common share and one Series A preferred share. The Series A preferred shares will have no voting rights, no conversion rights and no distribution rights. The only right associated with the Series A preferred shares will be a priority distribution upon the sale of the Company’s assets. The priority would be equal to $11.00 per Series A preferred share, and no more, before any distributions are made to the holders of any other shares. The Series A preferred shares will not be separately tradable from the common shares to which they relate.

 

From the Company’s initial capitalization on January 20, 2004 through September 30, 2004, the Company incurred costs of approximately $22,976,386 related to its offering. These costs are reflected as a reduction to shareholders’ equity. As of September 30, 2004, the Company has closed on a total of 20,459,702 Units, representing net proceeds of $199,699,381.

 

6


Table of Contents

Earnings per Common Share

 

Basic earnings per common share is computed based upon the weighted average number of shares outstanding during the year. Diluted earnings per share is calculated after giving effect to all potential common shares that were dilutive and outstanding for the year. Series B convertible shares are not included in earnings per common share until such time it becomes probable that such shares can be converted to common shares.

 

Cash and cash equivalents

 

Cash and 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. Cash equivalents are placed with high credit quality institutions and the balances may, at times, exceed federal depository insurance limits.

 

Comprehensive Income

 

The Company recorded no comprehensive income during the period reported.

 

Stock Incentive Plans

 

As the exercise price of the Company’s stock options equals the market price of the underlying stock, the Company has not recognized any stock compensation expenses associated with its stock options during the period from initial capitalization through September 30, 2004.

 

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.

 

Income Taxes

 

The Company intends to make an election to be treated, and expects to qualify, as a REIT under the Internal Revenue Code of 1986, as amended. As a REIT, the Company will be allowed a deduction for the amount of dividends paid to its shareholders, thereby subjecting the distributed net income of the Company to taxation only at the shareholder level. The Company’s continued qualification as a REIT will depend on its compliance with numerous requirements, including requirements as to the nature of its income and distribution of dividends.

 

The Company has established Apple Six Hospitality Management, Inc. as a 100% owned taxable REIT subsidiary (“TRS”). The TRS leases all hotels from the Company and is subject to income tax at regular corporate rates on any income that it earns. No income tax expense has been recorded for the period January 20, 2004 through September 30, 2004 as the entity has incurred losses. No tax benefit has been recorded since realization is uncertain.

 

Start Up Costs

 

Start up costs incurred other than offering costs are expensed as incurred.

 

7


Table of Contents

Use of Estimates

 

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

 

Note 2

 

Summary of Acquisitions

 

Effective May 28, 2004, the Company closed on the purchase of a Springhill Suites by Marriott hotel in Ft. Worth, Texas, which contains 145 suites, and began operations in May 2004. The hotel offers one and two room suites with the amenities generally offered by upscale extended-stay hotels. The gross purchase price of the hotel was $13.3 million, all cash.

 

Effective June 8, 2004, the Company closed on the purchase of a Courtyard by Marriott hotel in Myrtle Beach, South Carolina, which contains 135 suites and was in operation when acquired. The hotel offers one and two room suites with the amenities generally offered by upscale extended-stay hotels. The gross purchase price of the hotel was $9.2 million, all cash.

 

Effective July 7, 2004, the Company closed on the purchase of a full service Marriott hotel in Redmond, Washington, which contains 262 rooms, of which 4 are suites, and began operations in June 2004. The hotel offers guest rooms, together with related amenities, that are consistent with its operation as a full service hotel. The gross purchase price of the hotel was $64 million, all cash.

 

The aggregate gross purchase price of $86.5 million for these hotels was funded by the Company’s ongoing offering of units. The Company leased all of its hotels to its wholly-owned taxable REIT subsidiary under master hotel lease agreements. No goodwill or intangible assets were recorded in connection with any of the acquisitions.

 

The Company also used the proceeds of its ongoing offering to pay 2% of the aggregate gross purchase price for these hotels, which equals $1,730,800, as a brokerage commission to Apple Six Realty Group, Inc. (“ASRG”). This entity is wholly owned by Glade M. Knight, who is one of the Company’s directors and its Chief Executive Officer. These costs have been capitalized to investment in properties.

