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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 


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

For the quarterly period ended September 30, 2014

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______

Commission File Number 000-54651

Apple REIT Ten, Inc.
(Exact name of registrant as specified in its charter)
 
 
Virginia   27-3218228
(State or other jurisdiction
of incorporation or organization)
 
(IRS Employer
Identification No.)
     
814 East Main Street
Richmond, Virginia
  23219
(Address of principal executive offices)    (Zip Code)
 
(804) 344-8121
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer   o
 
Accelerated filer   o
 
Non-accelerated filer   x
 
Smaller reporting company  o
       
(Do not check if a smaller
reporting company)
   

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

Number of registrant’s common shares outstanding as of November 1, 2014: 91,037,588
 
 
 

 
APPLE REIT TEN, INC.
FORM 10-Q
INDEX

 
Page Number
PART I.  FINANCIAL INFORMATION
 
   
 
Item 1.
 
       
   
3
       
   
4
       
   
5
       
   
6
       
 
Item 2.
16
       
 
Item 3.
27
       
 
Item 4.
27
       
PART II.  OTHER INFORMATION
 
   
 
Item 1.
28
       
 
Item 2.
28
       
 
Item 6.
30
       
31
 
This Form 10-Q includes references to certain trademarks or service marks. The Courtyard ® by Marriott, Fairfield Inn and Suites® by Marriott, Marriott®, Residence Inn® by Marriott, SpringHill Suites® by Marriott and TownePlace Suites® by Marriott trademarks are the property of Marriott International, Inc. or one of its affiliates. The Hampton Inn and Suites®, Hilton Garden Inn®, Home2 Suites® by Hilton, and Homewood Suites® by Hilton trademarks are the property of Hilton Worldwide Holdings, Inc. or one or more of its affiliates. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above referenced terms are used.
 
 
 

 
PART I.  FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
APPLE REIT TEN, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
   
September 30, 2014
   
December 31, 2013
 
   
(unaudited)
       
Assets            
Investment in real estate, net of accumulated depreciation of $64,313 and
$43,076, respectively
  $ 800,193     $ 764,579  
Energy investment
    100,329       100,340  
Restricted cash-furniture, fixtures and other escrows
    11,041       10,843  
Due from third party managers, net
    8,604       4,327  
Other assets, net
    6,009       9,865  
        Total Assets
  $ 926,176     $ 889,954  
                 
Liabilities
               
Credit facility
  $ 2,800     $ 74,039  
Mortgage debt
    120,423       122,501  
Accounts payable and other liabilities
    12,180       10,642  
        Total Liabilities
    135,403       207,182  
                 
Shareholders' Equity
               
Preferred stock, authorized 30,000,000 shares; none issued and outstanding
    0       0  
Series A preferred stock, no par value, authorized 400,000,000 shares;
issued and outstanding 91,334,230 and 78,868,484 shares, respectively
    0       0  
Series B convertible preferred stock, no par value, authorized 480,000 shares;
issued and outstanding 480,000 shares
    48       48  
Common stock, no par value, authorized 400,000,000 shares; issued and
outstanding 91,334,230 and 78,868,484 shares, respectively
    894,839       772,388  
Distributions greater than net income
    (104,114 )     (89,664 )
        Total Shareholders' Equity
    790,773       682,772  
                 
        Total Liabilities and Shareholders' Equity
  $ 926,176     $ 889,954  
 
See notes to consolidated financial statements.
 
 
3

 
APPLE REIT TEN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Revenues:
                       
    Room
  $ 52,614     $ 40,166     $ 153,365     $ 104,647  
    Other
    4,177       3,595       13,220       10,922  
Total revenue
    56,791       43,761       166,585       115,569  
                                 
Expenses:
                               
    Operating
    14,275       11,028       41,173       28,956  
    Hotel administrative
    4,320       3,359       12,918       8,967  
    Sales and marketing
    4,801       3,841       13,976       10,015  
    Utilities
    2,252       1,695       6,145       4,094  
    Repair and maintenance
    1,980       1,656       6,168       4,088  
    Franchise fees
    2,520       1,862       7,426       4,810  
    Management fees
    1,676       1,345       5,278       3,691  
    Property taxes, insurance and other
    3,308       2,959       9,981       7,822  
    General and administrative
    1,369       1,119       4,461       3,305  
    Acquisition related costs
    13       2,935       1,054       4,904  
    Depreciation
    7,226       5,748       21,237       15,082  
Total expenses
    43,740       37,547       129,817       95,734  
                                 
Operating income
    13,051       6,214       36,768       19,835  
                                 
    Investment income
    3,530       3,533       10,475       4,467  
    Interest expense
    (1,867 )     (1,478 )     (6,541 )     (3,802 )
                                 
Income before income taxes
    14,714       8,269       40,702       20,500  
                                 
    Income tax expense
    (1,203 )     (87 )     (2,934 )     (244 )
                                 
Net income
  $ 13,511     $ 8,182     $ 37,768     $ 20,256  
                                 
Basic and diluted net income per common share
  $ 0.15     $ 0.11     $ 0.45     $ 0.29  
Weighted average common shares outstanding - basic and diluted
    90,267       74,887       84,605       70,308  
 
See notes to consolidated financial statements.
 
 
4

 
APPLE REIT TEN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
   
Nine Months Ended
 
   
September 30,
 
   
2014
   
2013
 
Cash flows from operating activities:
           
Net income
  $ 37,768     $ 20,256  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation
    21,237       15,082  
Other non-cash expenses, net
    397       197  
Changes in operating assets and liabilities:
               
Increase in due from third party managers, net
    (4,052 )     (4,050 )
(Increase) decrease in other assets, net
    731       (927 )
Increase in accounts payable and other liabilities
    610       1,930  
Net cash provided by operating activities
    56,691       32,488  
                 
Cash flows used in investing activities:
               
Cash paid for energy investment
    0       (100,000 )
Cash paid for the acquisition of hotel properties
    (40,207 )     (177,379 )
Deposits and other disbursements for potential acquisitions
    (325 )     (1,528 )
Capital improvements
    (12,276 )     (6,543 )
(Increase) decrease in capital improvement reserves
    (899 )     4,044  
Investment in other assets
    0       (1,450 )
Net cash used in investing activities
    (53,707 )     (282,856 )
                 
Cash flows from financing activities:
               
Net proceeds related to issuance of Units
    134,820       128,409  
Redemptions of Units
    (12,508 )     (14,611 )
Distributions paid to common shareholders
    (52,218 )     (43,389 )
Proceeds from (payments on) credit facility
    (71,239 )     35,103  
Payments of mortgage debt
    (1,585 )     (1,144 )
Financing costs
    (254 )     (530 )
Net cash provided by (used in) financing activities
    (2,984 )     103,838  
                 
Decrease in cash and cash equivalents
    0       (146,530 )
                 
Cash and cash equivalents, beginning of period
    0       146,530  
                 
Cash and cash equivalents, end of period
  $ 0     $ 0  
                 
Supplemental information:
               
Interest paid
  $ 6,867     $ 3,823  
Income taxes paid
  $ 3,665     $ 308  
 
See notes to consolidated financial statements.
 
 
5

 
APPLE REIT TEN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.  Organization and Summary of Significant Accounting Policies

Organization

Apple REIT Ten, Inc. together with its wholly owned subsidiaries (the “Company”) is a Virginia corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. The Company was formed to invest in hotels and other income-producing real estate in selected metropolitan areas in the United States. Initial capitalization occurred on August 13, 2010, when 10 Units, each Unit consisting of one common share and one Series A preferred share, were purchased by Apple Ten Advisors, Inc. (“A10A”) and 480,000 Series B convertible preferred shares were purchased by Glade M. Knight, the Company’s Chairman and Chief Executive Officer. The Company began operations on March 4, 2011, when it purchased its first hotel. The Company’s fiscal year end is December 31. The Company has no foreign operations or assets and its operating structure includes only one reportable segment. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated. Although the Company has interests in variable interest entities through its energy investment and purchase commitments, it is not the primary beneficiary as the Company does not have any elements of power in the decision making process of these entities, and therefore does not consolidate the entities. As of September 30, 2014, the Company owned 49 hotels located in 17 states with an aggregate of 6,188 rooms.

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 2013 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the twelve month period ending December 31, 2014.

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.

Reclassifications

Certain amounts in the 2013 consolidated financial statements have been reclassified to conform to the 2014 presentation with no effect on previously reported net income or shareholders’ equity.

Offering Costs

On July 31, 2014, the Company concluded its best-efforts offering of Units by David Lerner Associates, Inc., the managing underwriter, which received a selling commission and a marketing expense allowance based on proceeds of the Units sold. Additionally, the Company incurred other offering costs including legal, accounting and reporting services. These offering costs were recorded by the Company as a reduction of shareholders’ equity. As of the conclusion of the offering, the Company had sold 96.1 million Units for gross proceeds of approximately $1.1 billion and proceeds net of offering costs of approximately $943.0 million. Offering costs included approximately $105.2 million in selling commissions and marketing expenses and approximately $3.9 million in other offering costs.
 
 
6


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 common 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 for the three and nine months ended September 30, 2014 or 2013. As a result, basic and diluted 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.

Income Taxes

To qualify as a REIT for federal income tax purposes, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 90 percent of its adjusted taxable income to its shareholders. As a REIT, the Company generally is not subject to federal corporate income tax on that portion of its taxable income that is currently distributed to shareholders. The Company is subject to certain state and local taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. In addition, the Company’s taxable REIT subsidiary (“Lessee”), which leases the Company’s hotels and owns the Company’s energy investment, is subject to federal and state income taxes. The Company accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Valuation allowances are provided if, based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Prior to 2014, the Lessee had net operating loss carryforwards to offset taxable income. Based on taxable income through September 30, 2014, the Lessee has generated taxable income in excess of its net operating loss carryforwards and has accrued approximately $2.4 million in estimated federal and state income tax or approximately 40% of the excess taxable income.

Recent Accounting Standard

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which affects virtually all aspects of an entity’s revenue recognition. The core principle of the new standard is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those years. Early adoption is not permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

2.  Investment in Real Estate

The Company acquired two hotels during the first nine months of 2014. The following table sets forth the location, brand, manager, date acquired, number of rooms and gross purchase price for each hotel. All dollar amounts are in thousands.

City
 
State
 
Brand
 
Manager
 
Date Acquired
 
Rooms
   
Gross Purchase Price
 
Oklahoma City
 
OK
 
Hilton Garden Inn
 
Raymond
 
1/31/2014
    155     $ 27,353  
Oklahoma City
 
OK
 
Homewood Suites
 
Raymond
 
1/31/2014
    100       17,647  
    Total
                    255     $ 45,000  
 
 
7

 
At the date of purchase, the purchase price for these properties was funded primarily by borrowings under the Company’s unsecured revolving credit facility. The Company also used borrowings under its unsecured credit facility to pay approximately $1.0 million in acquisition related costs, including $0.9 million, representing 2% of the gross purchase price for these hotels, as a brokerage commission to Apple Suites Realty Group, Inc. (“ASRG”), which is 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive Officer, and approximately $0.1 million in other acquisition related costs, including title, legal and other related costs. These costs are included in acquisition related costs in the Company’s consolidated statements of operations for the nine months ended September 30, 2014.

For the two hotels acquired during the first nine months of 2014, the amount of revenue and operating income (excluding acquisition related costs totaling $1.0 million) included in the Company’s consolidated statement of operations from the acquisition date to the period ending September 30, 2014 was approximately $6.6 million and $1.2 million, respectively.

The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary (or a subsidiary thereof) under master hotel lease agreements.

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

As of September 30, 2014, the Company owned 49 hotels, located in 17 states, consisting of the following:
 
   
Total by
   
Number of
 
Brand
 
Brand
   
Rooms
 
Hilton Garden Inn
    11       1,719  
Homewood Suites
    10       1,100  
Hampton Inn & Suites
    9       1,089  
Courtyard
    4       519  
TownePlace Suites
    4       387  
Fairfield Inn & Suites
    3       310  
Home2 Suites
    3       304  
Residence Inn
    2       244  
SpringHill Suites
    2       206  
Marriott
    1       310  
      49       6,188  
 
At September 30, 2014, the Company’s investment in real estate consisted of the following (in thousands):

Land
  $ 73,266  
Building and Improvements
    727,070  
Furniture, Fixtures and Equipment
    60,658  
Franchise Fees
    3,512  
      864,506  
Less Accumulated Depreciation
    (64,313 )
Investment in Real Estate, net
  $ 800,193  
 
 
8


As of September 30, 2014, the Company had outstanding contracts for the potential purchase of four additional hotels, which were under construction, for a total purchase price of $89.6 million. The Fort Lauderdale Residence Inn hotel, which opened in October 2014, was acquired on October 24, 2014.  Closing on the remaining three hotels is expected upon completion of construction. Assuming all conditions to closing are met, the purchase of these three hotels should close over the next 15 months from September 30, 2014. Although the Company is working towards acquiring these three hotels, there are many conditions to closing that have not yet been satisfied and there can be no assurance that a closing will occur under the outstanding purchase contracts. The following table summarizes the location, brand, expected number of rooms, refundable (if the seller does not meet its obligations under the contract) contract deposits paid, and gross purchase price for each of the contracts outstanding at September 30, 2014. All dollar amounts are in thousands.
 
Location
 
Brand
 
Rooms
   
Deposits Paid
   
Gross Purchase Price
 
Fort Lauderdale, FL (b)
 
Residence Inn
    156     $ 3     $ 23,088  
Shenandoah, TX (a)
 
Courtyard
    124       3       15,872  
Cape Canaveral, FL (a)
 
Homewood Suites
    153       3       25,245  
Rosemont, IL
 
Hampton Inn & Suites
    158       300       25,400  
          591     $ 309     $ 89,605  
________
(a) If the seller meets all of the conditions to closing, the Company is obligated to specifically perform under the contract. As the property is under construction, at this time, the seller has not met all of the conditions to closing.
(b) Property was acquired October 24, 2014.
 
As there can be no assurance that all conditions to closing will be satisfied, the Company includes deposits paid for hotels under contract in other assets, net in the Company’s consolidated balance sheets, and in deposits and other disbursements for potential acquisitions in the Company’s consolidated statements of cash flows. The purchase price for the Fort Lauderdale Residence Inn was funded from borrowings under the Company’s credit facility, and it is anticipated that the purchase price for the remaining outstanding contracts will be funded from borrowings under the Company’s credit facility if a closing occurs.

3.  Energy Investment

On June 7, 2013, the Company became the preferred member of Cripple Creek Energy, LLC (“CCE”) pursuant to the limited liability company agreement it entered into with Eastern Colorado Holdings, LLC as the common member (“Common Member”). On April 30, 2014, the Common Member exercised its right to extend the redemption date of the Company’s $100 million preferred interest (energy investment) in CCE until June 1, 2015.

4.  Credit Facility

On July 26, 2013, the Company entered into an unsecured revolving credit facility with a commercial bank in an initial amount of $75 million. On October 3, 2013, the credit agreement was amended to increase the amount of the facility to $100 million and to allow for future increases in the amount of the facility up to $150 million, subject to certain conditions. The amount of the facility was increased to $150 million on January 30, 2014 and reduced back to $100 million on August 14, 2014. The credit facility is utilized for acquisitions, hotel renovations, working capital and other general corporate funding purposes, including distributions and the possible payment of redemptions. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part, at any time. The credit facility matures in July 2015; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to July 2016. Interest payments are due monthly and the interest rate, subject to certain exceptions, is equal to the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 2.75%, depending upon the Company’s leverage ratio, as calculated under the terms of the credit agreement. The Company is also required to pay an unused facility fee of 0.25% or 0.35% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during each quarter. As of September 30, 2014, the credit facility had an outstanding principal balance of $2.8 million and an annual interest rate of approximately 2.40%. As of December 31, 2013, the credit facility had an outstanding principal balance of $74.0 million and an annual interest rate of approximately 2.42%.
 
 
9


The credit facility contains customary affirmative covenants, negative covenants and events of default. In addition, the credit facility contains covenants restricting the level of certain investments and quarterly financial covenants which include, among others, a minimum net worth, maximum debt limits, minimum debt service and fixed charge coverage ratios, and maximum distributions. The Company was in compliance with all applicable covenants at September 30, 2014.

5.  Fair Value of Financial Instruments

The Company estimates the fair value of its debt and energy investment by discounting the future cash flows of each instrument at estimated market rates consistent with the maturity of an instrument with similar credit terms and credit characteristics, which are Level 3 inputs. Market rates take into consideration general market conditions and maturity. At September 30, 2014, the carrying value of the Company’s energy investment approximated fair value. As of September 30, 2014, the carrying value and estimated fair value of the Company’s debt was approximately $123.2 million and $126.5 million. As of December 31, 2013, the carrying value and estimated fair value of the Company’s debt was $196.5 million and $198.1 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 at arm’s 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 (including the relationships discussed in this section) and are required to approve any significant modifications to existing relationships, as well as any new significant related party transactions. There have been no changes to the contracts and relationships discussed in the Company’s 2013 Annual Report on Form 10-K. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. 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 term the “Apple REIT Entities” means the Company, Apple REIT Six, Inc. (“Apple Six”), Apple REIT Seven, Inc. (“Apple Seven”), Apple REIT Eight, Inc. (“Apple Eight”) and Apple Hospitality REIT, Inc., formerly known as Apple REIT Nine, Inc. (“Apple Hospitality”). The term the “Advisors” means Apple Six Advisors, Inc., Apple Seven Advisors, Inc., Apple Eight Advisors, Inc., Apple Nine Advisors, Inc. (“A9A”), A10A, ASRG and Apple Six Realty Group, Inc. The Advisors are wholly owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Executive Chairman, and formerly Chairman and Chief Executive Officer, of Apple Hospitality. Another member of the Company’s Board of Directors is also on the Board of Directors of Apple Hospitality, and Mr. Justin G. Knight, the Company’s President, has been appointed to the Board of Directors of Apple Hospitality, effective January 1, 2015.