 

Note 3

 

Line of Credit

 

During the first quarter of 2004, the Company obtained an unsecured line of credit in a principal amount of $400,000 to fund some of its offering expenses. The lender was Wachovia Bank, N.A. On May 13, 2004, the line of credit was repaid in full and was extinguished.

 

8


Table of Contents

Note 4

 

Related Parties

 

The Company is party to a property acquisition and disposition agreement with ASRG, pursuant to which ASRG serves as real estate advisor in connection with the Company’s acquisition and disposition of real estate assets. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is payable for these services. As of September 30, 2004, $1,730,800 was paid to ASRG relating to the Company’s recent acquisitions.

 

The Company is party to an advisory agreement with Apple Six Advisors, Inc. (“ASA”), pursuant to which ASA provides management services to the Company. An annual fee ranging from .1% to .25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services. ASA utilizes Apple Hospitality Two, Inc. to provide these services. As of September 30, 2004, $258,402 had been incurred and expensed under this agreement.

 

Glade M. Knight is Chairman and CEO of ASRG, Cornerstone Realty Investment Trust, Inc., Apple Hospitality Two, Inc., Apple Hospitality Five, Inc., and ASA.

 

Note 5

 

Series B Convertible Preferred Stock

 

The Company has issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman, Chief Executive Officer and President of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.

 

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

 

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

 

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

 

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

 

9


Table of Contents

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

 

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

 

Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into a number of common shares based upon the gross proceeds raised through the date of conversion in the $1 billion offering made by this prospectus according to the following table:

 

Gross Proceeds Raised from

Sales of

Units through Date of

Conversion


  

Number of Common Shares

through Conversion of

One Series B Convertible Preferred Share


$200 million

   4.83721

$250 million

   6.11068

$300 million

   7.29150

$350 million

   8.49719

$400 million

   9.70287

$450 million

   10.90855

$500 million

   12.11423

$550 million

   13.31991

$600 million

   14.52559

$650 million

   15.73128

$700 million

   16.93696

$750 million

   18.14264

$800 million

   19.34832

$850 million

   20.55400

$900 million

   21.75968

$950 million

   22.96537

$1 billion

   24.17104

 

In the event that after raising gross proceeds of $1 billion, the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest 50 million.

 

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

 

10


Table of Contents

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. Although the fair market value cannot be determined at this time, compensation expense if the maximum offering is achieved could range from $0 to in excess of $63 million (assumes $11 per unit fair market value). Based on equity raised through September 30, 2004, if a triggering event had been probable, compensation expense would have ranged from $0 to $12.8 million.

 

Note 6

 

Management Agreements

 

The Company’s Marriott brand hotels are subject to management agreements under which Marriott or its affiliates (the “Manager”) manages the hotels and provides the Company access to Marriott’s intellectual property and proprietary sales and reservation system, generally for an initial term of 30 years with renewal terms at the option of the Company or the Manager of up to 3 additional 10 year terms. The agreements generally provide for payment of base management fees, which are calculated annually and are a percentage of sales, incentive management fees over a priority return (as defined in the management agreements), system fees and marketing fees. Additionally, these agreements have termination provisions for the Company if certain operating results are not achieved.

 

Total expenses incurred through September 30, 2004 for management fees and franchise fees were $216,250. These expenses are included in management fees in the consolidated statements of operation.

 

Note 7

 

Pro Forma Information

 

The following unaudited pro forma information for the nine months ended September 30, 2004, is presented as if the acquisitions of the 3 hotels occurred on January 1, 2004. The pro forma information does not purport to represent what the Company’s results of operations would actually have been if such transactions, in fact, had occurred on January 1, 2004, nor does it purport to represent the results of operations for future periods.

 

    

For the period January 1, 2004

through

September 30, 2004

(in thousands, except per share data)


Hotel revenues

   $ 6,505

Net income

   $ 198

Net income per share-basic and diluted

   $ 0.02

 

The pro forma information reflects adjustments for actual revenues and expenses of the 3 hotels acquired as of September 30, 2004 for the respective period in 2004 prior to acquisition by the Company. 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) common stock raised during 2004 to purchase these hotels has been adjusted to reflect issuances as of January 1, 2004.

 

11


Table of Contents

Note 8

 

Subsequent Events

 

In October 2004, the Company declared and paid $1,500,391 or $.073 per share, in a distribution to its common shareholders.