Effective March 1, 2014, Apple Seven and Apple Eight merged with and into Apple Hospitality. Pursuant to the terms and conditions of the merger agreement, dated as of August 7, 2013 (the “Merger Agreement”), upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight ceased (the “A7 and A8 mergers”). Prior to the A7 and A8 mergers, Glade M. Knight was Chairman and Chief Executive Officer of Apple Seven and Apple Eight and another member of the Company’s Board of Directors was also on the Board of Directors of Apple Seven and Apple Eight. As contemplated in the Merger Agreement, Apple Hospitality became self-advised, Apple Hospitality, Apple Seven and Apple Eight terminated their advisory agreements with their respective Advisors, and Apple Fund Management, LLC (“AFM”) became a wholly owned subsidiary of Apple Hospitality.
 
 
10


Concurrently with the execution of the Merger Agreement, on August 7, 2013, Apple Hospitality entered into a subcontract agreement, as amended, (the “Subcontract Agreement”) with A10A. Pursuant to the Subcontract Agreement, A10A subcontracts its obligations under the advisory agreement between A10A and the Company (the “Advisory Agreement”) to Apple Hospitality. The Subcontract Agreement provides that, effective with the A7 and A8 mergers on March 1, 2014, Apple Hospitality provides to the Company the advisory services contemplated under the Advisory Agreement and Apple Hospitality receives the fees and expenses payable under the Advisory Agreement from the Company. The Company also signed the Subcontract Agreement to acknowledge the terms of the Subcontract Agreement. The Subcontract Agreement has no impact on the Company’s Advisory Agreement with A10A.

ASRG Agreement

The Company has a contract with ASRG to acquire and dispose of real estate assets for the Company. A fee of 2% of the gross purchase price or gross sale price in addition to certain reimbursable expenses is paid to ASRG for these services. As of September 30, 2014, payments to ASRG for fees under the terms of this contract have totaled approximately $16.6 million since inception. Of this amount, the Company incurred $0.9 million and $3.5 million for the nine months ended September 30, 2014 and 2013, which is included in acquisition related costs in the Company’s consolidated statements of operations.

A10A Agreement

The Company is party to an Advisory Agreement with A10A, pursuant to which A10A provides management services to the Company. As discussed above, effective with the A7 and A8 mergers on March 1, 2014, A10A subcontracts its obligations under this agreement to Apple Hospitality. Prior to March 1, 2014, A10A provided these management services through AFM, which prior to the A7 and A8 mergers was a wholly-owned subsidiary of A9A. An annual fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses as described below, is payable to A10A for these management services.

Total advisory fees incurred by the Company under the Advisory Agreement are included in general and administrative expenses and totaled approximately $1.0 million and $0.6 million for the nine months ended September 30, 2014 and 2013 respectively. Of this amount, $0.8 million was paid to Apple Hospitality for the nine months ended September 30, 2014, pursuant to the Subcontract Agreement. At December 31, 2013, $0.4 million of the 2013 advisory fee had not been paid and was included in accounts payable and other liabilities in the Company’s consolidated balance sheet. This amount was paid during the first quarter of 2014. No amounts were outstanding at September 30, 2014.

Apple REIT Entities and Advisors Cost Sharing Structure

In addition to the fees payable to ASRG and A10A, the Company reimbursed to ASRG or A10A, or paid directly to AFM or Apple Hospitality on behalf of ASRG or A10A, approximately $2.0 million and $1.3 million for the nine months ended September 30, 2014 and 2013. The costs are included in general and administrative expenses and are for the Company’s allocated share of the staffing and related costs provided by AFM and Apple Hospitality through their relationships with A10A and ASRG.

The Company incurs professional fees such as accounting, auditing, legal and reporting, which are included in general and administrative expenses in the Company’s consolidated statements of operations. To be cost effective, these services received by the Company are shared as applicable by the Company and the other Apple REIT Entities. The professionals cannot always specifically identify their fees for one company; therefore management allocates these costs across the companies that benefit from the services, which, following the A7 and A8 mergers, include only the Company and Apple Hospitality. The Company and other Apple REIT Entities have incurred legal fees associated with the legal proceeding discussed herein. The total costs for the legal matter discussed herein for all of the Apple REIT Entities (excluding Apple Six after its merger in May 2013) was approximately $0.3 million for the nine months ended September 30, 2014, of which approximately $58,000 was allocated to the Company.
 
 
11


Apple Air Holding, LLC (“Apple Air”) Membership Interest

Included in other assets, net on the Company’s consolidated balance sheet as of September 30, 2014 and December 31, 2013 is a 26% equity investment in Apple Air. As of September 30, 2014, the other member of Apple Air was Apple Hospitality, which owned a 74% interest. The Company’s equity investment was approximately $1.0 million and $1.2 million as of September 30, 2014 and December 31, 2013. 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 nine months ended September 30, 2014 and 2013, the Company recorded a loss of approximately $179,000 and $109,000 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. Through its equity investment, the Company has access to Apple Air’s aircraft primarily for acquisition, asset management and renovation purposes. Total costs paid for the usage of the aircraft for the nine months ended September 30, 2014 and 2013 were approximately $135,000 and $218,000.

7.  Shareholders’ Equity
 
Series B Convertible Preferred Stock

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

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

Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.

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

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

(2) the termination or expiration without renewal of the Advisory Agreement with A10A, 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.
 
 
12

 
Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 12.11423 common shares. The conversion rate is based on the total gross proceeds raised in the Company’s best-efforts offering which concluded on July 31, 2014. If the Company were to raise additional gross proceeds in an offering up to a total of $2 billion, the conversion ratio would increase up to 24.17104. In the event that the Company raises gross proceeds in a subsequent public offering above the initial $2 billion, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/100 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $100 million.

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

Expense related to the issuance of 480,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B convertible preferred shares can be converted and the amount paid for the Series B convertible preferred shares. Although the fair market value cannot be determined at this time, expense, if a triggering event occurs, would range from $0 to $64.0 million (assumes $11 per common share fair market value) and approximately 5.8 million common shares would be issued.

Unit Redemption Program

In April 2012, the Company instituted a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92.5% of the price paid per Unit if the Units have been owned for less than five years, or 100% of the price paid per Unit if the Units have been owned more than five years. The maximum number of Units that may be redeemed in any given year is three percent (3%) of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. Since the inception of the program through September 30, 2014, the Company has redeemed approximately 4.7 million Units in the amount of $48.4 million, including 1.2 million Units in the amount of $12.5 million and 1.4 million Units in the amount of $14.6 million during the nine months ended September 30, 2014 and 2013. As contemplated in the program, beginning with the October 2012 redemption, and for certain redemptions thereafter, the Company redeemed Units on a pro-rata basis due to the 3% limitation discussed above, with approximately 8% of the requested shares redeemed in the fourth quarter of 2012, 12% in the first quarter of 2013, 60% in the second quarter of 2013 and 68% in the first quarter of 2014. For all other scheduled redemption dates through September 30, 2014, the Company redeemed 100% of the redemption requests. The following is a summary of the Unit redemptions during 2013 and the first nine months of 2014:
 
Redemption Date
 
Total Requested Unit
Redemptions at
Redemption Date
   
Units Redeemed
   
Total Redemption
Requests Not
Redeemed at
Redemption Date
 
                   
First Quarter 2013
    938,026       114,200       823,826  
Second Quarter 2013
    1,063,625       637,779       425,846  
Third Quarter 2013
    677,855       677,855       0  
Fourth Quarter 2013
    609,079       609,079       0  
First Quarter 2014
    357,013       242,644       114,369  
Second Quarter 2014
    479,078       479,078       0  
Third Quarter 2014
    496,839       496,839       0  
 
 
13

 
Distributions

The Company’s annual distribution rate as of September 30, 2014 was $0.825 per common share, payable monthly. For the three months ended September 30, 2014 and 2013, the Company made distributions of $0.20625 per common share for a total of $18.6 million and $15.4 million. For the nine months ended September 30, 2014 and 2013, the Company made distributions of $0.61875 per common share for a total of $52.2 million and $43.4 million.

8.  Pro Forma Information

The following unaudited pro forma information for the nine months ended September 30, 2014 and 2013 is presented as if the acquisitions of the Company’s 18 hotels acquired after December 31, 2012 had occurred on the latter of January 1, 2013 or the opening date of the hotel. The pro forma information does not purport to represent what the Company’s results of operations would actually have been if such transactions, in fact, had occurred on these applicable dates, nor does it purport to represent the results of operations for future periods. Amounts are in thousands, except per share data.
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2014
   
2013
   
2014
   
2013
 
                         
Total revenues
  $ 56,791     $ 49,355     $ 166,585     $ 147,194  
Net income
    13,511       12,228       37,768       25,601  
Net income per share - basic and diluted
  $ 0.15     $ 0.16     $ 0.45     $ 0.35  
 
The pro forma information reflects adjustments for actual revenues and expenses of the 18 hotels acquired during 2013 and 2014 for the respective period owned prior to acquisition by the Company. Net income has been adjusted as follows: (1) interest income has been adjusted to reflect the reduction in cash and cash equivalents required to fund the acquisitions; (2) interest expense has been adjusted to reflect additional borrowings required to fund a portion of the acquisitions; (3) interest expense related to prior owner’s debt which was not assumed has been eliminated; (4) depreciation has been adjusted based on the Company’s basis in the hotels; and (5) transaction costs have been adjusted for the acquisition of existing businesses.

9.  Legal Proceedings

On April 23, 2014, the United States Court of Appeals for the Second Circuit (the “Second Circuit”) entered a summary order in the consolidated class action referred to in the Company’s prior filings as the In re Apple REITs Litigation matter. In the summary order, the Second Circuit affirmed the dismissal by the United States District Court for the Eastern District of New York (the “District Court”) of the plaintiffs’ state and federal securities law claims and the unjust enrichment claim. The Second Circuit also noted that the District Court dismissed the plaintiffs’ remaining state common law claims based on its finding that the complaint did not allege any losses suffered by the plaintiff class, and held that, to the extent that the District Court relied on this rationale, its dismissal of the plaintiffs’ state law breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, and negligence claims is vacated and remanded for further proceedings consistent with the summary order. Following remand, on June 6, 2014, defendants moved to dismiss plaintiffs’ remaining claims. The Company will defend against the claims remanded to the District Court 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.
 
 
14


10.  Subsequent Events

In October 2014, the Company declared and paid approximately $6.3 million, or $0.06875 per outstanding common share, in distributions to its common shareholders.

In October 2014, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 0.3 million Units in the amount of $3.0 million, representing 100% of the requested Unit redemptions.

On October 24, 2014, the Company closed on the purchase of a 156-room Residence Inn in Fort Lauderdale, Florida.  The gross purchase price is $23.1 million.

 
 

 
 
15


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

Forward-Looking Statements

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. Forward-looking statements are typically identified by use of terms such as “may,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “target,” “goal,” “plan,” “should,” “will,” “predict,” “potential” and similar expressions that convey the uncertainty of future events or outcomes. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the ability of the Company to implement its acquisition strategy and operating strategy; the Company’s ability to manage planned growth; changes in general political, economic and competitive conditions and specific market conditions; adverse changes in the real estate and real estate capital markets; financing risks; the outcome of current and future litigation; regulatory proceedings or inquiries; changes in laws or regulations or interpretations of current laws and regulations that impact the Company’s business, assets or classification as a real estate investment trust; and the ability of the Company to realize its anticipated return on its energy investment as well as the ability of the underlying business to implement its operating strategy, which is subject to numerous government regulations and other risks inherent in the oil and gas 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 this 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 (“SEC”). Any forward-looking statement that the Company makes speaks only as of the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statements or cautionary factors, as a result of new information, future events, or otherwise, except as required by law.

Overview

Apple REIT Ten, 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, which has a limited operating history, was formed to invest in hotels and other income-producing real estate in selected metropolitan areas in the United States. The Company was initially capitalized on August 13, 2010, with its first investor closing on January 27, 2011 under its initial best-efforts offering of Units (each Unit consists of one common share and one Series A preferred share). Effective July 31, 2014, the Company concluded its best-efforts offering of Units, with a total of 96.1 million Units sold, gross proceeds of approximately $1.1 billion and proceeds net of offering costs of approximately $943.0 million. As of September 30, 2014, the Company owned 49 hotels (two acquired during the first nine months of 2014, 16 acquired during 2013, five acquired during 2012 and 26 acquired during 2011). Accordingly, the results of operations include only results from the date of ownership of the properties.

Hotel Operations

Although hotel performance can be influenced by many factors including local competition, local and general economic conditions in the United States and the performance of individual managers assigned to each hotel, performance of the Company’s hotels as compared to other hotels within their respective local markets, in general, has met the Company’s expectations for the period owned. The hotel industry and the Company continue to see improvement in both revenues and operating income for comparable hotels as compared to the prior year. Although the economy in the United States has slowly continued to improve, there is no way to predict future general economic conditions, and there are certain factors that could negatively affect the lodging industry and the Company, including but not limited to, increased hotel supply in certain markets, labor uncertainty both for the economy as a whole and the lodging industry in particular, global volatility and government fiscal policies. The Company and industry are forecasting a mid to upper-single digit percentage increase in revenue and operating income for the full year of 2014 as compared to 2013 for comparable hotels, with the trend expected to continue into 2015.
 
 
16


In evaluating financial condition and operating performance, the most important indicators on which the Company focuses are revenue measurements, such as average occupancy, average daily rate (“ADR”) and revenue per available room (“RevPAR”), and expenses, such as hotel operating expenses, general and administrative expenses and other expenses as described below.

The following is a summary of the results from operations of the 49 hotels owned as of September 30, 2014 for their respective periods of ownership by the Company:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(in thousands, except statistical data)
 
2014
   
Percent of Revenue
   
2013
   
Percent of Revenue
   
2014
   
Percent of Revenue
   
2013
   
Percent of Revenue
 
                                                 
Total revenue
  $ 56,791       100 %   $ 43,761       100 %   $ 166,585       100 %   $ 115,569       100 %
Hotel operating expenses
    31,824       56 %     24,786       57 %     93,084       56 %     64,621       56 %
Property taxes, insurance and other expense
    3,308       6 %     2,959       7 %     9,981       6 %     7,822       7 %
General and administrative expense
    1,369       2 %     1,119       3 %     4,461       3 %     3,305       3 %
                                                                 
Acquisition related costs
    13               2,935               1,054               4,904          
Depreciation
    7,226               5,748               21,237               15,082          
Investment income
    3,530               3,533               10,475               4,467          
Interest expense
    1,867               1,478               6,541               3,802          
Income tax expense
    1,203               87               2,934               244          
                                                                 
Number of hotels
    49               43               49               43          
ADR
  $ 120             $ 114             $ 121             $ 116          
Occupancy
    77 %             74 %             75 %             73 %        
RevPAR
  $ 92             $ 84             $ 91             $ 85          
Total rooms sold(1)
    437,589               352,807               1,266,952               905,011          
Total rooms available(2)
    569,381               477,730               1,683,799               1,236,348          
________
                                                               
(1) Represents the number of room nights sold during the period.
 
(2) Represents the number of rooms owned by the Company multiplied by the number of nights in the period.
 
 
Hotels Owned

The Company commenced operations in March 2011 upon the purchase of its first hotel property. The following table summarizes the location, brand, manager, date acquired, number of rooms and gross purchase price for each of the 49 hotels the Company owned as of September 30, 2014. All dollar amounts are in thousands.
 