 

In October 2004, the Company closed on an additional 3,024,232 shares, representing gross proceeds of $33,266,555 and proceeds net of selling and marketing costs of $29,939,899.

 

On October 12, 2004, the Company closed on the purchase of 8 hotels, under 8 separate contracts, for an aggregate gross purchase price of $95,600,000. These hotels contain a total of 962 guest rooms or suites. The hotels offer one and two room suites with the amenities generally offered by upscale extended-stay hotels and are located in Alaska, Arizona, California, and Colorado.

 

As of October 31, 2004, purchase contracts remain in effect for two other hotels (located in Anchorage, Alaska and Foothill Ranch, California) for an aggregate gross purchase price of $18,900,000. These hotels contain a total of 185 guest rooms or suites.

 

Note 9

 

Industry Segments

 

As of September 30, 2004, the Company owned one full service and two extended-stay hotels that generate rental and other property related income. The Company separately evaluates the performance of each of its hotel properties. However, because each of the hotel properties has similar economic characteristics, facilities, and services, the properties have been aggregated into a single segment. All segment disclosure is included in or can be derived from the Company’s consolidated financial statements.

 

12


Table of Contents

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operation

 

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

 

Overview

 

Apple REIT Six, Inc. (together with its wholly owned subsidiaries, the “Company”), is a Virginia corporation that intends to qualify as a real estate investment trust (“REIT”) for federal income tax purposes. The Company, which owns three properties and has a limited operating history, was formed to invest in hotels, residential apartment communities and other selected real estate in selected metropolitan areas in the United States. Initial capitalization occurred on January 20, 2004, when 10 shares of common stock and Series A preferred stock were purchased by Apple Six Advisors, Inc. and 240,000 shares of Series B Preferred shares were purchased by Mr. Glade M. Knight, the Company’s Chairman, Chief Executive Officer and President. The Company’s fiscal year end is December 31. The consolidated financial statements include the accounts of the Company and its direct or indirect subsidiaries Apple Six Hospitality, Apple Six Residential, Apple Six Ventures and Apple Six Hospitality Management. All intercompany accounts and transactions have been eliminated. The performance of the Company’s hotels can be influenced by many factors, including local hotel competition, local and national economic conditions and the performance of the individual managers assigned to its hotels. In evaluating financial condition and operating performance, the most important matters on which the Company focuses are revenue measurements, such as average occupancy, average daily rate and revenue per available room, and expenses, such as hotel operating expenses, general and administrative and other expenses described below.

 

Hotels Owned

 

The Company commenced operations in May 2004 upon the purchase of its first hotel property. As of September 30, 2004, the Company owned a total of 3 hotel properties, with a total of 542 rooms or suites.

 

13


Table of Contents

The following table summarizes the locations of and number of guest rooms and suites for the 3 hotels the Company owned at September 30, 2004:

 

City

  State

  Franchise/Brand

 

Date

Acquired


 

# of Rooms

/Suites


Fort Worth   Texas   Springhill Suites®   May 2004   145
Myrtle Beach   South Carolina   Courtyard®   June 2004   135
Redmond   Washington   Marriott®   July 2004   262
               
                542
               

 

The purchase price for all of the hotels was funded by the Company’s ongoing best efforts offering of Units. The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary under hotel lease agreements. The Company also used the proceeds of its offering to pay $1,730,800, approximately 2% of the gross purchase price for these hotels, as a commission to Apple Six Realty Group, Inc. (“ASRG”), 100% owned by Glade M. Knight, the Company’s Chairman and Chief Operating Officer.

 

No goodwill or intangible assets were recorded in connection with any of the acquisitions.

 

Management Agreements

 

The Company’s Marriott brand hotels are subject to management agreements under which Marriott or its affiliates (the “Manager”) manages the hotels and provides the Company access to Marriott’s intellectual property and proprietary sales and reservation system, generally for an initial term of 30 years with renewal terms at the option of the Company or the Manager of up to 3 additional 10 year terms. The agreements generally provide for payment of base management fees, which are calculated annually and are a percentage of sales, incentive management fees over a priority return (as defined in the management agreements), system fees and marketing fees. Additionally, these agreements have termination provisions for the Company if certain operating results are not achieved.

 

Total expenses incurred during the through September 30, 2004 for management fees and franchise fees were $216,250. These expenses are included in management fees in the consolidated statements of operation.