 
17

 
City
 
State
 
Brand
 
Manager
 
Date Acquired
 
Rooms
   
Gross Purchase Price
 
Denver
 
CO
 
Hilton Garden Inn
 
Stonebridge
 
3/4/2011
    221     $ 58,500  
Winston-Salem
 
NC
 
Hampton Inn & Suites
 
McKibbon
 
3/15/2011
    94       11,000  
Charlotte
 
NC
 
Fairfield Inn & Suites
 
Newport
 
3/25/2011
    94       10,000  
Columbia
 
SC
 
TownePlace Suites
 
Newport
 
3/25/2011
    91       10,500  
Mobile
 
AL
 
Hampton Inn & Suites
 
McKibbon
 
6/2/2011
    101       13,000  
Gainesville
 
FL
 
Hilton Garden Inn
 
McKibbon
 
6/2/2011
    104       12,500  
Pensacola
 
FL
 
TownePlace Suites
 
McKibbon
 
6/2/2011
    97       11,500  
Knoxville
 
TN
 
SpringHill Suites
 
McKibbon
 
6/2/2011
    103       14,500  
Richmond
 
VA
 
SpringHill Suites
 
McKibbon
 
6/2/2011
    103       11,000  
Cedar Rapids
 
IA
 
Hampton Inn & Suites
 
Schulte
 
6/8/2011
    103       13,000  
Cedar Rapids
 
IA
 
Homewood Suites
 
Schulte
 
6/8/2011
    95       13,000  
Hoffman Estates
 
IL
 
Hilton Garden Inn
 
Schulte
 
6/10/2011
    184       10,000  
Davenport
 
IA
 
Hampton Inn & Suites
 
Schulte
 
7/19/2011
    103       13,000  
Knoxville
 
TN
 
Homewood Suites
 
McKibbon
 
7/19/2011
    103       15,000  
Knoxville
 
TN
 
TownePlace Suites
 
McKibbon
 
8/9/2011
    98       9,000  
Mason
 
OH
 
Hilton Garden Inn
 
Schulte
 
9/1/2011
    110       14,825  
Omaha
 
NE
 
Hilton Garden Inn
 
White
 
9/1/2011
    178       30,018  
Des Plaines
 
IL
 
Hilton Garden Inn
 
Raymond
 
9/20/2011
    252       38,000  
Merillville
 
IN
 
Hilton Garden Inn
 
Schulte
 
9/30/2011
    124       14,825  
Austin/Round Rock
 
TX
 
Homewood Suites
 
Vista
 
10/3/2011
    115       15,500  
Scottsdale
 
AZ
 
Hilton Garden Inn
 
White
 
10/3/2011
    122       16,300  
South Bend
 
IN
 
Fairfield Inn & Suites
 
White
 
11/1/2011
    119       17,500  
Charleston
 
SC
 
Home2 Suites
 
LBA
 
11/10/2011
    122       13,908  
Oceanside
 
CA
 
Courtyard
 
Marriott
 
11/28/2011
    142       30,500  
Skokie
 
IL
 
Hampton Inn & Suites
 
Raymond
 
12/19/2011
    225       32,000  
Tallahassee
 
FL
 
Fairfield Inn & Suites
 
LBA
 
12/30/2011
    97       9,355  
Gainesville
 
FL
 
Homewood Suites
 
McKibbon
 
1/27/2012
    103       14,550  
Nashville
 
TN
 
TownePlace Suites
 
LBA
 
1/31/2012
    101       9,848  
Jacksonville
 
NC
 
Home2 Suites
 
LBA
 
5/4/2012
    105       12,000  
Boca Raton
 
FL
 
Hilton Garden Inn
 
White
 
7/16/2012
    149       10,900  
Houston
 
TX
 
Courtyard
 
LBA
 
7/17/2012
    124       14,632  
Huntsville
 
AL
 
Hampton Inn & Suites
 
LBA
 
3/14/2013
    98       11,466  
Huntsville
 
AL
 
Home2 Suites
 
LBA
 
3/14/2013
    77       9,009  
Fairfax
 
VA
 
Marriott
 
White
 
3/15/2013
    310       34,000  
Houston
 
TX
 
Residence Inn
 
Western
 
6/7/2013
    120       18,000  
Denton
 
TX
 
Homewood Suites
 
Chartwell
 
7/26/2013
    107       11,300  
Maple Grove
 
MN
 
Hilton Garden Inn
 
North Central
 
7/26/2013
    120       12,675  
Oklahoma City (West)
 
OK
 
Homewood Suites
 
Chartwell
 
7/26/2013
    90       11,500  
Omaha
 
NE
 
Hampton Inn & Suites
 
North Central
 
7/26/2013
    139       19,775  
Omaha
 
NE
 
Homewood Suites
 
North Central
 
7/26/2013
    123       17,625  
Phoenix
 
AZ
 
Courtyard
 
North Central
 
7/26/2013
    127       10,800  
Phoenix
 
AZ
 
Hampton Inn & Suites
 
North Central
 
7/26/2013
    125       8,600  
Phoenix
 
AZ
 
Homewood Suites
 
North Central
 
7/26/2013
    134       12,025  
Colorado Springs
 
CO
 
Hampton Inn & Suites
 
Chartwell
 
11/8/2013
    101       11,500  
Franklin
 
TN
 
Courtyard
 
Chartwell
 
11/8/2013
    126       25,500  
Franklin
 
TN
 
Residence Inn
 
Chartwell
 
11/8/2013
    124       25,500  
Dallas
 
TX
 
Homewood Suites
 
Western
 
12/5/2013
    130       25,350  
Oklahoma City
 
OK
 
Hilton Garden Inn
 
Raymond
 
1/31/2014
    155       27,353  
Oklahoma City
 
OK
 
Homewood Suites
 
Raymond
 
1/31/2014
    100       17,647  
    Total
                    6,188     $ 829,786  
 
 
18

 
The purchase price for these properties, net of debt assumed was funded primarily by proceeds from the Company’s best-efforts offering of Units and borrowings under its revolving credit facility. The Company assumed approximately $121.2 million of debt secured by nine of its hotel properties.

The Company also used the proceeds of its best-efforts offering and borrowings under its revolving credit facility to pay approximately $16.6 million, representing 2% of the gross purchase price for these hotels, as a commission to Apple Suites Realty Group, Inc. (“ASRG”), which is 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive Officer. The Company leases all of its hotels to its wholly-owned taxable REIT subsidiary (or a subsidiary thereof) under master hotel lease agreements. No goodwill was recorded in connection with any of the acquisitions.

Energy Investment

On June 7, 2013, the Company became the preferred member of Cripple Creek Energy, LLC (“CCE”) pursuant to the limited liability company agreement it entered into with Eastern Colorado Holdings, LLC as the common member (“Common Member”). On April 30, 2014, the Common Member exercised its right to extend the redemption date of the Company’s $100 million preferred interest (energy investment) in CCE until June 1, 2015.

Results of Operations

The Company began operations on March 4, 2011 when it purchased its first hotel. As of September 30, 2014, the Company owned 49 hotels (of which two were acquired during 2014) with 6,188 rooms as compared to 43 hotels, with a total of 5,452 rooms as of September 30, 2013. As a result, a comparison of 2014 operating results to prior year results is not meaningful.

Hotel performance is impacted by many factors including the economic conditions in the United States as well as each locality. Economic indicators in the United States have shown evidence of a sustainable recovery, which continues to overall positively impact the lodging industry. As a result, the Company’s room revenue for comparable hotels improved 8% for the third quarter of 2014 as compared to the third quarter of 2013 and 7% in the first nine months of 2014 as compared to the same period of 2013. The Company expects continued improvement in revenue and operating income for the full year of 2014 as compared to 2013, with the trend continuing into 2015.

Revenues

The Company’s principal source of revenue is hotel revenue, consisting of room and other related revenue. For the three months ended September 30, 2014 and 2013, the Company had total revenue of approximately $56.8 million and $43.8 million. For the nine months ended September 30, 2014 and 2013, the Company had total revenue of approximately $166.6 million and $115.6 million. This revenue reflects hotel operations for the 49 hotels acquired through September 30, 2014 for their respective periods of ownership by the Company. For the three months ended September 30, 2014 and 2013, the hotels achieved combined average occupancy of approximately 77% and 74%, ADR of $120 and $114 and RevPAR of $92 and $84. For the nine months ended September 30, 2014 and 2013, the hotels achieved combined average occupancy of approximately 75% and 73%, ADR of $121 and $116 and RevPAR of $91 and $85. ADR is calculated as room revenue divided by the number of rooms sold, and RevPAR is calculated as occupancy multiplied by ADR. For the 31 comparable hotels (hotels owned since January 1, 2013), occupancy, ADR and RevPAR increased 5%, 4% and 9% respectively for the three months ended September 30, 2014, and increased 4%, 3% and 7% respectively for the nine months ended September 30, 2014 compared to the same periods in 2013.

The Company’s hotels in general have shown results consistent with industry and brand averages for the period of ownership. Although certain markets were negatively impacted by harsh weather conditions earlier this year and reduced government spending, with continued overall demand and room rate improvement, the Company and industry are forecasting a mid to upper-single digit percentage increase in revenue for the full year of 2014 as compared to 2013 for comparable hotels, with the trend expected to continue into 2015. The Company will continue to pursue market opportunities to improve revenue.
 
 
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In addition, five of the hotels owned as of September 30, 2014 have been opened within the past two years. Generally, newly constructed hotels require 12 to 24 months to establish themselves in their respective markets. Therefore, revenue for these hotels is expected to be below market levels for this period of time.

Expenses

Hotel operating expenses relate to the 49 hotels acquired through September 30, 2014 for their respective periods owned and consist of direct room expenses, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. For the three months ended September 30, 2014 and 2013, hotel operating expenses totaled approximately $31.8 million and $24.8 million, or 56% and 57% of total revenue. For the nine months ended September 30, 2014 and 2013, hotel operating expenses totaled approximately $93.1 million and $64.6 million, or 56% of total revenue in each period. As noted above, five of the hotels acquired by the Company opened within the past two years. As a result, although operating expenses will increase with a full year of ownership for all properties, it is anticipated that operating expenses as a percentage of revenue for the properties owned at September 30, 2014 will decline as new properties establish themselves within their respective markets. The benefit of newly opened hotels reducing expenses as a percentage of revenue as they become established was offset by a slight increase in labor costs during the first nine months of 2014 as compared to the first nine months of 2013 and utility and maintenance costs associated with a more harsh winter than 2013 in many markets. Labor costs are likely to continue to grow at increased rates due to government regulations surrounding wage rates, healthcare and other benefits. Although operating expenses will increase as revenue increases, the Company will continue to work with its management companies to reduce costs as a percentage of revenue where possible while maintaining quality and service levels at each property.
 
Property taxes, insurance, and other expense for the three months ended September 30, 2014 and 2013 totaled approximately $3.3 million and $3.0 million, or 6% and 7% of total revenue. For the nine months ended September 30, 2014 and 2013, property taxes, insurance, and other expense totaled approximately $10.0 million and $7.8 million, or 6% and 7% of total revenue. As discussed above, with the addition of five newly opened hotels, taxes, insurance and other expense as a percentage of revenue is anticipated to decline as the properties become established in their respective markets. However, for comparable hotels, taxes have increased for certain properties due to the reassessment of property values by localities resulting from the improved economy, partially offset by decreases in 2014 due to successful appeals of tax assessments at certain locations.

General and administrative expense for the three months ended September 30, 2014 and 2013 totaled approximately $1.4 million and $1.1 million. For the nine months ended September 30, 2014 and 2013, general and administrative expense totaled approximately $4.5 million and $3.3 million. The principal components of general and administrative expense are advisory fees and reimbursable expenses, legal fees, accounting fees, the Company’s share of the loss in its investment in Apple Air Holding, LLC, and reporting expense. The increase in general and administrative expense was driven by increased advisory fees as the Company reached the next fee tier under its advisory agreement with Apple Ten Advisors, Inc. due to improved results of operations and increased reimbursable expenses due to the growth of the Company.
 
Acquisition related costs for the three months ended September 30, 2014 and 2013 were approximately $13,000 and $2.9 million. For the nine months ended September 30, 2014 and 2013, acquisition related costs were approximately $1.1 million and $4.9 million. The Company has expensed as incurred all transaction costs associated with the acquisitions of existing businesses, including title, legal, accounting and other related costs, as well as the brokerage commission paid to ASRG. The decrease is due to the acquisition of two hotels with a total purchase price of $45.0 million in the first nine months of 2014 compared to 12 hotels with a total purchase price of $176.8 million in the first nine months of 2013.
 
 
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Depreciation expense for the three months ended September 30, 2014 and 2013 totaled approximately $7.2 million and $5.7 million. For the nine months ended September 30, 2014 and 2013, depreciation expense was approximately $21.2 million and $15.1 million. Depreciation expense represents expense of the Company’s 49 hotel buildings and related improvements, and associated personal property (furniture, fixtures and equipment), for their respective periods owned.

Investment income for the three months ended September 30, 2014 and 2013 totaled approximately $3.5 million in each period. For the nine months ended September 30, 2014 and 2013, investment income totaled approximately $10.5 million and $4.5 million. Investment income included $10.5 million and $4.3 million earned on the Company’s energy investment, acquired in June 2013, in the first nine months of 2014 and 2013.

Interest expense during the three months ended September 30, 2014 and 2013 totaled approximately $1.9 million and $1.5 million. For the nine months ended September 30, 2014 and 2013, interest expense totaled approximately $6.5 million and $3.8 million and is net of approximately $0.4 million and $0.2 million of interest capitalized associated with renovation projects. Interest expense primarily arose from debt assumed with the acquisition of nine of the Company’s hotels (loans assumed on three hotels in 2013, one hotel in 2012 and five hotels in 2011) and, beginning in July 2013, borrowings on the Company’s $100 million credit facility.

Income tax expense during the three months ended September 30, 2014 and 2013 totaled approximately $1.2 million and $0.1 million. For the nine months ended September 30, 2014 and 2013, income tax expense totaled $2.9 million and $0.2 million. The increase in income tax expense is due primarily to increases in taxable income for the Company’s taxable REIT subsidiary. Due to improvement in operating results at its hotels and due to the income from its energy investment, the taxable REIT subsidiary has realized the benefit of its historic operating loss carryforwards and for the first nine months of 2014 has recorded estimated federal and state income tax expense of approximately $2.4 million, or approximately 40% of taxable income in excess of its net operating loss carryforwards. The Company anticipates additional taxable income and associated tax expense for the remainder of the year.

 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 at arm’s 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 and are required to approve any significant modifications to existing relationships, as well as any new significant related party transactions. The Board of Directors is not required to approve each individual transaction that falls under the related party relationships. 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.

Effective March 1, 2014, Apple REIT Seven, Inc. (“Apple Seven”) and Apple REIT Eight, Inc. (“Apple Eight”) merged with and into Apple Hospitality REIT, Inc., formerly known as Apple REIT Nine, Inc. (“Apple Hospitality”). Pursuant to the terms and conditions of the merger agreement, dated as of August 7, 2013 (the “Merger Agreement”), upon completion of the mergers, the separate corporate existence of Apple Seven and Apple Eight ceased (the “A7 and A8 mergers”). Glade Knight is Executive Chairman and formerly Chairman and Chief Executive Officer of Apple Hospitality. Another member of the Company’s Board of Directors is also on the Board of Directors of Apple Hospitality, and Mr. Justin G. Knight, the Company’s President, has been appointed to the Board of Directors of Apple Hospitality, effective January 1, 2015. Prior to the A7 and A8 mergers, Glade Knight was Chairman and Chief Executive Officer of Apple Seven and Apple Eight and another member of the Company’s Board of Directors was also on the Board of Directors of Apple Seven and Apple Eight.
 
 
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The Company is managed by ASRG, who provides the Company with property acquisition and disposition services, and Apple Ten Advisors, Inc. (“A10A”), who provides the Company with day-to-day management services. The Company pays fees and reimburses certain expenses to ASRG and A10A for these services. Prior to March 1, 2014, A10A provided these management services through Apple Fund Management, LLC (“AFM”), which, at that time, was a wholly-owned subsidiary of Apple Nine Advisors, Inc. Effective with the A7 and A8 mergers on March 1, 2014, A10A subcontracts its obligations under the advisory agreement between A10A and the Company to Apple Hospitality. The subcontract agreement provides that, effective with the A7 and A8 mergers, Apple Hospitality will provide to the Company the advisory services contemplated under the A10A advisory agreement and that Apple Hospitality will receive the fees and expense reimbursements payable under the A10A advisory agreement from the Company. The Company also signed the subcontract agreement to acknowledge the terms of the subcontract agreement. The subcontract agreement has no impact on the Company’s advisory agreement with A10A.

See Note 6 titled Related Parties in the Company’s Unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this Quarterly Report on Form 10-Q for additional information concerning the Company’s related party transactions.

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

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

Upon the Company’s liquidation, the holder of the Series B convertible preferred shares is entitled to a priority liquidation payment before any distribution of liquidation proceeds to the holders of the common shares. However, the priority liquidation payment of the holder of the Series B convertible preferred shares is junior to the holders of the Series A preferred shares’ distribution rights. The holder of a Series B convertible preferred share is entitled to a liquidation payment of $11.00 per number of common shares each Series B convertible preferred share would be convertible into according to the formula described below. In the event that the liquidation of the Company’s assets results in proceeds that exceed the distribution rights of the Series A preferred shares and the Series B convertible preferred shares, the remaining proceeds will be distributed between the common shares and the Series B convertible preferred shares, on an as converted basis.

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

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

(2) the termination or expiration without renewal of the advisory agreement with A10A, or if the Company ceases to use ASRG to provide property acquisition and disposition services; or

(3) the Company’s common shares are listed on any securities exchange or quotation system or in any established market.
 
 
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Upon the occurrence of any conversion event, each Series B convertible preferred share may be converted into 12.11423 common shares. The conversion rate is based on the total gross proceeds raised in the Company’s best-efforts offering which concluded on July 31, 2014. If the Company were to raise additional gross proceeds in an offering up to a total of $2 billion, the conversion ratio would increase up to 24.17104. In the event that the Company raises gross proceeds in a subsequent public offering above the initial $2 billion, each Series B convertible preferred share may be converted into an additional number of common shares based on the additional gross proceeds raised through the date of conversion in a subsequent public offering according to the following formula: (X/100 million) x 1.20568, where X is the additional gross proceeds rounded down to the nearest $100 million.

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

Expense related to the issuance of 480,000 Series B convertible preferred shares to Mr. Knight will be recognized at such time when the number of common shares to be issued for conversion of the Series B convertible preferred shares can be reasonably estimated and the event triggering the conversion of the Series B convertible preferred shares to common shares occurs. The expense will be measured as the difference between the fair value of the common stock for which the Series B convertible preferred shares can be converted and the amount paid for the Series B convertible preferred shares. Although the fair market value cannot be determined at this time, expense, if a triggering event occurs, would range from $0 to $64.0 million (assumes $11 per common share fair market value) and approximately 5.8 million common shares would be issued.

Liquidity and Capital Resources

Capital Resources

The Company was initially capitalized on August 13, 2010, with its first investor closing on January 27, 2011. The Company raised capital through its best-efforts offering of Units by David Lerner Associates, Inc., the managing dealer, which received selling commissions and a marketing expense allowance based on proceeds of the Units sold. From the initial capitalization on August 13, 2010 through the conclusion of the offering on July 31, 2014, the Company closed on a total of 96.1 million Units representing gross proceeds of approximately $1.1 billion and proceeds net of offering costs of approximately $943.0 million. The Company incurred costs of approximately $109.1 million related to this offering.
 