 

Results of Operations

 

Since operations commenced on May 28, 2004, with the Company’s first acquisition, a comparison to prior year results is not possible. In general, the performance of the Company’s hotels have met expectations for the short period held. Hotel performance is impacted by many factors including local hotel competition and local and national economic conditions in the United States. As a result, there can be no assurance that the Company’s operating performance will continue to meet expectations.

 

14


Table of Contents

Revenues

 

The Company’s principal source of revenue is hotel suites revenue and related other revenue. Hotel operations included were for the 3 hotels acquired through September 30, 2004 and the respective periods owned. For the period from January 20, 2004 (initial capitalization) through September 30, 2004, the Company had suite revenue and other revenue of $4,836,935 and $717,633, respectively. For the period acquired through September 30, 2004, the hotels achieved average occupancy of 62%, ADR of $115 and RevPAR of $71. ADR, or average daily rate, is calculated as room revenue divided by the number of rooms sold, and RevPAR, or revenue per available room, is calculated as occupancy multiplied by ADR. RevPAR is expected to increase as newly opened properties gain market share.

 

For the period from January 20, 2004 (initial capitalization) through September 30, 2004, the Company had interest income of $242,955. Interest income represents earnings on excess cash invested in short term money market instruments.

 

Expenses

 

For the period from January 20, 2004 (initial capitalization) through September 30, 2004, hotel direct expenses of the hotels totaled $3,906,878 or 81% of suite revenue. This expense as a percentage of sales is expected to decline as revenue ramps up for newly opened properties.

 

Taxes, insurance, and other expense for the period from January 20, 2004 (initial capitalization) through September 30, 2004 was $210,526 or 4% of suite revenue.

 

General and administrative expense for the period from January 20, 2004 (initial capitalization) through September 30, 2004 was $395,330 or 8% of suite revenue. The Company anticipates this percentage to continue to decrease as its asset base grows.

 

Depreciation expense for the period from January 20, 2004 (initial capitalization) through September 30, 2004 was $674,645. This amount represents depreciation expense of its 3 hotels and related personal property for the respective periods owned.

 

Liquidity and Capital Resources

 

The Company is raising capital through a “best-efforts” offering of Units by David Lerner Associates, Inc. (the “Managing Dealer”), which receives selling commissions and a marketing expense allowance based on proceeds of the shares sold.

 

Each Unit consists of one common share and one Series A preferred share. The Series A preferred shares will have no voting rights, no conversion rights and no distribution rights. The only right associated with the Series A preferred shares will be a priority distribution upon the sale of the Company’s assets. The priority would be equal to $11.00 per Series A preferred share, and no more, before any distributions are made to the holders of any other shares. The Series A preferred shares will not be separately tradable from the common shares to which they relate.

 

From the Company’s initial capitalization on January 20, 2004 through September 30, 2004, the Company incurred costs of approximately $22,976,386 related to its offering. These costs are reflected as a reduction to shareholders’ equity. As of September 30, 2004, the Company has closed on a total of 20,459,702 Units, representing gross proceeds and proceeds net of selling, marketing fees, and other costs of approximately $222,675,767 and $199,699,381, respectively.

 

15


Table of Contents

Through September 30, 2004, the Company had paid distributions totaling approximately $4,144,380 or $0.33 per share. As the Company did not acquire its first hotel until May 28, 2004, substantially the entire distribution was a return of capital. The Company intends to continue paying distributions on a monthly basis at an annual rate of 8%; however, since there can be no assurance of the Company’s ability to acquire properties that provide income at this level, there can be no assurance as to the classification or duration of the distributions at this rate.

 

The Company intends to acquire real estate properties with its available cash. Although the Company is currently performing due diligence on several possible acquisitions, the timing of finding suitable properties is dependant upon many external factors and there can be no assurances as to the length of time to utilize all proceeds of its best-efforts offering for investment in Real Estate. The Company’s proceeds raised and not invested in Real Estate are held as cash or cash equivalents.

 

Related Party Transactions

 

The Company is party to a property acquisition and disposition agreement with ASRG, pursuant to which ASRG serves as real estate advisor in connection with the Company’s acquisition and disposition of real estate assets. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is payable for these services. As of September 30, 2004, $1,730,800 had been paid to ASRG relating to the Company’s recent acquisitions.

 

The Company is party to an advisory agreement with Apple Six Advisors, Inc. (“ASA”), pursuant to which ASA provides management services to the Company. An annual fee ranging from .1% to .25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services. ASA utilizes Apple Hospitality Two, Inc. to provide these services. As of September 30, 2004, $258,402 had been expensed under this agreement.

 

Glade M. Knight is Chairman and CEO of ASRG, Cornerstone Realty Investment Trust, Apple Hospitality Two, Inc., Apple Hospitality Five, Inc., and ASA.

 

Series B Convertible Preferred Stock

 

The Company has authorized 240,000 shares of Series B convertible preferred stock. The Company has issued 240,000 Series B convertible preferred shares to Glade M. Knight, Chairman, Chief Executive Officer and President of the Company, in exchange for the payment by him of $0.10 per Series B convertible preferred share, or an aggregate of $24,000. The Series B convertible preferred shares are convertible into common shares pursuant to the formula and on the terms and conditions set forth below.

 

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

 

Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation

 

16


Table of Contents

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

 

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

 

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

 

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

 

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

 

Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into a number of common shares based upon the gross proceeds raised through the date of conversion in the $1 billion offering made by this prospectus according to the following table:

 

Gross Proceeds Raised from

Sales of

Units through Date of

Conversion


 

Number of Common Shares

through Conversion of

One Series B Convertible Preferred Share


$200 million

  4.83721

$250 million

  6.11068

$300 million

  7.29150

$350 million

  8.49719

$400 million

  9.70287

$450 million

  10.90855

$500 million

  12.11423

$550 million

  13.31991

$600 million

  14.52559

$650 million

  15.73128

$700 million

  16.93696

$750 million

  18.14264

$800 million

  19.34832

$850 million

  20.55400

$900 million

  21.75968

$950 million

  22.96537

$1 billion

  24.17104

 

In the event that after raising gross proceeds of $1 billion, the Company raises additional gross proceeds in a subsequent public offering, each Series B convertible preferred share may be

 

17


Table of Contents

converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/50 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest 50 million.

 

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

 

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. Although the fair market value cannot be determined at this time, compensation expense if the maximum offering is achieved could range from $0 to in excess of $63 million (assumes $11 per unit fair market value). Based on equity raised through September 30, 2004, if a triggering event had been probable, compensation expense would have ranged from $0 to $12.8 million.

 

Impact of Inflation

 

Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation. Competitive pressures may, however, limit the operators’ ability to raise room rates. Currently the Company is not experiencing any material impact from inflation.

 

Seasonality

 

The hotel industry historically has been seasonal in nature. Seasonal variations in occupancy at its hotels may cause quarterly fluctuations in its revenues. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand to make distributions.

 

Subsequent Events

 

In October 2004, the Company declared and paid $1,500,391 or $.073 per share, in a distribution to its common shareholders.

 

In October 2004, the Company closed on an additional 3,024,232 shares, representing gross proceeds of $33,266,555 and proceeds net of selling and marketing costs of $29,939,899.

 

On October 12, 2004, the Company closed on the purchase of 8 hotels, under 8 separate contracts, for an aggregate gross purchase price of $95,600,000. These hotels contain a total of 962 guest rooms or suites. The hotels offer one and two room suites with the amenities generally offered by upscale extended-stay hotels and are located in Alaska, Arizona, California, and Colorado. The purchase price was funded by the Company’s cash on hand. Additionally, the Company paid $1,912,000, representing 2% of the aggregate gross purchase price, as a commission to ASRG.

 

18


Table of Contents

As of October 31, 2004, purchase contracts remain in effect for 2 other hotels (located in Anchorage, Alaska and Foothill Ranch, California) for an aggregate gross purchase price of $18,900,000. These hotels contain a total of 185 guest rooms or suites. Although the Company believes there is a reasonable probability that it will acquire these hotels, there can be no assurance that all of the conditions to closing will be satisfied.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

 

The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of September 30, 2004, the Company’s financial instruments were not exposed to significant market risk due to interest rate risk, foreign currency exchange risk, commodity price risk or equity price risk. The Company will be exposed to changes in short term money market rates as it invests the proceeds from its sale of Units pending use in acquisitions. Based on the Company’s cash invested at September 30, 2004, of $102,565,125, every 100 basis points change in interest rates will impact the Company’s annual net income by approximately $1,025,651, all other factors remaining the same. Cash invested pending acquisitions will vary substantially during the coming year based on the amount of proceeds raised and the timing of acquisitions.