On July 26, 2013, the Company entered into an unsecured revolving credit facility with a commercial bank in an initial amount of $75 million. On October 3, 2013, the credit agreement was amended to increase the amount of the facility to $100 million and to allow for future increases in the amount of the facility up to $150 million, subject to certain conditions. The amount of the facility was increased to $150 million on January 30, 2014 and reduced back to $100 million on August 14, 2014. The credit facility will be utilized for acquisitions, hotel renovations, working capital and other general corporate funding purposes, including distributions and the possible payment of redemptions. Under the terms of the credit agreement, the Company may make voluntary prepayments in whole or in part, at any time. The credit facility matures in July 2015; however, the Company has the right, upon satisfaction of certain conditions, including covenant compliance and payment of an extension fee, to extend the maturity date to July 2016. Interest payments are due monthly and the interest rate, subject to certain exceptions, is equal to the one-month LIBOR (the London Inter-Bank Offered Rate for a one-month term) plus a margin ranging from 2.25% to 2.75%, depending upon the Company’s leverage ratio, as calculated under the terms of the credit agreement. The Company is also required to pay an unused facility fee of 0.25% or 0.35% on the unused portion of the revolving credit facility, based on the amount of borrowings outstanding during each quarter. As of September 30, 2014, the credit facility had an outstanding principal balance of $2.8 million and an annual interest rate of approximately 2.40%.
 
 
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The credit facility contains customary affirmative covenants, negative covenants and events of default. In addition, the credit facility contains covenants restricting the level of certain investments and the following quarterly financial covenants (capitalized terms are defined in the credit agreement):

·  
Minimum Net Worth shall not be less than $450 million;
·  
Total Indebtedness to Total Asset Value must not exceed 50%;
·  
Total Secured Indebtedness to Total Asset Value must not exceed 30%;
·  
Ratio of Adjusted Net Operating Income to Fixed Charges for the four trailing quarters must equal or exceed two;
·  
Ratio of Adjusted Net Operating Income attributable to Unencumbered Hotels to Implied Debt Service for the four trailing quarters must equal or exceed two;
·  
Distributions cannot exceed $0.825 per share per year;
·  
Additional Unsecured Indebtedness (other than this credit facility) shall not exceed $2.5 million; and
·  
Unencumbered Leverage Ratio must be less than 45%.

The Company was in compliance with all applicable covenants at September 30, 2014, and anticipates being in compliance for the remainder of 2014 and into 2015.

Capital Uses

The Company’s principal sources of liquidity are the cash flow generated from properties the Company has or will acquire, distributions received on its energy investment and proceeds from its $100 million revolving credit facility. In addition, the Company may borrow additional funds, subject to the approval of the Company’s Board of Directors. The Company anticipates that cash flow from operations, distributions from the Company’s energy investment and availability under its $100 million revolving credit facility will be adequate to meet its anticipated liquidity requirements, including debt service, capital improvements, required distributions to shareholders to maintain its REIT status and planned Unit redemptions. The Company intends to use borrowings under its credit facility to purchase the hotels under contract if a closing occurs.

To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income.  Distributions during the first nine months of 2014 totaled approximately $52.2 million and were paid at a monthly rate of $0.06875 per common share. For the same period, the Company’s cash generated from operations was approximately $56.7 million. In February 2011, the Company’s Board of Directors established a policy for an annualized distribution rate of $0.825 per common share, payable in monthly distributions. The Company intends to continue paying distributions on a monthly basis, consistent with the annualized distribution rate established by its Board of Directors. The Company’s Board of Directors, upon the recommendation of the Audit Committee, may amend or establish a new annualized distribution rate and may change the timing of when distributions are paid. The Company’s objective in setting a distribution rate is to project a rate that will provide consistency over the life of the Company taking into account acquisitions and capital improvements, ramp up of new properties and varying economic cycles. To meet this objective, the Company may require the use of debt in addition to cash from operations. Since, in previous periods, a portion of distributions have been funded with proceeds from the offering of Units and borrowings under its credit facility, the Company’s ability to maintain its current intended rate of distribution will be based on its ability to generate cash from operations at this level, as well as the Company’s ability to utilize currently available financing, or the Company’s ability to obtain additional financing. Since there can be no assurance that the properties already acquired or that will be acquired will provide income at this level, or that the Company will be able to obtain additional financing, there can be no assurance as to the classification or duration of distributions at the current rate. Proceeds of the offering which were distributed are not available for investment in properties.
 
 
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In April 2012, the Company instituted a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92.5% of the price paid per Unit if the Units have been owned for less than five years, or 100% of the price paid per Unit if the Units have been owned more than five years. The maximum number of Units that may be redeemed in any given year is three percent (3%) of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. Since the inception of the program through September 30, 2014, the Company has redeemed approximately 4.7 million Units in the amount of $48.4 million, including 1.2 million Units in the amount of $12.5 million and 1.4 million Units in the amount of $14.6 million during the nine months ended September 30, 2014 and 2013. As contemplated in the program, beginning with the October 2012 redemption, and for certain redemptions thereafter, the Company redeemed Units on a pro-rata basis due to the 3% limitation discussed above, with approximately 8% of the requested shares redeemed in the fourth quarter of 2012, 12% in the first quarter of 2013, 60% in the second quarter of 2013 and 68% in the first quarter of 2014. For all other scheduled redemption dates through September 30, 2014, the Company redeemed 100% of the redemption requests. The following is a summary of the Unit redemptions during 2013 and the first nine months of 2014:
 
Redemption Date
 
Total Requested Unit
Redemptions at
Redemption Date
   
Units Redeemed
   
Total Redemption
 Requests Not
Redeemed at
Redemption Date
 
                   
First Quarter 2013
    938,026       114,200       823,826  
Second Quarter 2013
    1,063,625       637,779       425,846  
Third Quarter 2013
    677,855       677,855       0  
Fourth Quarter 2013
    609,079       609,079       0  
First Quarter 2014
    357,013       242,644       114,369  
Second Quarter 2014
    479,078       479,078       0  
Third Quarter 2014
    496,839       496,839       0  
 
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements and certain loan agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. The Company expects that this amount will be adequate to fund required repair, replacement, and refurbishments and to maintain the Company’s hotels in a competitive condition. As of September 30, 2014, the Company held approximately $8.6 million in reserve for capital expenditures. During the first nine months of 2014, the Company invested approximately $13.2 million in capital expenditures and anticipates spending an additional $10 million to $15 million in the next 12 months. The Company does not currently have any existing or planned projects for development.

As of September 30, 2014, the Company had outstanding contracts for the potential purchase of four additional hotels, which were under construction, for a total purchase price of $89.6 million. The Fort Lauderdale Residence Inn hotel, which opened in October 2014, was acquired on October 24, 2014.  Closing on the remaining three hotels is expected upon completion of construction. Assuming all conditions to closing are met, the purchase of these three hotels should close over the next 15 months from September 30, 2014. Although the Company is working towards acquiring these three hotels, there are many conditions to closing that have not yet been satisfied and there can be no assurance that a closing will occur under the outstanding purchase contracts. The following table summarizes the location, brand, expected number of rooms, refundable (if the seller does not meet its obligations under the contract) contract deposits paid, and gross purchase price for each of the contracts outstanding at September 30, 2014.  All dollar amounts are in thousands.
 
Location
 
Brand
 
Rooms
   
Deposits Paid
   
Gross Purchase Price
 
Fort Lauderdale, FL (b)
 
Residence Inn
    156     $ 3     $ 23,088  
Shenandoah, TX (a)
 
Courtyard
    124       3       15,872  
Cape Canaveral, FL (a)
 
Homewood Suites
    153       3       25,245  
Rosemont, IL
 
Hampton Inn & Suites
    158       300       25,400  
          591     $ 309     $ 89,605  
________
                           
(a) If the seller meets all of the conditions to closing, the Company is obligated to specifically perform under the contract. As the property is under construction, at this time, the seller has not met all of the conditions to closing.
 
(b) Property was acquired October 24, 2014.
                       
 
 
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Although the Company is working towards acquiring these hotels, there are many conditions to closing that have not yet been satisfied and there can be no assurance that a closing will occur under the outstanding purchase contracts. The purchase price for the Fort Lauderdale Residence Inn was funded from borrowings under the Company’s credit facility, and it is anticipated that the purchase price for the remaining outstanding contracts will be funded from borrowings under its credit facility if a closing occurs.

As part of the cost sharing arrangements discussed herein under Related Parties, the day-to-day transactions may result in amounts due to or from Apple Hospitality. To efficiently manage cash disbursements, the Company, Apple Hospitality, A10A or ASRG may make payments for any or all of the related companies. Under the cash management process, each of the companies may advance or defer up to $1 million at any time. Each month, any outstanding amounts are settled among the affected companies. This process allows each Company to minimize its cash on hand, which, in turn, reduces the cost of each companies’ credit facilities. The process does not have a significant impact on any of the companies.