 

Item 4. Controls and Procedures

 

Senior management, including the Chief Executive Officer and Chief Accounting Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and Chief Accounting Officer have concluded that the Company’s disclosure controls and procedures are effective and that there have been no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Since that evaluation process was completed, there have been no significant changes in internal controls or in other factors that could significantly affect these controls.

 

19


Table of Contents

PART II. OTHER INFORMATION

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The following tables set forth information concerning the Offering and the use of proceeds from the Offering as of September 30, 2004:

 

                    
               Proceeds

Units Registered:

                       
     4,761,905    Units    $ 10.50 per Unit    $ 50,000,000
     86,363,636    Units    $ 11 per Unit      950,000,000
                     

Totals:

   91,125,541    Units           $ 1,000,000,000

Units Sold:

                       
     4,761,905    Units    $ 10.50 per Unit    $ 50,000,000
     15,697,797    Units    $ 11 per Unit      172,675,767
                     

Totals:

   20,459,702    Units           $ 222,675,767

Expenses of Issuance and Distribution of Units

      

1. Underwriting discounts and commission

   $ 22,267,566

2. Expenses of underwriters

     —  

3. Direct or indirect payments to directors or officers of the Company or their associates, to ten percent shareholders, or to affiliates of the Company

     —  

4. Fees and expenses of third parties

     708,820
                     

Total Expenses of Issuance and Distribution of Common Shares

   $ 22,976,386
                     

Net Proceeds to the Company

   $ 199,699,381
                     

1. Purchase of real estate (including repayment of indebtedness incurred to purchase real estate)

   $ 89,381,070

2. Interest on indebtedness

     —  

3. Working capital

     108,587,511

4. Fees to the following (all affiliates of officers of the Company):

     —  

Apple Suites Realty Group, Inc.

     1,730,800

5. Fees and expenses of third parties:

      

a. Legal

     —  

b. Accounting

     —  

6. Other

     —  
                     

Total of Application of Net Proceeds to the Company

   $ 199,699,381
                     

 

20


Table of Contents

Item 6. Exhibits

 

Exhibit

Number


 

Description


3.1   Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-112169) effective April 23, 2004)
3.2   Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to the registrant’s registration statement on Form S-11 (SEC File No. 333-112169) effective April 23, 2004)
10.1   Management Agreement dated as of July 22, 2002 between Marriott International, Inc. and Redmar Property, L.P., as assigned by Consent, Assignment and Assumption and Amendment of Management Agreement dated as of July 6, 2004, but effective June 12, 2004, among Marriott International, Inc., Redmar Property, L.P., Apple Six Hospitality Management, Inc. and Apple Six Hospitality, Inc. regarding the Redmond, Washington hotel (Incorporated by reference to Exhibit 10.7 to the Post-Effective Amendment No. 2 to the Registrant’s Registration Statement o Form S-11 (SEC File No. 333-112169) filed on July 29, 2004)
10.2   Owner Agreement dated as of July 6, 2004, but effective as of June 12, 2004, among apple Six Hospitality Management, Inc., Apple Six Hospitality, Inc. and Marriott International, Inc. (Incorporated by reference to Exhibit 10.8 to the Post-Effective Amendment No. 2 to the Registrant’s Registration Statement o Form S-11 (SEC File No. 333-112169) filed on July 29, 2004)

 

21


Table of Contents
31.1   Certification of the registrant’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH).
31.2   Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Action of 2002 (FILED HEREWITH).
32.1   Certification of the Company’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH).
32.2   Certification of the Company’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Action of 2002 (FILED HEREWITH).

 

22


Table of Contents

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Apple REIT Six, Inc.

   

By:

 

/s/ Glade M. Knight


 

Date: November 4, 2004

 

   

Glade M. Knight,

   
   

Chairman of the Board,

   
   

Chief Executive Officer,

   
   

and President

   
   

(Principal Executive Officer)

   

By:

 

/s/ Bryan Peery


 

Date: November 4, 2004

 

   

Bryan Peery,

   
   

Chief Accounting Officer

   
   

(Principal Financial and Principal Accounting Officer)

   

 

23