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.

Business Interruption

Being in the real estate industry, the Company is exposed to natural disasters on both a local and national scale. Although management believes there is adequate insurance to cover this exposure, there can be no assurance that such events will not have a material adverse effect on the Company’s financial position or results of operations.

Seasonality

The hotel industry historically has been seasonal in nature. Seasonal variations in occupancy at the Company’s hotels may cause quarterly fluctuations in its revenues. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. 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 or available financing sources to make distributions.

Recent Accounting Standard

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which affects virtually all aspects of an entity’s revenue recognition. The core principle of the new standard is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those years. Early adoption is not permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

Subsequent Events

In October 2014, the Company declared and paid approximately $6.3 million, or $0.06875 per outstanding common share, in distributions to its common shareholders.

In October 2014, under the guidelines of the Company’s Unit Redemption Program, the Company redeemed approximately 0.3 million Units in the amount of $3.0 million, representing 100% of the requested Unit redemptions.

On October 24, 2014, the Company closed on the purchase of a 156-room Residence Inn in Fort Lauderdale, Florida.  The gross purchase price is $23.1 million.
 
 
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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of September 30, 2014, the Company’s financial instruments were not exposed to significant market risk due to foreign currency exchange risk, commodity price risk or equity price risk. The Company will be exposed to changes in short term money market rates as it invests its cash or borrows on its credit facility. Based on the Company’s outstanding balance under its credit facility at September 30, 2014, of $2.8 million, every 100 basis points change in interest rates will impact the Company’s annual net income by approximately $28,000, all other factors remaining the same. The Company’s cash balance at September 30, 2014 was $0.

Item 4.  Controls and Procedures
 
Senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2014. 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.
 
 
 
 
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PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

On April 23, 2014, the United States Court of Appeals for the Second Circuit (the “Second Circuit”) entered a summary order in the consolidated class action referred to in the Company’s prior filings (including the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013) as the In re Apple REITs Litigation matter. In the summary order, the Second Circuit affirmed the dismissal by the United States District Court for the Eastern District of New York (the “District Court”) of the plaintiffs’ state and federal securities law claims and the unjust enrichment claim. The Second Circuit also noted that the District Court dismissed the plaintiffs’ remaining state common law claims based on its finding that the complaint did not allege any losses suffered by the plaintiff class, and held that, to the extent that the District Court relied on this rationale, its dismissal of the plaintiffs’ state law breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, and negligence claims is vacated and remanded for further proceedings consistent with the summary order. Following remand, on June 6, 2014, defendants moved to dismiss plaintiffs’ remaining claims. The Company will defend against the claims remanded to the District Court 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.

Item 2.  Unregistered Sales Of Equity Securities And Use Of Proceeds

The Company registered, effective January 19, 2011, 182,251,082 Units (each Unit consisting of one common share and one Series A preferred share). The initial best-efforts offering expired on January 19, 2014. However, on January 17, 2014, the Company filed a new Registration Statement which was declared effective by the Securities and Exchange Commission on April 10, 2014 to continue offering the 96,502,475 Units that remained unsold as of that date at $11.00 per Unit. The Company concluded its best-efforts offering of Units on July 31, 2014. The managing underwriter was David Lerner Associates, Inc. The following tables set forth information concerning the total best-efforts offering and the use of proceeds from the offering as of September 30, 2014. All amounts are in thousands, except per Unit data:
 
Units Registered:
               
                 
      9,524   Units 
$10.50 per Unit
  $ 100,000  
      172,727   Units
$11 per Unit
    1,900,000  
Totals:
    182,251  
Units
    $ 2,000,000  
                     
Units Sold:
                   
                     
      9,524   Units
$10.50 per Unit
  $ 100,000  
      86,550   Units 
$11 per Unit
    952,055  
Totals:
    96,074  
Units
      1,052,055  
                     
Expenses of Issuance and Distribution of Units
             
                     
1. Underwriting discounts and commission
    105,206  
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
    3,888  
Total Expenses of Issuance and Distribution of Common Shares
    109,094  
Net Proceeds to the Company
  $ 942,961  
                     
1. Purchase of real estate (net of debt proceeds and repayment)
  $ 715,380  
2. Deposits and other costs associated with potential real estate acquisitions
    328  
3. Purchase of Preferred Membership Interest in energy company
    100,000  
4. Repayment of other indebtedness, including interest expense paid
    23,248  
5.  Investment and working capital
    84,261  
6. Fees to the following (all affiliates of officers of the Company):
       
a. Apple Ten Advisors, Inc. (excludes reimbursed expenses)
    3,148  
b. Apple Suites Realty Group, Inc. (excludes reimbursed expenses)
    16,596  
7. Fees and expenses of third parties
    -  
8. Other
    -  
Total of Application of Net Proceeds to the Company
  $ 942,961  
 
 
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Unit Redemption Program

In April 2012, the Company instituted a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92.5% of the price paid per Unit if the Units have been owned for less than five years, or 100% of the price paid per Unit if the Units have been owned more than five years. The maximum number of Units that may be redeemed in any given year is three percent (3%) of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price of redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program.

Since the inception of the program through September 30, 2014, the Company has redeemed approximately 4.7 million Units in the amount of $48.4 million, including 1.2 million Units in the amount of $12.5 million and 1.4 million Units in the amount of $14.6 million during the nine months ended September 30, 2014 and 2013. As contemplated in the program, beginning with the October 2012 redemption, and for certain redemptions thereafter, the Company redeemed Units on a pro-rata basis due to the 3% limitation discussed above, with approximately 8% of the requested shares redeemed in the fourth quarter of 2012, 12% in the first quarter of 2013, 60% in the second quarter of 2013 and 68% in the first quarter of 2014. For all other scheduled redemption dates through September 30, 2014, the Company redeemed 100% of redemption requests. The Company has a number of cash sources, including cash from operations and proceeds from borrowings on its credit facility from which it can make redemptions. See the Company’s complete consolidated statements of cash flows for the nine months ended September 30, 2014 and 2013 included in the Company’s interim financial statements in Item 1 of this Form 10-Q for a further description of the sources and uses of the Company’s cash flows. The following is a summary of the Unit redemptions during 2013 and the first nine months of 2014:
 
Redemption Date
 
Total Requested Unit
Redemptions at
Redemption Date
   
Units Redeemed
   
Total Redemption
Requests Not
Redeemed at
Redemption Date
 
                   
First Quarter 2013
    938,026       114,200       823,826  
Second Quarter 2013
    1,063,625       637,779       425,846  
Third Quarter 2013
    677,855       677,855       0  
Fourth Quarter 2013
    609,079       609,079       0  
First Quarter 2014
    357,013       242,644       114,369  
Second Quarter 2014
    479,078       479,078       0  
Third Quarter 2014
    496,839       496,839       0  

The following is a summary of redemptions during the third quarter of 2014 (no redemptions occurred in August and September of 2014).
 
Issuer Purchases of Equity Securities
 
   
(a)
   
(b)
   
(c)
   
(d)
 
Period
 
Total Number of Units Purchased
   
Average Price Paid per Unit
   
Total Number of Units Purchased as Part of Publicly Announced Plans or Programs
   
Maximum Number of Units that May Yet Be Purchased Under the Plans or Programs
 
July 2014
    496,839     $ 10.29       496,839         (1)

(1) The maximum number of Units that may be redeemed in any 12 month period is limited to up to three percent (3.0%) of the weighted average number of Units outstanding from the beginning of the 12 month period, subject to the Company’s right to change the number of Units to be redeemed.
 
 
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Item 6.  Exhibits
 
Exhibit Number
Description of Documents
   
3.1
Articles of Incorporation of the Registrant, as amended. (Incorporated by reference to Exhibit 3.1 to amendment no. 4 to the registrant’s registration statement on Form S-11 (SEC File No. 333-168971) filed January 7, 2011 and effective January 19, 2011)
   
3.2
Bylaws of the Registrant, as amended.  (Incorporated by reference to Exhibit 3.2 to amendment no. 3 to the registrant’s registration statement on Form S-11 (SEC File No. 333-168971) filed December 20, 2010 and effective January 19, 2011)
   
10.68
First amendment to credit agreement dated July 26, 2013 between Apple Ten Hospitality, Inc. and Wells Fargo Bank, National Association. (Incorporated by reference to Exhibit 10.68 to registrant’s quarterly report on Form 10-Q (SEC File No. 000-54651) filed May 8, 2014)
   
31.1
   
31.2
   
32.1
   
101
The following materials from Apple REIT Ten, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text and in detail (FILED HEREWITH)
 
 
 
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
Apple REIT Ten, Inc.
   
       
By:
/s/    GLADE M. KNIGHT 
 
Date: November 5, 2014
 
Glade M. Knight,
   
 
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
   
       
By:
/s/    BRYAN PEERY 
 
Date: November 5, 2014
 
Bryan Peery,
   
 
Chief Financial Officer
(Principal Financial and Principal Accounting Officer)
   

 
 
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